Interpretive Letter to Howard L. Kramer, Schiff Hardin & Waite
August 19, 2002
Mr. Howard L. Kramer
Schiff Hardin & Waite
1101 Connecticut Avenue, NW
Washington, DC 20036
Re: Application of NASD Rule 2320(g)(1) to ATS and ECN Quotations
Dear Mr. Kramer:
This is in response to your letter dated May 28, 2002, in which you requested interpretive guidance concerning the application of NASD Rule 2320(g)(1) to quotations displayed in the OTC Bulletin Board ("OTCBB") by the alternative trading system ("ATS") operated by GlobeNet Securities, Inc. ("GlobeNet"). Specifically, you inquire whether quotations of electronic communication networks ("ECNs") and ATSs, including the GlobeNet ATS, entered on the OTCBB would constitute both priced quotations and dealer quotations for purposes of Rule 2320(g)(1).
GlobeNet is registered with the Securities and Exchange Commission ("SEC") as a broker-dealer and is a member of NASD. The GlobeNet ATS trades the equity securities of issuers that are current in their periodic filings with the SEC and meet certain qualification requirements imposed by GlobeNet.
Any NASD member in good standing that enters into a subscriber agreement with GlobeNet can become a subscriber to the GlobeNet ATS. Only subscribers are permitted to submit orders into the GlobeNet ATS. The orders can be for the subscriber’s proprietary account or on behalf of a customer of the subscriber. Both limit and market orders can be entered into the GlobeNet ATS.
Subscribers are fully responsible for compliance with NASD sales practice rules, including NASD Rule 2320, with respect to customers for whom they enter orders into the GlobeNet ATS. Nevertheless, to make the GlobeNet ATS as "user friendly" as possible to subscribers, it contains certain functionalities to assist subscribers in their best execution efforts. Specifically, for securities that also are traded on the OTCBB, the GlobeNet ATS scans for the best bid and ask on the OTCBB before executing a match internally. If the OTCBB does not have a better price, the GlobeNet ATS will match an order internally on a price-time priority basis. If a better price is found on the OTCBB, the GlobeNet ATS rejects the order and routes the order to the broker-dealer whose quote is displayed on the OTCBB. Any order that is not routed or matched upon entry is placed on the GlobeNet ATS’s Open Order Book. An order is canceled at the end of the trading session if a match is not found.
NASD Rule 2320(g) requires members that execute transactions in non-Nasdaq securities on behalf of customers to contact a minimum of three dealers (or all dealers if there are three or fewer) and obtain quotations to determine the best inter-dealer market for the security, if there are fewer than two quotations displayed on an inter-dealer quotation system that permits quotation updates on a real time basis.
As a result of the approval of SR-NASD-2002-44, ECNs and ATSs now are permitted to post quotes and participate in the OTCBB in the same manner that market makers currently participate.1 In this regard, you inquire whether a priced quote by an ECN or ATS on the OTCBB for a non-Nasdaq security would be considered a priced quote for purposes of Rule 2320(g)(1). Thus, you request confirmation that (1) any combination of at least two priced quotations from dealers, ECNs, or ATSs, including the GlobeNet ATS, on the OTCBB would satisfy a broker-dealer’s obligation under Rule 2320(g)(1); and (2) when only one priced quotation appearing on the OTCBB for a non-Nasdaq security is an ECN or ATS, that quotation can be considered as one of the three dealer quotations the broker-dealer is required to obtain.
The staff believes that priced quotations by an ECN or ATS displayed on the OTCBB would be considered priced quotations for purposes of compliance with Rule 2320(g)(1). Accordingly, with respect to both scenarios described above, an ECN or ATS quotation displayed on the OTCBB can be included as one of the two or three quotations, as applicable, required under Rule 2320(g)(1). However, it is important to note that, to the extent known, only one quote may be attributed to each market maker for purposes of compliance with the Rule 2320(g). As a result, if an ECN or ATS is displaying an order on the OTCBB placed by a market maker that also is displaying its own quotation, only one quotation may be attributed to the specific market maker for purposes of compliance with Rule 2320(g).2
Compliance with Rule 2320(g), in and of itself, does not mean the member has met its best execution obligations under NASD Rule 2320. Best execution requires each member to use reasonable diligence to ascertain the best inter-dealer market for a security, and to buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions.
I hope this letter is responsive to your inquiry. Please note that the opinions expressed in this letter are staff opinions only and have not been reviewed or endorsed by the Board of Governors of NASD. This letter responds only to the issues you have raised based on the facts as you have described them in your letter, and does not necessarily address any other rule or interpretation of NASD or all the possible regulatory and legal issues involved.
Stephanie M. Dumont
Associate General Counsel
Alan M. Wolper, Director
1 See Securities Exchange Act Release No. 45915 (May 10, 2002), 67 FR 35171 (May 17, 2002).
2 The staff also notes that it would be inconsistent with NASD rules for members to display multiple quotes through an ECN or ATS purposefully to circumvent Rule 2320(g).