SEC Approves Amendments to the OATS Rules
OATS Reporting Requirements
Effective Date: May 8, 2006
Legal & Compliance
On September 28, 2005, the Securities and Exchange Commission (SEC) approved amendments to Rules 6950 through 6957 (OATS Rules) relating to the Order Audit Trail System (OATS).1 The amendments to the OATS Rules: (1) implement the OATS reporting requirements for manual orders (OATS Phase III); (2) provide that members are required to capture and report the time the order is received by the member from the customer for all orders; (3) expand the order transmittal requirements to include orders routed to a member's trading desk or trading department; (4) exclude certain members from the definition of "Reporting Member" for those orders that meet specified conditions and are recorded and reported to OATS by another member; and (5) permit NASD to grant exemptive relief from the OATS reporting requirements in certain circumstances to members that meet specified criteria.
The OATS Rules, as amended, are set forth in Attachment A of this Notice. In this Notice, NASD also is publishing information regarding the registration requirements for OATS reporting, as well as questions and answers regarding the application of the amended OATS reporting requirements. The amended OATS reporting requirements and OATS Phase III become effective May 8, 2006. In addition, NASD is publishing revised OATS Reporting Technical Specifications, incorporating the amendments described herein. The OATS Reporting Technical Specifications can be found on NASD's Web site at Regulatory Systems>OATS>Technical Specifications.
Questions regarding this Notice may be directed to the Legal Section, Market Regulation, at (240) 386-5126; or Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8071. For technical questions regarding OATS reporting, please contact the OATS Help Desk at (800) 321-NASD.
On March 6, 1998, the SEC approved the OATS Rules.2 OATS provides a substantially enhanced body of information regarding orders and transactions that improves NASD's ability to conduct surveillance and investigations of member firms for potential violations of NASD rules and the federal securities laws. OATS is designed, at a minimum, to: (1) provide an accurate, time-sequenced record of orders and transactions, beginning with the receipt of an order at the first point of contact between the broker-dealer and the customer or counterparty and further documenting the life of the order through the process of execution; and (2) provide for market-wide synchronization of clocks used in connection with the recording of market events.
The OATS Rules generally impose obligations on member firms to record in electronic form and report to NASD on a daily basis certain information with respect to orders originated or received by NASD members relating to securities listed on NASDAQ. OATS captures this order information reported by NASD members and integrates it with quote and transaction information to create a time-sequenced record of orders and transactions. This information is critical to NASD staff in conducting surveillance and investigations of member firms for violations of federal securities laws and NASD rules.
The OATS requirements were implemented in three phases. All members were required to synchronize their computer system clocks and all mechanical clocks that record times for regulatory purposes by August 7, 1998, and July 1, 1999, respectively. In addition, in Phase I, electronic orders received at the trading department of a market maker and those received by electronic communication networks (ECNs) were required to be reported to OATS as of March 1, 1999. In Phase II, additional information relating to market maker and ECN electronic orders and all other electronic orders were required to be reported to OATS starting on August 1, 1999. As described in more detail below, the OATS Rules will apply to all manual orders (Phase III) as of May 8, 2006.3
Since the implementation of OATS, NASD staff has reviewed OATS activities with the goal of identifying ways in which to improve OATS and enhance its effectiveness as a regulatory tool. In this regard, NASD staff identified several changes to OATS that it believed would enhance NASD's automated surveillance for compliance with trading and market making rules such as Interpretive Material (IM) 2110-2, (commonly referred to as the "Manning Rule"), the SEC's Order Handling Rules and a member firm's best execution obligations. NASD proposed these changes in SR-NASD-00-23, which the SEC recently approved.
Specifically, on September 28, 2005, the SEC approved amendments to the OATS Rules to: (1) implement the OATS reporting requirements for manual orders (OATS Phase III); (2) provide that members are required to capture and report the time orders are received by the member from the customer for all orders; (3) expand the order transmittal requirements to include orders routed to a member's trading desk or trading department; (4) exclude certain members from the definition of "Reporting Member" for those orders that meet specified conditions and are recorded and reported to OATS by another member; and (5) permit NASD to grant exemptive relief from the OATS reporting requirements in certain circumstances to members that meet specified criteria.4
Implementation of OATS Phase III for Manual Orders
During Phase II, the OATS Rules apply only to orders in NASDAQ-listed securities that are captured in an electronic order routing or execution system. Upon implementation of Phase III, pursuant to Rule 6957(c), the OATS Rules will apply to all orders for NASDAQ securities received or originated by an OATS Reporting Member. This includes orders received via telephone, email or any other method. Accordingly, OATS reporting requirements will now apply equally to electronic orders and manual orders upon implementation of Phase III with two exceptions: (1) members will not be required to pass a routed order identifier for manually transmitted orders; and (2) members will be required to report the type of account5 for which the order is submitted only to the extent that information is available. NASD anticipates, however, that this account type information should be readily available for most OATS reportable orders.
Definition of Time of Receipt
Rule 6954 requires certain identifying information be recorded at various critical points during the life of an order, thereby assisting NASD in carrying out its regulatory responsibilities. In particular, Rule 6954(b)(16) requires that members record and report the date and time the order is originated or received by a Reporting Member ("time of receipt"). During OATS Phase II, which only applies to electronic orders, the time of receipt for an electronic order has been interpreted as the time an order is captured by a firm's electronic order handling or execution system. Upon the implementation of Phase III, the time of receipt for all orders, whether electronic or manual, will be the time the order is received by the member from the customer. As such, depending on the specific facts and circumstances, the time an order is captured in a member's electronic order handling or execution system may not be the time of receipt for OATS purposes.
Expansion of Order Transmittal Requirements
In addition to the time that an order is received by the customer, it also is critical to NASD automated surveillance systems that OATS capture the time that an order is received by the trading desk or department.6 Given that orders may be routed to multiple locations within a firm prior to reaching the trading desk, the amendments require firms to capture the various receipt times (customer receipt time, trading desk receipt time, etc.) by expanding the OATS order transmittal requirements that apply to intra-firm routes to include orders routed to the trading department.7 Specifically, if an order is not received immediately at the trading desk or department, members are required to capture information relating to the transfer of that order to the trading department under the order transmittal requirements of Rule 6954(c). The amended OATS Rules also require that members provide information on the nature of the department to which an order was transmitted, the number of shares to which the transmission applies, and any special handling requests. As with other technical requirements relating to OATS, NASD has specified in the OATS Reporting Technical Specifications how firms should report this information.
Exclusion from the Definition of "Reporting Member"
Certain members engage in non-discretionary order routing processes whereby, immediately after receipt of a customer order, the member routes the order, by electronic or other means, to another member ("receiving Reporting Member") for further routing or execution at the receiving Reporting Member's discretion. Currently, the OATS Rules generally require both the member with which the order originated and the receiving Reporting Member to create and report new order reports and possibly route reports.8 Because this may result in the receipt of duplicative information by OATS, the OATS Rules have been amended to require, in such instances, that only the receiving Reporting Member report OATS data. Accordingly, pursuant to Rule 6951(n), a member would not be required to report OATS data regarding an order, if the following conditions are met:
In addition to eliminating the reporting of duplicative information to OATS, the amended rule will reduce the regulatory burdens on members, particularly smaller members, that route all their orders to another receiving Reporting Member by means of a non-discretionary order routing process, for execution or further routing purposes.10
Exemptive Relief from the OATS Reporting Requirements
New paragraph (d) of Rule 6955 and amended Rule 9610(a) permit NASD to grant exemptive relief to certain members from the reporting requirements of the OATS Rules under the procedures set forth in the Rule 9600 Series. Specifically, members that meet the following criteria would be eligible to request an exemption to the OATS reporting requirements for manual orders:
Any exemptive relief granted would expire no later than two years from the date the member receives the exemptive relief. At or prior to the expiration of a grant of exemptive relief, members meeting the specified criteria may request a subsequent exemption. In addition, NASD's exemptive authority will be in effect for five years from May 8, 2006.
The exemptive authority will provide NASD the ability to grant relief to members meeting the specified criteria in situations where, for example, reporting of such information would be unduly burdensome for the member or where temporary relief from the rules (in the form of additional time to achieve compliance) would permit the member to avoid unnecessary expense or hardship.
Members should note that this exemption is available only for manual orders and only relieves the member of its obligation to transmit to OATS all information required to be recorded under Rule 6954. Members that are granted an exemption still must record all information as required under Rule 6954 and be prepared to submit that information to NASD on an as-requested basis.
Implementation of the Amendments to the OATS Rules
In recognition of the technological burdens that may be imposed on members as a result of the new requirements, the implementation date for the amendments to the OATS Rules is six months from the date of this Notice, which coincides with the publication of the revised OATS Reporting Technical Specifications relating to SR-NASD-00-23. The revised OATS Reporting Technical Specifications can be found on NASD's Web site at Regulatory Systems>OATS>Technical Specifications. In addition, NASD will ensure that adequate time for testing is incorporated into the implementation schedule and will make the testing environment available as of March 27, 2006.
Registration for OATS Reporting
Members that have not previously been subject to the OATS Rules that now meet the definition of an OATS Reporting Member, and do not otherwise qualify for, and receive, an exemption from the OATS Rules, must register for OATS by completing a Subscriber Initiation and Registration Form (SIRF) and obtaining an OATS user ID and password. Firms may obtain a SIRF, along with detailed instructions for completing and submitting the form, on NASD's OATS Web site. Information on how to obtain the appropriate user IDs and passwords is also available on NASD's OATS Web site. Members must complete and submit a SIRF, as well as request a user ID and password by no later than April 24, 2006. Members that fail to complete and return a SIRF, as well as obtain a user ID and password by April 24, 2006, will be unable to report OATS data to NASD beginning May 8, 2006.
If a member qualifies for the exclusion from the definition of a Reporting Member under Rule 6951(n), that member must ensure that a valid written agreement, as required under Rule 6951(n)(4), is in place with the receiving Reporting Member by May 8, 2006. NASD will be monitoring firms' use of this exclusion closely and may periodically request a copy of written agreements as part of its routine OATS surveillance activities.
If a member chooses to request an exemption from the OATS Rules pursuant to Rule 6955(d), a written request must be submitted to NASD's Market Regulation Department by no later than February 1, 2006 to ensure that the request can be processed by May 8, 2006. NASD will make every effort to expeditiously review each request so that exemptions will be in place beginning May 8, 2006. NASD notes that members meeting the requirements for an exemption from the OATS Rules must formally request and obtain approval from NASD before the exemption becomes effective. Firms meeting the requirements for exemption, but that do not formally request such exemption, are not automatically exempted and will be in violation of the OATS Rules if they do not begin reporting OATS data on May 8, 2006.
Questions and Answers
To help members implement the amendments to the OATS Rules and OATS Phase III, NASD staff is publishing the following questions and answers relating to the OATS Rules.
Detailed exemption request procedures, including a list of all required supporting documentation, will be published shortly on NASD's OATS Web site. To ensure that exemption requests can be processed prior to the May 8, 2006 implementation date, exemption requests must be submitted to NASD no later than February 1, 2006.
1See Securities Exchange Act Release No. 52521 (September 28, 2005), 70 FR 57909 (October 4, 2005) (File No. SR-NASD-00-23).
2See Securities Exchange Act Release No. 39729 (March 6, 1998), 63 FR 12559 (March 13, 1998).
3See Rule 6957(c).
4See supra note 1.
5 The account type code reflects whether the order was received for the account of an investor, received from another broker-dealer, originated by the member for a proprietary account, or received for the account of an employee.
6 For purposes of the OATS Rules, the term "trading department" refers to the function within the firm that is responsible for executing orders in NASDAQ equity securities. For an ECN, for example, this may be interpreted as either the trading system (where orders are executed automatically without trader intervention) or the trading department (where orders are executed with the assistance of traders). See Letter from NASD Regulation to Charles R. Hood, dated July 30, 1998.
7See amendments to Rule 6954(c). In furtherance of this provision, the OATS Reporting Technical Specifications require that this information be reported to OATS via a "Desk Report" or by populating desk information on the New Order, Combined Order/Route or Combined Order/Execution Reports.
8 OATS Frequently Asked Questions C29 provides that in instances where a member uses another member firm's electronic order routing or execution system to route orders for execution by that same member firm, the originating member would not be required to report OATS data until Phase III.
9 If any delay results in the routing of an order due to systems problems or other reasons, the member with which the order originated would be required to report OATS data.
10 This exclusion does not change a member's requirement to capture and retain the time an order was received from a customer under SEC Rule 17a-3(a)(6).
11See Letter from NASD Regulation to Charles R. Hood, dated July 30, 1998.
New language is underlined; deletions are in brackets.
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6954. Recording of Order Information
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6955. Order Data Transmission Requirements
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6957. Effective Date
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9600. Procedures For Exemptions