Notice To Members 93-62

Requirements Governing Real-Time Trade Reporting in Over-the-Counter Equity Securities

Published Date:

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Executive Summary

On July 16, 1993, the Securities and Exchange Commission (SEC) approved an NASD rule change to implement real-time trade reporting for members' over-the-counter transactions in equity securities that were not previously reportable to the NASD in this manner.1 The equity securities covered by this rule change are those for which members now submit aggregate volume and price range data pursuant to Schedule H to the NASD By-Laws. Regional listings that are ineligible for transaction reporting over the Consolidated Tape are also covered. The new reporting requirements closely track those applicable to Nasdaq-listed securities and will replace the existing reporting procedure under Schedule H. This rule change takes effect on December 20, 1993. The text of the rule change follows this Notice.

Background and Description of Rule Change

The SEC recently approved an NASD rule change (File No. SR-NASD-92-48) that will require real-time reporting of members' over-the-counter transactions in OTC equity securities which are those not classified as a "designated security" for purposes of the reporting requirements contained in Parts XI and XII of Schedule D, or as an "eligible security" in Schedule G to the NASD By-Laws. The securities covered by this rule change are those for which members now submit aggregate volume and price range data pursuant to Section 2 of Schedule H to the NASD By-Laws. When this rule change takes effect on December 20, 1993, Schedule H reporting will be eliminated for these securities.

Today, many OTC equity securities are quoted in the NASD's OTC Bulletin Board® service (OTCBB) and/or in a printed quotation medium such as the Pink Sheets™ publication. It should be noted that the new reporting requirements extend to members' over-the-counter transactions in all issues classified as OTC equity securities regardless of whether they are quoted in any particular quotation medium.2 Additionally, the requirements will encompass over-the-counter trades in a small number of equities that are listed on one or more regional stock exchanges, but do not qualify for transaction reporting via the Consolidated Tape facility. Members' principal trades in such securities currently fall within the scope of Schedule H reporting.3 Hence, the new reporting rules will supplant Schedule H reporting for these transactions as well.

The NASD will implement the new trade-reporting regime in two phases. Beginning in December, the NASD will collect and process transaction reports of OTC equity securities exclusively for regulatory purposes. During the first half of 1994, the second phase will commence with real-time dissemination of these transaction reports via the Nasdaq network and the networks of commercial vendors.4 At that point, member firms and their customers will be able to access last-sale price and volume information for OTC equity securities throughout the business day.

The requirements governing trade-by-trade reporting for OTC equity securities — within 90 seconds of execution — mirror the requirements that members have observed for many years respecting issues listed on the Nasdaq National Market®. For example, the data elements comprising a transaction report for an OTC equity security will be identical to those now required for reporting trades in Nasdaq securities through the Automated Confirmation Transaction (ACTSM) service: security symbol, number of shares, transaction price, and a symbol indicating whether the trade is a buy, sell, or cross.5 Similarly, the reported price must exclude any markup, markdown, or commission associated with the transaction. Trade reports may be entered through the Nasdaq Workstation® service or a Computer-to-Computer Interface (CTCI) with the ACT processor6. The comparison and risk management functions offered by ACT will be available for transactions in OTC equity securities provided they are eligible for processing through the facilities of the National Securities Clearing Corporation.

These new requirements distinguish between an "OTC market maker" and a "non-market maker" for purposes of fixing the reporting obligation in a given situation. The term "OTC market maker" is defined as an NASD member that holds itself out as a market maker by entering proprietary quotations or indications of interest for a particular OTC equity security in any interdealer quotation system (e.g., the Pink Sheets or OTCBB). A firm is classified as a "non-market maker" based on the absence of a market-making commitment in any inter-dealer quotation system for the particular OTC equity security. Thus, a firm may be an OTC market maker in some issues and a non-market maker in others.

In transactions between two firms qualified as an OTC market maker in the OTC equity security, only the member representing the sell side reports. If the transaction is between an OTC market maker and a non-market maker in the security, the OTC market maker must always report the transaction. If both members are non-market makers, only the member on the sell side reports the transaction. In transactions between a member and a non-member (e.g., a customer), the member must report.

When implemented, this rule change will materially enhance the NASD's regulatory data base and permit automated surveillance comparable to The Nasdaq Stock Market. The collection of transactional data for OTC equity securities through ACT will also allow the NASD to eliminate Schedule H price/volume reporting for these issues. From an operational standpoint, the new reporting rules will provide consistent trade-reporting and audit-trail requirements across all market segments that the NASD regulates. Finally, development of a facility for collecting and disseminating transaction price and volume data for OTC equity securities will support the NASD's efforts to gain SEC designation of the OTCBB as an automated quotation system for penny stocks pursuant to Securities Exchange Act Section 17B.

Questions regarding this Notice may be directed to Michael J. Kulczak, Associate General Counsel, NASD Office of General Counsel at (202) 728-8811 or NASD Market Surveillance at (800) 925-8156 or (301) 590-6080.

1 SEC Release No. 34-32647 (July 16, 1993) 58 FR 39262 (July 22, 1993).

2 The term "OTC equity security" excludes "restricted securities," as defined by Rule 144(a)(3) under the Securities Act of 1933, as well as any securities designated in The PORTALSM Market. Such securities are currently excluded from Schedule H reporting as well.

3 The reporting of price and volume information pursuant to Section 2 of Schedule H is limited to a member's principal transactions. Under the new reporting rule for OTC equity securities, a member will be required to report dual-agency and principal trades within 90 seconds of execution.

4 However, OTC equity securities trade reports submitted for foreign/ADR issues will not be disseminated. These transaction reports will be captured solely for regulatory purposes. This limitation traces to SEC concerns relating to the trading of unregistered foreign securities (either directly or in ADR form) in the U.S. over-the-counter markets. Nevertheless, such trade reports would still be required to be submitted within 90 seconds following execution.

5 Entry of counter-party information is mandated under paragraph (d)(4) of the ACT Rules for trade comparison and audit trail purposes.

6 Additionally, the ACT service desk is available to receive transactional reports by telephone in the event of system failure. The service desk will also accept transaction reports in OTC equity securities from firms that do not have Nasdaq Workstation service, provided that the level of such trading activity remains de minimis.

Text of New Part XIII to Schedule D To the NASD By-Laws

(Note: New text is underlined; deleted text is in brackets.)

Reporting Transactions in Over-the-Counter Equity Securities

Part XIII

This Part has been adopted pursuant to Article VII of the Corporation's By-Laws and sets forth the trade reporting requirements applicable to members' transactions in equity securities for which real-time trade reporting is not otherwise required (hereinafter referred to as "OTC Equity Securities"). Members shall utilize the Automated Confirmation Transaction Service ("ACT") for trade reporting in OTC Equity Securities.

Section 1 — Definitions

(a) Terms used in this Part shall have the same meaning as those defined in the Association's By-Laws and Rules of Fair Practice unless otherwise specified herein.
(b) "OTC Equity Security" means any equity security not classified as a "designated security," for purposes of Parts XI and XII of Schedule D to the Corporation's By-Laws. This term also includes certain exchange-listed securities that do not otherwise qualify for real-time trade reporting because they are not "eligible securities" as defined by Section 1(d) of Schedule G to the NASD By-Laws. The term "OTC Equity Security" shall not include "restricted securities," as defined by Rule 144(a)(3) under the Securities Act of 1933, nor any securities designated in the PORTAL Market.
(c) "Automated Confirmation Transaction Service" or ACT is the service that, among other things, accommodates reporting and dissemination of last sale reports in OTC Equity Securities. Regarding those OTC Equity Securities that are not eligible for clearance and settlement through the facilities of the National Securities Clearing Corporation, the ACT comparison function will not be available. However, ACT will support the entry and dissemination of last sale data on such securities.
(d) "OTC Market Maker" means a member of the Association that holds itself out as a market maker by entering proprietary quotations or indications of interest for a particular OTC Equity Security in any inter-dealer quotation system, including any system that the Securities and Exchange Commission has qualified pursuant to Section 17B of the Securities Exchange Act of 1934. A member is an OTC Market Maker only in those OTC Equity Securities in which it displays market making interest via an inter-dealer quotation system.
(e) "Non-Market Maker" means a member of the Association that is not an OTC Market Maker with respect to a particular OTC Equity Security.

Section 2 — Transaction Reporting

(a) When and How Transactions are Reported
(1) OTC Market Makers shall, within 90 seconds after execution, transmit through ACT last sale reports of transactions in OTC Equity Securities executed during normal market hours. Transactions not reported within 90 seconds after execution shall be designated as late.
(2) Non-Market Makers shall, within 90 seconds after execution, transmit through ACT or the ACT service desk (if qualified pursuant to Part IX of Schedule D to the By-Laws), or if ACT is unavailable due to system or transmission failure, by telephone to the Market Operations Department, last sale reports of transactions in OTC Equity Securities executed during normal market hours. Transactions not reported within 90 seconds after execution shall be designated as late.
(3) Last sale reports of transactions in OTC Equity Securities executed between 9:00 a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT within 90 seconds after execution and shall be designated as ".T" trades to denote their execution outside normal market hours. Last sale reports of transactions in OTC Equity Securities executed between the hours of 4:00 p.m. and 5:15 p.m. Eastern Time shall also be transmitted through ACT within 90 seconds after execution; trades executed and reported after 4 p.m. Eastern Time shall be designated as ".T" to denote their execution outside normal market hours.
(4) All members shall report weekly to the Market Operations Department, on a form designated by the Board of Governors, last sale reports of transactions in OTC Equity Securities that are executed outside the hours of 9:00 a.m. and 5:15 p.m. Eastern Time.
(5) A pattern or practice of late reporting without exceptional circumstances may be considered conduct inconsistent with high standards of commercial honor and just and equitable principles of trade, in violation of Article III, Section 1 of the Rules of Fair Practice.
(b) Which Party Reports Transaction
(1) In transactions between two OTC Market Makers, only the member representing the sell side shall report.
(2) In transactions between an OTC Market Maker and a Non-Market Maker, only the OTC Market Maker shall report.
(3) In transactions between two Non-Market Makers, only the member representing the sell side shall report.
(4) In transactions between a member and a customer, the member shall report.
(c) Information To Be Reported

Each last sale report shall contain the following information:
(1) Symbol of the OTC Equity Security;
(2) Number of shares;
(3) Price of the transaction as required by paragraph (d) below; and
(4) A symbol indicating whether the transaction is a buy, sell, or cross.
(d) Procedures for Reporting Price and Volume

Members that are required to report pursuant to paragraph (b) above shall transmit last sale reports for all purchases and sales in OTC Equity Securities in the following manner:
(1) For agency transactions, report the number of shares and the price excluding the commission charged.
(2) For dual agency transactions, report the number of shares only once, and report the price excluding the commission charged.
(3) For principal transactions, except as provided below, report each purchase and sale transaction separately and report the number of shares and the price. For principal transactions that are executed at a price which includes a mark-up, markdown or service charge, the price reported shall exclude the mark-up, mark-down or service charge. Such reported price shall be reasonably related to the prevailing market, taking into consideration all relevant circumstances including, but not limited to, market conditions with respect to the OTC Equity Security, the number of shares involved in the transaction, the published bids and offers with size displayed in any inter-dealer quotation system at the time of the execution (including the reporting firm's own quotation), the cost of execution and the expenses involved in clearing the transaction.
Exception: A "riskless" principal transaction in which a Non-Market Maker, after having received from a customer an order to buy, purchases the security as principal from another member or customer to satisfy the order to buy or, after receiving from a customer an order to sell, sells the security as principal to another member or customer to satisfy the order to sell, shall be reported as one transaction in the same manner as an agency transaction, excluding the mark-up or mark-down.
(e) Transactions Not Required To Be Reported

The following types of transactions shall not be reported:
(1) Transactions which are part of a primary distribution by an issuer or a registered secondary distribution (other than "shelf distributions") or of an unregistered secondary distribution;
(2) Transactions made in reliance on Section 4(2) of the Securities Act of 1933;
(3) Transactions where the buyer and seller have agreed to trade at a price substantially unrelated to the current market for the security;
(4) Purchases or sales of securities effected upon the exercise of an option pursuant to the terms thereof or the exercise of any other right to acquire securities at a pre-established consideration unrelated to the current market.

Interpretation of the Board of Governors

The Corporation seeks to emphasize the obligations of members to report transactions in OTC Equity Securities within 90 seconds after execution. All transactions in OTC Equity Securities not reported within 90 seconds after execution shall be reported as late, and the Corporation routinely monitors members' compliance with the 90 second requirement. If the Corporation finds a pattern or practice of unexcused late reporting, that is, repeated reports of executions in OTC Equity Securities after 90 seconds without reasonable justification or exceptional circumstances, the member may be found to be in violation of Article III, Section 1 of the Corporation's Rules of Fair Practice. Exceptional circumstances will be determined on a case-by-case basis and may include conditions such as extreme volatility in an OTC Equity Security, or in the market as a whole. Timely reporting of all transactions in OTC Equity Securities is necessary and appropriate for the fair and orderly operation of the marketplace, and to ensure the collection of adequate information for surveillance purposes; the Corporation will, therefore, view noncompliance as a rule violation.

Part [XIII] XIV

Mutual Fund Quotation Program