April 23, 2003
Andre E. Owens, Esq.
Re: Rule 10a-1; Exemptive Relief under Short Sale Rule
Dear Mr. Owens:
In your letter dated April 17, 2003, as supplemented by telephone conversations with the staff, you request on behalf of ITG, Inc., a registered broker-dealer, an exemption from Rule 10a-1 under the Securities Exchange Act of 1934 ("Exchange Act") for transactions executed through ITG's Portfolio System for Institutional Trading ("POSIT").
We understand the facts to be as follows:
You state that POSIT is an alternative trading system that matches buying and selling interest among institutional investors and broker-dealers at various set times during the day. POSIT was designed to meet the special needs of institutional customers, including broker-dealers, who trade in terms of portfolios of stocks by providing an electronic order entry mechanism to facilitate trading in portfolios. POSIT also allows participants to enter single stock orders. Customers generally transmit their orders (which are unpriced) by means of electronic interfaces, or by telephone or facsimile to the ITG trading desk. Customer orders are not displayed and are matched confidentially by the computer in accordance with a predetermined algorithm. Regular Matches occur at random times during specific one-minute windows from 9:45 a.m. to 9:46 a.m.; 10:00 a.m. to 10:01 a.m.; 10:30 a.m. to 10:31 a.m.; 11:00 a.m. to 11:01 a.m.; 11:30 a.m. to 11:31 a.m.; 12:00 p.m. to 12:01 p.m.; 12:30 p.m. to 12:31 p.m.; 1:00 p.m. to 1:01 p.m.; 1:30 p.m. to 1:30 p.m.; 2:00 p.m. to 2:01 p.m.; 2:30 p.m. to 2:31 p.m.; 3:00 p.m. to 3:01 p.m. and 3:30 p.m. to 3:31 p.m.
All POSIT trades involving exchange-listed securities are priced and executed at the midpoint of the best bid and offer in the primary market for the security at the time of the match. This match will sometimes take place at a price that is below the last reported price for that security in the consolidated transaction reporting system. Absent an exemption, short sale orders executed in POSIT Regular Matches could result in violations of Rule 10a-1.1
You believe that short sales executed through POSIT do not involve the types of abuses that Rule 10a-1 is designed to address. In support of this, you note that: all POSIT trades are processed on an anonymous basis and prices are fixed at the mid-point of the best bid and offer in the primary market for the security; there is no price discovery within POSIT because orders are not displayed and all trades occur in accordance with a predetermined algorithm;2 and no participant can be assured of a match and no participant knows precisely when the match will occur. You also state that all short sale orders entered in POSIT will be appropriately marked in accordance with applicable rules. You also state that ITG will not conduct a match for a security that is the subject of a trading halt on the primary exchange at the time of the match. You further note that ITG, through its proprietary POSIT Watch System, monitors changes to bids and offers for stocks traded in POSIT to look for signs of manipulation. If ITG suspects that a subscriber has engaged in a manipulative activity through POSIT, ITG will report such activity to the NASD.
In view of the passive nature of pricing for the POSIT system, you have requested that the Commission grant an exemption from Rule 10a-1 for ITG's institutional customers, including broker-dealers, that execute short sale transactions through POSIT's Regular Matches.
Rule 3b-3 under the Exchange Act defines the term "short sale," and Rule 10a-1 governs short sales generally. Paragraph (a) of Rule 10a-1 covers transactions in any security registered on a national securities exchange, if trades in such security are reported pursuant to an "effective transaction reporting plan" ("Reported Securities"). A short sale of a Reported Security listed on a national securities exchange may not be effected at a price either: (1) below the last reported price of a transaction reported in the consolidated transaction reporting system ("minus tick"); or (2) at the last reported price if that price is lower than the last reported different price ("zero-minus tick").
Absent relief, trades effected in POSIT Regular Matches involving short sales of exchange-listed Reported Securities would have to comply with the "tick test" of paragraph (a) of Rule 10a-1. As described above, Regular Matches in POSIT occur at the mid-point of the inside bid and offer, which can result in short sales being effected at prices lower than the last reported sale price. Based on your representations, in particular, that: POSIT Regular Matches will occur at an externally derived price within the existing market and above the current best bid; there is no price discovery within POSIT because orders are not displayed and all trades occur in accordance with a predetermined algorithm; no participant can be assured of receiving a match; and the matches will occur on a random basis within each window so no participant knows precisely when the match will occur, the Division is of the view that POSIT trades would not appear to involve the types of abuses that Rule 10a-1 was designed to address.
Accordingly, on the basis of your representations and the facts presented, the Commission hereby grants, on a one-year pilot basis,3 an exemption from Rule 10a-1 to permit short sales effected during POSIT Regular Matches, as described above, without complying with the "tick" provisions of the rule, subject to the following conditions:
The foregoing exemption from Rule 10a-1(a) is based solely on your representations and the facts presented, and is strictly limited to the application of this rule to the proposed transactions and the operation of the POSIT system as described above. Such transactions should be discontinued, pending presentation of the facts for our consideration, in the event that any material change occurs with respect to any of those facts and representations. The exemption granted herein is subject to modification or revocation if at any time the Commission or the Division determines that such action is necessary or appropriate in furtherance of the purposes of the Exchange Act. This exemption supersedes the 1994 Exemption, and does not apply to transactions effected in the POSIT system prior to the date of this exemption.
In addition, your attention is directed to the anti-fraud and anti-manipulation provisions of the Exchange Act, particularly Sections 9(a) and 10(b), and Rule 10b-5 thereunder. Responsibility for compliance with these and any other applicable provisions of the federal securities laws must rest with ITG, Inc. and with participants effecting transactions on POSIT. This Division expresses no view with respect to any other questions that the proposed transactions may raise, including, but not limited to, the adequacy of the disclosure concerning, and the applicability of any federal or state laws to, the proposed transactions.
For the Commission, by the Division of Market
Larry E. Bergmann
Incoming letter is in PDF format.