 |
Home | Previous Page | |
|
||
 |
|
|
|
||
 |
|
|
|
|
|||||||||||||||
|
|
|||||||||||||||
|
|
January 3, 2005 Laura S. Pruitt, Esq.
Dear Ms. Pruitt: In your letter dated January 3, 2005, as supplemented by telephone conversations with the staff of the Division of Market Regulation ("Division"), you requested on behalf of ITG Inc. ("ITG"), a registered broker-dealer and a member of the National Association of Securities Dealers ("NASD"), assurance from the Division that it would not recommend to the Securities and Exchange Commission ("SEC" or "Commission") that the Commission take action against it for failure to comply with the order marking requirements of Rule 200(g) of Regulation SHO under the Securities Exchange Act of 1934, as amended ("Exchange Act"), if short sale orders submitted to ITG's Portfolio System for Institutional Trading ("POSIT") that are exempted from the short sale price tests of Exchange Act Rule 10a-1 and/or NASD Rule 3350 are marked as "short" as opposed to "short exempt." A copy of your letter is attached to this response. By including a copy of your correspondence, we avoid having to repeat or summarize the facts you presented. The defined terms in this letter have the same meaning as in your letter, unless otherwise noted. In your letter you make certain representations, including the following:
Response:Rule 200(g) of Regulation SHO provides that a broker-dealer must mark all sell orders of any equity security as "long," "short," or "short exempt." Rule 200(g)(2) requires that a short sale order must be marked "short exempt" if the seller is relying on an exception from the tick test of Rule 10a-1 of the Exchange Act or any short sale price test of any exchange or national securities association. Based on your representations, in particular, that: (i) POSIT utilizes a filter, which is updated daily, that will prevent the execution of any short sale transaction in a non-actively-traded security on a downtick/down bid; (ii) POSIT's short sale price test exemptions are publicly known and all POSIT subscribers (and the affected regulators) are aware of POSIT's exemption from the short sale price restrictions; (iii) POSIT executions, including short sales in POSIT, are readily identifiable on the consolidated tape by securities industry participants; (iv) even if a POSIT match resulted in a short sale order being executed on a downtick or down bid, market participants would be aware that such reported execution was part of a POSIT match and was therefore exempted from the tick test and/or bid test, so that no additional downward price pressure on the price of that particular security would result from the POSIT execution price; (v) marking POSIT orders as "short" as opposed to "short exempt" would not result in any confusion to market participants; (vi) under no circumstances will a short sale order submitted to POSIT be permitted to be marked "long;" and (vii) ITG will maintain and provide the Division, upon request, separately retrievable written records pertaining to each short sale transaction effected in POSIT, the Division is of the view that marking such POSIT orders "short" as opposed to "short exempt" is not inconsistent with the purposes underlying Rule 200(g) of Regulation SHO. Accordingly, on the basis of your representations and the facts presented, and without necessarily concurring in your analysis, the Division will not recommend to the Commission enforcement action under Rule 200(g) if short sale orders submitted to POSIT that are exempted from the short sale price tests of Exchange Act Rule 10a-1 and/or NASD Rule 3350 are marked as "short" as opposed to "short exempt." This position concerns enforcement action only and does not represent a legal conclusion with respect to the applicability of statutory or regulatory provisions of the federal securities laws. Moreover, this position is based on the facts you have presented and the representations you have made, and any different facts or conditions may require a different response. In addition, this position 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. Finally, the Division expresses no view with respect to any other questions that the proposed activities may raise, including the applicability of other federal or state laws to those activities. 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. 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. Very truly yours, James A. Brigagliano Incoming Letter:January 3, 2005 VIA FACSIMILE AND HAND DELIVERYMr. James A. Brigagliano Re: No-Action Relief From Rule 200(g) of Regulation SHO Dear Mr. Brigagliano: On behalf of our client, ITG Inc. ("ITG"), we respectfully request assurance from the staff of the Division of Market Regulation (hereafter, the "Division"), that it would not recommend to the Securities and Exchange Commission ("SEC" or "Commission") that the Commission take action against it for failure to comply with the order marking requirements of Rule 200(g) of Regulation SHO under the Securities Exchange Act of 1934, as amended ("Exchange Act"), if short sale orders submitted to ITG's Portfolio System for Institutional Trading ("POSIT") that are exempted from the short sale price tests of Exchange Act Rule 10a-1 and/or NASD Rule 3350 are marked as "short" as opposed to "short exempt." ITG is a broker-dealer registered with the Commission under Section 15 of the Exchange Act and a member of the National Association of Securities Dealers ("NASD"). The current request for no-action relief is being sought in light of the new short sale order marking requirements of Rule 200(g) of Regulation SHO that will be in effect as of January 3, 2005. I. BackgroundITG both conducts an agency brokerage business and operates several alternative trading systems, including POSIT. POSIT conducts periodic matches of confidential, unpriced orders from institutional investors and broker-dealers at various set times during the trading day. All equity securities registered under Section 12 of the Exchange Act, including securities listed on a registered exchange and securities approved for trading on Nasdaq (Nasdaq National Market and SmallCap securities), are eligible for matching in POSIT. The price used for transactions involving Nasdaq securities executed during regular POSIT matches is the mid-point of the national best bid and offer ("NBBO") at the time of the match, while the price used for transactions involving exchange-listed securities executed during regular matches is the mid-point of the bid-offer spread at the time of the match as quoted on the primary exchange for the particular exchange-listed stock. ITG clients may submit orders to POSIT via electronic interfaces, or by telephone or facsimile through the ITG trading desk. There is no assurance that any order submitted to POSIT will receive an execution in any given POSIT match. ITG has received exemptions from the "tick test" requirements of Exchange Act Rule 10a-1 and from the "bid test" requirements of NASD Rule 3350 for short sales effected in certain POSIT matches (referred to as "Regular Matches").1 One of the conditions for such relief is that short sale orders entered in POSIT will be marked appropriately. Currently, short sale orders sent to ITG for submission to POSIT are marked "short." II. Rule 200(g) under Regulation SHO and Need for ReliefRule 200(g) of Regulation SHO generally provides that a broker-dealer must mark all sell orders of any equity security as "long," "short," or "short exempt." Rule 200(g)(2) states that "[a] short sale order shall be marked "short exempt" if the seller is relying on an exception from the tick test of 17 CFR 240.10a-1, or any short sale price test of any exchange or national securities association." Because POSIT has received exemptions from the short sale price restrictions under Exchange Act Rule 10a-1 and NASD Rule 3350, orders submitted to POSIT for inclusion in a regular POSIT match would be required to be marked as "short exempt" under Rule 200(g)(2). As discussed below, because of ITG's dual role as both an agency broker and operator of POSIT, and the interaction of POSIT with other ITG ATSs, strict compliance with Rule 200(g) will be extremely difficult, if not impossible, to achieve with respect to orders submitted to POSIT. In addition, absent no-action relief from the requirement to mark short sale orders submitted to POSIT as "short exempt," many of the orders sent to ITG for inclusion in a POSIT match may be inappropriately marked in the first instance. As a result, and for the reasons discussed below, we believe that short sale orders submitted to POSIT that are exempted from the short sale price tests of Exchange Act Rule 10a-1 and/or NASD Rule 3350 should be excepted from Rule 200(g)(2)'s "short exempt" marking requirement, and that those orders should be permitted to be marked as "short" pursuant to Rule 200(g) of Regulation SHO. III. DiscussionCurrently, customer short sale orders sent to ITG for order handling and execution, including those orders submitted to POSIT for participation in a regular POSIT match, are marked as "short." As of January 3, 2005, Rule 200(g) of Regulation SHO will require broker-dealers to mark all orders as "long," "short," or "short exempt." In its capacity as an agency broker-dealer, ITG will be required under Regulation SHO to mark the orders of its customers, including short sales, appropriately. Thus, short sale orders sent to ITG for inclusion in a regular POSIT match, but not those short sale orders sent to ITG for handling and execution through some other means, would have to be marked "short exempt" under the new marking rules. The difficulty for ITG with respect to compliance with the soon-to-be effective short sale marking requirements of Regulation SHO arises from ITG's dual role as both agency broker and operator of POSIT, and the relationships between ITG's differing order execution systems. In this regard, ITG customers (including broker-dealer clients) may not know, at the time they send their short sale orders via electronic means to ITG for handling, whether those orders should properly be marked "short" or "short exempt" because the customer may not know whether the order will be sent to POSIT or some other execution venue that is not exempt from the short sale pricing restrictions. Similarly, ITG itself may not know, at the time its agency desk receives a short sale order from a client (including a broker-dealer subscriber) or an order is received for another of ITG's ATSs, whether that order should be appropriately marked "short" or "short exempt," because ITG may not know the identity of the eventual execution destination of that order. For example, a customer may send a short sale order to the ITG agency trading desk via electronic means for handling. Currently, as well as under Rule 200(g) of Regulation SHO, that order appropriately would be marked "short." If the ITG trader handling that order determines that the order should be included in the next POSIT match, he will send that electronic order to POSIT for inclusion in that match. When that order reaches POSIT, however, the order's marking would have to be changed to "short exempt." If that same order does not receive an execution in the next POSIT match, however, the order would be either sent back to the ITG trading desk for further handling or forwarded to another ITG ATS (which would not have an exemption from the short sale pricing restrictions as does POSIT), and the short sale order again would need to be marked merely "short." Likewise, ITG's TriAct ATS, which is not exempt from short sale price restrictions, interacts closely with POSIT.2 Certain ITG clients sending orders to reside in TriAct may request that their unexecuted orders be routed by TriAct to POSIT for inclusion in the next scheduled POSIT match. If those orders are not executed in POSIT, they are automatically returned to TriAct. These orders would have to be marked "short" while residing in TriAct, re- marked "short exempt" when sent to POSIT, and then re-marked again as merely "short" when returned to TriAct. This could entail changing the marking on those same orders numerous times during the trading day. In addition, it should be noted that not all orders sent to POSIT are exempt from short sale pricing restrictions. POSIT's exemption from the short sale pricing restrictions is conditioned, among other things, on the fact that the particular security being sold short is an "actively traded" security. POSIT utilizes a filter, which is updated daily, that will prevent the execution of any short sale transaction in a non-actively-traded security on a down tick/down bid. At the time a customer sends an order to sell a security short to POSIT, however, he may not know whether the security involved is an actively-traded security that is eligible for the exemption from the short sale price test. Thus, if the customer was to mark his short sale order sent to POSIT as "short exempt" but the security involved was not able to be sold short in POSIT on a down tick/down bid because it was not "actively traded," that order would be incorrectly marked. Similarly, only certain POSIT matches ("Regular Matches") are exempted from the short sale pricing restrictions. In addition to operating these Regular Matches in POSIT, however, ITG may sometimes use POSIT to effect internal crosses of orders for certain of its clients ("Directed Crosses"), and on a more limited basis, ITG conducts supplementary POSIT matches ("Supplementary Matches") when warranted by substantial levels of liquidity in the market. Neither the Directed Crosses nor the Supplementary Matches are exempted from the short sale pricing restrictions, so short sale orders submitted to POSIT for inclusion in one of these types of matches would appropriately be marked "short," not "short exempt." Having all orders submitted to POSIT marked as "short" would help alleviate the possibilities for confusion between the different matches run through POSIT and the improper marking of short sale orders submitted to POSIT. As you can see, due to the inter-relatedness of ITG trading systems and the fact that ITG is both an agency broker and the operator of POSIT, ITG faces difficult systems programming challenges to ensure appropriate order marking at each stage of processing an order once it is received by ITG. Without relief, it is unlikely that ITG would be able to make all of the significant systems changes needed, and test those changes, to be able to change incoming customer orders to include a "short exempt" marking when an order is forwarded to POSIT and remove that marking in favor of a mere "short" marking when executed through a different ITG system, or vice-versa, by January 3, 2005. Furthermore, ITG's clients (including broker-dealer clients that have marking obligations themselves) may not know, at the time they send electronic short sale orders to ITG for handling, whether those orders should appropriately be marked "short" or "short exempt" under Rule 200(g). No amount of programming changes by ITG could fix that problem on the front-end for orders sent electronically to ITG by clients for submission to POSIT. Yet even if ITG were able to implement the necessary systems programming changes that would enable ITG to change a short sale order it has received that is already marked as "short" to attach a "short exempt" modifier when that order is submitted to POSIT and then remove such modifier to re-mark the same order as "short" when it is transferred to another ITG trading system or the ITG agency trading desk for handling and execution, we do not believe that such a requirement would further any significant customer protection objective with respect to orders submitted to POSIT. POSIT's short sale price test exemptions are broad in scope - they apply to all listed, Nasdaq NMS and Nasdaq SmallCap securities that are "actively traded" (and meet the rest of the conditions in the exemptive letters from the NASD and SEC). This exemptive relief is publicly known, and all POSIT subscribers (and the affected regulators) are certainly aware of POSIT's exemption from the short sale price restrictions. We also understand that POSIT executions, including short sales in POSIT, are readily identifiable on the consolidated tape by securities industry participants. Thus, even if a POSIT match resulted in a short sale order being executed on a down tick or down bid, market participants would be aware that that reported execution was part of a POSIT match and was therefore exempted from the tick test and/or bid test, so that no additional downward pressure on the price of that particular security would result from the POSIT execution price. Thus, continuing to mark POSIT orders as "short" would not result in any confusion to market participants. Furthermore, the relief requested only pertains to the marking of short sale orders submitted to POSIT as "short" as opposed to "short exempt" - under no circumstances would a short sale order submitted to POSIT be permitted to be marked "long." As it already does in connection with POSIT's exemption from the short sale price restrictions of Exchange Act Rule 10a-1, ITG will maintain and provide the Division of Market Regulation, upon request, separately retrievable written records pertaining to each short sale transaction effected in POSIT. IV. ConclusionBased on the foregoing, we respectfully request that the Division grant the requested no-action relief from the short sale marking requirements of Rule 200(g) of Regulation SHO with respect to short sale transactions submitted to POSIT, such that short sale orders submitted to POSIT that are exempted from the short sale price tests of Exchange Act Rule 10a-1 and/or NASD Rule 3350 may continue to be marked as "short" as opposed to "short exempt." If you have any questions or require further information, please do not hesitate to call me at (202) 778-6400, or Jennifer Connors, ITG's Director of Global Compliance, at (212) 444-6342. Thank you for your attention to this request. Very truly yours, Laura S. Pruitt cc: Jennifer Connors, Director of Global Compliance, ITG Endnotes
|
| Home | Previous Page | Modified: 01/07/2005 |