October 20, 2004
Mr. Michael J. Simon
Dear Mr. Simon:
Section 11(a) under the Securities Exchange Act of 1934 ("Exchange Act") prohibits a member of a national securities exchange from effecting transactions on that exchange for its own account, the account of an associated person, or an account over which it or its associated person exercises discretion (collectively, covered accounts) unless an exception applies.1 Among the transactions excepted are those by a dealer acting in the capacity of a market maker,2 bona fide arbitrage or hedge transactions,3 and proprietary transactions by certain members that yield priority, parity, and precedence to non-members (except those non-members who are affiliated with members).4
In addition, Rule 11a2-2(T) under the Exchange Act5 -- known as the "effect versus execute" rule -- provides exchange members with an exemption from the Section 11(a) prohibition. To comply with Rule 11a2-2(T)'s conditions, a member (1) must transmit the order from off the exchange floor, (2) may not participate in the execution of the transaction once it has been transmitted to the member performing the execution, (3) may not be affiliated with the executing member, and (4) with respect to an account over which the member has investment discretion, neither the member nor its associated person may retain any compensation in connection with effecting the transaction without express written consent from the person authorized to transact business for the account in accordance with the Rule.
In a letter dated June 15, 2004, the Staff of the Division of Market Regulation ("Division") stated that when a member sends an order for its own account, coupled with a customer order, to the exchange with the understanding that its order will trade in whole or in part with its customer's order, ahead of other trading interest, that member may not rely on Rule 11a2-2(T) for an exemption from the prohibition set forth in Section 11(a)(1) of the Exchange Act. Upon further review of the issue, the Staff of the Division believes that a member may rely on Rule 11a2-2(T) when submitting such orders for execution, as long as all the conditions set forth under the Rule are met, including the condition that the member not be affiliated with the executing member. In this regard, the Commission has previously stated that this condition is satisfied when automated exchange facilities are used, so long as the design of these systems ensures that members do not possess any special or unique trading advantages in handling their orders after transmitting them to the exchange.6 However, if an automated trading system provides members with special or unique trading advantages in the handling of their orders after transmitting them to the Exchange, it may not satisfy the unaffiliated broker requirement under the Rule.7
If you have any question regarding this letter, please contact Elizabeth King at (202) 942-0140 or Kelly Riley at (202) 942-0752.
Robert L. D. Colby
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