Division of Trading and Markets:

Responses to Frequently Asked Questions Concerning Rule 611 and Rule 610 of Regulation NMS

April 4, 2008 Update (last updated on June 8, 2007)

Responses to these frequently asked questions (“FAQs”) were prepared by and represent the views of the staff of the Division of Trading and Markets (“Staff”). They are not rules, regulations, or statements of the Securities and Exchange Commission (“Commission”). Further, the Commission has neither approved nor disapproved of these interpretive answers.

For Further Information Contact: Theodore S. Venuti, Special Counsel, at (202) 551-5658; Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-6628.

INTRODUCTION

On April 6, 2005, the Commission adopted Regulation NMS, a series of initiatives designed to modernize and strengthen the national market system for equity securities. Regulation NMS was published in Securities Exchange Act Release No. 51808 (Jun. 9, 2005), 70 FR 37496 (Jun. 29, 2005) (“NMS Release”). It includes: (1) Rule 610, which addresses access to markets; (2) Rule 611, which provides intermarket price priority for displayed and accessible quotations; (3) Rule 612, which establishes minimum pricing increments; and (4) amendments to the joint-industry plans and rules governing the dissemination of market data. This document jointly addresses Rule 611 and Rule 610 because the price priority and access issues arising under the two rules often are intertwined.¹ On May 18, 2006 and January 24, 2007, the Commission extended the compliance dates for the Rules to a series of five dates, beginning on October 16, 2006.²

Rule 611, among other things, requires trading centers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent “trade-throughs” – the execution of trades at prices inferior to protected quotations. To be protected, a quotation must, among other things, be immediately and automatically accessible and be the best bid or best offer of a national securities exchange or national securities association (collectively, “self-regulatory organizations” or “SROs”). In addition, Rule 611(b) sets forth a series of exceptions that are designed to provide efficient and workable intermarket price priority. The exception that is likely to be used most frequently is for intermarket sweep orders (“ISOs”). The ISO exception enables a destination trading center to execute an ISO immediately at its limit price or better, while also requiring that additional ISOs, as necessary, be routed to execute against the full displayed size of any better-priced protected quotations. The ISO exception thereby both furthers the price priority objectives of Rule 611 and facilitates “best-price” routing practices – the automated routing of orders to one or more trading centers displaying the best-priced quotations available for an NMS stock at any particular time.

Rule 610, in turn, requires fair and non-discriminatory access to quotations, establishes a limit on access fees to harmonize the pricing of quotations across different trading centers, and requires each SRO to adopt, maintain, and enforce written rules that, among other things, prohibit their members from engaging in a pattern or practice of displaying quotations that lock or cross protected quotations.

Compliance with Rules 610 and 611 can be summarized in terms of the following four principal categories of securities industry participants:

1. Networks. Three Networks disseminate consolidated quotation and transaction data to the public pursuant to joint-SRO market data plans.³ The Network data streams will identify the SRO best bids and best offers that are protected quotations, as well as transactions that are excepted from Rule 611 (see FAQs 1.01 to 1.03 below).

2. Automated Trading Centers. Only automated trading centers can directly display protected quotations in the Network quotation streams. The two types of automated trading centers are SRO trading facilities and participants in FINRA’s Alternative Display Facility (“ADF”) (see FAQ 2.01 below). These trading centers are subject to a series of requirements, beyond those applicable to trading centers in general, designed to assure that their quotations are fully accessible by other trading centers and order routers. FAQs 2.01 to 2.08 below primarily address compliance by automated trading centers with Rules 610 and 611.

3. Trading Centers. Trading centers execute transactions in NMS stocks. In addition to automated trading centers, they include OTC market makers, alternative trading systems, and any other broker-dealers that execute orders internally as principal or agent. FAQs 3.01 to 3.24 below primarily address compliance by trading centers with Rules 610 and 611.

4. Order Routers. Order routers are responsible for the routing of orders in NMS stocks on behalf of customers or themselves. In addition to automated trading centers and trading centers, they include any other broker-dealers responsible for routing orders. FAQs 4.01 to 4.10 below primarily address compliance by order routers with Rules 610 and 611.

The following questions and answers have been compiled by the Staff to assist in the application of Rule 611 and Rule 610. They presume that the reader will be familiar with the Rules themselves, as well as the defined terms set forth in Rule 600(b) of Regulation NMS. Some of the more significant of such defined terms include automated quotation, automated trading center, bid or offer, intermarket sweep order, manual quotation, NMS stock, protected bid or protected offer, protected quotation, quotation, regular trading hours, SRO display-only facility, SRO trading facility, trade-through, and trading center. The questions and answers are intended to provide general guidance. Facts and circumstances of particular transactions may differ, and the Staff notes that even slight variations may require different responses. In addition, the questions and answers reflect current technological and other industry conditions and may require modification in the future if such conditions change materially. The Commission is not bound by the Staff’s statements.

The Staff may update these FAQs periodically. In each update, the FAQs modified or added after publication of the last version will be marked with “MODIFIED” or “NEW”.

The interpretive questions addressed in this document are as follows:

Section 1: Network Quotation and Transaction Data

Section 2: Automated Trading Centers

Section 3: Trading Centers

Section 4: Order Routers

Section 5: SRO Lock/Cross Rules

Section 6: Data Policies and Procedures

Section 7: Miscellaneous

Section 8: Compliance Dates

RESPONSES TO FREQUENTLY ASKED QUESTIONS

Section 1: Network Quotation and Transaction Data

Question 1.01: Identifying Automated and Manual Quotations

To be a protected quotation under Rule 611, a quotation must be automated, but the consolidated quotation stream that currently is disseminated to the public does not identify quotations as automated or manual. How will quotations be marked so that the public can readily identify automated and manual quotations?

Answer: The three Networks, which disseminate consolidated quotation data for NMS stocks to the public, have agreed to adopt uniform identifiers for manual and automated quotations. Quotations will have a condition code “B” if manual on the bid, “A” if manual on the offer, and “H” if manual on both the bid and the offer.⁴ Quotations without any condition codes will be automated.

In addition, the Networks have assigned a number of condition codes for quotations (such as “non-firm” quotations) that render them ineligible for inclusion in the Networks’ calculation of a national best bid and offer. For example, Network A and Network B have added or redefined the condition codes for non-automated quotations displayed by the NYSE or Amex under specified market conditions.⁵ None of these quotations with condition codes can be protected quotations under Rule 611.

Question 1.02: Identifying Transactions Excepted or Exempted from Rule 611

Will there be any public disclosure identifying transactions that are executed pursuant to an exception or an exemption from Rule 611?

Answer: Yes, the Network’s consolidated transaction data will include condition codes identifying transactions that are executed in reliance on specified exceptions and exemptions from Rule 611. Paragraph (b) of the Rule sets forth exceptions that are designed primarily to promote intermarket price priority. A trading center’s policies and procedures to prevent trade-throughs under Rule 611(a) are not required to prevent transactions that are executed in compliance with these exceptions or with an exemption from Rule 611. Rule 611(d) provides that the Commission may grant exemptions from the Rule that are necessary or appropriate in the public interest and consistent with the protection of investors.

In the NMS Release, the Commission noted that increased transparency concerning excepted transactions would be beneficial because it would give timely notice to the public that a transaction qualified for an exception.⁶ Consistent with this view, the Networks have assigned a uniform set of condition codes to identify transactions that are executed pursuant to an exception or exemption from Rule 611.⁷ The Networks will disseminate this information to the public in the consolidated transaction data for NMS stocks.

Question 1.03: Interruption of Network Quotation Data

Do the trade-through requirements of Rule 611 continue to apply when the Network quotation data for one or more NMS stocks is interrupted due to problems at the Network data processor?

Answer: No, the trade-through requirements of Rule 611 do not apply to an NMS stock when the relevant Network for such stock is unable to disseminate quotations on a real-time basis. As defined in Rule 600(b)(57), a “protected bid” or “protected offer” must, among other things, be disseminated pursuant to an effective national market system plan. The Networks disseminate real-time quotations in NMS stocks pursuant to the joint-SRO market data plans (which are effective national market system plans). Accordingly, when the Network processor is unable to disseminate real-time quotations for an NMS stock pursuant to such plans, there can be no protected quotations in the NMS stock and the trade-through requirements of Rule 611 do not apply.

Section 2: Automated Trading Centers

Question 2.01: Types of Automated Trading Centers

To be a protected quotation under Rule 611, a quotation must be displayed by an automated trading center. What types of trading centers can be “automated trading centers” under Regulation NMS?

Answer: The requirements for automated trading centers are set forth in Rule 600(b)(4). They are relevant only for those trading centers that intend to display protected quotations, as defined in Rule 600(b)(57) and (58), in the Network quotation streams. These trading centers are either SRO trading facilities, as defined in Rule 600(b)(72), or trading centers that display quotations in FINRA’s ADF. The ADF is the single existing example of an SRO display-only facility, as defined in Rule 600(b)(71). Accordingly, only SRO trading facilities and ADF participants are subject to the requirements for automated trading centers. In addition, the anti-discrimination and other access requirements of Rule 610(a) and (b) apply only to quotations displayed by SRO trading facilities and ADF participants.

Other types of trading centers, such as over-the-counter (“OTC”) market makers, which typically provide quotations to SRO trading facilities that are executed through such facilities, are not subject to the requirements for automated trading centers (assuming they do not choose to become ADF participants). Rather, the SRO trading facility itself must meet such requirements for all quotations displayed through such facility, no matter what their source.

Question 2.02: Procedures for New Automated Trading Centers

After the phase-in of compliance with Rule 611 is complete, what procedures will apply when a new automated trading center intends to commence displaying protected quotations?

Answer: The Extension Release notes that, after the phase-in of compliance with Rule 611 is complete, new automated trading centers can begin displaying protected quotations only pursuant to established rules or procedures.⁸ In particular, such quotations “must be commenced pursuant to an approved SRO proposed rule change or other established SRO procedure that provides sufficient notice to the industry, as well as all necessary information (such as final technical specifications), that will enable industry participants to meet their regulatory responsibilities.”⁹ New automated trading centers that are SRO trading facilities will be subject to the proposed rule change requirements of Section 19(b) of the Exchange Act. Given the need for market participants to receive sufficient advance notice of all sources of protected quotations, SROs will be unable to use the notice filing procedures of Form Pilot to initiate new automated trading centers. New automated trading centers that are ADF participants will be subject to procedures adopted by FINRA to enable market participants to maintain appropriate access to all ADF participants.¹⁰

Question 2.03: Requirements for Identifying Quotations as Automated or Manual

What are the requirements that govern automated trading centers in identifying their quotations as automated or manual?

Answer: The definition of an automated trading center in Rule 600(b)(4) requires, among other things, that a trading center (1) implement such systems, procedures, and rules as are necessary to render it capable of meeting the requirements for automated quotations, as defined in Rule 600(b)(3); and (2) immediately identify its quotations as manual whenever it has reason to believe it is not capable of displaying automated quotations. The definition of automated quotation requires, among other things, that a trading center provide an immediate response to incoming immediate-or-cancel ("IOC") orders and immediately update its quotations.¹¹

Consequently, automated trading centers must monitor their systems on a real-time basis to assess whether they are functioning properly. If an automated trading center has reason to believe that it is not capable, because of systems or other problems, of immediately and automatically transmitting responses to IOC orders and immediately and automatically updating quotations, the trading center is required, at a minimum, to identify such quotations as manual. An automated trading center experiencing serious problems also should consider whether it is capable of meeting the “firm quote” requirements of Rule 602(b) and should identify its quotations as non-firm or withdraw its quotations as appropriate.

In addition, an automated trading center should adopt policies and procedures for responding to notices that it receives from other trading centers indicating that they have elected to use the “self-help” exception of Rule 611(b)(1) (see FAQ 4.07 below). The self-help exception allows trading centers and order routers to bypass the protected quotations of an automated trading center that is experiencing systems problems. Immediately upon invoking the exception, the electing entity must notify the bypassed automated trading center. As part of its policies and procedures under Rule 600(b)(4)(i), an automated trading center should, at a minimum, provide a mechanism for receiving self-help notifications, as well as assign personnel to monitor the receipt of such notifications on a real-time basis, so that potential systems problems can be promptly evaluated and appropriately addressed.

The affirmative duty of automated trading centers to identify their quotations appropriately is a vitally important element of Regulation NMS. It will help promote the smooth and efficient functioning of intermarket price priority and trading in general. Timely and accurate identification of quotations will give investors, broker-dealers, and other trading centers essential information concerning the status of quotations in NMS stocks, thereby minimizing the extent to which the systems problems of a particular trading center can interfere with efficient trading throughout the national market system. For example, when a trading center experiencing systems problems promptly fulfills its duty to cease identifying its quotations as automated and thereby removes them from trade-through protection, it will not be necessary for other trading centers or order routers to invoke the self-help exception.

Question 2.04: Automated Trading Centers/Order-Delivery ECNs

Under Rule 600(b)(3)(iii), an automated trading center is required to provide an immediate response to an IOC order without routing the order elsewhere. Can an SRO trading facility meet this requirement if it displays quotations submitted by an order-delivery ECN?

Answer: An SRO trading facility that displays quotations submitted by an order-delivery ECN can meet the requirement of Rule 600(b)(3)(iii) only if such quotations are closely integrated within the SRO trading facility. An “order-delivery ECN” submits quotations that are displayed within an SRO trading facility, while also simultaneously executing buy and sell orders internally as agent for its subscribers. To preclude the potential for double liability on a single order (e.g., an order executing internally in the ECN immediately before the quotation that reflects such order is executed in the SRO trading facility), the SRO trading facility does not immediately execute orders against the ECN quotation, but delivers the orders to the ECN to assure that the quotation is still available. If so, the order is executed automatically at the ECN and reported back through the SRO execution facility.

Whether the quotations of an order-delivery ECN are closely integrated within the SRO trading facility will be determined from the standpoint of those who route orders to the SRO trading facility. The SRO trading facility must be capable of providing a response to incoming orders that does not significantly vary between orders handled entirely within the SRO trading facility and orders delivered to the ECN. Consequently, the systems that connect the SRO trading facility and ECN must be of very high reliability and speed. In addition, the SRO rules that govern orders delivered to the ECN must assure fast and efficient handling and quotation updates, subject only to addressing the potential for double liability.

Question 2.05: Order-Delivery ECNs/Multiple Display of Same Quotation in Network Data Stream

Is it permissible for an order-delivery ECN to submit the same quotation simultaneously to multiple automated trading centers for display in the Network quotation stream?

Answer: No, such a use of the order-delivery functionality would misrepresent the available liquidity for an NMS stock. For example, an ECN that submitted the same 1000-share quotation to two SRO trading facilities, while intending to use the order-delivery feature of each SRO to avoid double liability through multiple executions against the same quotation, would overstate by 1000 shares the true liquidity available for the stock. Similarly, display of the same quotation by the ECN directly through the ADF and indirectly on an order-delivery basis through an SRO trading facility would be impermissible. Note, however, that display of the same quotation directly in the ECN’s proprietary data stream (i.e., not in the Network quotation stream) and indirectly in the Network data stream through an SRO trading facility on an order-delivery basis would not raise similar concerns because the quotation would appear in the Network data stream as only a single protected quotation.

Question 2.06: Reserve Size of Automated Quotations

Is a trading center that displays an automated quotation required to execute an IOC order against the available reserve size for such quotation?

Answer: Yes, the definition of automated quotation in Rule 600(b)(3)(ii) requires that a trading center immediately and automatically execute an IOC order against an automated quotation up to its full size. As discussed in the NMS Release, the term “full size” includes both the displayed size and the reserve size for such automated quotation.¹² The requirement that IOC orders be executed against reserve size is designed to promote efficient intermarket trading by, among other things, minimizing the frequency of unintentional locked or crossed markets.

For example, assume that a trading center’s protected bid is $20.05 with a displayed size of 1500 shares and a reserve size of 3000 shares. A market participant routes an IOC order to sell 5000 shares with a limit price of $20.05 to execute against the protected bid. The trading center would be required to execute the order immediately at $20.05 for 4500 shares (the 1500-share displayed size plus the 3000-share reserve size) and immediately cancel the remaining 500-share balance.

Question 2.07: Scope of ADF Protected Quotations

Can the quotations of two or more ADF participants be consolidated and reflected in a protected bid or a protected offer of the ADF?

Answer: No, the best bid of the ADF must reflect the quotation of a single ADF participant, and the best offer of the ADF must reflect the quotation of a single ADF participant. Under Rule 600(b)(57), the definition of protected bid and protected offer is limited to the best bid and offer (“BBO”) of a national securities exchange and the ADF. The NMS Release notes that one of the policy objectives of this definition is to treat exchange markets comparably with the ADF. The Commission therefore specified that a protected bid or protected offer must be accessible by routing an order to a single protected quotation at a single destination (i.e., a single exchange trading facility or a single ADF participant).¹³

Accordingly, when two or more ADF participants are quoting the best price for an NMS stock, the ADF must identify a single participant quotation for its best bid and size and a single participant quotation for its best offer and size. The Networks will identify such ADF participants in the Network quotation streams that are disseminated to the public.¹⁴

Question 2.08: Treatment of ISOs by Automated Trading Centers

To comply with the ISO exception, Rule 600(b)(30) requires that ISOs be routed to execute against the full displayed size of better-priced protected quotations. What requirements apply to the automated trading center displaying a protected quotation when it receives an ISO?

Answer: At a minimum, an ISO designation indicates the order router’s intention to execute against an automated trading center’s protected quotation (assuming that the price of the protected quotation on arrival of the order is within the ISO’s limit price). An ISO therefore triggers both the firm quote requirements of Rule 602(b) and the limitation on fees of Rule 610(c). The destination trading center is required to execute the ISO at a price at least as favorable as the price of the protected quotation (unless previously executed or withdrawn),¹⁵ and any execution at the price of the protected quotation (regardless whether executed against displayed or reserve size) is subject to the fee limitation of Rule 610(c).¹⁶

Complications could arise, however, if the destination trading center intends to charge any fees in excess of the limitation in Rule 610(c) (“high fees”) for order executions that do not fall within the scope of Rule 610(c) (e.g., for an execution that includes prices other than the price of a protected quotation). One example is if a trading center is holding undisplayed orders at better prices than its protected quotation, against which the ISO would normally execute pursuant to the trading center’s priority rules. If the trading center intended to charge a high fee for this execution, the order router potentially could be charged a fee higher than the limited fee that was expected when the ISO was routed. Another example is if the price of a trading center’s protected quotation improved after an ISO was routed. In these circumstances, the limit price of the ISO would be inferior to the improved price of the trading center’s protected quotation. Although the trading center would execute the order against the new, better-priced protected quotation to the extent of the quotation’s available size (and with a limited fee), any residual portion of the ISO might be executed at the inferior limit price of the ISO. Again, the order router potentially could be charged a fee higher than the limited fee that was expected when it routed the ISO.

To address the potential problems created by high-fee executions, the NMS Release states that trading centers intending to charge high fees must provide a functionality that enables market participants to assure that they will never inadvertently be charged a fee in excess of the limitation in Rule 610(c).¹⁷ Accordingly, any trading center that intends to charge high fees must provide a separate functionality (such as an order designation) that allows the router of an ISO to indicate affirmatively that it is willing to accept a high-fee execution. In the absence of such an affirmative indication, the trading center cannot charge fees for execution of an ISO that exceed the limitations of Rule 610(c).

Moreover, the trading center cannot simply decline to provide any execution of an ISO merely because of the order router’s unwillingness to accept a high-fee execution. For example, the trading center must provide an order execution that meets the firm quote requirements of Rule 602(b). In addition, if the ISO is also marked as IOC (which triggers the requirements for automated quotations in Rule 600(b)(3)), the trading center must provide an order execution up to the full size of its protected quotation at a price that is at least as good as the price of its protected quotation.

Section 3: Trading Centers

Question 3.01: Handling Unexecuted Portions of ISOs

Does Regulation NMS require trading centers to cancel any portion of an ISO that cannot be executed immediately?

Answer: No, Regulation NMS neither requires a trading center to cancel immediately the unexecuted portion of an ISO nor prohibits it from doing so. To assure an immediate cancellation and response, order routers should use the IOC designation. Trading centers, in turn, will have the option of adopting rules requiring that the unexecuted portion of ISOs be immediately canceled. If, however, a trading center chooses not to cancel the portion of ISOs that cannot be executed immediately, its rules will need to address appropriately the subsequent handling of the unexecuted portions. For example, such rules would need to comply with the relevant SRO rule on the display of locking or crossing quotations (see FAQ 5.01 below). In addition, any subsequent execution would not qualify for the original ISO exception created by the initial routing of the ISO. The exception will expire after the ISO exhausts the liquidity that is immediately available at the trading center. Consequently, a subsequent execution of the remaining balance of an ISO must independently comply with Rule 611 (e.g., by not trading through a protected quotation or newly qualifying for a Rule 611 exception).

Question 3.02: Documenting Non-Trade-Through Prices (MODIFIED)

A broker-dealer executes a block trade for a customer at a price that does not trade through a protected quotation at the time of execution. When the trade is reported to the relevant SRO, however, the price is inferior to a protected quotation. How should the broker-dealer demonstrate its compliance with Rule 611?

Answer: The broker-dealer should implement procedures that reliably document the time of execution of the trade.¹⁸ Time of execution for purposes of Rule 611 would be when final agreement is reached on the stock, price, and size of the trade. The identity of the parties to the trade could be added subsequently. To be reliable, the documentation must be generated simultaneously with the time of execution and not be subject to retrospective alteration. For example, the time of execution could be documented manually by machine-stamping the current time on a paper order ticket (with all order tickets numbered and accounted for), or documented electronically by inputting an order ticket into an automated system (with the system maintaining a record of all inputs). As part of the broker-dealer’s periodic surveillance procedures under Rule 611(a)(2), trade prices should be compared with protected quotations at the time of execution, as reliably documented, to affirm that such quotations were not traded through.

Question 3.03: Executing and Reporting Block Trades Pursuant to ISO Exception (MODIFIED)

A broker-dealer intends to utilize the ISO exception to execute a block trade for a customer at a price inferior to one or more protected quotations. How should the block trading desk execute and report the block trade in compliance with the ISO exception?

Answer: Under Rule 611(b)(6), the broker-dealer is required to route, simultaneously with execution of the block trade, an ISO to execute against the full displayed size of any protected quotation with a price superior to the block trade price. To meet this requirement, the broker-dealer will need to utilize an automated system that is capable of ascertaining current protected quotations and simultaneously routing the necessary ISOs. As part of the broker-dealer’s periodic surveillance under Rule 611(a)(2), ISOs should be compared with the relevant protected quotations to affirm that the ISOs were properly routed (see FAQ 6.03 below). The Staff does not believe that it would be possible for manual routing of ISOs to comply with the requirement in Rule 611(b)(6).

The extent to which a routed ISO will receive an execution at the destination trading center cannot be known at the time of routing (for example, the protected quotation may already have been executed against or cancelled prior to arrival of the ISO). As a result, a broker-dealer could face practical issues in implementing the block trade for its customer, including (1) transferring to the customer the benefit of any better prices obtained through executed ISOs, (2) handling the residual size of ISOs that did not receive a fill, and (3) reporting the block trade to the relevant SRO.¹⁹ The Staff believes that there are several ways for a broker-dealer reasonably to address these practical issues, depending on the preferences of its customers.

If, for example, a customer consents to not receiving the benefit of any better prices obtained by the ISOs, the broker-dealer could report the block trade immediately on the routing of the ISO orders because the block trade size would not be affected by any fills of the ISOs. By giving its informed consent, the customer would, in effect, recognize that the block price was determined, at least in part, by a judgment of the extent to which the broker-dealer would receive fills of the ISOs at better prices.

If, however, the broker-dealer’s customer wished to receive the benefit of any better prices obtained by the ISOs, reporting the block trade is more problematic because its ultimate size will not be known until responses are received to the ISOs (i.e., any fills will reduce the size of the block trade). If the ISOs are also marked as IOC, the Staff believes that the reporting of the block trade could await responses to the IOC/ISOs for a reasonable time (e.g., five seconds or less). At that point, the size of the block trade would be reduced to reflect any fills of the ISOs, and the block trade could be reported to the relevant SRO as an ISO execution. Importantly, however, all material terms of the block trade would need to have been finally agreed upon at the time when the ISOs were routed, subject only to adjusting the block trade size to reflect ISO fills. Under these circumstances, the Staff would consider the broker-dealer to have met the “simultaneous routing” requirement of Rule 611(b)(6). Therefore, the broker-dealer would not be required to route any additional ISOs when the block trade is reported to the relevant SRO.

In addition, the “execution time” of the block trade for purposes of complying with NASD trade reporting rules is the time that the firm has determined all the material terms of the block trade, including, but not limited to, the final number of shares executed after reflecting any fills of routed ISOs.²⁰ In these circumstances, the execution time on the trade report will be different than the time the broker-dealer uses to determine whether ISOs were properly routed to execute against any better-priced protected quotations. In surveiling for compliance with Rule 611(b)(6) in this context, the broker-dealer should compare routed ISOs with the protected quotations that were displayed at the time of routing.

Further complications could arise if the broker-dealer does not receive a response within a reasonable time to all of the ISOs. To address this situation (which should not occur frequently because of the immediate response requirement for IOC orders), the customer could agree, in advance, to consider the lost IOC/ISO to be unexecuted and to include its size in the block trade at the block price. Alternatively, the block trade could be reported at a reduced size to reflect the lost IOC/ISO, pending its ultimate resolution.

Question 3.04: Riskless Principal Transactions

To fill a customer order for an NMS stock, a broker-dealer effects, as riskless principal, one or more trades and assigns the trades at the same prices to the customer in compliance with the relevant SRO rule on riskless principal reporting. Pursuant to such SRO rule, the “second legs” of the riskless principal transactions are not publicly reported to the Network trade stream. Would the second legs of the riskless principal transactions be considered separate transactions for purposes of compliance with Rule 611?

Answer: No, the second leg of a riskless principal transaction that complies with a relevant SRO riskless principal rule would not constitute a separate transaction for purposes of complying with Rule 611. The second legs therefore would not constitute trade-throughs, regardless of their prices. The relevant SRO rule must provide that the initial trades are assigned to the customer at the same prices and that the second legs are not reported publicly in the Network trade stream. Of course, the first legs of the riskless principal transactions would need to comply with Rule 611.

Question 3.05: Net Prices

A broker-dealer buys a block of an NMS stock as principal from a customer. Consistent with the broker-dealer’s understanding with its customer, the trade price reported to the relevant SRO is lowered by two cents per share to compensate the block trading desk for committing its capital. Does this “net price” determine the price of the trade for all purposes under Rule 611?

Answer: Yes, the net price reported to the SRO (and thereafter disseminated in the Network data stream) is the price of the block trade for all purposes under Rule 611, such as determining whether a trade-through occurred and routing the necessary orders to execute against protected quotations to comply with the ISO exception.

Question 3.06: Relation Between Rule 611 Exceptions and NASD Trade Modifiers

NASD rules currently specify a number of modifiers for its members to use when they report trades in certain NMS stocks, including “.PRP” and “.W”. Do all trades reported pursuant to these NASD rules qualify for an exception under Rule 611(b)?

Answer: No, the exceptions set forth in Rule 611(b), including the benchmark exception of Rule 611(b)(7) and the stopped order exception of Rule 611(b)(9), are not coextensive with the NASD rules on trade modifiers. Unlike the benchmark and stopped order exceptions, the NASD rules were not formulated to reflect the price priority objectives of Rule 611. Consequently, although many trades currently reported with a trade modifier will qualify for a Rule 611 exception, the terms and conditions of a particular trade must be evaluated in light of the language of Rule 611(b) to determine whether it qualifies for an exception.

Question 3.07: Benchmark Exception/Average Price Trades

To fill a large customer order to buy an NMS stock, a broker-dealer effects, as principal, a series of smaller trades to accumulate a position in the stock. The broker-dealer then sells the position to the customer at a price that is the volume-weighted average price of all the smaller trades. If the “second leg” does not meet the requirements of the relevant SRO riskless principal rule, is the second leg of this transaction subject to Rule 611 and, if so, does it meet the terms of the benchmark exception in paragraph (b)(7) of the Rule?

Answer: The second leg of the principal transaction is subject to Rule 611 if it does not fall within the relevant SRO riskless principal rule. The second leg would, however, qualify for the benchmark exception in Rule 611(b)(7) if the customer agreed to the average-price benchmark at the time the order was submitted.

Question 3.08: Benchmark Exception/Reasonably Determinable Compensation

Assume the same facts as in FAQ 3.07 above, except that the customer agreed to accept a trade price that was two cents per share in excess of whatever turned out to be the volume-weighted average price of the broker-dealer’s accumulating trades. Would the second leg of the principal transaction qualify for the benchmark exception?

Answer: No, the agreement to add a specific amount to the trade price would disqualify the transaction for the benchmark exception because this part of the trade price was designed to provide compensation for the trade to the broker-dealer that was reasonably determinable at the time the commitment to execute the order was made. The benchmark exception is intended to facilitate the execution of large orders. It contemplates that broker-dealers generally will attempt to accumulate a position to fill a large order in transactions that are subject to Rule 611 to help them meet the benchmark price.²¹ It therefore allows the broker-dealer to fill the order to the customer in a transaction whose price is benchmarked to a price that is not related, directly or indirectly, to the quoted price of the stock at the time of the transaction and for which the material terms were not reasonably determinable at the time the commitment to execute the order was made. In the scenario set forth in the above question, the customer would have agreed to a specific amount, separate from the average price benchmark, that was designed to provide reasonably determinable compensation to the broker-dealer, and this reasonably determinable amount would have been included in the trade price that was reported to the SRO and thereafter disseminated in the Network trade stream. Under these circumstances, the second leg of the principal transaction does not qualify for the benchmark exception.

Question 3.09: Benchmark Exception/Opening Prices

A broker-dealer receives an order outside of regular trading hours. At the time of order receipt, the broker-dealer agrees to execute the order at a market’s opening price. Would an execution of the order at such opening price qualify for the benchmark exception, even if the execution was delayed because of a processing back-up in the broker-dealer’s systems?

Answer: Yes, an order execution benchmarked to a market’s opening price in the future would qualify for the benchmark exception.²² The delay in processing the order would not disqualify the transaction.

Question 3.10: Stopped Order Exception/Modified Orders

Rule 611(b)(9) provides an exception for the execution of certain stopped orders for which a trading center has guaranteed a price to its customer. After the original submission of a non-stopped order, a broker-dealer and its customer agree to modify the order by adding a guaranteed price and making such order a stopped order. Does the subsequent modification of the order to add a guaranteed price allow the order to qualify for the stopped order exception?

Answer: Yes, the subsequent modification of the order to add the new term of a guaranteed price would constitute the time of receipt of the stopped order for purposes of Rule 611(b)(9). Of course, all other terms of the exception must be met, including the requirement that the order be executed at a price that renders it “underwater” from the perspective of the broker-dealer that is giving the guarantee (i.e., the broker-dealer sells to the customer at a price below the national best bid, or buys from the customer at a price above the national best offer).

Question 3.11: Stopped Order Exception/Error Correction Transactions

Because of a systems problem or human error, a trading center fails to execute a customer order properly. Upon subsequent discovery of the error, the trading center agrees with the customer to correct the error by executing the order at a price that is favorable to the customer at the time of the error correction. Does the exception in Rule 611(b)(9) for the execution of stopped orders apply to the error correction transaction?

Answer: Yes, the trading center’s execution of a bona fide error correction transaction would qualify for the exception in Rule 611(b)(9). Upon discovery of the trading center’s error, the trading center has agreed to modify the order and to execute the order at a guaranteed price consistent with the parties’ original understanding of how the order should have been handled (see FAQ 3.10 above). Given that the order was for the account of a customer, the customer agreed to the correction price, and the correction price was favorable to the customer (i.e., at the time of the error correction transaction, the price was below the national best bid for customer buy orders or above the national best offer for customer sell orders), the error correction transaction qualifies for the stopped order exception.

Question 3.12: Exemption for Qualified Contingent Trades (MODIFIED)

Is there an exemption from Rule 611 for certain types of transactions in NMS stocks that are contingent on the execution of related transactions?

Answer: Yes, the Commission has issued an exemptive order for “qualified contingent trades,”²³ which subsequently was modified to remove the minimum size limitation in the exemption as originally issued.²⁴ The exemption applies to any trade-throughs caused by the execution of an order involving one or more NMS stocks (each an “Exempted NMS Stock Transaction”) that are components of a qualified contingent trade.

A qualified contingent trade is defined as a transaction consisting of two or more component orders, executed as agent or principal, that meets each of the following elements: (1) at least one component order is for an NMS stock; (2) all components are effected with a product or price contingency that either has been agreed to by the respective counterparties or arranged for by a broker-dealer as principal or agent; (3) the execution of one component is contingent upon the execution of all other components at or near the same time; (4) the specific relationship between the component orders (e.g., the spread between the prices of the component orders) is determined at the time the contingent order is placed; (5) the component orders bear a derivative relationship to one another, represent different classes of shares of the same issuer, or involve the securities of participants in mergers or with intentions to merge that have been announced or since cancelled;²⁵ and (6) the Exempted NMS Stock Transaction is fully hedged (without regard to any prior existing position) as a result of the other components of the contingent trade.²⁶

The exemption for qualified contingent trades is not restricted to dealers or the over-the-counter market. It can be used by any trading center that meets the terms of the exemption.

Question 3.13: Exemption for Certain Sub-Penny Trade-Throughs

Rule 612 of Regulation NMS generally prohibits sub-penny quoting in NMS stocks, except for quotations with a price of less than $1.00 per share. Is there an exemption from Rule 611 for sub-penny trade-throughs of these low-priced quotations?

Answer: Yes, the Commission has adopted an exemption from Rule 611 to address the difficulty of protecting low-priced quotations that can be priced in sub-penny increments.²⁷ It determined that Rule 611 should reflect the very small minimum pricing increments allowed by Rule 612 for quotations that are priced at less than $1.00 per share. Such quotations can be priced in increments as small as $0.0001. Potentially, intermarket price priority for displayed quotations would be much less workable and efficient if fully applicable to quotations that were priced in increments of less than $0.01, particularly for trading centers that display quotations and execute orders against such quotations.

Under the terms of the exemption, trading centers are exempted from the requirement in Rule 611(a) to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs when: (1) the price of the protected quotation that is traded through is $1.00 or less; and (2) the price of the trade-through transaction is less than $0.01 away from the price of the protected quotation that was traded through (“Sub-Penny Trade-Throughs”).

Given that Sub-Penny Trade-Throughs are exempt from Rule 611, orders with limit prices less than $0.01 away from a protected quotation of $1.00 or less need not be marked as ISOs to allow the destination trading center to execute the order without regard to such protected quotation. Note, however, that the exemption applies only to the execution of transactions that are trade-throughs and does not apply to the requirements for routing ISOs. Accordingly, any order marked as an ISO must fully meet the applicable requirements for ISOs in Rule 600(b)(30), Rule 611(b)(5) and (6), Rule 611(c), and the ISO exception to the SRO locked/crossed rules (see FAQ 5.02 below). In particular, ISOs must be routed to execute against all protected quotations specified by the relevant rule requirements, regardless of whether the ISO limit price is less than $0.01 away from the price of a protected quotation.

Question 3.14: ISO Exception/Agency Cross Transactions

A broker-dealer intends to use the ISO exception to execute an agency cross transaction for two customers at a price inferior to one or more protected quotations. Are the procedures for executing and reporting block transactions discussed in FAQ 3.03 above also available for an agency cross transaction?

Answer: Yes, the response to FAQ 3.03 also applies to an agency cross transaction at a trade-through price that was facilitated by a broker-dealer on behalf of two customers. If the customer receiving a price inferior to a protected quotation (i.e., buying at a price above a protected offer or selling at a price below a protected bid) consents to not receiving any better prices obtained through fills of ISOs, the broker-dealer could report the agency cross transaction immediately on the routing of the ISOs because the size of the agency cross transaction would not be reduced by any fills of the ISOs. The broker-dealer could route the necessary ISOs in a principal capacity, subject to compliance with applicable SRO rules.²⁸ Alternatively, if the customer receiving the inferior price wished to receive the benefit of any better ISO prices, the broker-dealer could use the routing/reporting procedures discussed in FAQ 3.03 to complete the agency cross transaction.

In addition, the customer receiving the favorable price in agency cross transaction (i.e., buying below the price of a protected bid or selling above the price of a protected offer) potentially could decline to participate in the transaction if the size of the agency cross transaction were reduced by any ISO fills. In this case, the broker-dealer could facilitate the transaction by agreeing to offset any reduction in the size of the agency cross transaction through a simultaneous principal trade with the customer. Under these circumstances, both the agency cross transaction and the principal trade would qualify for the ISO exception in Rule 611(b)(6).

Question 3.15: Benchmark Exception/Conversion of Foreign Ordinary Shares to ADRs (MODIFIED)

A broker-dealer’s customer wants to purchase American Depositary Receipts (“ADRs”). The broker-dealer agrees to sell ADRs to the customer at a price based on the weighted average execution price to purchase the foreign ordinary shares underlying the ADRs, the prevailing foreign exchange rate, any foreign taxes associated with the conversion (e.g., a stamp duty), and an anticipated fee that the broker-dealer expects to incur for converting ordinary shares to ADRs (collectively, the “ADR Equivalent Price”). The anticipated fee for converting the ordinary shares to ADRs represents either: (1) the actual fee charged by a third party for the conversion (which amount is passed on in its entirety from the customer to the third party), or (2) a reasonable estimate by the broker-dealer of the likely cost of such conversion based on externally observable circumstances that do not result in reasonably determinable compensation to the broker-dealer. In limited instances, the broker-dealer may not incur a conversion fee if it is later able to obtain the ADRs through an offsetting purchase from another customer. Would a broker-dealer’s sale of the ADRs to its customer at the ADR Equivalent Price qualify for the benchmark exception of Rule 611(b)(7)?

Answer: Yes, the sale of the ADRs to the broker-dealer’s customer would qualify for the benchmark exception in Rule 611(b)(7). Each component of the ADR Equivalent Price is integrally related to the conversion process for obtaining the ADRs necessary to fill the customer’s order and does not include any reasonably determinable compensation for the broker-dealer (see FAQ 3.08 above). In addition, the amount of any anticipated fee included in the ADR Equivalent Price may not exceed the standard fee published by a depositary for the conversion of foreign ordinary shares to ADRs. As part of its policies and procedures reasonably designed to assure compliance with the exception, the broker-dealer should reasonably document that any such estimated conversion fee included in the ADR Equivalent Price meets these requirements.

Similarly, in cases where some ADRs are available in the market to satisfy the customer’s order, the broker-dealer’s sale of ADRs to the customer would qualify for the benchmark exception if the price was based on the volume-weighted average of (1) the ADR Equivalent Price for converted ADRs, and (2) the price of any ADRs purchased in the market to help fill the customer’s order.

Question 3.16: Benchmark Exception/VWAP Trades

How should a broker-dealer determine whether an intra-day volume-weighted average price (“VWAP”) trade will qualify for the benchmark exception of Rule 611(b)(7)?

Answer: Whether an intra-day VWAP trade qualifies for the exception in Rule 611(b)(7) will necessarily depend on the specific facts and circumstances of the trade. The price of an intra-day VWAP trade will be determined with reference to the reported trades in a stock or group of stocks during a specified time period. To qualify for the benchmark exception, the trade must be at a price that was not based, directly or indirectly, on the quoted price of the NMS stock at the time of execution and for which the material terms were not reasonably determinable at the time the commitment to execute the order was made. A variety of factors are relevant to this determination, including the historical trading characteristics of the NMS stock or stocks involved (including, among other factors, the extent to which any such stock or stocks have been actively or less actively traded, and the price volatility of such stock or stocks), the time between the commitment to execute the VWAP order and the beginning of the VWAP period, and the duration of the VWAP period.

For example, as described in the NMS Release,²⁹ a customer order submitted at 9:00 am seeking an intra-day VWAP from market opening until 1:00 pm would qualify for the benchmark exception. In other circumstances, a commitment to execute a customer order seeking an intra-day VWAP that was submitted well in advance of the VWAP period could qualify for the benchmark exception, even if the VWAP period is shorter than one-half of the trading day. Similarly, a customer order seeking an intra-day VWAP that was submitted shortly before the start of the VWAP period could qualify for the benchmark exception, as long as the VWAP period was sufficiently long given the characteristics of the stock or stocks involved that the price was not reasonably determinable at the time the commitment to execute the order was made.

In addition, broker-dealers may have difficulty in achieving actual VWAP for certain stocks or groups of stocks. In these cases, the broker-dealer and customer can agree to adjust the VWAP benchmark by including a factor that reflects the variability in achieving actual VWAP. Such a factor would qualify for the benchmark exception if any amount in excess of or less than the VWAP is based on externally observable circumstances that do not result in reasonably determinable compensation to the broker-dealer (see FAQ 3.08 above). For example, to the extent a broker-dealer historically has observed a ten basis point shortfall in achieving VWAP for a particular stock or group of stocks over a specified period of time, a benchmark of VWAP plus or minus ten basis points would satisfy the requirements of the exception in Rule 611(b)(7). As part of its policies and procedures reasonably designed to assure compliance with the exception, the broker-dealer must have and maintain reasonable documentation of the externally observable circumstances.

As with all exceptions and exemptions from Rule 611, broker-dealers intending to use the benchmark exception for intra-day VWAP trades must establish, maintain, and enforce written policies and procedures reasonably designed to assure compliance with the terms of the exception, as well as regularly surveil to ascertain the effectiveness of their policies and procedures and take prompt action to remedy deficiencies in them.

Question 3.17: Benchmark Exception/Average Price Residual Trades

A broker-dealer’s customer wants to sell 100,000 shares of an NMS stock on a not-held basis prior to the end of the trading day. The broker-dealer agrees to sell such shares as agent. Broker-dealer and customer also agree, at a time when the final execution price is not reasonably determinable, that any residual amounts not sold by 3:00 p.m. will be sold by the broker-dealer as principal at the volume-weighted average price of the executions of the order prior to that time. Broker-dealer sells 80,000 shares as agent prior to 3:00 p.m. at a volume-weighted average price of $50 per share and buys the remaining 20,000 shares as principal at $50 per share. The national best protected bid at the time the broker-dealer executes its principal trade with the customer is $51 per share. May the broker-dealer execute the principal trade at $50 per share using the benchmark exception under Rule 611(b)(7)?

Answer: Yes, the residual principal trade of 20,000 shares would qualify for the benchmark exception because the execution of the order was not based, directly or indirectly, on the quoted price of the NMS stock at the time of execution and the commitment to fill the residual amount of the order at a volume-weighted average price was made at a time when the material terms of the residual trade were not reasonably determinable. Other facts and circumstances, however, could lead to a different result. For example, an agreement, subsequent to the time of the original commitment to sell the shares as agent, to execute the residual amount of the order at a reasonably determinable price, or at a price that would result in reasonably determinable compensation for the broker-dealer (see FAQ 3.08 above), would not qualify for the benchmark exception. In addition, this response does not address whether the residual principal trade would satisfy any best execution responsibilities that the broker-dealer may owe to its customer.

Question 3.18: Benchmark Exception/ETF Trading

A broker-dealer’s customer wants to purchase shares of an exchange traded fund (“ETF”). The broker-dealer agrees to sell the ETF shares to the customer at a price based on the weighted average price of: (1) transactions in a basket of stocks highly correlated to the ETF; (2) transactions in ETF futures; or (3) in some cases where ETF shares may be available in the market, the blended weighted average price of stock basket transactions, ETF futures transactions, and transactions in ETF shares available in the market. The broker-dealer effects the transactions in stock baskets, ETF futures, and/or ETF shares as principal and then sells ETF shares to the customer at the agreed upon weighted average price. If the weighted average price is higher/lower than the best protected offer/bid in the market for the ETF at the time of the trade with the customer, may the broker-dealer nevertheless print the ETF trade in reliance upon the benchmark exception of Rule 611(b)(7)?

Answer: If the price was not reasonably determinable at the time the commitment to execute the order was made, the sale of ETF shares to the customer at a weighted average price of transactions effected in: (1) a basket of stocks highly correlated to the ETF, (2) ETF futures, or (3) a combination of stock baskets, ETF futures, and ETF shares, would fall within the exception in Rule 611(b)(7). This response also would apply to trades involving other comparable instruments that are NMS stocks, such as broker-dealer’s sale to a customer of portfolio depository receipts, holding company depository receipts, and index fund shares.

Question 3.19: Exemption for Error Correction Transactions

Is there an exemption from Rule 611 for certain transactions that are necessary to correct bona fide errors?

Answer: Yes, the Commission has issued an exemptive order for certain error correction transactions.³⁰ The exemption applies to transactions executed by a trading center to correct a “bona fide error,”³¹ which is defined as: (1) the inaccurate conveyance or execution of any term of an order including, but not limited to, price, number of shares or other unit of trading; identification of the security; identification of the account for which securities are purchased or sold; lost or otherwise misplaced order tickets; short sales that were instead sold long or vice versa; or the execution of an order on the wrong side of a market; (2) the unauthorized or unintended purchase, sale, or allocation of securities, or the failure to follow specific client instructions; (3) the incorrect entry of data into relevant systems, including reliance on incorrect cash positions, withdrawals, or securities positions reflected in an account; or (4) a delay, outage, or failure of a communication system used to transmit market data prices or to facilitate the delivery or execution of an order.³²

A transaction will qualify for the exemption if it meets the following terms (“Error Correction Transaction”): (1) the trading center effects the transaction solely to correct a bona fide error; (2) the bona fide error is evidenced by objective facts and circumstances, and the trading center maintains documentation of such facts and circumstances; (3) the trading center records the transaction in its error account; (4) the trading center establishes, maintains, and enforces written policies and procedures that are reasonably designed to address the occurrence of errors and, in the event of an error, the use and terms of a transaction to correct the error in compliance with this exemption; and (5) the trading center regularly surveils to ascertain the effectiveness of its policies and procedures to address errors and transactions to correct errors and takes prompt action to remedy deficiencies in such policies and procedures.

The exemption applies only to the Error Correction Transaction itself. It does not, for example, apply to any subsequent trades effected by a trading center to eliminate a proprietary position connected with the Error Correction Transaction.

Question 3.20: Exemption for Print Protection Transactions

Is there an exemption from Rule 611 for certain transactions that enable a trading center to offer print protection to its customers?

Answer: Yes, the Commission has issued an exemptive order for certain transactions that provide print protection to a trading center’s customers.³³ The exemption applies to the execution of an order by a trading center that meets the following conditions (“Print Protection Transaction”): (1) the order is displayed in whole or in part by an automated trading center that displays protected quotations; (2) after the order is displayed, a transaction (“Triggering Transaction”) is reported pursuant to a transaction reporting plan (as defined in Rule 600(b)(32) of Regulation NMS) at a price that is inferior to the price of the displayed order; (3) the Triggering Transaction is reported as qualifying for the ISO exception in paragraphs (b)(5) or (b)(6) of Rule 611; (4) the trading center executes the order promptly after the Triggering Transaction is reported; (5) the contra side of the order is provided by a broker-dealer who has responsibility for the order; (6) the size of the transaction does not exceed the total of the displayed size and reserve size of the order displayed on the automated trading center; and (7) the trading center establishes, maintains, and enforces written policies and procedures that are reasonably designed to assure compliance with the terms of this exemption, and the trading center regularly surveils to ascertain the effectiveness of such policies and procedures and takes prompt action to remedy deficiencies in them.

The exemption applies only to the execution of the Print Protection Transaction itself. It does not, for example, apply to any trades executed by the trading center that are connected with the Print Protection Transaction.

Question 3.21: Exemption for Non-Convertible Preferred Securities (NEW)

Is there an exemption from Rule 611 for transactions in non-convertible preferred securities?

Answer: Yes, the Commission has issued an order exempting non-convertible preferred securities from Rule 611(a).³⁴ The exemption recognizes that non-convertible preferred securities have characteristics analogous to fixed income instruments. Given these characteristics, non-convertible preferred securities typically are priced based on yield and trade more like fixed income instruments than like common stocks. Although granting an exemption from Rule 611 for non-convertible preferred securities, the Commission emphasized that transactions in such securities remain subject to all other applicable regulatory requirements. For example, broker-dealers continue to owe a duty of best execution to their customers, particularly retail customers, with respect to their handling and execution of customer orders in non-convertible preferred securities.

Question 3.22: Benchmark Exception/Average Price Order with Guaranteed Price (NEW)

A broker-dealer’s customer submits a not-held order to purchase 100,000 shares of an NMS stock. The broker-dealer intends to accumulate the 100,000 shares in the market as principal for the purpose of filling the customer’s order. The broker-dealer agrees to sell the shares to the customer at the volume-weighted average price of the accumulated shares, but also guarantees an execution of the order at no worse than a specified price. At the time the broker-dealer commits to execute the order, it is not reasonably determinable whether the execution price will be the volume-weighted average price or the guaranteed price. The broker-dealer subsequently accumulates the 100,000 shares at a volume-weighted average price that is higher than the guaranteed price and therefore sells the shares to the customer at the guaranteed price. The transaction price for the customer buy order is higher than the national best offer at the time of execution, and therefore the transaction does not qualify for the stopped order exception in Rule 611(b)(9). Does the transaction nevertheless qualify for the benchmark exception in Rule 611(b)(7)?

Answer: Yes, the transaction qualifies for the benchmark exception because it was not based, directly or indirectly, on the quoted price of the NMS stock at the time of execution and the material terms of the order were not reasonably determinable at the time the broker-dealer committed to execute the order. In particular, the execution price of the order was not reasonably determinable at the time the broker-dealer committed to execute the order and did not result in any reasonably determinable compensation to the broker-dealer.

The broker-dealer’s agreement to stop an average price order at a guaranteed price, and its subsequent execution at the guaranteed price, does not mean that the transaction cannot qualify for the benchmark exception in Rule 611(b)(7) and must be assessed solely under the stopped order exception in Rule 611(b)(9). Rather, an order can be evaluated separately under each exception. Based on the particular facts and circumstances of a transaction, the transaction may qualify for both exceptions, only one of the exceptions, or neither of the exceptions.

If, for example, it is reasonably determinable that the order will be executed at the guaranteed price, the transaction would not qualify for the benchmark exception (though it still could qualify for the stopped order exception, assuming it otherwise meets the terms of such exception). Moreover, if the guaranteed price was added to the order after it was originally accepted, the order would need to be evaluated at the later time to determine whether an execution at the guaranteed price would qualify for the benchmark exception. Finally, the benchmark exception could apply to an execution at the guaranteed price only to the extent that the broker-dealer actually accumulated shares of the NMS stock in the market to fill the customer’s order. If the accumulated quantity were less than the full size of the order, the benchmark exception could apply only to the quantity that was accumulated, assuming all other terms of the exception were satisfied.

Question 3.23: Agency Block Transactions with Non-Trade-Through Prices that are Individually Negotiated (NEW)

A broker-dealer acts as agent in arranging block transactions between two or more parties at prices that are individually negotiated either through communications with personnel of the broker-dealer or through direct communications between the parties to the transactions. The negotiations may occur through a conversation (e.g., by telephone) or through automated messages (e.g., e-mail, instant messaging, or other electronic communications system). The parties agree to a price that is at or within the best protected quotations at some point during the negotiations. After the parties agree to this price, the transaction information is captured in an automated system of the broker-dealer in a reasonable time. In some transactions, particularly for securities with volatile quoted prices, the individually negotiated price may not be at or within the best protected quotations at the time the transaction terms are captured in the automated system. To address this problem, the broker-dealer implements a policy and procedure pursuant to which the broker-dealer’s personnel affirm that the transaction price was at or within the best protected quotations at some point during the 20-second period up to and including the time the transaction terms are captured in the automated system. Alternatively, the broker-dealer implements a policy and procedure pursuant to which the broker-dealer’s automated system checks to affirm that the transaction price was at or within the best protected quotations at some point during the 20-second period up to and including the time the transaction terms are captured in the automated system. If the transaction is affirmed pursuant to one of the alternative policies and procedures, the broker-dealer considers the transaction as a non-trade-through transaction for purposes of Rule 611. Do these alternative policies and procedures for handling agency block transactions with individually negotiated prices comply with Rule 611(a)?

Answer: Yes, either of the alternative policies and procedures for affirming that the individually negotiated price of an agency block transaction was at or within the best protected quotations at some point during the 20-second period up to and including the time the transaction terms are captured in an automated system of the broker-dealer would be a reasonable policy and procedure to prevent trade-throughs under Rule 611(a). In this context, the broker-dealer is acting as agent to arrange large transactions at prices that generally will be favorable for each party (i.e., at or within the best protected quotations). The broker-dealer thereby is performing a useful service in enabling its customers to find contra-side liquidity in large sizes. Given the desire of some block customers to negotiate prices individually, either of the alternative policies and procedures is a reasonable way for the broker-dealer to address the practical difficulties of individually negotiating a price that is intended to be at or within the best protected quotations and capturing the transaction terms in an automated system.

A transaction would qualify as an individually negotiated agency block transaction for purposes of this FAQ if: (1) the broker-dealer arranging the transaction does not participate in such transaction as principal, except as riskless principal in compliance with the relevant SRO rule on riskless principal reporting;³⁵ (2) at least one of the parties individually negotiating the price of the transaction is a “customer,” as defined in Rule 600(b)(16) of Regulation NMS;³⁶ and (3) the transaction is of block size, as defined in Rule 600(b)(9) of Regulation NMS. To meet the regular surveillance requirement of Rule 611(a)(2), the broker-dealer should periodically check to assure that its personnel are accurately affirming prices within the 20-second period, or that its automated system is accurately affirming prices within the 20-second period.

Question 3.24: Stopped Order Exception/Manually Negotiated Principal Transactions (NEW)

A broker-dealer operates a trading desk that, among other things, executes customer orders as principal at prices that are manually negotiated between customers and the broker-dealer’s traders. After the customer and trader manually agree to a price, the trader immediately begins inputting the transaction information into an automated system of the broker-dealer and completes the input in a reasonable time. The price is “above water” at the time of agreement from the perspective of the broker-dealer (i.e., the price is below the national best bid for a customer sell order or above the national best offer for a customer buy order); however, due to volatile quoted prices, the manually negotiated price is “underwater” at the time of input into the automated system (i.e., the price is above the national best offer for a customer sell order or below the national best bid for a customer buy order). Would the transaction qualify for the stopped order exception of Rule 611(b)(9)?

Answer: Yes, the transaction would meet the “underwater price” requirement of Rule 611(b)(9)(iii) and qualify for the stopped order exception, assuming all other terms of the exception are satisfied. Under Rule 611(a)(1), a trading center is required to establish, maintain, and enforce written policies and procedures that are reasonably designed to assure compliance with the terms of the exceptions in Rule 611(b). Given the desire of some customers to seek capital commitments from broker-dealers at manually negotiated prices, the broker-dealer’s practice of having its traders immediately input the transaction information into an automated system is one reasonable way to comply with Rule 611. In particular, the broker-dealer reasonably can refer to quoted prices at the time of input to determine compliance with Rule 611 for manually negotiated transactions. Consequently, if the broker-dealer has agreed to execute a customer order at a manually negotiated price that is underwater at the time of input into an automated system, the transaction would meet the underwater price requirement of Rule 611(b)(9)(iii), notwithstanding that the broker-dealer did not document the order as a stopped order at the outset of the transaction.

Section 4: Order Routers

Question 4.01: Rule 611/Order-Routing Tools

Will order routers be able to control the handling of their orders to comply with Rule 611, or must they rely on trading centers themselves to execute and route orders in compliance with the Rule?

Answer: Order routers will have three basic tools, if they choose to use them, to control the handling of their orders to comply with Rule 611. They are (1) a limit price, (2) an IOC designation, and (3) an ISO designation. Use of a limit price precludes any execution at a price inferior to such price. Use of an IOC designation triggers the requirements for automated quotations set forth in Rule 600(b)(3) of Regulation NMS, particularly the requirement that the trading center provide an immediate response to the order (see FAQ 2.03 above). The response must be a fill, in full or in part, or a non-fill, and a cancellation of any unfilled balance of the order, without routing the order away to another trading center. Finally, use of an ISO designation enables the destination trading center to execute the order immediately without regard to better-priced protected quotations displayed by automated trading centers. When an order is designated as an ISO, the broker-dealer routing the order must assume the responsibility for transmitting additional orders, as necessary, to execute against any better-priced protected quotations (see FAQs 4.02 to 4.06 below). The ISO designation also informs the destination trading center that the fees for any order execution should not exceed the limitation of fees set forth in Rule 610(c), unless the order router affirmatively expresses its willingness to accept an order execution beyond the scope of the fee limitation (see FAQ 2.08 above).

The coordinated use of a limit price, IOC designation, and ISO designation should be particularly valuable for those who wish to conduct automated best-price routing strategies. For example, when multiple trading centers are displaying the best price for an NMS stock, an investor can route a single IOC/ISO to the most preferred of these trading centers, thereby allowing the preferred trading center to execute the order immediately even if quotations may have changed while the order was in transit (see FAQ 4.04 below). If an order router wishes to execute a large order by sweeping both the protected quotations and depth-of-book quotations at one or more preferred trading centers, it can implement this strategy by routing large-sized IOC/ISOs with aggressive limit prices to the preferred trading centers, while routing additional IOC/ISOs, as necessary, to less preferred trading centers that are priced and sized to execute against only the better-priced protected quotations of those trading centers. All of the destination trading centers will be authorized to execute the IOC/ISOs immediately, without regard to the protected quotations displayed by other trading centers.

Question 4.02: Reasonable ISO Routing Arrangements

How should trading centers and broker-dealers structure their ISO routing arrangements to address the risk of systems problems that could impair the routing function?

Answer: Rule 611(a)(1) requires trading centers to establish, maintain, and enforce policies and procedures that are reasonably designed to assure compliance with the terms of the ISO exception. Similarly, Rule 611(c) requires trading centers and broker-dealers to take reasonable steps to establish that ISOs meet the requirements of Rule 600(b)(30). In structuring their ISO routing arrangements, trading centers and broker-dealers should reasonably address the potential for systems problems. In particular, the routing arrangements should be highly reliable and incorporate appropriate policies and procedures to monitor performance of routing systems to affirm that they are functioning properly. Moreover, if a primary routing system experiences problems that render it incapable of routing ISOs to execute against one or more better-priced protected quotations, a trading center or broker-dealer will not be able to continue to take advantage of the various ISO exceptions unless its routing arrangements have incorporated at least one reasonable alternative means of routing the required ISOs to the appropriate automated trading centers.

Question 4.03: Routing ISOs with Assistance of Third-Party Service Providers

Can a broker-dealer responsible for routing ISOs retain the services of a third-party service provider to meet the requirements of Rule 611?

Answer: Yes, a broker-dealer responsible for routing ISOs is permitted to retain the services of another entity for assistance in meeting the requirements of Rule 611, but such broker-dealer would remain ultimately responsible for compliance with the Rule.³⁷ For example, Rule 611(c) requires a broker-dealer to take reasonable steps to establish that the ISOs for which it is responsible meet the requirements set forth in the definition of an ISO in Rule 600(b)(30). To meet this requirement when retaining a third-party service provider, the broker-dealer must, at a minimum, adopt reasonable procedures to assure that the service provider is capable of meeting the requirements of Rule 611 and to monitor the service provider’s performance on a continuing basis.

Question 4.04: Routing Single ISO to Best Displayed Price

Is it permissible for an order router that does not intend to sweep any inferior prices to designate a single limit order as an ISO when it will be routed to only one trading center that is displaying a protected quotation with the best price for an NMS stock (either alone or with other trading centers), without routing an order to another trading center?

Answer: Yes, an order router that does not intend to sweep any inferior prices can designate a single order as an ISO when it is routed to a trading center displaying the best-priced quotation for a stock. The ISO designation will allow the destination trading center to execute the order immediately, even if another trading center displays a better-priced protected quotation after the ISO is routed and before the ISO is executed by the destination trading center. The definition of an ISO requires that, simultaneously with the routing of an ISO under subparagraph (i) of Rule 600(b)(30), one or more additional ISOs are routed under subparagraph (ii), as necessary, to execute against the full displayed size of any better-priced protected quotations. If there are no protected quotations with better prices than the limit price of the subparagraph (i) ISO at the time of routing, then it is not necessary to route any additional ISOs under subparagraph (ii). In addition, the size of the subparagraph (i) ISO need not equal or exceed the full displayed size of the protected quotation.

For example, if three trading centers are displaying protected bids that equal the national best bid for a stock, it would be appropriate for a best-price order router to route a sell ISO of any size to any one of them, to any two of them, or to all three. In each case, there would be no better-priced protected bids that necessitated the routing of additional sell orders.

Note, however, that the use of an ISO designation discussed in this question and response is limited to best-price order-routing strategies that will not sweep any inferior prices. In contrast, whenever an order router intends to sweep one or more inferior prices, an ISO must be routed to execute against every better-priced protected quotation. For example, if a trading center intends to use the exception in Rule 611(b)(6) to enable such trading center to execute a trade at an inferior price, the trading center must route ISOs to execute against the full displayed size of all better-priced protected quotations.

Question 4.05: Routing ISOs Directly to ECNs

An ECN submits quotations to an SRO trading facility for display in Network quotation data. Under what circumstances can market participants route ISOs directly to the ECN to access the ECN's quotations, rather than to the SRO trading facility?

Answer: Whether market participants can route ISOs directly to an ECN that is displaying quotations in an SRO trading facility will depend on the particular context. Whenever the relevant rule provision requires that an ISO be routed to execute against the full displayed size of a protected quotation, such ISO must be routed directly to the SRO trading facility that is directly displaying the protected quotation in the Network quotation stream. In other contexts when an ISO is not required by rule, such ISO can be routed either to the SRO trading facility or directly to the ECN. For example, if an ECN is displaying a quotation that equals the NBBO, a market participant executing a best-price routing strategy can route an ISO with a limit price at the NBBO directly to the ECN under Rule 600(b)(30)(i). Using an ISO in this context will assure that the ECN can execute the ISO without regard to protected quotations at any automated trading center, even if such quotations change while the ISO is in transit (see FAQ 4.04 above).

Question 4.06: Routing ISOs After Receiving Cancellations

As part of a best-price routing strategy, an order router transmits an ISO to execute against a protected quotation at Trading Center A. Trading Center A responds with a “no-fill” or “partial-fill” cancellation of the ISO. If the price of the protected quotation at Trading Center A does not change, is it permissible for such order router to continue to route ISOs to other trading centers for one full second, without routing a new ISO to execute against the same-priced protected quotation at Trading Center A?

Answer: Yes, waiting one full second to route a new ISO to an unchanged price at a trading center (after receiving a no-fill or partial fill cancellation of a previous ISO seeking to execute against a protected quotation at such trading center) would qualify as a reasonable policy and procedure under Rule 611(a)(1) to prevent trade-throughs, as well as a reasonable step under Rule 611(c) to establish that orders meet the requirements for ISOs set forth in Rule 600(b)(30).

In the NMS Release, the Commission recognized the practical challenges of implementing intermarket price priority at the level of sub-second time increments.³⁸ In the national market system, multiple trading centers across the country simultaneously quote and trade in NMS stocks. Particularly for active stocks, many orders can seek to execute against a single displayed quotation, many trades can be executed, and many quotations can be updated, all within a single second.

In recent years, industry participants have acquired substantial practical experience with policies and procedures for automated best-price routing strategies. After the compliance date for Rule 611, the Staff believes that trading centers and broker-dealers should continue to have considerable flexibility in adapting such policies and procedures to address the practical challenges of implementing best-price routing strategies in compliance with the Rule. As long as such policies and procedures are reasonably designed to route orders to execute against the full displayed size of protected quotations prior to the execution of a trade at an inferior price, it will be appropriate to use the ISO designation as a means to implement the best-price routing strategy. Waiting one second before re-routing to a trading center’s protected quotation, after receiving a partial-fill or no-fill response to an order seeking to execute against the trading center’s quotation at the same price, would be one example of a reasonable policy and procedure.

Question 4.07: Self-Help Exception/Elements of Policies and Procedures

What elements must be included in a trading center’s policies and procedures to implement the self-help exception?

Answer: The NMS Release specifies a minimum of three elements that must be included in a trading center’s policies and procedures to comply with the self-help exception: (1) notice, (2) systems assessment and response, and (3) objective parameters.³⁹ On any given trading day, a wide variety of systems problems potentially can arise in the internal systems of a trading center, as well as in the linkages between trading centers and between trading centers and broker-dealers. In addition, the scope of a problem can vary widely (e.g., a systems problem at a trading center can affect only a single stock, a group of stocks, or all stocks). The self-help exception is designed to promote efficient intermarket price priority by providing a flexible tool that generally will allow trading to continue while affected trading centers identify the problem and respond appropriately. Each of the three elements of a trading center’s policies and procedures will further this objective.

Notice. A trading center that elects to use the self-help exception must notify the trading center whose quotations are bypassed. The notice can be sent by electronic mail and must be sent immediately upon use of the exception. The self-help notice is intended to give the bypassed trading center an opportunity to assess whether its systems are in fact malfunctioning. For example, if a trading center receives many self-help notices in a short period of time, they provide strong evidence that it is, in fact, the trading center’s systems that have a problem. The notice requirement also is generally intended to facilitate communications between the electing trading center and the bypassed trading center that could help identify the source of the problem and promote its resolution. To meet this objective, the notice should, at a minimum, provide a mechanism for communication with someone at the electing trading center who will be able to respond to inquiries concerning the notice. As noted in FAQ 2.03 above, automated trading centers that display protected quotations must provide a mechanism for receiving self-help notifications, as well as assign personnel to monitor the receipt of such notifications on a real-time basis so that potential systems problems can be promptly evaluated and appropriately addressed.

Systems Assessment and Response. When an order router initially fails to receive immediate responses to IOC orders from the destination trading center, the precise source of the problem often may not immediately be clear. The problem could be located in the internal systems of the destination trading center, but it also could be located in the internal systems of the order router or in the connections that the order router used to access the destination trading center. As discussed in FAQ 4.02 above, all ISO routers must adopt routing arrangements that reasonably address the risk of systems problems that could impair the routing function. These arrangements should include appropriate policies and procedures to monitor the performance of routing systems to affirm that they are functioning properly. An order router is not entitled to bypass protected quotations pursuant to the self-help exception if it has reason to believe that an order-response problem is not attributable to a problem with systems for which the destination trading center is responsible. For example, if the order router has experienced repeated problems with its own systems in reaching a particular destination trading center, it is not entitled to elect the self-help exception when such problems reoccur. Moreover, an order router that appropriately elects to initiate use of the self-help exception cannot simply assume at that point that a problem lies elsewhere. The order router must assess whether the cause of a problem lies with its own systems or connections and, if so, take immediate steps to resolve the problem appropriately.⁴⁰

Objective Parameters. The NMS Release states that a trading center must adopt objective parameters to govern its use of the self-help exception, noting that the repeated failure of a destination trading center to respond within one second to an incoming IOC order (after adjusting for order transmission time) would justify use of the exception.⁴¹ Beyond this basic parameter of a repeated failure to turn around an IOC order within one second, trading centers are free to adopt reasonable policies and procedures that are consistent with the flexible purposes of the self-help exception. Such policies and procedures should address the specific circumstances that will trigger the exception, the stock or stocks that will be affected, and the specific circumstances that will terminate the exception.

In recent years, many market participants have developed best-price routing practices and have considerable experience in dealing with trading centers when systems problems occur. The Staff anticipates that many of the policies and procedures already developed to deal with systems problems will qualify as reasonable parameters for use of the self-help exception. Such policies and procedures are likely to evolve as the securities industry gains experience interacting with Regulation NMS-compliant trading systems.

Question 4.08: Addressing Failure to Provide Immediate Response to a Single Order

Aside from the self-help exception, does an order router have any flexibility in addressing a failure by an automated trading center to provide an immediate response to an IOC order?

Answer: Yes, but only in the limited context of a failure to provide an immediate response to a specific protected quotation. The NMS Release notes that, as part of its policies and procedures to reasonably prevent trade-throughs, a trading center that routed an order to another trading center to access the full displayed size of a protected quotation would be entitled to continue trading without regard to such quotation until a response was received to the order.⁴² To the extent, however, that an order router wished to bypass the destination trading center’s protected quotations more generally, it would be required to use the self-help exception.

Question 4.09: Combined Use of ISO and Self-Help Exceptions

When routing orders to other trading centers to comply with the ISO exception, does Rule 611 permit the routing trading center to bypass a trading center with respect to which the routing trading center is currently exercising the self-help exception? If so, is any broker-dealer responsible for routing ISOs also entitled to bypass a trading center experiencing systems problems that would justify use of the self-help exception?

Answer: When routing orders to meet the requirements for ISOs set forth in Rule 600(b)(30), a trading center can decline to route orders to execute against the protected quotations of a trading center experiencing systems problems for which the routing trading center has triggered the self-help exception of Rule 611(b)(1). This combined use of the self-help and ISO exceptions would be a reasonable policy and procedure under Rule 611(a).

In addition, a broker-dealer responsible for routing ISOs, but which does not fall within the definition of trading center in Rule 600(b)(78) because it does not execute orders internally as agent or principal, would nevertheless be entitled to use the combined ISO/self-help exceptions if it elects to comply with the requirements applicable to trading centers under Rule 611(a). For example, such a broker-dealer would need to adopt the reasonable policies and procedures required by Rule 611(a)(1) to implement the self-help exception (including sending notice to the problem trading center – see FAQ 4.07 above), as well as comply with Rule 611(a)(2) by regularly surveiling to ascertain the effectiveness of its policies and procedures.

Question 4.10: Routing ISOs Through a Conduit Broker-Dealer or Trading Center

A broker-dealer seeking to take advantage of the ISO exceptions in Rule 611 or in the SRO lock/cross rules may not have direct connectivity to all automated trading centers that display protected quotations. Is it permissible for a broker-dealer to use the services of another broker-dealer or trading center solely as a conduit for routing ISOs to one or more of such automated trading centers?

Answer: Yes, a broker-dealer can structure its ISO routing arrangements in a variety of ways to obtain connectivity to automated trading centers, including using another broker-dealer or trading center solely as a conduit through which to route ISOs. The requirements for these arrangements will depend on the specific structure chosen by the broker-dealer, and particularly on the extent to which the broker-dealer itself chooses to perform ISO routing functions. Two of the essential steps in routing ISOs are, first, to take a snapshot of the relevant protected quotations and, second, to transmit to the appropriate automated trading centers any ISOs that are necessary to execute against such protected quotations under applicable rules.

Rule 611(c) provides that the broker-dealer or trading center responsible for the routing of an ISO must take reasonable steps to establish that the ISO meets the requirements for ISOs. For every ISO, there must be at least one broker-dealer or trading center that is responsible under Rule 611(c). ISO routing structures can vary, and the identity of the broker-dealer or trading center that is responsible for routing an ISO can vary as well. As a result, all broker-dealers and trading centers that intend to participate in ISO routing arrangements must assure that, for any particular ISO, there is no confusion as to who is performing the necessary ISO functions and who is a responsible broker-dealer or trading center under Rule 611(c).

For example, one possible structure would make use of a “conduit” broker-dealer or trading center. In this structure, the originating broker-dealer (i.e., a broker-dealer that intends to take advantage of the ISO exception either for itself or on behalf of a customer) would perform the essential ISO routing functions, such as taking a snapshot of protected quotations and transmitting the necessary ISOs to execute against protected quotations. Rather than establishing connections to all automated trading centers, such a broker-dealer might want to engage the services of another broker-dealer or trading center solely as a conduit through which to transmit ISOs to one or more automated trading centers.

This conduit routing structure is appropriate as long as the originating broker-dealer and the conduit broker-dealer or trading center have clearly delineated who will perform the necessary ISO routing functions. In particular, it should be clearly understood that the originating broker-dealer is the sole responsible broker-dealer under Rule 611(c). Under these circumstances, the conduit broker-dealer or trading center could accept the ISO and handle it strictly in accordance with the instructions of the originating broker-dealer. This conduit would not be a responsible broker-dealer or trading center under Rule 611(c) and would not be required to perform any other ISO functions (e.g., take an additional snapshot of protected quotations or affirm that the originating broker-dealer has transmitted other ISOs appropriately). In addition, if the conduit is a trading center that both executes trades and routes orders, the trading center must act solely in a routing capacity with respect to conduit ISOs, with no possibility of the trading center executing the conduit ISOs internally.

Section 5: SRO Lock/Cross Rules

Question 5.01: SRO Rules Addressing Locking/Crossing Quotations

Rule 610(d) requires the SROs to adopt rules addressing locking and crossing quotations. Will the SROs adopt a consistent approach in developing their rules?

Answer: Each of the SROs has adopted rules incorporating a consistent approach to locking and crossing quotations.⁴³ Among other things, they require that locks and crosses of protected quotations be reasonably avoided and prohibit a pattern or practice of displaying locking or crossing quotations. The rules do not restrict the display of automated quotations that lock or cross manual quotations. In addition, the SRO lock/cross rules include several exceptions that are analogous to those included in Rule 611(b), such as the ISO exception (see FAQ 5.02 below), the self-help exception (see FAQ 5.03 below), and the crossed protected quotation exception.

Question 5.02: ISO Exception to SRO Lock/Cross Rules

The SRO rules addressing locking and crossing quotations include an ISO exception under which market participants are permitted to “ship-and-post.” Do the routing requirements for this exception vary in any respect from the routing requirements for other uses of ISOs?

Answer: Yes, the ISO exception from the SRO lock/cross rules varies from other ISO exceptions with respect to the scope of protected quotations to which ISOs must be routed. For example, Rule 611(b)(6) requires that ISOs be routed to execute against all protected quotations with better prices than the price of the excepted trade-through transaction. The ISO exception to the SRO lock/cross rules, in contrast, requires that ISOs be routed to execute against all protected quotations with a price that is equal to the display price (i.e., those protected quotations that would be locked by the displayed quotation), as well as all protected quotations with prices that are better than the display price (i.e., those protected quotations that would be crossed by the displayed quotation).

Question 5.03: Self-Help Exception to SRO Lock/Cross Rules

How should market participants implement the self-help exception to the SRO lock/cross rules?

Answer: Market participants should implement the self-help exception to the SRO locked/crossed rules in the same manner as they implement the self-help exception to Rule 611 (see FAQ 4.07 above). For example, if a market participant has already notified a trading center that it has elected the self-help exception with respect to Rule 611, no further notification is necessary to elect the self-help exception to the SRO lock/cross rules. In addition, the same policies and procedures for systems assessment and response and for objective parameters should be used for the self-help exception of both Rule 611 and the SRO lock/cross rules.

Section 6: Data Policies and Procedures

Question 6.01: Rule 611 Compliance/Data Latency

In the national market system, trading centers across the U.S. simultaneously display quotations and execute trades in the same NMS stocks. Given the latencies in transmitting data among these trading centers, as well as among broker-dealers that route ISOs to execute against the protected quotations displayed by trading centers, how will regulators assess the compliance of trading centers and broker-dealers with Rule 611?

Answer: In the NMS Release, the Commission stated that, assuming a trading center has implemented reasonable policies and procedures for handling data (see FAQ 6.02 below), a trading center’s compliance with Rule 611 “will be assessed based on the time that orders and quotations are received, and trades are executed, at that trading center.”⁴⁴ The same standard will be used to assess the compliance of broker-dealers in routing ISOs under Rule 611(c).

The data that bears on Rule 611 compliance can be divided into three categories: (1) the order and trade data of each trading center or broker-dealer (“Firm”), with internal time stamps reflecting when it was processed by each Firm (“Firm-Specific Order and Trade Data”); (2) the protected quotation data received by each Firm, with internal time stamps reflecting when it was received by the Firm (“Firm-Specific Quotation Data”); and (3) the protected quotation and trade data of the Network processors, with time stamps assigned by such processors (“Network Data”). Assuming reasonable data handling policies and procedures, compliance by individual Firms with Rule 611 will be assessed based on Firm-Specific Order and Trade Data and Firm-Specific Quotation Data, and not on Network Data (the relevance of Network Data to Rule 611 is discussed in FAQ 6.04 below).

Question 6.02: Data Handling Policies and Procedures

What are examples of matters that need to be addressed in a Firm’s data handling policies and procedures?

Answer: As noted in FAQ 6.01 above, compliance by individual Firms with Rule 611 will be based on that Firm’s own data, assuming that the Firm has implemented reasonable data handling policies and procedures. Such policies and procedures should address latencies in obtaining protected quotation data from the sources of such data. The Firm should implement reasonable steps to monitor such latencies on a continuing basis and take appropriate steps to address a problem immediately should one develop.

In addition, a Firm should adopt reasonable policies and procedures for synchronizing its internal clocks, to the extent that it uses different clocks to assign time-stamps to its order, trade, and quotation data. For example, different trading desks or systems at a Firm potentially could use different clocks to assign time-stamps to trades executed by such desks or systems, and these clocks could be different from the clock that is used to assign time stamps to protected quotations as they are received. The Firm should synchronize these internal clocks to enable the Firm to reasonably determine through its compliance procedures that the trading desks and order handling systems are executing trades and routing orders in compliance with Rule 611.

Question 6.03: Data Maintenance Policies and Procedures

An enormous volume of updates of protected quotations will be disseminated each trading day for the thousands of NMS stocks, particularly for actively traded stocks. Does Rule 611 require that each Firm maintain a comprehensive database of all Firm-Specific Quotation Data so that every trade and every routed ISO can be evaluated?

Answer: No, Rule 611 does not require Firms to maintain a comprehensive database of Firm-Specific Quotation Data if (1) the Firm has implemented reasonable policies and procedures that include periodic review of its compliance with Rule 611, and (2) the Firm retains sufficient Firm-Specific Quotation Data to demonstrate the reasonableness of its Rule 611 compliance reviews. The reasonableness of a particular Firm’s compliance reviews will be assessed in light of its individual characteristics, including its volume of trading and routing. In general, however, Firms must conduct periodic reviews for specific time periods that are reasonably designed to test the effectiveness of a firm’s policies and procedures for preventing trade-throughs and for complying with the Rule’s exceptions. For these time periods, the Firm should maintain Firm-Specific Quotation Data so that the effectiveness of its policies and procedures can be adequately evaluated by regulatory authorities. For example, a Firm could randomly select three trading days per month for review (known only to its compliance personnel) and maintain all relevant “snapshots” of the Firm-Specific Quotation Data from those days that are necessary to demonstrate the reasonableness of its policies and procedures to regulators. Under existing regulatory requirements, Firms already are required to maintain their Firm-Specific Order and Trade Data.

Question 6.04: Rule 611 Compliance/Relevance of Network Data

What is the relevance of Network Data for assessing compliance with Rule 611?

Answer: As noted in FAQ 6.01 above, the Network processors disseminate to the public a stream of trade and quotation data, with time-stamps, for each NMS stock. In this respect, Network Data is unlike Firm-Specific Order and Trade Data and Firm-Specific Quotation Data, which will have time stamps that vary to some extent from Firm to Firm. As a result, Network Data constitutes a common reference point for quotations and trades in NMS stocks that will be readily available to the public, Firms, and regulatory authorities.

As discussed in FAQs 6.01 and 6.02 above, the compliance of an individual Firm will be assessed based on the data it sees at the time it trades and routes orders, assuming it has implemented reasonable data handling policies and procedures. As a practical matter, however, Firms should be aware that Network Data, as the single available common reference point for quotations and trades in NMS stocks, may be used by regulatory authorities, as an initial matter, to gauge their compliance with Rule 611 generally.

For example, regulatory authorities may examine the Network data for comparable Firms to assess whether any Firm has an exceptionally high trade-through rate. If so, the relevant regulatory authority is likely to contact such Firm and ask for an explanation. At this point, the focus will shift from Network Data to (1) the reasonableness of the Firm’s policies and procedures, particularly for handling data and reviewing for compliance with Rule 611, and (2) the Firm-Specific Order and Trade Data and the Firm-Specific Quotation Data that support the results of the Firm’s compliance reviews. The Firm will want to be in a position to demonstrate that its policies and procedures are reasonable. For example, it could present Firm-specific data from its periodic compliance reviews showing that trades that might appear to be trade-throughs in the Network data are in fact “false positives” that were not trade-throughs at the Firm.

Firms also should recognize that the widely available Network Data could be a valuable external tool for assessing the effectiveness of their internal policies and procedures. For example, an examination of the Network Data might reveal particular types of stocks, times of day, or types of trading conditions in which the Firm appears to generate a high rate of trade-throughs. The Firm could use this information to fashion its compliance reviews to assess these specific potential problem areas. Such compliance reviews could reveal that the trade-throughs in the Network Data are false positives, as well as the explanation for why they appear to be trade-throughs in the Network Data. Conversely, compliance reviews targeted on the problem areas may reveal weaknesses in the Firm’s policies and procedures that the Firm could correct with timely action. In either case, policies and procedures that include the use of Network Data may enable the Firm to provide a more effective response to regulatory inquiries.

Section 7: Miscellaneous

Question 7.01: Application of Rule 610 and Rule 611 Outside of Regular Trading Hours

To what extent do Rule 610 and Rule 611 apply outside of regular trading hours?

Answer: The definition of “trade-through” in Rule 600(b)(77) is limited to trades during “regular trading hours.” Accordingly, a trading center’s policies and procedures under Rule 611 are not required to address trades that occur outside of regular trading hours, and the exceptions in Rule 611(b), including the ISO exception, are not needed outside of regular trading hours. Rule 600(b)(64) defines the term “regular trading hours” as the time between 9:30 a.m. and 4:00 p.m. Eastern Time, but provides that regular trading hours can be changed to other times by the procedures established pursuant to Rule 605(a)(2). To date, these procedures have not been used to alter the 9:30 to 4:00 time period (see FAQ 7.02 below).

In contrast, the definition of “automated quotation” in Rule 600(b)(3) is not limited to a particular time period. A trading center that chooses to identify its quotations as “automated” outside of regular trading hours must comply with the requirements specified in the Rule 600(b)(3) for automated quotations. In addition, the access requirements of Rule 610(a), (b), and (c) are not limited to regular trading hours. Note, however, that the fee limitations of Rule 610(c) apply (either directly or through the definition of “protected quotation” in Rule 600(b)(57)) only to quotations that are the BBOs of a national securities exchange or a national securities association. Accordingly, the limitations are not operative when these entities are not disseminating a BBO.

Question 7.02: Modifying Regular Trading Hours

What is the process for modifying the definition of regular trading hours in Rule 600(b)(64)?

Answer: As noted in FAQ 7.01 above, Rule 600(b)(64) defines the term “regular trading hours” as the time between 9:30 a.m. and 4:00 p.m Eastern Time, or such other time as is set forth in the procedures established pursuant to Rule 605(a)(2) of Regulation NMS. Pursuant to Rule 605(a)(2), the SROs jointly participate in a plan (“Rule 605 Plan”) establishing procedures for market centers to follow in making available to the public the monthly reports required by Rule 605.⁴⁵ Section X of the Rule 605 Plan establishes procedures for specifying regular trading hours for purposes of the definition in Rule 600(b)(64). It provides that the SRO maintaining the primary listing for an NMS security shall specify the regular trading hours for such security if they are to be other than 9:30 to 4:00. To effect such a specification, the SRO must submit a proposed rule change to the Commission under Section 19 of the Exchange Act.

To date, the Commission has not approved an SRO rule modifying the definition of regular trading hours for purposes of Rule 600(b)(64).⁴⁶ Given the importance to the securities industry of any change to the definition of regular trading hours that would affect compliance with Regulation NMS, an SRO proposed rule change to modify the definition should explicitly state that the hours specified in Rule 600(b)(64) are to be changed and identify the NMS stocks that would be affected. The public then will have an opportunity to comment on the effect of the modification on compliance with Regulation NMS.

Question 7.03: Odd-Lot Orders and Odd-Lot Portions of Mixed-Lot Orders

Do Rule 610 or Rule 611 apply to odd-lot orders (those with sizes of less than one round lot in an NMS stock) or to the odd-lot portions of mixed-lot orders?

Answer: No, Rule 610 and Rule 611 do not apply to odd-lot orders or to the odd-lot portions of mixed-lot orders. Rule 600(b)(8) defines “bid” or “offer” as the bid price or offer price for one or more round lots of an NMS security. This definition is embedded in the definition of “quotation” in Rule 600(b)(62), as well as the definition of “protected bid” or “protected offer” in Rule 600(b)(57). Consequently, trading centers are permitted to establish their own rules for handling odd-lot orders and the odd-lot portions of mixed-lot orders. For example, although trading centers are not required to handle odd-lot orders or the odd-lot portions of mixed lot orders in accordance with the requirements for automated quotations set forth in Rule 600(b)(3), they are free to incorporate such requirements in their rules if they wish to do so.

Question 7.04: Rule 611 and Rule 10a-1 – Trading Centers Using Different Tick Tests

Exchange Act Rule 10a-1, which addresses short sales in exchange-registered securities, permits an exchange to adopt a short-sale rule that uses a tick test based on the last sale effected on that exchange, rather than a tick test based on the consolidated last sale reported pursuant to an effective transaction reporting plan. As a result, it is possible for such an exchange to receive a short sale order at a price that would be executable under Rule 10a-1 on that exchange, but not executable under Rule 10a-1 at another trading center using the consolidated tick test that was displaying a protected bid at a higher price. How should the exchange handle the short sale order?

Answer: Given that the short sale order would be executable at the exchange at a lower price than the protected quotation at the other trading center, the exchange would be allowed to route an ISO to the other trading center that was marked as a “short exempt” order, thereby freeing the other trading center to execute the order at the higher price of its protected bid without regard to the tick restrictions of Rule 10a-1.

Question 7.05: Rule 611 and Rule 10a-1 – Broker-Dealer Routing of ISOs to Facilitate Customer Long Sales

As discussed in FAQ 3.03 above, a broker-dealer that intends to use the ISO exception to execute a block order for a customer may, if the customer gives its informed consent, retain the benefit of any fills of the ISOs at better prices than the block trade price. If the customer order is long, but the broker-dealer does not have a long position in the NMS stock, should the broker-dealer nonetheless mark the ISOs as “short exempt”?

Answer: Yes, if the broker-dealer is routing the ISOs solely to facilitate its execution of a customer’s long sale in compliance with Rule 611, the broker-dealer should mark the ISOs as “short exempt” to allow the destination trading centers to execute the orders against better-priced protected quotations without regard to the tick restrictions of Rule 10a-1. Such ISOs should not be marked as “long.”

Question 7.06: Rule 611 and Rule 605 – Special Handling of Certain ISOs

Rule 605 of Regulation NMS requires market centers to prepare monthly reports on order execution quality for covered orders in NMS stocks. Orders for which customers request special handling are excluded from the definition of covered orders in Rule 600(b)(15). How should market centers treat ISOs in their Rule 605 reports?

Answer: A market center should exclude an ISO from its Rule 605 report if the ISO has a limit price that is inferior to the NBBO at time of order receipt (i.e., the limit price is less than the national best bid for sell orders or higher than the national best offer for buy orders). All other ISOs should be included in a trading center’s Rule 605 reports, absent another applicable exclusion from the definition of covered order.

As discussed in FAQ 4.01 above, ISOs can be used to achieve a variety of trading objectives, including both the sweep of multiple price levels and a best-price routing strategy. By marking an order as an ISO, the router indicates to the destination trading center that it has simultaneously routed additional ISOs, as necessary, to any better-priced protected quotations. When the limit price of an ISO is equal to or better than the NBBO at time of order receipt, there can be no better-priced quotations elsewhere, and the router is simply seeking an order execution at the best displayed price or better. In contrast, when the limit price of an ISO is inferior to the NBBO at time of order receipt, the customer is effectively instructing the trading center that it can execute the order at a price inferior to the NBBO, even if one or more trading centers are displaying better prices. This instruction constitutes a request for special handling at the trading center that excludes the ISO from the definition of covered order in Rule 600(b)(15). The execution prices of such excluded ISOs are likely to be inferior to the execution prices of orders with the same limit prices that are not ISOs. Consequently, excluding such ISOs from Rule 605 reports should enhance the comparability of order execution quality statistics across different market centers.

Section 8: Compliance Dates

Question 8.01: Extension of Compliance Dates for Rules 610 and 611

Prior to the initial phase-in of compliance by all market participants with Rules 610 and 611, will market participants have an opportunity to gain experience with the new NMS order types, quotation identifiers, and trade identifiers, as well as the new trading systems currently being developed to comply with Regulation NMS at various trading centers?

Answer: The Commission has extended the original compliance dates for Rules 610 and 611 to a series of five dates for different functional stages of compliance.⁴⁷ The extended compliance dates are as follows: (1) October 16, 2006 (“Specifications Date”) – final date for publication on Internet web site of applicable SROs of final technical specifications for interaction with Regulation NMS-compliant trading systems of all automated trading centers (both SRO trading facilities and ADF participants) that intend to qualify their quotations for trade-through protection under Rule 611 during the Pilot Stocks Phase and All Stocks Phase (as defined below); (2) March 5, 2007 (“Trading Phase Date”) – final date for full operation of Regulation NMS-compliant trading systems of all automated trading centers that intend to qualify their quotations for trade-though protection during the Pilot Stocks Phase and All Stocks Phase; (3) July 9, 2007 (“Pilot Stocks Phase Date”) – start of full industry compliance with Rules 610 and 611 for 250 NMS stocks; (4) August 20, 2007 (“All Stocks Phase Date”) – start of full industry compliance with Rules 610 and 611 for all remaining NMS stocks; and (5) October 8, 2007 (“Completion Date”) – completion of phased-in compliance with Rules 610 and 611.

The revised compliance dates provide additional time for automated trading centers to finalize development of their Regulation NMS-compliant trading systems. The extended dates also provide additional time for market participants to establish the necessary access to such trading systems and to gain practical experience with them.

Question 8.02: Failure of Automated Trading Centers to Meet Specifications Date or Trading Phase Date

What would be the consequences if an automated trading center failed to meet the Specifications Date or Trading Phase Date?

Answer: The extended compliance dates are designed to provide all automated trading centers (i.e., an SRO trading facility or ADF participant) with sufficient time to post final technical specifications for their Regulation NMS-compliant trading systems and to commence full operation of such systems. Securities industry participants need certainty concerning the protected quotations for which they will be required to afford trade-through protection during the Pilot Stocks Phase and All Stocks Phase. Moreover, to prevent potentially serious disruption to NMS implementation efforts, the industry needs this certainty well in advance of the Pilot Stocks Phase Date. Accordingly, the Commission stated in the Extension Release that it may consider whether to issue an order exempting all industry participants from trade-through and lock/cross responsibilities with respect to any trading center not identified in the exemptive order as having met the Specifications Date and the Trading Phase Date.⁴⁸

The Staff intends to assess compliance by SRO trading facilities and ADF participants with the Specifications Date and Trading Phase Date. After each date, it will recommend that the Commission issue an exemptive order identifying those automated trading centers that met the dates. The Staff would recommend that the order exempt industry participants from trade-through and lock/cross responsibilities during the phase-in periods with respect to all trading centers not explicitly identified in the order.

Question 8.03: Effect of Trading Phase Date on Market Participants Other than Automated Trading Centers

The Trading Phase Date applies directly to automated trading centers that intend for their quotations to qualify as protected quotations during the phase-in periods. How may other market participants be affected when automated trading centers commence operation of their Regulation NMS-compliant trading systems?

Answer: Market participants that route orders to automated trading centers will want to consider the implications for their routing strategies of the operation of Regulation NMS-compliant trading systems on the Trading Phase Date. Absent an exception or exemption, SRO trading facilities and ADF participants will not execute trades at prices that would trade through protected quotations displayed by other automated trading centers if such trade-throughs can be reasonably prevented. This change likely will be most significant for Nasdaq-listed stocks for which there currently is no intermarket trade-through rule.

Many automated trading centers intend to offer outbound routing services to access better-priced protected quotations at other automated trading centers. Nevertheless, market participants that want to control the handling of their own orders (see FAQ 4.01 above) may want to be prepared to comply with the ISO-routing requirements of Rule 600(b)(30) on the Trading Phase Date.

¹ The Staff separately has prepared responses to frequently asked questions concerning Rule 612. See Division of Trading and Markets, Responses to Frequently Asked Questions Concerning Rule 612 (Minimum Pricing Increment) of Regulation NMS (available on the Commission’s Internet Web site at http://www.sec.gov).

² Securities Exchange Act Release No. 53829 (May 18, 2006), 71 FR 30038 (May 24, 2006) (“Extension Release”); Securities Exchange Act Release No. 55160 (Jan. 24, 2007), 72 FR 4202 (Jan. 30, 2007) (“Extension Release II”). See FAQs 8.01 to 8.03 below for more information on the extended compliance dates.

³ The Networks and joint-SRO market data plans are described in the NMS Release, 70 FR at 37503, 37558.

⁴ See NASDAQ, UTP Vendor Alert #2005-036, “SIP Enhancement Release 8.0 Planned for 1st Quarter 2006” (Oct. 31, 2005) (“NASDAQ SIP Quote Notice”) (available at www.nasdaqtrader.com); Securities Industry Automation Corporation (“SIAC”), Notice to CQS Multicast Line Data Recipients, “New and Redefined Quote Conditions in CQS Quote Messages” (Sept. 18, 2006) (“SIAC Quote Notice) (available at www.nysedata.com).

⁵ See SIAC Quote Notice, note 4 above.

⁶ 70 FR at 37535 n. 317.

⁷ NASDAQ, UTP Vendor Alert #2006-023, “SIP Enhancement Release 10.0 SEC Reg NMS Changes” (Sept. 12, 2006) (available at www.nasdaqtrader.com); SIAC, Notice to CQS Multicast Data Recipients, “CTS New Trade-Through Exempt Indicator, Sale Condition Enhancements and Rule 611 Trade Reporting Requirements” (Sept. 11, 2006) (available at www.nysedata.com).

⁸ Extension Release, 71 FR at 30041. The Extension Release identifies special requirements for automated trading centers to qualify their quotations for trade-through protection during the phase-in of compliance with Rule 611 (see FAQs 8.01 to 8.03 below).

⁹ Id.

¹⁰ See Securities Exchange Act Release No. 54537 (Sept. 28, 2006), 71 FR 59173 (Oct. 6, 2006) (approving SR-NASD-2006-091 to align NASD rules with Regulation NMS).

¹¹ See NMS Release, 70 FR at 37519. A deliberate delay (i.e., a time period in which a response is not sent or a quotation is not updated for no reasonable purpose) would violate the requirements of Rule 600(b)(3).

¹² See NMS Release at 37534 n. 313 (an automated quotation “must be immediately and automatically accessible up to its full size, which will include both the displayed and reserve size of the quotation”). In contrast, to qualify for the ISO exception, an ISO need only be routed to execute against the “full displayed size” of a protected quotation under Rule 600(b)(30)(ii). Routers of ISOs are not prohibited, however, from oversizing their ISOs in an attempt to sweep both displayed and reserve liquidity at a trading center. The NMS Release notes that, given the requirement that ISOs be routed to execute against protected quotations (even when the displayed size of such protected quotation may be less than the order router’s total trading interest), the trading centers that benefit from this protection for their quotations should be required to provide fair and efficient access to the full size available for the quotation. Id.

¹³ 70 FR at 37534.

¹⁴ See, e.g., NASDAQ SIP Quote Notice, note 4 above.

¹⁵ The ISO designation allows the trading center to execute the order immediately, regardless of any better-priced protected quotations displayed by other trading centers. In the absence of an ISO designation, the trading center would not be required to execute the order under Rule 602(b) if it would thereby trade through better-priced protected quotations at other trading centers.

¹⁶ See NMS Release, 70 FR at 37549 (“When triggered, the fee limitation of Rule 610(c) will apply to any order execution at the displayed price of the protected quotation or the BBO quotation. It therefore would encompass executions against both the displayed size and any reserve size at the price of those quotations.”).

¹⁷ 70 FR at 37546 (section III.A.2).

¹⁸ FAQ 3.23 below addresses policies and procedures reasonably designed to address the practical problems that arise in the context of agency block transactions with non-trade-through prices that are individually negotiated.

¹⁹ See NMS Release, 70 FR at 37527 n. 250 (noting that the Commission would work with the industry during implementation to achieve an appropriate resolution of these practical issues).

²⁰ See NASD Member Alert, “Guidance Relating to “Execution Time” for Purposes of Compliance with NASD Trade Reporting Rules” (June 13, 2007) (available at www.finra.org).

²¹ See NMS Release, 70 FR at 37536 (“any transactions effected by the broker-dealer during the course of the day to obtain sufficient stock to fill the benchmark order would remain subject to Rule 611”).

²² See NMS Release, 70 FR at 37536-37537 (benchmark exception encompasses execution of an order that is benchmarked to a market’s single-priced opening).

²³ Securities Exchange Act Release No. 54389 (Aug. 31, 2006), 71 FR 52829 (Sept. 7, 2006).

²⁴ Securities Exchange Act Release No. 57620 (April 4, 2008).

²⁵ Transactions involving securities of participants in mergers or with intentions to merge that have been announced would meet this aspect of the requested exemption. Transactions involving cancelled mergers, however, would constitute qualified contingent trades only to the extent they involve the unwinding of a pre-existing position in the merger participants’ shares. Statistical arbitrage transactions, absent some other derivative or merger arbitrage relationship between component orders, would not satisfy this element of the definition of a qualified contingent trade.

²⁶ A trading center may demonstrate that an Exempted NMS Stock Transaction is fully hedged under the circumstances based on the use of reasonable risk-valuation methodologies.

²⁷ Securities Exchange Act Release No. 54678 (Oct. 31, 2006), 71 FR 65018 (Nov. 6, 2006).

²⁸ See, e.g., NASD Interpretive Material 2110-2, Trading Ahead of Customer Limit Order.

²⁹ 70 FR at 37536.

³⁰ Securities Exchange Act Release No. 55884 (June 8, 2007), 72 FR 32926 (June 14, 2007).

³¹ The exemption solely addresses the status of a transaction under Rule 611. It presumes that the trading center has complied with all requirements applicable to error transactions, including SRO rules.

³² Absent a bona fide error as defined above, the exemption does not apply to a broker-dealer’s mere failure to execute a not-held order in accordance with a customer’s expectations.

³³ Securities Exchange Act Release No. 55883 (June 8, 2007), 72 FR 32927 (June 14, 2007).

³⁴ Securities Exchange Act Release No. 57621 (April 4, 2008).

³⁵ If one or more of the parties to the agency transaction wished to trade in greater size than the agency transaction, the broker-dealer could participate as principal in a separate transaction. This principal transaction would be reported separately from the agency transaction and would need to comply separately with Rule 611. See FAQ 3.24 below and NASD Notice to Members 99-66, “SEC Approves Prior Reference Price Trade Modifier, Changes to Bunching Rules, and Riskless Principal Trade Reporting Rules for the Third Market” (August 1999) (Attachment A, Question 21 addressing reporting requirements for agency cross transaction and an associated principal transaction).

³⁶ Rule 600(b)(16) defines “customer” as “any person that is not a broker or dealer.” If a broker-dealer is a party to the transaction (“party BD”), the arranging broker-dealer may not act in concert with the party BD to facilitate trades between the party BD and its customers.

³⁷ NMS Release, 70 FR at 37522, 37536.

³⁸ 70 FR at 37523.

³⁹ 70 FR at 37519 & n. 174, 37521-37522 & n. 194, 37535 & n. 318.

⁴⁰ See NMS Release, 70 FR at 37522.

⁴¹ 70 FR at 37519, 37535.

⁴² 70 FR at 37521 n. 194, 37536 n. 321.

⁴³ See, e.g., Securities Exchange Act Release No. 54537 (Sept. 28, 2006), 71 FR 59173 (Oct. 6, 2006) (approving SR-NASD-2006-091 to align NASD rules with Regulation NMS); Securities Exchange Act Release No. 54391 (Aug. 31, 2006), 71 FR 52836 (Sept. 7, 2006) (approving SR-NSX-2006-08 to amend NSX trading rules to provide for a price-time priority market and other related changes).

⁴⁴ 70 FR at 37523 n. 215.

⁴⁵ The text of the Rule 605 Plan is available at http://www.sec.gov/interps/legal/slbim12rappxa.htm.

⁴⁶ Amex has adopted a rule providing for the trading of certain of its listed securities until 4:15 (see Commentary .03 to Amex Rule 1), but the rule does not specify that it changes the definition of regular trading hours under Rule 600(b)(64) (or its predecessor section, Rule 11Ac1-5(a)(19), which was redesignated as Rule 600(b)(64) in the NMS Release). Accordingly, the definition of regular trading hours in Rule 600(b)(64) has not been modified for the Amex-listed securities.

⁴⁷ Extension Release II, 72 FR at 4203.

⁴⁸ 71 FR at 30039.

http://www.sec.gov/divisions/marketreg/nmsfaq610-11.htm