Broker-Dealer Alert
May 2007
Author:
www.klgates.com
Market Structure Report
C. Dirk Peterson
+1.202.778.9324
dirk.peterson@klgates.com
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Highlighted below are three regulatory developments of interest in the continuing evolution
of the regulation and structure of the U.S. securities markets.
Regulation NMS
A critical deadline is approaching in the phased implementation of Regulation NMS,
adopted by the SEC in the summer of 2005. This set of rules with revolutionary aspirations
addresses trading in national market system (“NMS”) securities (a $14-plus trillion market)
and the dissemination of market information through a purportedly more modernized and
robust regulatory structure. In a nutshell, the SEC’s goals were several: (i) eliminate
the Intermarket Trading System or “ITS”—a set of trading rules of market participants
participating in the ITS Plan (i.e., participants were all national securities exchanges that
trade in listed stocks and the NASD); (ii) create an environment that fosters electronic
trading; and (iii) protect those who bring value to the equity marketplace through order
protection obligations.
The SEC established a series of five phase-in periods (four of which have been completed).
Of immediate importance to the industry is the July 9 deadline for the “All Stocks Phase,”
which will require industry compliance with the “Access Rule” (Rule 610) and the “Order
Protection Rule” (Rule 611) for the remaining NMS securities that were not part of a pilot
phase in of March 2007.
The SEC staff has informally emphasized that Regulation NMS is a “policies and procedures
rule,” but has recognized the practicalities and difficulties of firms having policies and
procedures that address all possible contingencies in place by the July 9 deadline. A staff
representative noted that the SEC was willing to work with the industry within reason to
address operational issues as practical.
The SEC staff also has informally noted its expectation to issue additional FAQs and
exceptions, such as potentially for ETFs and bona fide error corrections, and expects to
send these to the Commissioners in the next week. The industry is generally seeking
greater clarity of, among other things, potential exceptions for preferred stocks, guidance
on certain block trading and interpretative guidance on the meaning of “time of trade” for
purposes of the rules. The industry is also anticipating additional guidance from the NASD
in the form of FAQs, which are expected to be published before the July 9 rollout.
Consolidation of SROs
In November 2006, NASD, Inc. and the NYSE Group, Inc. announced plans to consolidate
the regulation of their member firms and member organizations into a single self-regulatory
organization (“SRO”). The new SRO will be responsible for enforcement, arbitration and
sales practice. It also will be responsible for market regulation by contract with Nasdaq,
Amex, International Securities Exchange and the Chicago Climate Exchange. The NYSE
will retain its market surveillance and regulatory oversight of the market activities of and
trading on the NYSE.
Broker-Dealer Alert
The road to consolidation became significantly
smoother with last Thursday’s dismissal of a lawsuit
challenging the combination—Standard Investment
Chartered, Inc. v. National Association of Securities
Dealers, Inc. (No. 07-CV-2014). The gist of the
lawsuit challenged, among other things, the manner in
which the NASD’s by-laws were amended to approve
the consolidation, arguing that the approval was
obtained by deceptive and incomplete means. Although
potentially subject to extension, June 1, 2007 has been
set as the target date for the consummation of the new
SRO. Mary Schapiro, Chairman and CEO of NASD,
and Richard Ketchum, CEO of NYSE Regulation, are
scheduled to appear before Congress on May 17 and
are expected to assess the status of the consolidation.
In keeping with the merger, the NYSE is seeking to
craft a single rulebook, revising certain of its rules to
be compatible with NASD rules (the Manning Rule
and NYSE Rule 92 compatibility, at long last? Say
it’s not so!), and moving to a more principle-based
approach to rulemaking, notably dropping certain
express approval obligations in some of its rules (e.g.,
NYSE approval requirements in NYSE Rule 342 for
a supervisor to work for other affiliates in a holding
company structure).
The Rule 144A Market
The Rule 144A market, or “QIB” market as it is
colloquially known, may also experience vast
innovation in keeping with technological innovation
toward full automation and reporting. The 144A
market—so identified because the securities trading
in this market rely, at the initial offering stage, on a
securities registration exemption in Section 4(2) of
the Securities Act of 1933 and a resale exemption in
Rule 144A—has undergone significant growth, in part
because of the pressures of SOX compliance. Today,
it stands as a $1 trillion market.
On April 25, 2007, The Nasdaq Stock Market filed
amendments to its PORTAL® market, which was
created in 1990 in conjunction with the adoption of
Rule 144A, to (i) establish qualification requirements
for brokers and dealers that are Nasdaq members and
“qualified institutional buyers or “QIBs” that seek
access to PORTAL; and (ii) implement quotation,
trade negotiation and trade reporting functions in the
PORTAL market for PORTAL-designated securities.
These functions were first envisioned for this market
in 1990, but, according to Nasdaq, the lack of
technological development and the resistance to trade
reporting for 144A equity and debt prevented the
anticipated market transparency.
The SEC has published the proposals of Nasdaq for
public comment.
********
Given the evolution (and in some cases revolutionary
movements) in market structure, doubtlessly more
should be expected from the SEC and the SROs. Stay
tuned for additional Market Structure Reports as many
of these initiatives are implemented or as significant
events develop.
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