On November 5, 2008, the Securities and Exchange Commission ("SEC") approved the proposal from the Financial Industry Regulatory Authority, Inc. ("FINRA") to overhaul the trade reporting structure for over-the-counter ("OTC") equity transactions and to implement additional non-tape reporting requirements (the "Trade Reporting Rules"). The SEC's approval was published in the Federal Register on November 17, 2008.1 On January 23, 2009, FINRA published Regulatory Notice 09-08, announcing that the amendments are scheduled to go effective August 3, 2009.2
The SEC approved the Trade Reporting Rules substantially as proposed. As adopted, the rules: (1) replace the "market maker" and sell-side based OTC equity trade reporting structure with an executing-broker based reporting structure; and (2) require the member firm with the trade reporting obligation in connection with a transaction executed in a dual agency or a riskless principal capacity on behalf other member firms to submit second, non-tape reports to identify such other member firms that are not identified on the tape report or other trade reports submitted to FINRA. The new rules will apply to trades in National Market System ("NMS") securities, OTC Equity Securities, Direct Participation Program ("DPP") securities, and PORTAL equity securities.
In this update, we present a summary of the approved Trade Reporting Rules.
Trade Reporting Structure
Prior to the amendment, transactions between two market makers or two non-market makers were reported by the sell-side of the trade and transactions between a market maker and a non-market maker were reported by the market maker. Transactions between a member firm and a non-member firm are reported by the FINRA member. Transactions must be reported to FINRA within 90 seconds of execution.
The new Trade Reporting Rules replace the current market maker based structure with a simpler, more uniform structure for purposes of reporting OTC equity transactions to FINRA. The amended Trade Reporting Rules require the "executing party" to report trades to FINRA still within the generally required 90 second time period after execution. The "executing party" is defined as "the member that receives an order for handling or execution or is presented an order against its quote, does not subsequently re-route the order, and executes the transaction."3 Under this definition, the party "that is the 'final recipient' and determines the price" would have the obligation to report the transaction to the tape.4 For example:
Firm A and Firm B are market makers.
Stock XYZ is quoted at $10 bid by Firm B.
Firm A routes a sell order to Firm B for 1000 shares of XYZ stock at $10.
Firm B agrees to the terms of the routed order.
Firm B is the "executing party" and has the reporting obligation.
If an electronic communication network ("ECN") or an Alternative Trading System ("ATS") executes transactions on its system, then the ECN or the ATS is the "executing party" responsible for trade reporting. If the transactions are routed by the ECN or the ATS to another firm, then the firm receiving the routed order for execution is the "executing party" responsible for reporting.5
In transactions where the member firms cannot determine which party is the "executing party"? such as a negotiated trade over the phone ? the sell-side is responsible for reporting the transaction, unless the parties agree otherwise and the sell-side "contemporaneously documents" the agreement.6 In the absence of an agreement to the contrary, FINRA will presume that the sell-side is the "executing party" with the trade-reporting obligation.7
Firms may comply with the “contemporaneously documented agreement” requirement through the use of a blanket agreement, which expressly shifts the trade reporting obligation in a manually negotiated trade, where the sell-side has the reporting obligation, the parties agree that the other firm will have the reporting obligation.8 If the agreement is not specific on this point, it will have to be amended. The firm with the reporting obligation still remains responsible for compliance with the Trade Reporting Rules when another firm reports on its behalf and will be held liable for any reporting deficiencies.9
Non-Tape Reporting for Dual Agency or Riskless Principal Transactions
The amendment also requires member firms with a trade reporting obligation that are acting in a dual agency or riskless principal capacity on behalf of one or more other member firms to submit non-tape reports10 for the purpose of identifying such other firms as a party to the transaction.11 If the tape or other non-tape reports that have been submitted to FINRA sufficiently identify other members firms that are parties to the agency or riskless principal transactions, then the additional non-tape reports are not required.12 In cases where a member firm acts as agent and matches orders from multiple member firms, and the transaction is reported as a single transaction as one tape report, then the matching firm must submit a non-tape report for each of the member firms involved in the transaction.13 The non-tape report requirement applies only to the member firm with the trade reporting responsibility (i.e. the "executing party").14 The new reporting requirement does not apply when the firm acts as agent or riskless principal for a non-member or where the transaction is executed on and reported through an exchange. In the second instance, the firm has the option of submitting a non-tape (typically, a clearing-only) report to FINRA for the offsetting leg of the transaction.
FINRA clarified that the 90-second trade reporting rule does not apply to the new non-tape reports. Member firms can submit such reports by the end of the trading day.15 However, to qualify for the exemption from the prohibition on trading ahead of customer limit orders (the "Manning Rule") in a riskless principal transaction, the non-tape reports must be submitted contemporaneously with the execution of the offsetting transaction pursuant to NASD IM-2110-2.16 FINRA also clarified that the order audit trail system ("OATS") execution reports must match the related additional non-tape report submitted to FINRA.17