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  Division of Market Regulation:Staff Legal Bulletin No. 12R (Revised)

“Frequently Asked Questions About Rule 11Ac1-5”

Action: Publication of Division of Market Regulation Staff
Legal Bulletin

Date: June 22, 2001 (revised)

Summary: This staff legal bulletin sets forth the views of the
Division of Market Regulation in response to frequently asked questions
concerning Rule 11Ac1-5 under the Securities Exchange Act of 1934.

Supplementary Information: The statements in this legal
bulletin represent the views of the staff of the Division of Market
Regulation. This legal bulletin is not a rule, regulation, or statement
of the Securities and Exchange Commission (“Commission”).
Further, the Commission has neither approved nor disapproved its
content.

Contact Person: For further information, please contact Daniel
M. Gray, Senior Special Counsel, at (202) 942-4164, or Susie Cho,
Attorney, at (202) 942-0748, Division of Market Regulation, Securities
and Exchange Commission, 450 Fifth Street, N.W., Washington D.C.
20549-1001.

 

I. Introduction

On March 12, 2001, the Division of Market Regulation
(“Division”) originally issued this staff legal bulletin
addressing frequently asked questions concerning Exchange Act Rule
11Ac1-5 (“Rule”). This revision responds to additional issues
that have been raised since that time. In particular, Question 10 and
its response have been updated to reflect impending changes to Nasdaq’s
order execution and routing systems, and Questions 19 through 27 address
additional issues.

The Commission adopted the Rule in November 2000.1
It generally requires a “market center” (as defined in the
Rule) that trades national market system securities to make available to
the public monthly electronic reports that include uniform statistical
measures of execution quality. The Rule directed the self-regulatory
organizations (“SROs”) that trade national market system
securities to act jointly and submit to the Commission a new national
market system plan establishing procedures for market centers to follow
in making their monthly reports available to the public. The SROs
submitted such a plan on February 20, 2001 (“Joint-SRO Plan”),
and it has been approved by the Commission.
2
A copy of the Joint-SRO Plan is attached as Appendix A.

The initial compliance date for the Rule was moved back by one month
until May 1, 2001.
3
In addition, the Commission has issued a temporary exemption from the
reporting requirements of the Rule until July 31, 2001 for Nasdaq
securities.
4 Finally,
the Commission recently issued an exemption with respect to any market
center that is required to prepare a report that covers trading in May
2001.
5 Under the
exemption, such a market center is not required to make its May report
publicly available on an Internet site, as specified in the Joint-SRO
Plan. The market center must, however, prepare a May report internally
and make it available for inspection and examination by the Commission
staff. Reports that cover trading in June must be made publicly
available on an Internet site by the end of July in accordance with the
Joint-SRO Plan.

Since adoption of the Rule, the Division has received inquiries
concerning the implementation and operation of the Rule. The Division is
issuing this staff legal bulletin to address a variety of frequently
asked questions. The following questions and answers do not necessarily
contain a discussion of all the material considerations necessary to
reach the conclusions stated. Consequently, these questions and answers
are intended to provide general guidance, but the facts and
circumstances relating to particular market centers may differ, and the
staff notes that even slight variations may require different responses.
The Commission is not bound by these statements and may interpret the
Rule as it deems necessary or appropriate in the public interest or for
the protection of investors.

In addition, these questions and answers are premised on several
important assumptions. First, the discussions assume close familiarity
with the text of the Rule and the Adopting Release, and we urge you to
read carefully the Rule and Adopting Release. The responses are a
complement to, and not a substitute for, these sources. Second, the
terms used in this staff legal bulletin have the meanings set forth in
the definitions of paragraph (a) of the Rule.

The Division may update these questions and answers periodically by
issuing an updated staff legal bulletin. In each updated staff legal
bulletin, the questions and answers with modified or new material since
the last update will be marked as “modified” or “new.”

The interpretive questions addressed in this bulletin are as follows:

Question 1: Format of Monthly Reports and
Procedures for Making Reports Publicly Available

Question 2: Vendor or SRO Assistance in Making
Reports Available

Question 3: Definition of Market Center – Multiple
Trading Venues

Question 4: Integrated Broker-Dealer Firms – Orders
Received as Market Center and Orders Received Solely as Agent for
Routing

Question 5: Definition of Covered Order – Special
Handling Exclusions

Question 6: Exemption for Manually-Received Orders

Question 7: Locked and Crossed Quotes

Question 8: Trading Halts

Question 9: Activity Within the Intermarket Trading
System (“ITS”)

Question 10: Activity within SuperSOES and
SelectNet (modified)

Question 11: Partial Executions and/or Partial
Cancellations

Question 12: Orders Left Unexecuted and
Uncancelled at End of Regular Trading Hours

Question 13: Establishing Time of Order Receipt

Question 14: Orders Received in Same Second as a
Quote Change

Question 15: Time of Execution for
“Stopped” or “Guaranteed” Orders

Question 16: Adjusted or Voided Order Executions

Question 17: Calendar Month Reporting

Question 18: Phase-In of Reporting

Question 19: Exemption for Orders Received Prior
to Dissemination of Quotations by Primary Listing SRO (new)

Question 20: Filtering Potential Errors in
Consolidated Best Bid and Offer (new)

Question 21: Time of Consolidated Best Bid and
Offer (new)

Question 22: Rounding of Statistics (new)

Question 23: Modified Orders (new)

Question 24: Riskless Principal Orders (new)

Question 25: Exemption for Inactively Traded
Securities (new)

Question 26: Exemption for Small Market Centers (new)

Question 27: Exemption for Block Orders (new)

 

II. Questions and Answers

Question 1: Format of Monthly Reports and
Procedures for Making Reports Publicly Available

Q: What format and procedures should market centers follow in
preparing their monthly reports and making them available to the public?

A: The format of monthly reports and procedures for making them
available to the public are spelled out in the Joint-SRO Plan, attached
as Appendix A. In general, it requires market centers to make their
monthly reports available in the form of electronic data files
(standard, pipe-limited ASCII files). The Joint-SRO Plan also sets forth
in detail the required contents of the electronic data file, including
the identity and order of the 26 fields of information that the file
must contain.

Attached as Appendix B is a table indicating how a market center’s
statistics could appear for a single security “A” in a report
on trading for the month of May 2001. Appearing horizontally across the
page (designated as F1, F2, F3 . . . F26) are the 26 required fields of
information. A description of each of the fields may be found in
paragraphs (a)(1) through (a)(26) of Section VI of the Joint-SRO Plan.

Appearing vertically down the page are 20 records – one reflecting
each of the possible subcategories of order type (of which there are 5)
6
and order size (of which there are 4)
7
required for a single security. Sample statistics are provided in the
table for the first record (representing market orders for 100-499
shares) to give a general idea of what a market center’s statistics may
look like. A full report would contain separate records for each
individual national market system security upon which a market center
must report. Although there potentially could be as many as 20 separate
records for each individual security, Section VI(b) of the Joint-SRO
Plan provides that no record need be displayed if a market center
received no covered orders that fall within the particular subcategory
of security/order type/order size.

The electronic data files containing market center reports must be
made available for downloading (through FTP) without charge from an
Internet site (“Download Site”). Under Section VIII of the
Joint-SRO Plan, every market center will be responsible for making
arrangements with an SRO to act as the market center’s “Designated
Participant.” Designated Participants are responsible for assigning
a unique market center identification code (which must be set forth in
Field 2 of a market center’s electronic data file)
8
to each market center for which it acts as Designated Participant.

In addition, every market center must notify its Designated
Participant of the hyperlink to the market center’s Download Site. In
turn, each Designated Participant will maintain an Internet site
(“Link Site”) that includes a comprehensive list of hyperlinks
to the respective Download Sites for all of its market centers. In this
way, anyone who wishes to download all market center reports for each
month can be assured that, if they visit the Link Sites of all
Designated Participants, they will find hyperlinks to files containing
all market center reports.

Question 2: Vendor or SRO Assistance in Making
Reports Available

Q: Does the Rule require every market center to make its monthly
reports available to the public in a separate file on its own Internet
site, or is it permissible for a market center to arrange with other
entities (such as a vendor or a market center’s SRO) for assistance in
making the market center’s reports available?

A: A market center need not make its reports available on its own
Internet site. Market centers have the option to make arrangements with
other entities to perform the functions necessary to make their reports
available to the public. Nor must each market center’s report be
downloadable in a separate data file. Thus, for example, an SRO
may make the monthly reports for all of its members available in a
single file. Section VIII of the Joint-SRO Plan establishes procedures
that will allow the public to determine the name of the file containing
every market center’s reports and the location where the file can be
downloaded.

Question 3: Definition of Market Center –
Multiple Trading Venues

Q: Firm X acts both as an exchange specialist and as an OTC market
maker. How should Firm X report under the Rule?

A: Firm X operates as two separate market centers and must report
separately (with a separate market center identification code) on
trading in each venue.

The definitions in paragraph (a) of the Rule set out the different
types of market centers that must report under the Rule. The term
“market center” is defined in paragraph (a)(14) as “any
exchange market maker, OTC market maker, alternative trading system,
national securities exchange, or national securities association.”
An “exchange market maker” is defined in paragraph (a)(9) of
the Rule as “any member of a national securities exchange that is
registered as a specialist or market maker pursuant to the rules of such
exchange.” An “OTC market maker” is defined in paragraph
(a)(18) of the Rule as “any dealer that holds itself out as being
willing to buy from and sell to its customers, or others, in the United
States, a national market system security for its own account on a
regular or continuous basis otherwise than on a national securities
exchange in amounts of less than block size.”

Accordingly, Firm X, because it acts both as an exchange specialist
and as an OTC market maker, would be considered two separate market
centers under the Rule and must report separately on its trading in each
venue. The same result would hold if a firm acted as a specialist on two
different exchanges. The Rule is intended, among other things, to
provide investors and the public with order execution information that
will assist them in making order routing decisions. Different exchanges
have different trading rules and systems that can affect order execution
quality, as do firms when they act as OTC market makers. It therefore is
important that monthly reports under the Rule reflect these differences.

Question 4: Integrated Broker-Dealer Firms –
Orders Received as Market Center and Orders Received Solely as Agent for
Routing

Q: Firm X is an integrated broker-dealer that acts as an OTC market
maker in 500 national market system securities and also accepts orders
in other national market system securities solely as agent for routing
to other market centers for execution. In addition, Firm X sometimes
receives orders in its 500 market maker stocks that, either because of
specific customer instructions or the nature of the particular customer
(for example, an advisory client), Firm X is required to route as agent
to another market center for execution. How should Firm X report its
activities under the Rule?

A: The Rule applies to broker-dealers insofar as they act as a
“market center” with respect to orders received from other
persons. Consequently, for orders in securities for which Firm X does not
act as an OTC market maker, Firm X would not be acting as a market
center in those securities and therefore need not report on orders in
those securities that it receives as agent and routes elsewhere for
execution.

Conversely, the orders that Firm X receives from any person in the
500 securities in which it acts as an OTC market maker (and therefore is
a market center) generally must be included in Firm X’s monthly reports,
even if Firm X ultimately routes some of the orders to other market
centers for execution. These orders would be reflected in the
“shares executed at any other venue” statistic required by
paragraph (b)(1)(i)(E) of the Rule and otherwise would be reported in
exactly the same way as if the order were executed at Firm X.

If, however, Firm X receives orders in stocks for which it acts as an
OTC market maker that Firm X is required to route as agent to
another market center for execution (either because of specific customer
instructions or the nature of the particular customer — it is, for
example, an advisory client), then Firm X would not act as a market
center for these types of orders and need not include them in its
monthly reports.

Question 5: Definition of Covered Order – Special
Handling Exclusions

Q: The Rule’s definition of “covered order” specifically
excludes a number of types of orders for which the customer requests
special handling and therefore are not covered by the Rule. Are there
other types of orders that fall within the special handling exclusion,
such as fill-or-kill and average price orders?

A: The definition of covered order in paragraph (a)(8) of the Rule
does not specifically identify every type of order that may fall within
the “special handling” exclusion. In general, any market or
limit order for which the customer requests a type of handling that may
preclude the order from being executed promptly at the current market
price at the time of order receipt (subject only to a limit price) would
qualify for the special handling exclusion and not be covered by the
Rule. Accordingly, fill-or-kill orders are excluded because they must be
executed only at their full size (“executed only at their full
size” is one of the specific examples in the Rule of a special
handling order). In addition, average price orders (understood as orders
that are not intended to be executed promptly at the current market
price at the time of order receipt but at an average price over a period
of time) also would qualify as special handling orders and be excluded
from the Rule.

Question 6: Exemption for Manually-Received
Orders

Q: Is a market center required to report on orders that it receives
“manually” — otherwise than through automated systems?

A: Not now. The Commission has issued an exemption pursuant to
paragraph (c) of the Rule that temporarily exempts orders received by a
market center otherwise than through automated systems.
9

Although market centers receive the overwhelming majority of their
orders through automated systems, they also receive orders manually,
particularly those for large sizes. Many of these orders may qualify for
one of the “special handling” exclusions from the definition
of “covered order” under paragraph (a)(8) of the Rule.
Nevertheless, unless the necessary information is captured in automated
systems, it would be quite difficult to include these orders in the
required statistics or to efficiently demonstrate that a particular
exclusion applies. The exemption of manually-received orders from the
Rule is intended to facilitate timely compliance with the Rule until
market centers have automated systems in place to capture all orders.
10

Integrated broker-dealer firms, however, should be aware that the
exemption only covers orders that are routed directly by manual means to
the firm’s trading desk. Orders received manually from brokerage
customers, which are then input into an automated system for routing and
execution would not be eligible for the exemption and would continue to
be subject to the Rule. The time of receipt for such orders would be the
time that the orders are captured in the automated system.
11

In addition, this exemption is intended to facilitate compliance with
the Rule for orders that currently are not captured in automated
systems. Any change in order routing practices from automated to manual
means to avoid reporting of orders under the Rule would be the basis for
withdrawal of the exemption from that market center, and would raise
serious questions with respect to a broker-dealer’s obligation to obtain
the best execution of its customers’ orders.

Question 7: Locked and Crossed Quotes

Q: In several different contexts, the Rule requires reference to the
consolidated best bid and offer (“Consolidated BBO”)
disseminated pursuant to an effective national market system plan. How
should market centers report on orders whose statistics would be
affected by a Consolidated BBO that is locked or crossed?

A: If the Consolidated BBO is locked (the best bid to buy equals the
best offer to sell), the quotes still should be used for all purposes
under the Rule. If the Consolidated BBO is crossed (the best bid to buy
is higher the best offer to sell), a market center should follow the
procedures set forth below.

The Rule requires reference to a Consolidated BBO in four different
contexts: (1) classifying limit orders based on the Consolidated BBO at
the time of order receipt into one of four categories defined in the
Rule (marketable, inside-the-quote, at-the-quote, near-the-quote); (2)
calculating the average effective spread for market and marketable limit
orders based on the Consolidated BBO at the time of order receipt; (3)
classifying executions of market and marketable limit orders as
“with price improvement,” “at the quote,” or
“outside the quote” based on the Consolidated BBO at the time
of order receipt; and (4) calculating the average realized spread for
all five types of orders defined in the Rule (market orders and the four
types of limit orders) based on the Consolidated BBO five minutes after
the time of order execution (as opposed to the time of order
receipt).

When the Consolidated BBO is crossed for a significant period of
time, it raises serious questions whether the quotes continue to provide
a reliable benchmark for the statistical measures included in the Rule.
The Commission therefore has exempted all orders from the Rule that
would require reference to a Consolidated BBO that has been crossed for
30 seconds or more.
12
In light of this exemption, market centers should follow the following
procedure whenever a reference to the Consolidated BBO is necessary,
whether at the time of order receipt or the time of order execution:

First, use the Consolidated BBO if the quotes are not crossed, or are
locked.

Second, if the Consolidated BBO is crossed, reject the crossed quotes
and use the next-in-time uncrossed Consolidated BBO if there has been
less than 30 seconds between the last-in-time uncrossed Consolidated BBO
and the next-in-time uncrossed Consolidated BBO.

Third, if there has been 30 seconds or more between the last-in-time
uncrossed Consolidated BBO and the next-in-time uncrossed Consolidated
BBO, the affected order is exempted from the Rule and must be excluded
entirely from a market center’s report (even if the crossed Consolidated
BBO only affects a partial execution of the order).

The following examples illustrate how the foregoing procedure should
apply:

Example 7-1: At 11:08:10 a.m.,13
a market center receives a limit order to buy 100 shares of Security A
with a limit price of $20.75. The Consolidated BBO for Security A at the
time of order receipt is $20.75 bid and $20.75 offer.

The locked quotes should be used. The order therefore would be
classified as a “marketable limit order” under paragraph
(a)(15) of the Rule because the limit price is equal to the consolidated
best offer at the time of order receipt.
14
The midpoint of the Consolidated BBO for purposes of calculating an
effective spread for the execution is $20.75. If the buy order is
executed at a price of $20.75, the execution would be classified as
“at the quote” under paragraph (a)(10) of the Rule. If the buy
order is executed at any price lower than $20.75, the execution would be
classified as “with price improvement” under paragraph (a)(12)
of the Rule. The calculation of a realized spread for the execution
would be based on the midpoint of the Consolidated BBO five minutes
after the time of order execution, so that the locked quotes at the time
of order receipt would be irrelevant.

Example 7-2: At 2:47:20 p.m., a market center receives a
market order to sell 500 shares of Security A. The Consolidated BBO for
Security A at the time of order receipt is $55.40 bid and $55.30 offer.
The time of the last uncrossed Consolidated BBO was 2:47:05 p.m. The
next uncrossed Consolidated BBO is disseminated at 2:47:30 p.m. and is
$55.35 bid and $55.35 offer. The market center should reject the crossed
quotes at the time of order receipt and instead use the uncrossed quotes
at 2:47:30 p.m. (even though they were locked) as the Consolidated BBO
at the time of order receipt. The midpoint of the Consolidated BBO for
purposes of calculating the effective spread for the order execution is
$55.35. If the market order to sell is executed at a price higher than,
equal to, or lower than $55.35, the execution will be classified,
respectively, as “with price improvement, “at the quote,”
or “outside the quote.”

Example 7-3: Same facts as Example 7-2 except that the
next-in-time uncrossed Consolidated BBO after the time of order receipt
is disseminated at 2:47:40 p.m. Because the period between the
last-in-time uncrossed Consolidated BBO (2:47:05 p.m.) and the
next-in-time uncrossed Consolidated BBO (2:47:40 p.m.) is 30 seconds or
more, the market order to sell 500 shares of Security A is exempted from
the Rule and must be excluded from the market center’s monthly report.

Question 8: Trading Halts

Q: How should orders for a security be handled when they are received
during regular trading hours, but trading in the security is halted at
the market center either at the time of order receipt or shortly
thereafter? Does the answer differ depending on whether the trading halt
is a general regulatory halt or occurs solely at the particular market
center that received the order?

A: The manner of reporting on orders under the Rule will be the same
for all “announced” trading halts. To qualify as an
“announced” trading halt, the halt must be either a general
regulatory halt or a trading halt that is announced by a market center
in accordance with all applicable regulatory rules. Orders that are
received prior to and during the time of an announced trading halt
should be handled in accordance with the following procedures.

First, all orders received during the period that trading is halted
must be entirely excluded from a market center’s monthly report.
15

Second, if an order was received less than five minutes prior to the
trading halt and remains outstanding (in whole or in part) at the
time of the trading halt, the entire order is exempted from the Rule
16
and should be excluded from the market center’s monthly report.

Third, for orders that are executed less than five minutes
prior to the trading halt, the calculation of average realized spread
should use the last Consolidated BBO disseminated prior to the time of
the trading halt (analogous to the treatment of orders executed less
than five minutes prior to the close of regular trading hours that is
set forth in paragraph (a)(3) of the Rule).

Fourth, if an order was received five minutes or more prior to the
trading halt and remains outstanding (in whole or in part) at the time
of the trading halt, the order continues to be covered by the Rule;
provided, however, that for executions that occur after the end of the
trading halt, a market center may deduct the time period during which
trading was halted from the calculations using the time of execution of
the order.

The following examples illustrate how these foregoing procedures
should apply:

Example 8-1: At 10:45:30 a.m., Market Center X halts trading
in all securities because of a serious systems breakdown. It announces
the trading halt in accordance with all applicable regulatory rules. At
11:25:30 a.m., Market Center X resumes trading in all securities. All
orders received for execution by Market Center X from 10:45:30 a.m.
until 11:25:30 a.m. are exempted from the Rule and must be excluded from
Market Center X’s monthly report.

Example 8-2: Same facts as Example 8-1, except that Market
Center X receives a marketable limit order at 10:44:45 a.m. that is
unexecuted at the time trading is halted 45 seconds later. The order is
exempted from the Rule and must be excluded from Market Center X’s
monthly report.

Example 8-3: Same facts as Example 8-1, except that Market
Center X receives a marketable limit order for 500 shares at 10:42:15
a.m. that receives a partial execution of 200 shares at 10:42:20, with
the balance of 300 shares still unexecuted and outstanding at the time
of the trading halt. The entire order is exempted from the Rule and must
be excluded (including the 200-share execution) from Market Center X’s
monthly report.

Example 8-4: Same facts as Example 8-1, except that Market
Center X receives a near-the-quote limit order at 10:38:15 a.m. that is
unexecuted and outstanding at the time of the trading halt. At 11:28:05
a.m., after the end of the trading halt, the order is executed. Because
the order was received more than five minutes before the trading halt,
the order remains covered by the Rule, except that Market Center X may
deduct the 40-minute period of the trading halt from the time of
execution. The time of execution for non-marketable limit orders must
only be reported in one of the five time buckets set forth in paragraphs
(b)(1)(i)(F) through (J) of the Rule. Accordingly, the execution of the
order would fall within the time bucket for order executions between 5
and 30 minutes after the time of order receipt (11:28:05 minus 10:38:15
minus 40 minutes).

Question 9: Activity within the Intermarket
Trading System (“ITS”)

Q: Must a market center report on commitments to trade that are
received from other market centers pursuant to ITS Plan provisions?

A: Yes. Market centers are required to report under the Rule on
commitments to trade received pursuant to the ITS Plan procedures. If a
market center’s handling of ITS commitments to trade differs materially
from its handling of orders received through other mechanisms, it would
be permissible to report on ITS activity as a separate market center (i.e.,
by obtaining a separate market center identification code pursuant to
Section VIII of the Joint-SRO Plan for the market center’s ITS
activity).

Question 10: Activity within SuperSOES and
SelectNet (modified)

Q: How should orders sent to Nasdaq’s National Market Execution
System (“SuperSOES”) and through its SelectNet system be
reported under the Rule?

A: In the original issuance of this staff legal bulletin, the
Division addressed the application of the Rule to Nasdaq’s Small Order
Execution System (“SOES”) and SelectNet, as they currently
operate. It expressed the view that SOES, which delivers automatic
executions for limited types of orders, is itself a market center for
which Nasdaq must issue monthly reports. SelectNet, in contrast, is
merely an order routing system that does not deliver automatic
executions and is not a separate market center. Consequently, market
centers that receive preferenced orders through SelectNet as an
important means to access their displayed quotes must report on those
orders under the Rule. Analogous to the treatment of ITS activity set
forth in Question 9 above, if a market center’s handling of SelectNet
orders differs materially from its handling of orders received through
other mechanisms, it would be permissible to report on SelectNet orders
as a separate market center (i.e., by obtaining a separate market
center identification code pursuant to Section VIII of the Proposed Plan
for the market center’s SelectNet activity).

The basis for the Division’s view is the need for public information
concerning the quality of executions provided through systems that offer
general access to public quotes. One of the major objectives of the Rule
is to address problems associated with market fragmentation. Systems
that link market centers and provide an important means of access to
their public quotes help address fragmentation and maintain the
integrity of the public quote stream.
17
These vital functions will be furthered by the public availability of
information on the execution of orders routed through these systems.

Given Nasdaq’s intention and belief that significant changes to
SelectNet and SOES will be phased in by July 30, 2001, the Commission
has issued exemptions and the Division has updated its interpretive
guidance to reflect these changes.
18
Most importantly, SuperSOES will replace SelectNet as the primary means
of access to the public quotes of those market participants that accept
automatic executions through SuperSOES (“SuperSOES
Participants”), while SelectNet will remain an important means of
general access to the quotes of firms that are not SuperSOES
Participants.

Under Nasdaq rules, when SuperSOES is phased in for a security any
SelectNet participant (with one exception discussed below) that wishes
to preference a SuperSOES Participant through SelectNet may do so only
by sending orders that are all-or-none (“AON”) orders or
minimum acceptable quantity (“MAQ”) orders, either of which
must be for a size that is at least 100 shares greater than the
displayed amount of the preferenced participant’s quoted size. Firms
participating in SelectNet that are not SuperSOES Participants (such as
an ECN), however, would continue to received preferenced orders through
SelectNet for sizes equal to or less than their quoted size.

The Division views SuperSOES as a market center for which Nasdaq
should issue monthly reports under the Rule.
19
Consequently, the market centers against whose quotes SuperSOES delivers
an automatic execution would not be required to report on these
transactions. Importantly, however, a market center that first receives
orders for execution and then chooses to route them away to SuperSOES
for execution would continue to be required to report on these orders
(including them, for example, in its monthly reports as “shares of
covered orders executed at any other venue”).

The Division believes that AON and MAQ orders routed through
SelectNet to SuperSOES Participants for amounts at least 100 shares
greater than the firm’s displayed quote would not be covered orders, as
defined in paragraph (a)(8) of the Rule. The definition excludes orders
for which the customer requests special handling, including, but not
limited to, orders to be executed only at their full size. Given the
minimum size restrictions on AON and MAQ orders routed through SelectNet,
thereby eliminating SelectNet as a general means to access the firm’s
public quote, the Division believes that they are appropriately excluded
from covered orders. For market centers that are not SuperSOES
Participants (such as an ECN), however, SelectNet will remain an
important means of general access to their quotes. Accordingly, such
market centers must report on SelectNet orders under the Rule (assuming
they are not otherwise excluded from the definition of covered order).

The sole exception to the general rule that SuperSOES Participants
will not receive preferenced orders through SelectNet for sizes equal to
or less than their displayed quoted size relates to exchanges that trade
Nasdaq securities pursuant to unlisted trading privileges that are not
SuperSOES Participants (“UTP Exchanges”). Such UTP Exchanges
may continue to use SelectNet to access the quotes of SuperSOES
Participants. Given the ready access that automatic executions through
SuperSOES will provide to the quotes of SuperSOES Participants, as well
as the potentially significant costs associated with developing systems
to report only on a small number of SelectNet orders from UTP Exchanges,
the costs necessary to implement reporting on the orders would outweigh
the benefits of the reported information. Consequently, the Commission
has exempted from the definition of covered order in paragraph (a)(1) of
the Rule the SelectNet preferenced orders routed to a SuperSOES
Participant by a UTP Exchange.

In addition, in the event that the phase-in of SuperSOES, contrary to
Nasdaq’s current belief, is not completed by July 30, 2001, the
Commission has exempted all SelectNet preferenced orders routed to
SuperSOES Participants in Nasdaq securities for which the phase-in has
not been completed.

Finally, SelectNet “broadcast” orders (which are not
directed to any specific market center) would not be considered as
received for execution by any market center and therefore should not be
reported under the Rule.

Question 11: Partial Executions and/or Partial
Cancellations

Q: How should a market center report on partial executions and
partial cancellations of orders under the Rule?

A: The Rule’s statistics are designed to handle multiple partial
executions and/or cancellations of an order. Immediately upon receipt by
a market center, an order is permanently classified as falling within
one of the 20 possible records relating to a subcategory of
security/order type/order size. Thereafter, all executions and/or
cancellations of the order will be included in the fields of information
for that single record. Except for the field of information for total
number of covered orders, all of the other fields of information
required by the Rule are reported in terms of number of shares or
share-weighted amounts. Consequently, each partial execution or
cancellation can be reflected separately in the statistics.

Example 11-1: A market center receives a market order to buy
3000 shares of Security A at 3:30:00 p.m. The Consolidated BBO for
Security A at the time of order receipt is $25.30 bid and $25.60 offer.
The market center executes the order in three partial executions: 400
shares at $25.50 at 3:30:08 p.m., 1000 shares at $25.55 at 3:30:15 p.m.,
and 1600 shares at $25.60 at 3:31:02 p.m.

The market center would report on the 3000 share market order as
follows. First, the order would be classified at the time of order
receipt as falling within the record for Security A/market orders/2000
to 4999 shares. Thereafter, all information relating to the order will
be included in one of the fields for that single record. Thus, 400
shares would fall within the field for shares executed from 0-9 seconds;
1000 shares would fall within the field for shares executed from 10-29
seconds; and the remaining 1600 shares would fall within the field for
shares executed from 30-59 seconds.

Next, in calculating effective spreads, each partial execution would
be treated separately and weighted according to the size of the partial
execution. Thus, the effective spread for the first execution would be
10 cents: 25.50 minus 25.45 (the midpoint of the Consolidated BBO at the
time of order receipt) multiplied by 2; the effective spread for the
second execution would be 20 cents: 25.55 minus 25.45 multiplied by 2;
and the effective spread for the execution would be 30 cents:
25.60 minus 25.45 multiplied by 2. The 10 cent effective spread would be
weighted by 400 shares, the 20 cent effective spread would be weighted
by 1000 shares, and the 30 cent effective spread would be weighted by
1600 shares.

The remaining fields of information required for an order would be
calculated in an analogous manner (e.g., a separate realized
spread would be calculated for each partial execution).

Example 11-2: Same facts as Example 11-1, except that the
1600 shares were cancelled by the customer prior to execution. All
calculations discussed above under Example 11-1 would remain the same
for the first two partial executions, but the 1600 shares would
now simply be included in the field of information for shares cancelled
prior to execution.

Question 12: Orders Left Unexecuted and
Uncancelled at End of Regular Trading Hours

Q: How should a market center report on orders received during
regular trading hours, but that remain unexecuted and uncancelled at the
end of regular trading hours on the day of order receipt?

A: Orders left unexecuted and uncancelled, in whole or in part, at
the end of regular trading hours on the day of order receipt should be
reflected in the market center’s monthly report as having been received.
No further information, however, should be reported concerning the
unexecuted part of such orders, regardless of whether they are executed
or cancelled in the hours, days, or weeks after the end of regular
trading hours on the day of order receipt. In other words, a market
center’s statistical report should reflect the disposition of orders
solely during regular trading hours on the day of order receipt, and
each day begins with a clean slate of orders.

Example 12-1: A market center receives a 500 share
at-the-quote limit order in Security A at 10:45:00 a.m. on April 30. At
10:45:08, 300 shares of the order are executed at the limit price. The
remaining balance of 200 shares is left unexecuted at the end of regular
trading hours on April 30. At 9:45:00 on the next day, May 1, the
remaining 200 shares are executed.

The market center would reflect the order in its April report as
follows. A single at-the-quote limit order for 500 shares would be
reflected as having been received. The 300 share partial execution would
be included in the field of information for shares executed at the
market center and shares executed from 0-9 seconds after the time of
order receipt. In addition, a realized spread would be calculated for
the partial execution (the Rule does not require an effective spread and
price improvement/disimprovement statistics for non-marketable limit
orders). Nothing would be reported concerning the 200-share execution
that occurred the following day, either in the market center’s April
report or in the market center’s May report.

Question 13: Establishing Time of Order Receipt

Q: How should a market center establish the time it receives an order
when the order passes through various automated systems before it
actually reaches the point at which it is executed? What about an
integrated broker-dealer firm that initially receives orders from its
brokerage customers?

A: A market center must assign a time of order receipt to its orders
at the time they first are captured in an automated order handling
system operated by, or on behalf of, the market center. For an
integrated broker-dealer that receives orders from its brokerage
customers, the time of order receipt is the time that it first captures
these orders in the firm’s automated order handling system.
20

The time of order receipt is an essential element in calculating
nearly every one of the Rule’s statistics, such as assigning quotes as
benchmarks for effective spread and price improvement statistics, as
well as calculating speed of execution statistics. In the Adopting
Release, the Commission emphasized that “it is critically important
for market centers to assign a time of receipt (including seconds) to
orders in a prompt, consistent, and non-manipulatory manner” and
that “failure to meet the standard would be a serious violation of
the Rule.
21
Examples of such compliance concerns would include a market center
queuing orders without immediately assigning a time stamp or a market
center implementing preliminary selection criteria (e.g., to
determine whether an order should be retained or routed to another
market center for execution) prior to the time that the orders are
marked as received and assigned a time of order receipt.

Question 14: Orders Received in Same Second as a
Quote Change

Q: The Rule requires market centers to record the time of order
receipt “to the second.” How should a market center assign a
Consolidated BBO to an order that is received during the same second as
one or more quote changes?

A: A market center may use any neutral algorithm to assign a
Consolidated BBO to orders that are received during the same second as
one or more quote changes. An algorithm is neutral if it chooses the
quote in a consistent manner without reference to its impact on the
market center’s statistics. For example, it would not be
appropriate for a market center to adopt an algorithm that assigns the
intra-second Consolidated BBO with the highest offer to market orders to
buy and the Consolidated BBO with the lowest bid to market orders to
sell.

Question 15: Time of Execution for
“Stopped” or “Guaranteed” Orders

Q: Is it permissible for a market center to assign an execution time
to orders when they are “stopped” or “guaranteed” an
execution at no worse than a specific price and later assigned a
specific execution price?

A: Yes. The statistical measures required by the Rule may be
calculated using the guarantee time as the time of order execution, but
only under the following conditions. First, the guarantee must be made
pursuant to an SRO rule setting forth the standards for guaranteed or
stopped executions. Second, the customer must be immediately informed of
the guarantee and the guarantee price. Third, the guarantee must be
with no opportunity for rescission. Finally, the guarantee price
must be no worse than the Consolidated BBO at the time of order receipt
and for the full size of the order.

If guarantee time is used as the time of execution for an order, it
must be used for all purposes under the Rule, including both the
calculation of speed of execution statistics and the calculation of
average realized spread, as defined in paragraph (a)(3) of the Rule.

Question 16: Adjusted Or Voided Order Executions

Q: How should a market center report an order execution whose terms
are subsequently adjusted or an order execution that is voided entirely?

A: If the terms of an order execution are adjusted or the execution
is voided within a normal settlement cycle, the market center should
report on the order in accordance with the terms of execution as they
were finally received by the customer. Orders not adjusted or voided
until after the normal settlement cycle should be reported as they were
originally executed.

Example 16-1: A market center originally executes a market
order to buy 200 shares of Security A at $15.80. The next day and prior
to settlement, the market center receives an “exceptions
report” indicating that the order should have been executed at a
more favorable price to the customer. The market center adjusts the
price to $15.70 and gives this price to the customer. The market center
should report on the order based on a $15.70 execution price. All other
reporting would remain the same (e.g., time of order execution).

Question 17: Calendar Month Reporting

Q: Should a market center’s monthly report encompass all trading days
that fall within a calendar month, as opposed to settlement days that
fall within the calendar month?

A: A market center’s monthly report should encompass all trading days
that fall within the calendar month. Thus, orders received and executed
on April 30 must be reported in a market center’s April report, even
though trades were not settled until May.

Question 18: Phase-In of Reporting

Q: The Adopting Release set forth a phase-in of compliance dates for
the Rule in three stages. Is it permissible for a market center to begin
reporting on all securities covered by the Rule on the initial
compliance date?

A: Yes. Nothing prohibits a market center from reporting on all
national market system securities covered by the Rule prior to the
scheduled phase-in dates.

Question 19: Exemption for Orders Received Prior
to Dissemination of Quotations by Primary Listing SRO (new)

Q: How should a market center report under the Rule on an order that
is received prior to dissemination of the first quotations for a trading
day by the SRO with the primary listing for the security?

A: The Commission has exempted from the Rule any order that is
received prior to the dissemination of the first firm, uncrossed
quotations for a trading day by the primary listing SRO for the relevant
security.
22 The
definition of covered order in paragraph (a)(8) of the Rule encompasses
only those orders that are received during regular trading hours
(beginning at 9:30 a.m. Eastern Time unless otherwise specified in
accordance with the Joint-SRO Plan) and at a time when a Consolidated
BBO is being disseminated. When the primary listing SRO has not yet
disseminated its first quotations in a security, the remaining
quotations that may be disseminated often can result in quoted spreads
that vary significantly from the norm. The exemption will assure that
such quoted spreads do not skew the execution quality statistics
included in the monthly market center reports and reduce their
comparability.

Question 20: Filtering Potential Errors in
Consolidated BBO (new)

Q: How should a market center report under the Rule when the
Consolidated BBO used to calculate the Rule’s statistics appears to be
erroneous?

A: Market centers should apply two standard filters to address a
potentially erroneous Consolidated BBO (in addition to the procedure for
handling crossed quotes addressed in Question 7 above). First, the
Commission has exempted any order received during a time when the
Consolidated BBO reflects a spread (the difference between the offer and
the bid) that exceeds $1 plus 5% of the midpoint of the Consolidated
BBO.
23

Second, a market center should reject a potentially erroneous
Consolidated BBO in calculating any of the Rule’s statistics if both (1)
the midpoint of such Consolidated BBO (the “variant BBO”)
varies by more than 20% from the midpoint of the immediately preceding
Consolidated BBO (the “original BBO”), and (2) the midpoint of
the next succeeding Consolidated BBO (“correcting BBO”)
reverts back to within 20% of the midpoint of the original BBO. In this
case, the market center should use the correcting BBO for orders that
otherwise would refer to the variant BBO. If, however, the midpoint of
the correcting BBO does not revert back to within 20% of the midpoint of
the original BBO, the market center should accept the variant BBO.

Question 21: Time of Consolidated BBO (new)

Q: Is it permissible for a market center to calculate its statistical
measures of execution quality under the Rule based on the time that its
systems receive the Consolidated BBO from the central processor for the
applicable national market system plan, rather than the time that such
processor assigns to the Consolidated BBO when it is disseminated?

A: No. Market centers must calculate their statistics based on the
time that the central processor for the applicable national market
system plan assigns to the Consolidated BBO when it is disseminated. One
of the important objectives of the Rule is to generate execution quality
statistics that are comparable among different market centers.
Benchmarking the order executions of all market centers to a
Consolidated BBO with a single time will further this objective.

Question 22: Rounding of Statistics (new)

Q: The Joint-SRO Plan for Rule 11Ac1-5 requires that certain
statistics be carried out to either one or four decimal places. Should
these statistics be rounded or truncated to such decimal place?

A: The statistics should be rounded to the appropriate decimal place,
with a “5” rounded up.

Question 23: Modified Orders (new)

Q: How should a market center report under the Rule on an order that
is modified by the customer after submission, such as when the customer
changes the limit price on a limit order, removes the stop price on a
stop order, or removes a special handling instruction?

A: Except for a reduction in the size of an order (addressed in
Question 11 above as a partial cancellation of an order), order
modifications should be reported as a cancellation of the original order
and a submission of a new order as replacement for the cancelled order.
A market center should report on the replacement order (assuming it
falls within the definition of covered order) just as it would any other
new order. An adjusted or voided order execution is addressed is
Question 16 above.

Question 24: Riskless Principal Orders (new)

Q: How should a market center report under the Rule on an order that
it receives and executes as riskless principal?

A: The market center executing an order as riskless principal should
reflect the order in its monthly report as executed at such market
center (not at another venue), using the time that the order was
executed at such market center.

Question 25: Exemption for Inactively Traded
Securities (new)

Q: Is a market center required to report on orders in all national
market system securities, even those that are inactively traded?

A: No. The Commission has exempted orders in national market system
securities that are inactively traded.
24
The exemption covers any national market system security that did not
average more than five reported transactions per trading day, as
disseminated pursuant to an effective transaction reporting plan, for
each of the preceding six months (or such shorter time that the security
has been designated a national market system security). An inactive
security will lose its exemption only after its average daily reported
transactions have exceeded five for each of the preceding six months.
Orders in exempted securities need not be included in a market center’s
monthly report, but a market center is free to include them if it
chooses to do so.

Question 26: Exemption for Small Market Centers (new)

Q: Are any small market centers exempt from the Rule?

A: The Commission has exempted from the Rule certain small market
centers that do not focus their business on the most actively traded
securities.
25
Small market centers often may be significant sources of liquidity in
the securities of small and medium companies, but have fewer
transactions than large market centers over which to distribute the cost
of generating the monthly execution quality reports. The Commission
therefore is concerned that the costs of compliance for small market
centers, as well as the potential costs if small market centers cease
supplying liquidity, potentially could outweigh the benefits of their
monthly reports. If a small market center chooses, however, to focus a
significant part of its business in very actively traded securities, it
should compete on the same terms as larger market centers that trade
those securities.

The exemption covers any market center that reported fewer than 200
transactions per trading day on average over the preceding six month
period in securities that are covered by the Rule (that is, national
market system securities that do not qualify for the inactively traded
security exemption), but only if more than 90% of such transactions were
in securities that are not included in the Nasdaq-100 Index or the
S&P 500 Composite Stock Price Index. Once a market center’s average
daily reported transactions for the preceding six-month period reach
200, or the percentage of its reported transactions in Nasdaq-100 and
S&P 500 securities reaches 10% or greater for the preceding
six-month period, the market center would cease to qualify for the
exemption. The market center then would be required to begin collecting
the requisite order data for the following full month and make its
monthly report for that month publicly available by the end of the next
month thereafter. For example, if the market center ceased to qualify
for the exemption based on trading during the six-month period from
January through June, the market center must begin collecting order data
for August and make its monthly report (covering August) publicly
available by the end of September.

A broker-dealer that routes orders to a market center that does not
generate monthly execution quality reports continues to have a duty to
monitor the quality of executions received to obtain the best execution
of those orders.

Question 27: Exemption for Block Orders (new)

Q: Is there any maximum size restriction on the orders that must be
included in a market center’s monthly report?

A: Yes. The Commission has exempted from the Rule any order with a
size of 10,000 shares or greater.
26
One of the primary objectives of the Rule is to generate statistical
measures of execution quality that provide a fair and useful basis for
comparisons among different market centers. Large orders have been
excluded to assure greater comparability of statistics in the largest
size category of 5000 or greater shares.

Attachments
* Appendix A (Joint-SRO Plan)
* Appendix B (Table with Rule 11Ac1-5 Sample Statistics)
Footnotes
1 Securities Exchange Act Release No. 43590 (November 17, 2000), 65 FR 75414 (“Adopting Release”).
2 Securities Exchange Act Release No. 44177 (April 12, 2001), 66 FR 19814.
3 Securities Exchange Act Release No. 44060 (March 9, 2001), 66 FR 15028.
4 Letter to Stuart J. Kaswell, Senior Vice President and General Counsel, Securities Industry Association, from Annette L. Nazareth, Director, Division, dated April 12, 2001.
5 Letter to Darla C. Stuckey, Assistant Secretary, New York Stock Exchange, Inc., from Annette L. Nazareth, Director, Division, dated June 22, 2001 (“NYSE Letter”).
6 The codes for order types are set forth in Section VI(a)(5) of the Joint-SRO Plan as follows: market orders – “11”; marketable limit orders – “12”; inside-the-quote limit orders – “13”; at-the-quote limit orders – “14”; near-the-quote limit orders – “15”.
7 The codes for order sizes are set forth in Section VI(a)(6) of the Proposed Plan as follows: 100-499 shares – “21”; 500-1999 shares – “22”; 2000-4999 shares – “23”; 5000 or more shares – “24”. As discussed in Question 27, the Commission has exempted orders with sizes of 10,000 shares or greater.
8 See Section VI(a)(2) of the Joint-SRO Plan.
9 See Letter from Annette L. Nazareth, Director, Division, SEC, to Stuart J. Kaswell, Senior Vice President and General Counsel, Securities Industry Association, dated March 12, 2001 (“SIA Exemption Letter”).
10 For example, NASD Regulation currently is working on implementing Phase Three of the Order Audit Trail System (“OATS”), which would cover orders that are received manually by a firm’s trading department. Exchange markets also are developing automated systems to capture manual orders.
11 See Question 13 below.
12 See SIA Exemption Letter, note 9 above.
13 The time of order receipt and time of order execution must be recorded “to the second” under paragraphs (a)(20) and (a)(21) of the Rule.
14 Note that the limit order could not be classified as an at-the-quote limit order because the definition of “at-the-quote limit order” in paragraph (a)(13) of the Rule only applies to “non-marketable limit orders.”
15 To be a “covered order” under paragraph (a)(8) of the Rule, an order must be received during “regular trading hours” (defined in paragraph (a)(19) of the Rule) and during a time when a Consolidated BBO is being disseminated pursuant to an effective national market system plan. Consequently, any orders received during a regulatory trading halt (when no Consolidated BBO will be disseminated) are excluded from the definition of covered order. In addition, to assure uniform treatment of orders affected by trading halts, the Commission has exempted orders received during non-regulatory trading halts that are announced in accordance with all applicable regulatory rules. See SIA Exemption Letter, note 9 above.
16 See SIA Exemption Letter, note 9 above.
17 See Securities Exchange Act Release No. 34-43084 (July 28, 2000), 65 FR 48406, section IV.B, “Strengthening Price Priority.”
18 Letter to Richard G. Ketchum, President, The Nasdaq Stock Market, Inc., from Annette L. Nazareth, Director, Division, dated June 22, 2001.
19 Similarly, the Division views Nasdaq’s Computer Assisted Execution System (“CAES”), which delivers automatic executions for exchange-listed securities, as a market center for which Nasdaq should issue monthly reports under the Rule.
20 In this respect, integrated broker-dealers will assign a time of order receipt under the Rule in the same way that such a time is assigned under the NASD’s OATS rules. See Securities Exchange Act Release No. 43344 (Sept. 26, 2000), 65 FR 59038 (NASD proposed rule change relating to amendments to Order Audit Trail System Rules).
21 Adopting Release, note 1 above, section III.C.1.
22 Letter to Theodore Karn, President, Market Systems, Inc., from Annette L. Nazareth, Director, Division, dated June 22, 2001 (“MSI Letter”).
23 MSI Letter, note 22 above.
24 Letter to Richard Romano, Chair, and Carl P. Sherr, Vice-Chair, NASD Small Firms Advisory Board, from Annette L. Nazareth, Director, Division, dated June 22, 2001 (“Small Firms Letter”).
25 Small Firms Letter, note 24 above.
26 NYSE Letter, note 5 above.

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