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95-24 SEC Approves Recordkeeping And Reporting Requirements For Trading Systems Operated By Broker/Dealers
Effective June 1, 1995, the Securities and Exchange Commission (SEC) is adopting Rule 17a-23 and Form 17A-23 under the Securities Exchange Act of 1934. The Rule requires broker/dealers that operate automated trading systems to maintain participant, volume, and transaction records, and to report system activity to the SEC and, in certain circumstances, to their designated examining authority (DEA). Broker/dealers currently operating automated trading systems subject to the Rule must file their initial operation reports no later than July 1, 1995.
Currently, firms that operate automated trading systems must be registered broker/dealers and keep records relating to general brokerage activity, but are not required to keep records that separately identify transactions effected through their systems. These firms need not provide readily accessible summaries of system volume, identify the securities trading on their systems, or describe how their systems operate.
In 1989, the SEC attempted to formalize its oversight of automated trading systems by proposing Rule 15c2-10. That Rule was directed at certain securities trading and information systems, referred to as proprietary trading systems, that were not operated as facilities of a registered national securities exchange or association. This proposal was withdrawn in February 1994.
In the interim, many firms sponsoring screen-based, broker/dealer trading systems (BDTSs) have been operating according to no-action letters obtained from the SEC. Generally, these letters provide relief from registration as a national securities exchange or association, and require supplemental recordkeeping and reporting by the sponsor.
In January 1994, the SEC published its Market 2000: An Examination of Current Equity Market Developments, a study that recommended close monitoring of BDTSs to understand the implications of integrating these systems into existing market structures. The SEC proposed Rule 17a-23 shortly after publishing the study and recently determined to adopt the Rule with certain modifications.
SEC Rule 17a-23
As adopted, the Rule requires a broker/dealer that sponsors a BDTS to make and keep current specified records and to file reports with the SEC and its DEA on Form 17A-23.
Broker/Dealer Trading Systems
In finalizing the rule, the SEC modified the definition of BDTS to mean any system that provides a mechanism, automated in full or in part, for:
- collecting or disseminating system orders; and
- matching, crossing, or executing system orders, or otherwise facilitating agreement to the basic terms of a purchase or sale of a security between system participants, or between a system participant and the system sponsor, through use of the system or through the system sponsor. Members should note that a system must meet both criteria to be considered a BDTS.
System sponsors are required to keep and make available to the SEC, upon request, these records:
- daily summaries of trading in the system;
- identities of system participants(including any affiliations between those participants and the sponsor); and
- time-sequenced records of each transaction effected through the system.
These records must be kept for three years, the first two years in an easily accessible place.
Members should note that the Rule does not dictate a format for maintaining information nor require that such information be maintained separately from other records, provided the sponsor can retrieve promptly the information upon request in the format and for the time periods specified in the Rule.
The Rule requires a BDTS sponsor to file specified reports using Form 17A-23, which contains three parts:
- Part I—Operation Reports, including the initial operation report that must be filed at least 20 calendar days before the operation of the system and subsequent reports that must be filed at least 20 calendar days before implementing any material change to the operation of the system.
- Part II—Quarterly Reports, which must be filed within 30 calendar days after the end of the calendar quarter.
- Part III—Final Report, which must be filed within 10 calendar days after a sponsor ceases to operate the trading system.
Parts I and III of the form must be filed with the SEC and the sponsor's DEA. Part II is filed with the SEC only; however, the sponsor must make the reports available to its DEA upon request. Members for whom the NASD is the DEA should submit their required reports to the NASD Market Surveillance Department, 9513 Key West
Avenue, 4th Floor, Rockville, MD 20850-3389.
Rule 17a-23 is effective on June 1, 1995. Sponsors of systems currently in operation must submit the information required by Part I of Form 17A-23 no later than July 1, 1995.
* * *
Members operating automated trading systems are urged to review the SEC release concerning Rule 17a-23 in its entirety. The release, which appeared in the December 28, 1994, Federal Register, follows this Notice. Questions concerning this Notice may be directed to James Bohlin, Assistant Director, NASD Market Surveillance, at (301) 5906789.
17 CFR Parts 240 and 249
[Release No. 34–35124; File No. S7–3-94]
Recordkeeping and Reporting Requirements for Trading Systems Operated by Brokers and Dealers
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
SUMMARY: The Securities and Exchange Commission is adopting Rule 17a-23 ("Rule") and Form 17A-23 under the Securities Exchange Act of 1934 to establish recordkeeping and reporting requirements for brokers and dealers that operate automated trading systems. Under the Rule, registered broker-dealers that sponsor these systems would be required to maintain participant, volume, and transaction records, and to report system activity to the Commission and, in certain circumstances, to an appropriate self-regulatory organization.
EFFECTIVE DATE: June 1, 1995.
FOR FURTHER INFORMATION CONTACT: Kristen N. Geyer, Senior Counsel, 202/ 942–0799, Office of Automation and International Markets, Division of Market Regulation, Securities and Exchange Commission (Mail Stop 5–1), 450 Fifth Street, N.W., Washington, DC 20549.
On February 9, 1994, the Securities and Exchange Commission ("Commission") proposed for comment Rule 17a-23 ("Proposed Rule")1 and Form 17A-23 ("Proposed Form")2 under the Securities Exchange Act of 1934 ("Act").3 The Proposed Rule would have required specific recordkeeping and reporting by registered broker-dealer sponsors of certain automated trading systems (as defined in the Rule, "Broker-Dealer Trading System," or "BDTS"). The Proposed Form specified the information to be included in each Filing required by the Proposed Rule.
The Commission received ten comment letters in response to the Proposing Release. Commenters generally supported the Proposed Rule's goal of standardizing recordkeeping and reporting for BDTSs.4 The majority of commenters recommended specific modifications to the Proposed Rule. Two commenters. the National Association of Securities Dealers ("NASD") and the New York Stock Exchange ("NYSE"), objected to the Commission's overall regulatory treatment of certain BDTSs and the competitive implications of such regulatory treatment.5
After considering the comments, the Commission is adopting the Rule and Form, with certain modifications. The Commission does not believe that these modifications materially alter the scope of the Proposed Rule or the entities to which it applies. The recordkeeping and reporting approach adopted in the Rule will provide the Commission with information necessary to effectively monitor, evaluate, and examine such systems.
In January 1994, the Commission's Division of Market Regulation ("Division") published its Market 2000 Study,6 which reviewed, among other things, the Commission's existing oversight of automated trading systems. The Study recognized that the activities of such systems differ from the activities of traditional broker-dealers, and recommended that the Commission closely monitor the effects of proliferation of such systems.7 The Commission proposed Rule 17a-23 immediately following publication of the Market 2000 Study.8
The majority of commenters supported the concept of a recordkeeping and reporting rule and recognized the importance of ongoing monitoring and evaluation of technological advances in the securities industry.9 Several commenters, however, questioned the necessity for applying the Proposed Rule to specific types of systems. In particular, two commenters suggested that the Proposed Rule should not apply to systems that allow a dealer's customers and other dealers to execute orders against the sponsoring dealer's bid or offer (i.e., "hit" the sponsor's quotations) through automated means ("automated dealer systems").10 Another commenter objected to application of the Proposed Rule to non-equity systems.11
In the Proposing Release, the Commission noted that, although automated systems have proliferated in the securities industry, the Commission receives little information about such systems.12 The Commission concluded that its efforts to gauge the effect of automation on the U.S. markets and to regulate broker-dealers that operate such systems appropriately are being hindered by a lack of critical information regarding the activity of BDTSs.
The Commission identified three ways in which additional information about BDTSs would assist in evaluating, monitoring, and examining such systems. First, the Rule will allow the Commission to evaluate BDTSs with regard to national market system goals.13 The Commission noted in the Proposing Release that BDTSs have the potential to significantly affect trading patterns, market transparency, and the distribution of trading activity among different markets; consequently, access to uniform, reliable information about BDTSs is critical to the Commission's evaluation of these issues.14 This is true regardless of whether such systems automate the market-making function, automate an order-interaction function, or automate trading of illiquid or non equity securities.
Second, the information will help the Commission to monitor the competitive effects of these systems and to ascertain whether broker-dealer regulation remains appropriate for the operation of BDTSs.15 As is clear from the comments, the ongoing debate regarding the competitive consequences of the Commission's regulation of BDTSs remains vigorous.16 Finally, the Ruin, will help the Commission identify areas where monitoring of such systems may be improved and where self-regulatory organization ("SRO") surveillance may be more appropriately tailored to the detection of fraudulent, deceptive, and manipulative practices in an automated environment.17
Notwithstanding the views of commenters that the risks posed by automated market-maker systems are sufficiently addressed by existing broker-dealer regulations18 or that automated systems are less susceptible to manipulation than traditional broker-dealers,19 the Commission believes that the evolution of both automated broker systems and automated dealer systems present new challenges in maintaining market quality and customer protection. BDTSs contribute to the concentration of order flow among a few, large, automated broker-dealers, execute trades at a more rapid rate than traditional services, and make execution of the customers' orders dependent on the reliability of the automated system rather than individual traders.
The Commission believes that the Rule as adopted will provide important information to assist it in accomplishing these goals, without imposing unnecessary or overly burdensome requirements that do not relate to the purposes of the Rule.
As adopted, the Rule requires a registered broker-dealer who acts as the sponsor20 of a "broker-dealer trading system" to make and keep current specified records, and file reports with the Commission (and, in certain circumstances, with the appropriate SRO) on Form 17A-23.
The Rule as proposed and adopted would apply to registered brokers or dealers21 that sponsor a "broker-dealer trading system." Commenters requested clarification of which automated systems would be considered "broker-dealer trading systems" as defined in the Proposed Rule.22 Several commenters suggested narrowing the definition of BDTS to exempt certain systems. In particular, two commenters questioned the inclusion of automated dealer systems that allow a dealer's customers and other dealers to execute against the sponsoring dealer's bids and offers.23 One commenter also recommended that the Commission exempt non-equity trading systems from application of the Proposed Rule.24 In view of the comments, the Commission has simplified the definition of BDTS and clarified the Rule's application to various systems, as discussed below, but has not materially altered the scope of the Rule.
The definition of "broker-dealer trading system" has been modified in the Rule to mean any system that meets the following criteria: the system must provide a mechanism, automated in full or in part, for (1) collecting or disseminating system orders and (2) matching, crossing, or executing system orders, or otherwise facilitating agreement to the basic terms of a purchase or sale of a security between system participants, or between a system participant and the system sponsor, through use of the system. As made clear in the Rule, the term "broker-dealer trading system" does not include any system that does not meet both of these requirements.
The modified definition of BDTS captures the essential features of the types of systems that the Proposed Rule was intended to encompass, The Proposed Rule also described several types of systems that were excluded from the definition of BDTS.25 As discussed below, the Commission believes that those systems continue to be excluded from the Rule as adopted, because they do not meet the required characteristics of a BDTS as defined.26
As adopted, the Rule applies to systems that may be only partially automated, as well as to fully automated systems. Some systems may automate the collection and dissemination of orders through a screen available for viewing by participants, but require participants to contact the sponsor by telephone in order to finalize a trade based on such orders. Other systems may collect orders via telephone contact with customers, and enter those orders into a system that automates the matching of such orders. Although neither of these systems are "fully" automated, both are BDTSs under the Rule as adopted. The lack of complete automation does not alter the potential market effects of automated execution systems, nor does it alter the need to tailor oversight of the sponsor to reflect the distinctive characteristics of automated systems. The Commission notes in particular that it is not necessary for participants to have the ability to enter orders electronically through a system terminal or screen in order for the system to be subject to the Rule. Some systems permit customers to participate in the system's matching, crossing, or other features by communicating orders to the sponsor by telephone, to be entered into the system by the sponsor's trading personnel.27
This lack of automated access to a system does not exempt such a system from application of the Rule.
The Rule applies only to those automated trading systems that offer users the ability to effect securities transactions through their use of the system, either with other participants or with the system sponsor. Numerous automated systems have developed that facilitate securities trading, but do not create opportunities to effect transactions apart from the facilities of established markets. These systems range from purely informational "bulletin board" systems that allow participants to announce their trading interest (typically by posting quotation or order information and participant telephone numbers on the system's screen)28 to "routing" systems that direct order flow to an exchange or other established market or dealer but do not otherwise interact with such order flow. Bulletin boards, routing systems, and other similar systems essentially disperse information; they do not allow users to effect securities transactions with other system participants or with the system sponsor through the system. Accordingly, such systems are not subject to the Rule. In the Commission's view, these "non-execution" systems do not create the same potential for market effects and correspondingly create less need for ongoing monitoring and evaluation by the Commission than systems that fall within the definition of broker-dealer trading system.29
Two commenters argued that the Proposed Rule only should apply to systems that offer a "locked-in trade" between or among customers or other dealers as part of an interactive system.30 These commenters questioned the Commission's rationale for applying the Proposed Rule to automated dealer systems, arguing that automated dealer systems "do no more than what any market-maker has done since the enactment of the 1934 Act," other than providing fuller automation of the market-maker function.31 One commenter supported inclusion of automated dealer systems in the Proposed Rule.32
The Commission has concluded that the Rule should apply to automated dealer systems as well as other BDTSs. Systems that automate execution functions make it possible for a broker-dealer to concentrate a significant volume of securities transactions. This is true whether such an "execution" system allows participants to interact directly with each other, or whether the system allows participants to interact with a single dealer. As discussed above and in the Proposing Release, this potential concentration of volume outside of national market systems may have significant market effects. The Commission believes that in today's highly complex, integrated trading environment, it must fully consider the effect of technological advances on the broker-dealer's role in both auction market and dealer market trading.33
The Rule as adopted applies both to systems trading equity and systems trading non-equity securities. One commenter objected to application of the Proposed Rule to systems that deal exclusively with non-equity instruments.34 That commenter noted that "[t]he nature of and detail imposed by these recordkeeping and reporting requirements suggest that the real intention behind the Proposed Rule is to enable the SEC to gather and evaluate information on BDTSs dealing in equity instruments only."35
The need for uniform, reliable information as discussed above and in the Proposing Release is equally applicable to systems trading non-equity securities. It is probable that sponsors will continue to create BDTSs to facilitate transactions in products that do not trade in organized markets, including various debt and derivative products. Systems that trade these non equity, and typically less liquid, securities are especially opaque under existing regulations; they are not integrated into market quotation and reporting mechanisms to the same degree as systems that trade equity products. Some of these "niche" systems may provide the only readily identifiable source of trading in a particular instrument. The Rule will help alleviate the difficulty of obtaining accurate information on a regular basis about trading in these instruments.
The Commission recognizes that information that is relevant to equity security trading may not be relevant to non-equity security trading. Accordingly, the Rule and Form direct the sponsor of a non-equity trading system to provide information relevant to such non-equity securities (such as number of bonds, contracts, etc.).36
Three commenters urged the Commission to reconsider its regulatory approach to BDTSs, or in the alternative to reconsider its regulation of traditional markets.37 Specifically, both the NYSE and the NASD identified concerns regarding the competitive implications of the Commission's adoption of a recordkeeping and reporting rule governing BDTSs in light of the regulatory structures that apply to registered exchanges and interdealer quotation systems.38 The Commission does not believe it is necessary at this time to adopt regulations governing BDTSs beyond those existing requirements applicable to the broker-dealer sponsors of such systems and the enhanced recordkeeping and reporting that will be provided pursuant to the Rule. The Commission is not precluded from reconsidering the issues raised by the commenters concerning the Commission's regulatory approach to BDTSs at a later time, should circumstances warrant such reconsideration.
These commenters also urged the Commission to reconsider its regulation of trading services provided by registered exchanges and securities associations. In particular, commenters recommended that the Commission streamline its requirements governing the filing of SRO rule proposals, and that SROs be allowed to develop trading systems under the same regulatory requirements applicable to BDTSs.39 In that regard, the Commission notes that today it has adopted amendments to the Commission's rules governing the SRO rule filing process.40 The Commission also notes that the regulation of SRO trading services is largely dictated by statutory requirements. Consequently, SRO operation of trading systems outside of existing SRO regulations would require a careful, case-by-case analysis under the Act. BDTSs are governed by the regulatory structure applicable to other registered broker-dealers. The Commission has not created a separate regulatory structure for BDTS trading; it has adopted enhanced recordkeeping and reporting for such systems.
Under the Rule, system sponsors are required to keep and make available to the Commission, upon request, records of: (1) daily summaries of trading in the system; (2) the identities of system participants (including any affiliations between those participants and the sponsor); and (3) time-sequenced records of each transaction effected through the system. The sponsor is required to keep these records, as well as any notices provided by the sponsor to participants, for three years (the first two years in an easily accessible place). The Commission has modified some of the proposed recordkeeping requirements in response to comments as discussed below.
The Commission requested comment on whether the Proposed Rule's requirements would be duplicative or burdensome. Commenters suggested that the recordkeeping requirements appear to be duplicative of those already required under other rules promulgated under Section 17, and questioned the justification for such duplication.41 Two commenters expressed reservations that the Proposed Rule would penalize broker-dealers that use automation to become more efficient, and would thus deter further automation.42 Only one commenter stated that the Proposed Rule would impose undue financial burden on BDTS sponsors.43 No commenter provided information sufficient to quantify the extent to which BDTSs would be financially burdened by the Proposed Rule.
While existing regulations require registered broker-dealers to maintain much of the information required under the Rule, they do not require broker-dealers to keep records that present BDTS activity separately from other brokerage activity.44 Consequently, the Commission does not have ready access to system-specific information. The Commission's ability, and the ability of SROs,45 to adequately evaluate, monitor, and examine these systems is correspondingly limited.46 Although the Rule may result in changes to some existing BDTS sponsors' recordkeeping practices, the Commission believes that it has made sufficient provision in the Rule to minimize the need for BDTS sponsors to keep duplicative records. The Rule does not dictate a format for maintaining Information and does not require BDTS sponsors to maintain such information separately from its other records, so long as the sponsor can promptly retrieve such information upon request in the format, and for the time periods, specified in the Rule.
Commenters questioned the need to retain information regarding specific applicants denied participation in the system, and indicated that quantifying such information would be difficult.47 In view of the comments, the Commission has deleted this requirement from the Rule. Sponsors, however, are required to describe, in filings under Part I and IA of Form 17A-2 3, the factors relied upon by the sponsor in granting participation in the system.
The Proposed Rule required sponsors to retain daily summaries of, among other things, securities trading in the system. The Proposed Rule also would have required sponsors to retain daily summaries identifying the number of "quotations" and "orders" placed in the system, expressed separately for limit and market orders and other relevant order specifications. This requirement was intended to provide the Commission with a basis for comparing potential system trading interest with trading volume. Commenters expressed concern that the configuration of specific systems would make it difficult to determine what would constitute a single "quotation" or "order."48 Commenters also noted that, depending upon system configuration, identifying the number of quotations or orders may not provide the Commission with useful information regarding system trading interest.49
The Commission has modified the Rule in view of these commenter concerns regarding the terms "quotations" and "orders."50 As adopted, the Rule requires sponsors to identify the number of "system orders,"51 or any other identifiable indicator that accurately reflects participant trading interest, as appropriate in light of system configuration. If applicable in light of system configuration, sponsors must express such number separately for priced and unpriced orders. In modifying this requirement, the Commission relies on the sponsor's knowledge of its system configuration to determine which statistics would provide the most accurate assessment of participant trading interest, and to retain those statistics accordingly.52
The Commission also has modified the Rule, in response to one commenter's concern, to clarify that a sponsor must be able to identify on a daily basis only those securities for which transactions have been executed through the system.53
Three commenters requested clarification of the extent to which communications to individual participants or non-written communications must be preserved as notices to participants under paragraph (c)(2)(ii) of the Proposed Rule.54 The Rule as adopted requires sponsors to preserve only those notices that are disseminated (whether through written or other means) generally to all participants, or to one or more classes of participants. The Rule does not require the sponsor to preserve communications directed solely to an individual participant.
Under the Rule as adopted, a BDTS sponsor is required to file reports with the Commission (and, in certain circumstances, with the appropriate SRO), in accordance with Form 17A-23. Form 17A-23 contains three parts: (1) operation reports, including initial operation reports filed at least 20 calendar days prior to the operation of the system and subsequent operation reports filed as necessary prior to implementing material system changes; (2) quarterly reports filed within 30 calendar days after the end of the calendar quarter;55 and (3) a final report filed within 10 calendar days after a sponsor ceases to operate the trading system. The operation reports would describe the system, its procedures for reviewing capacity, security and contingency planning, and protecting participant funds and securities (if an entity other than the sponsor will hold or safeguard participant funds or securities on a regular basis). It also would identify an appropriate system contact. The quarterly reports would contain summary trading information. The report notifying the Commission of cessation of operations would contain, in addition to the notification, a final transaction summary.
The Rule requires initial operation reports to be filed at least 20 days prior to operation, and subsequent operation reports regarding material changes to be filed at least 20 days prior to implementing such material change, or, where it is commercially impracticable to do so, as soon as possible after the sponsor determines that it will implement such material change and in any event no later than 10 days following the implementation of such change.
The Commission notes that the Rule does not require system sponsors that alter the operation of their BDTS subsequent to filing an initial operation report to file additional or amended operation reports prior to beginning operation. In the Commission's experience, it is not uncommon for automated systems to be altered routinely to respond to participant comments or concerns, incorporate technological advances, or otherwise upgrade a system's operation. Accordingly, sponsors that file initial operation reports with the Commission might alter the operation of their BDTS subsequent to such filing, but prior to beginning operation. If a sponsor materially changes system operation subsequent to filing an initial operation report, but prior to beginning operation, the sponsor should contact the Division to apprise them of such material change.
The Commission also notes that currently, material changes to automated systems generally require significant planning and development prior to implementation. Accordingly, the Commission believes that most sponsors will be able to notify the Commission at least 20 days prior to implementing a material change. Nonetheless, if a sponsor is able to implement a material system change on a greatly expedited basis, the Commission recognizes that it may not be commercially feasible to notify the Commission 20 days prior to implementation without delaying implementation. In such circumstances, the Rule allows a sponsor to notify the Commission as soon as possible after it determines to implement a material change, but in any event no later than 10 days following the implementation of such change.
As adopted, the Rule requires sponsors to file Parts I and III of Form 17A-23 with both the Commission and the SRO that is its designated examining authority. The quarterly reports covered by Part II of Form 17A-23 are required to be filed only with the Commission; however, the sponsor must make such reports available to the appropriate SRO upon request.56 Two commenters expressed concern that SRO access to information contained in reports filed pursuant to the Proposed Rule might adversely affect a BDTS's competitive position.57 One commenter recommended that the Commission require SROs to adopt procedures to restrict access to BDTS reports to the SRO's surveillance personnel, or, in the alternative, dispense with the reporting obligation.58
The Commission recognizes that the activities of SROs as both market operators and market regulators may create tension between the SROs and SRO members. For example, documents obtained in the conduct of an SRO's regulatory duties may contain competitively sensitive information. Notwithstanding this, SROs must have access to relevant member information in order to fulfill their self-regulatory obligations.59 The Commission believes that information contained in reports filed pursuant to the Rule will be critical to appropriately tailoring SRO examination and oversight of BDTS sponsors to reflect the distinctive characteristics and concerns of automated trading systems. Accordingly, the Rule continues to make such information available to SROs designated as a BDTS's examining authority. In order to address potential competitive issues, the Rule provides for filing of Rule 17a-23 reports directly with surveillance personnel designated by the examining SRO. The Commission notes that access to information made available to an SRO in its regulatory capacity should be rigorously restricted to those personnel who require it for surveillance and regulatory oversight purposes only. The Commission strongly urges SROs to carefully assess, and revise where necessary, their internal policies and procedures for protecting the confidentiality of sensitive information obtained in the course of fulfilling SRO regulatory responsibilities.
Two commenters requested that the Commission discuss whether reports filed pursuant to the Proposed Rule may be exempt from public disclosure under the Freedom of Information Act.60 The Commission notes that reports filed pursuant to the Rule will be deemed to be confidential. The Commission considers such reports to be exempt from disclosure under the Freedom of Information Act ("FOIA").61 The Commission will protect the confidentiality of reports filed pursuant to the Rule accordingly.62
Proposed Form 17A-23 would have required sponsors to report "lists of securities trading in the system," and to state whether it offers services that allow system participants to trade with entities outside of the United States. Commenters requested clarification that sponsors may comply with the Form by identifying the categories of securities that have actually traded in the system during the period covered by the report.63 After reviewing the comments, the Commission believes that the information required pursuant to Part I of Form 17A-23 is sufficient to provide summary information regarding the categories of securities trading, and that submission of lists identifying individual securities in the quarterly filings under Part II of Form 17A-23 would not be useful. Accordingly, the Commission has deleted this requirement from the Form. The Commission also has modified Parts I and II of Form 17A-23 to clarify that sponsors must report whether entities located outside of the United States have access to the system, and describe the nature of such access and foreign participation in the system in reports filed pursuant to Part I of the Form. Finally, the Commission has modified Part I of the Form and paragraph (d)(1) of the Rule to require system sponsors to update the information filed in Part I of the Form at least 20 days prior to implementing a material change to system operation, or, where it is commercially impracticable to do so, as soon as possible thereafter when the sponsor determines that it will implement such material change (and in any event no later than 10 calendar days following the implementation of such change).
The Rule will become effective on June 1, 1995. The Commission has modified the Rule to allow sponsors of systems currently operating to submit the information required by Part I of Form 17A-23 no later than July 1, 1995 (one month following the effective date), to provide sponsors of existing systems adequate time to prepare this filing.64
As discussed above, certain BDTS sponsors are subject to staff no-action letters that require those sponsors to provide operation and trading information to the Division that is comparable to that required in Form 17A-23.65 These staff no-action letters do not affect the obligation of any BDTS sponsor to comply with the Rule. Prior to effectiveness of the Rule, the Division will revise the conditions of no-action in each letter granted to a sponsor of an operating system that would be subject to the Rule, to eliminate duplicative reporting requirements. Sponsors of BDTSs subject to no-action letters that have further questions on complying with the Rule and conditions of no-action should contact the Division.
Section 23(a)(2) of the Act66 requires the Commission, in adopting rules under the Act, to consider the anticompetitive effects of such rules, if any, and to balance any impact against the regulatory benefits gained in terms of furthering the purposes of the Act. As discussed above, several commenters raised concerns regarding the competitive implications of the Proposed Rule. The Commission has considered the Rule in light of the comments and the standard cited in Section 23(a)(2). The Rule's establishment of reporting and recordkeeping requirements will not impose a significant burden on competition. All BDTSs will be subject to the same requirements, and the reporting and recordkeeping requirements, which are similar to those currently imposed on registered brokers and dealers, should not be unduly burdensome. In addition, the Commission has specifically considered competitive concerns relating to SRO access to such information.67 For the reasons discussed above, the Commission believes that adoption of the Rule will not impose any burden on competition not necessary or appropriate in furtherance of the Act.
The Commission has prepared a Final Regulatory Flexibility Analysis ("FRFA") regarding Rule 17a-23, in accordance with 5 U.S.C. §604. No public comment was received in response to the initial regulatory flexibility analysis. The FRFA notes the potential costs of operation and procedural changes that may be necessary to comply with the Rule. As more fully explained above, however, the Commission has determined that the proliferation of broker-dealer automated trading systems requires increased oversight to promote investor protection and to assess the impact of these systems on the securities markets. The Commission finds that the benefits of Rule 17a-23 outweigh the costs incurred by industry participants in complying with the Rule. A copy of the FRFA may be obtained by contacting Elaine M. Parroch, Attorney-Advisor, Office of Automation and International Markets, Division of Market Regulation, Securities and Exchange Commission. 450 Fifth Street, N.W. (Mail Stop 5–1), Washington, D.C 20549.
No public comment was received in response to proposed Rule 17a-23 with respect to the Paperwork Reduction Act of 1980, 44 U.S.C. §§ 3501 et seq.
The rules and regulations of the Commission are amended as follows, pursuant to the Securities Exchange Act of 1934 and particularly Sections 2, 3, 11A, 15(c), 17, and 23(a) thereof, 15 U.S.C. §§ 78b, 78c, 78k-l, 78o(c), 78q, and 78w(a).
List of Subjects in 17 CFR Parts 240 and 249
Reporting and recordkeeping requirements, Securities.
Text of Amendments
In accordance with the foregoing. Title 17, Chapter II of the Code of Federal Regulations is amended as follows:
PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
Section 240.17a-23 also issued under 15 U.S.C. 78b, 78c, 78o, 78q, and 78w(a);
* * * * *
§ 240.17a-23 Recordkeeping and Reporting Requirements relating to Broker-Dealer Trading Systems.
PART 249—FORMS, SECURITIES EXCHANGE ACT OF 1934
Authority: 15 U.S.C. 78a, et seq., unless otherwise noted;
* * * * *
Note: The text of Form 17A-23 appears as Appendix A to this document and will not appear in the Code of Federal Regulations.
§ 249.636 Form 17A-23, Information required of certain broker and dealer sponsors of broker-dealer trading systems pursuant to section 17 of the Securities Exchange Act of 1934 and §240.17a-23 of this chapter.
This form shall be used by every registered broker and dealer that is required to file reports under § 240.17a-23 of this chapter.
By the Commission.
Dated: December 20, 1994.
Margaret H. McFarland,
BILLING CODE 8010–01-PPDF TO BE INCLUDED PDF TO BE INCLUDED
U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
INSTRUCTIONS FOR COMPLETING FORM 17A-23
Unless the context clearly indicates otherwise, terms used in this Form have the meaning ascribed to them in the Securities Exchange Act of 1934 and Rule 17a-23 thereunder.
Rule 17A-23 requires that every registered broker or dealer that acts as the sponsor of a broker-dealer trading system: file Part I of Form 17A-23 at least 20 calendar days prior to operating or sponsoring a broker-dealer trading system; file Part IA of Form 17A-23 regarding a material change to operation of the system as described in any filing previously made with the Commission pursuant to Part I of Form 17A-23 at least 20 calendar days prior to implementing such material change, or, where it is commercially impracticable, as soon as possible thereafter when the sponsor determines that it will implement such material change (but in any event, no later than 10 calendar days following the implementation of such change); file Part II of Form 17A-23 within 20 calendar days after the end of each calendar quarter during which the sponsor operates or sponsors a broker-dealer trading system; and file Part III of Form 17A-23 within 10 calendar days after the sponsor ceases to operate or sponsor a broker-dealer trading system.
File the original and one copy of each Form 17A-23 filing with the SEC at Office of Automation and International Markets, Division of Market Regulation, 450 5th Street, N.W., Washington, DC 20549. Simultaneously with the filing of the original with the SEC, file one duplicate copy of each Part I, Part IA, and Part III Form 17A-23 filing with surveillance personnel designated by the self-regulatory organization that is the designated examining authority for the sponsor pursuant to Rule 17d-1. The sponsor must keep an exact copy of the filing for its records. All copies must be legible. The filing date of any Form 17A-23 filing is the date of its actual receipt by the SEC, provided that the filing complies with applicable requirements.
A sponsor may use the printed Form 17A-23 or a reproduction of it. In either case, complete page 1 of Form 17A-23 in the format provided. Number each page following page 1 consecutively, give the name of the broker-dealer trading system and the date at the top of each page, and identify the Part to which the Information on that page relates.
If the sponsor of a broker-dealer trading system has not previously filed a Form 17A-23 with respect to the system, complete page 1 and Part I. If the sponsor has previously completed Part I in a Form 17A-23 filed with respect to the system, and continues to operate or sponsor the system: complete page 1 and Part IA only, if filing Form 17A-23 as required prior to implementing a material change to system operation; complete page 1 and Part II only. If filing Form 17A-23 as required quarterly. If the sponsor has ceased to operate or sponsor the system, complete page 1 and Part III only. Provide information required by each Part of the Form by typing or printing the text of each item followed by the response thereto. Numerical information required by Parts II and III (Item 2) may be provided in chart form. For numerical responses, clearly indicate the information each number represents and the item number in the Form which requests such information. Print or type all items and responses. If sponsor intends to provide a number other than the number of system orders in response to Item 2, Part II, contact the Office of Automation and International Markets, Division of Market Regulation, prior to filing. If the information requested by any item is available in printed form, the printed material may be attached as an exhibit and referenced in the response to the item.
Sponsors that operate more that one broker-dealer trading system may file reports on Form 17A-23 relating to one or more systems. In each filing of Form 17A-23 that relates to more than one system operated by the sponsor, provide the required information separately for each system.
[FR Doc. 94–31656 Filed 12–27–94; 8.45am]
BILLING CODE 8010–01-C
1 17 CFR 240.17a-23.
2 17 CFR 249.636.
3 15 U.S.C. 78a et seq. See Securities Exchange Act Release No. 33605 (Feb. 9, 1994). 59 FR 8368 ("Proposing Release").
4 The comment letters and a summary of comments prepared by the Division of Market Regulation have been placed in Public File No. S7–3-94, which is available for inspection in the Commission's Public Reference Room. Commentors consisted of two industry associations, two self-regulatory organizations, four sponsors of automated proprietary trading systems, and two automated broker-dealers. See letters from: John F Olson, Chair, Committee on Federal Regulation of Securities, and Roger D. Blanc, Chair. Subcommittee on Market Regulation, the Business law Section of the American Bar Association, dated May 10, 1994 ("ABA"); Robert A. McTamaney, Attorney. Carter, Ledyard & Milburn (representing RMJ Securities Corporation, RMJ Options Trading Corporation, and RMJ Special Brokerage, Inc.), dated April 15, 1994 ("CLM/RMJ"); John E. Herzog, Chairman & CEO, Herzog, Heine, Geduld, dated April 12, 1994 ("HHG"); Charles R. Hood, Senior Vice President & General Counsel, Instinet Corporation, dated April 25, 1994 ("Instinet"): Alan II. Rudolph, Vice President, Intervest Financial Services, Inc. and President, CrossCom Trading Metwork. Inc., dated March 15, 1994 ("Intervest"); Raymond L. Killian. Jr., President & CEO. Investment Technology Group, Inc. (sponsor of Portfolio System for Institutional Trading ("POSIT")), dated May 18, 1994 ("ITG"); Leonard Mayer, Vice President, Mayer & Schweitzer, Inc., dated July 11, 1994 ("M4S"); Joseph R. Hardiman, President, National Association of Securities Dealers, Inc., dated May 27, 1994 ("NASD"; John El. Buck, Senior Vice President & Secretary, New York Stock Exchange, dated June 30, 1994 ("NYSE"); and Mark T Commander, Chairman of Self-Regulation & Supervisory Practices Committee. Securities Industry Association, dated June 17, 1994 ("SIA").
5 See letters from NASD and NYSE. The NASD expressly opposed adoption of the Proposed Rule.
6 Division of Market Regulation, Market 2000: An Examination of Current Equity Market Developments (January 1994) ("Market 2000 Study").
7 Id. at 26–27
8 See Proposing Release, supra note 3. Concurrently with the publication of the Proposed Rule, the Commission withdrew a previous rule proposal (Rule 15C2–10) which would have required certain BDTSs to seek Commission approval prior to operation of a proprietary trading system and imposed additional conditions on the operation of such systems. The Commission concluded that, based on its experience since 1989 in overseeing BDTSs, including the proposal of Rule 17a-23, a separate regulatory structure governing proprietary trading systems was not necessary at this time. See Securities Exchange Act Release No. 33621 (Feb. 14, 1994), 59 FR 8379.
9 See, e.g., Letter of ABA, at 1: Letter of HHG, at 1: Letter of ITG, at 1: and Letter of M&S, at 2.
10 See Letter of ABA. at 3; Letter of NASD, at 6.
11 See Letter of CLM/RMJ, at 3.
12 The extent of information currently accessible to the Commission, the history of the Commission's oversight of such systems, and other background information can be found in the Proposing Release See Proposing Release, supra note 3, 59 FR at 8369–71. Currently, BDTSs are subject to Commission oversight through broker-dealer registration, recordkeeping, and reporting requirements in the Act. In addition, sponsors of a number of BDTSs have obtained no-action assurances from the Division that it will not recommend enforcement action if the systems operate without registering as exchanges. These staff no-action letters require supplemental recordkeeping and reporting by the sponsor as a condition of the no-action position. See Proposing Release, supra note 3, 59 FR at 8369. The Rule does not address the issue of whether a particular trading system may be required to register as a national securities exchange, clearing agency, or other self-regulatory organization. Sponsors of BDTSs seeking relief from exchange, clearing agency, and other registration requirements may continue to request no-action positions from the Division.
13 See Proposing Release, supra note 3. 59 FR at 8369–70.
14 For example, in its Market 2000 Study, the Division advocated improving transparency for limit orders and after-hours trading, order-exposure rules, disclosure of broker-dealer order-handling practices, assessment of market quality by users of automated routing systems, and surveillance of third market trading. Market 2000 Study, supra. note 6, at 16–32. The Commission's consideration of each of these issues is directly affected by its understanding of different trading mechanisms, including BDTSs. In particular, the Commission must examine how, and the extent to. which, order flow is directed to different trading mechanism, the extent to which orders entered into different trading mechanisms are integrated into national quotation and trade reporting systems, the extent to which various trading mechanisms offer price improvement, and the order handling and execution practices of different trading mechanisms. Information reported pursuant to the Rule will assist the Commission in understanding how BDTSs operate and how they interact, and are integrated, with other market participants and mechanisms, and consequently will assist the Commission in evaluating these issues.
15 See Proposing Release, supra note 3, 59 FR at 8370.
16 Three commenters discussed the competitive implications of the Commission's adoption of a recordkeeping and reporting rule applicable to BDTSs. See Letter of ABA. at 2; Letter of NASD, at 5; and Letter of NYSE, at 2–4. Two of these commenters, the NASD and NYSE, opposed the Commission's determination not to adopt previously proposed Rule 15C2–10, which would have subjected sponsors to a number of procedural and substantive requirements. Cf. Securities Exchange Act Release No. 26708 (April 13, 1989). 54 FR 15429; Proposing Release, supra note 3, 59 FR at 8369.
17 See Proposing Release, supra note 3, 59 FR at 8370–71.
18 See Letter of ABA, at 2; Letter of NASD, at 5.
19 See Letter of Instinet, at 2–4.
20 The Rule defines a sponsor as "any entity that organizes, operates, administers, or otherwise directly controls a broker-dealer trading system." In addition, the Rule includes within this term any registered broker-dealer that regularly executes transactions on behalf of participants of a system operated by a non-registered entity. See Proposing Release, supra note 3, 59 FR at 8371
21 As noted in the Proposing Release, absent an exemption from or exception to the broker-dealer registration provisions of the Act, the types of activities conducted by BDTSs can be lawfully conducted only by a broker-dealer registered with the Commission pursuant to the Act. See Proposing Release, supra note 3, 59 FR at 8371. The Commission notes that the term "registered broker or dealer" is defined in Section 3(a)(48) of the Act, and includes the majority of broker-dealers. The term does not include government securities brokers or government securities dealers registered under Section 15C of the Act, which are required to comply with the recordkeeping and reporting requirements promulgated by the Department of the Treasury, 17 CFR 400 et seq., under the Government Securities Act of 1986, 15 U.S.C. 78o-5. Accordingly, the Rule would not apply to systems sponsored by broker-dealers registered solely under Section 15Cof the Act. In addition, the Rule would not apply to operators of systems that do not involve activities requiring broker-dealer registration. See Letters regarding Farmland Industries. Inc. (Aug. 26, 1991); Troy Capital Services, Inc. (May 1, 1990); Real Estate Financing Partnership (May 1, 1990); Ivestex Investment Exchange, Inc. (April 9, 1990): and Petroleum Information Corporation (Nov. 28, 1989). Cf. Securities Exchange Act Release No. 27017 July 11, 1989), 54 FR 30013, text accompanying n.66.
22 See, e.g., Letter of NASD, at 7 The Proposed Rule defined "broker-dealer trading system" as:
(i) any system that automates the execution of orders to buy or sell securities based on quotations of the system sponsor or its affiliates (whether such quotations are disseminated through the system, a quotation consolidation system operated pursuant to a plan approved by the Commission under Section 11A of the Act, an electronic interdealer quotation system operated by a registered national securities association, or otherwise or
(ii) any system that both automates the dissemination or collection of quotations, orders to buy or sell securities, or indications by any person announcing a general interest in buying or selling a security, submitted by entities other than the system sponsor and its affiliates, and provides a mechanism for matching or crossing, or for otherwise facilitating agreement between participants to the basic terms of a purchase or sale of a security through use of the system.
See Proposing Release, supra note 3, 59 FR at 8374.
23 See Letter of ABA, at 3; Letter of NASD, at 6.
24 See Letter of CLM/RMJ, at 3.
25 One commenter noted that the Proposing Release discussed other systems that the Proposed Rule would not encompass, but that were not expressly excluded from the definition of BDTS. The commenter requested that the Commission reconcile the Rule with the excluded systems described in the Proposing Release. See Letter of ALIA, at 3–4. Given the ongoing evolution of automated trading systems, however, the Commission believes it would be impractical to attempt to enumerate all types of systems that would not be considered "broker-dealer trading systems" under the Rule. In view of this, the Rule as adopted does not contain express exclusions.
26 The Proposed Rule excluded certain order routing systems. See Proposing Release, supra note 3. 59 FR at 8372 (Sections (b)(2)(ii)(A) and (B) of the Proposed Rule). These systems do not meet the requirements of the Rule as adopted, and therefore are not subject to the Rule. Specifically, systems that only allow participants to post trading interest, or only route orders to the execution facilities of established markets or other broker-dealers do not affect the purchase or sale of a security between system participants or between a system participant and the system sponsor through the system.
27 The Commission also notes in this context that transactions resulting from orders entered into the system through the sponsor's trading personnel would be considered to be executed through the system to the same extent as trades entered directly by system participants. One commenter noted that certain systems may permit the system sponsor to execute trades manually and to enter the matched trade into the system for reporting and other execution related activities. See Letter of M&S, at 2. The commenter suggested that system sponsors should not be required to segregate out such trades for purposes of the recordkeeping and reporting requirements of the Rule. Neither the Rule nor Form 17A-23 requires a system sponsor to segregate transaction records or reports based on the method by which the order was accepted into the system (i.e., telephone, computer terminal, etc.). System sponsors would not be required, therefore, to segregate out manually handled trades. The Commission expects, however, that a system's ability to process manually handled orders would be described in the system sponsor's filings pursuant to Part I of Form 17A-23.
28 The Commission uses the term "bulletin board systems" in this context to mean only those systems that allow participants to announce their trading interest, but do not provide further opportunity to interact with the system or the system sponsor to execute transactions. Such systems do not allow participants to agree to the terms of a transaction "through use of the system"; participants must contact each other outside of system facilities or the system sponsor to conclude a transaction. Therefore, such systems do not meet the definition of a BDTS under the Rule, and the Rule would not apply to these systems.
29 Although the Commission requested comment on whether the Proposed Rule should apply to "non-execution" systems, no commenter suggested that such systems be subject to the Rule. See Proposing Release, supra note 3, at 8373.
30 See Letter of ABA, at 3; Letter of NASD, at 5–6.
31 See Letter of NASD, at 6.
32 See Letter of NYSE, at 2.
33 The NASD in its comment letter suggested that market-maker execution systems should be distinguished from other BDTSs because the executions provided by a market-maker are based on the market-maker's own quotes, subject to its best execution obligations and affect the market-maker's own inventory. According to the NASD, other BDTSs permit the direct interaction of customer orders or provide for the quotations of multiple market-makers and are thus more akin to the functions performed by traditional markets. See Letter from NASD, at 6. The Commission is not persuaded that this difference in operation is a sufficient basis on which to exclude market-maker systems from the Rule. A broker-dealer firm sometimes trades for its own account as dealer and sometimes for the account of its customers as broker: in either case, the broker-dealer uses its facilities to bring together buyers and sellers with the intent of effecting a securities transaction. See Securities Exchange Act Release No. 27611 (Jan. 12, 1990), 55 FR 1890, 1898.
34 See Letter of CML/RMJ, at 3–5.
35 Id. In addition to CML/RMJ, one other sponsor of a system trading non-equity securities commented on the Proposed Rule. See Letter of Intervest.
36 See 17 CFR 240.17a23(c)(1)(ii)(B) and 249.636, Form 17A-23, Part II, 1.
37 See Letter of ABA, at 5–6: Letter of NASD, at 1–7; Letter of NYSE. at 1–2, 4.
38 See Letter of NASD, at 1–4; Letter of NYSE, at 1–2, 4. See also, Letter of ABA, at 5–6.
39 See Letter of ABA, at 5–6; Letter of NASD, at 5; Letter of NYSE, at 4.
40 See Securities Exchange Act Release No. 35123 (December 20, 1994). The amendments expand the category of proposed role changes that may become effective upon filing under Section 19(b)(3)(A) of the Act to include certain changes to existing systems and other noncontroversial filings.
41 See Letter of NASD, at 7 Cf Letter of SIA, at 2.
42 See Letter of ABA, at 3 and Letter of NASD, at 6.
43 See Letter of CLM/RMJ, at 3–1.
44 See Proposing Release, supra note 3. 59 FR at 8368–69.
45 Staff of the Division met with representatives of the NASD to discuss its use of the information provided by the records maintained pursuant to the Rule and the reports filed pursuant to Form 17A-23. The Commission expects that the NASD and other SROs that have the responsibility to examine and otherwise oversee BDTSs will use such information to tailor their oversight of BDTSs to reflect the distinctive features of automated broker-dealers.
46 See Proposing Release, supra note 3. 59 PR at 8370–71.
47 See Letter of ABA, at 5; Letter of CLM/RMJ, at 5; Letter of HHG. at 3–4; Letter of Instinet, at 6–7; Letter of ITG, at 2; Letter of NASD, at 7–8; and Letter of SIA, at 3.
48 See Letter of ABA, at 4; Utter of HHG, at 3; and Letter of Instinet, at 8–9.
49 See Letter of ABA, at 4 and Letter of Instinet, at 8–9. One commenter questioned the use of the term "quotations" in the Proposed Rule to refer to trading interest entered into an automated system, noting that its system users place "orders," not "quotations." See Letter of Instinet, at 8. The Commission does not believe that such distinctions between the terms "order" and "quotation" are relevant for purposes of this Rule.
50 A corresponding requirement in Form 17A-23, Part II, has been modified as well, for the reasons discussed above with regard to modification of the recordkeeping requirement in the Rule.
51 The Rule defines "system order" as any order or other communication or indication submitted by any system participant for entry into the system announcing an interest in purchasing or selling a security. The Rule also clarifies that the term "system order" does not include inquiries or indications of interest that are not entered into the system. 17 CFR 240.17a23(b)(4).
52 The Commission expects sponsors that intend to fulfill this requirement by retaining and reporting statistics other than system orders will contact staff of the Division to discuss which statistics the sponsor wishes to retain and report instead.
53 See Letter of ITG, at 2.
54 See Letter of ABA, at 4; Letter of Instinct, at 10; and Letter of ITG, at 2.
55 In the Proposing Release, the Commission solicited comments on the appropriate interval at which sponsors should file reports. See Proposing Release, supra note 3. 59 FR at 8373. No commenter addressed this issue. One commenter, however, requested that the Commission extend the time period for filing quarterly reports from 20 calendar days to 30 calendar days after the calendar quarter. See Letter of Instinet, at 11. The Rule has been modified accordingly.
56 The Commission has determined that summary trading information filed pursuant to Part II of Form 17A-23 are not critical to the SROs' routine oversight of BDTSs, although such information is useful for the Commission for the reasons discussed herein and may be useful to SROs for non-routine oversight of BDTS sponsors. Accordingly, the Commission has revised the Rule to require BDTS sponsors-to file reports pursuant to Part D of Form 17A-23 routinely with the Commission and to make such reports available to the appropriate SRO upon request.
57 See Letter of ABA, at 4–5 and Letter of Instinet, at 12–13.
58 See Letter of ABA, at 4–5.
59 See, e.g., Exchange Act Section 15A(b), 15 U.S.C. 78o-3(b).
60 See Letter of ABA, at 4; Letter of M&S, at 3.
61 Such reports constitute examination, operating or condition reports of a financial institution, and, as such, are exempt from disclosure under FOIA pursuant to 5 U.S.C. § 552(b)(8).
62 In addition, other exemptions from FOIA may be available, including the exemption provided by Section 552(b)(4) for trade secrets and commercial or financial information obtained from a person and privileged or confidential. The availability of this exemption depends upon a factual analysis which may require substantiation by the sponsor of the reporting BDTS.
63 See Letter of Instinet, at 11 and Letter of ITG, at 2.
64 Sponsors of existing BDTSs must submit a system description that is current as of the date of filing.
65 See note 12, supra.
66 15 U.S.C. 78w(a)(2).
67 See Availability of Reports to SROs, supra.