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88-103 Adoption of Rule Amendments - Effective Immediately Professional Trading in SOES

SUGGESTED ROUTING*

Senior Management
Institutional
Legal & Compliance
Operations
Trading

*These are suggested departments only. Others may be appropriate for your firm.

EXECUTIVE SUMMARY

The Securities and Exchange Commission (SEC) recently approved amendments to the Rules of Practice and Procedures for the Small Order Execution System (SOES or SOES Rules) proposed by the NASD to prohibit members from entering orders in SOES on behalf of a professional trading account. The rule amendments are designed to eliminate the abuse of SOES by Order Entry Firms that use the system to execute transactions for professional trading accounts.

The amendments are effective immediately.

BACKGROUND AND ANALYSIS

In 1984, SOES was created by the NASD to provide an efficient and economical facility for the execution of small, retail orders in NASDAQ securities by public customers. The system was intended to further the investment objectives of retail customers, who typically have longer-term trading goals than those of professional traders. Thus, SOES is available only for retail customer orders of specified, small size, and the SOES Rules prohibit members from breaking up larger orders for execution in SOES. In recent months, the NASD has become aware of instances in which some firms have been engaging in practices that could impact the viability of SOES. These practices include placing orders of professional traders or "day trades" through SOES. Most of these orders follow patterns of professional trades in that offsetting purchases and sales are made during the trading day.

The NASD is concerned that the execution in SOES of transactions of professional traders may distort the price at which retail investors are able to obtain execution of their transactions. To remedy the problem, earlier this year the NASD implemented SOES rule interpretations that prohibit certain securities industry professionals from entering orders into SOES for their personal accounts or for accounts of members of their immediate families. Other SOES rule interpretations permit the NASD to aggregate SOES trades entered within any five-minute period for accounts controlled by an associated person or a customer for determining compliance with SOES order-size limits.1

EXPLANATION OF AMENDMENTS

On December 15, 1988, the SEC approved the following amendments to SOES Rules to eliminate the entering and execution of certain orders in SOES by SOES Order Entry Firms. The new rule changes do the following:

  • Prohibit a member or person associated with a member from entering orders in SOES on behalf of a professional trading account.
  • Provide that compliance with this require ment is presumed if (1) the member instructs its as sociated persons that they shall not knowingly ac cept an order for SOES from a professional trading account and (2) the member has not been advised by the NASD that the account has been classified as a professional trading account.
  • Require members, upon written request from the NASD, to report information to the NASD concerning orders entered into SOES.
  • Specify that the NASD may identify accounts as professional trading accounts.
  • Define the term "professional trading account" to mean:
    (i) an account in which five or more day trades have been executed through SOES during any trading day; or
    (ii) an account in which there has been a professional trading pattern in SOES as demonstrated by a pattern or practice of executing day trades, executing a high volume of day trades in relation to the total transactions in the account, or executing a high volume of day trades in relation to the amount and value of securities held in the account.
  • Define the term "day trade" to mean the execution of offsetting trades in the same security for generally the same size during the same trading day.

The NASD believes that the amendments to the SOES Rules will eliminate the abusive practice of SOES members or persons associated with members using SOES for the execution of transactions for professional trading accounts. Such a practice is inconsistent with the original purpose of SOES, to facilitate the execution of small retail orders by public customers.

The NASD's automated surveillance systems are geared to monitor member compliance with these new requirements on an on-line basis.

The rule amendments shall be effective immediately.

Any questions regarding the notice may be directed to Dennis C. Hensley.Vice President and Deputy General Counsel, NASD, at (202) 728-8245, or Eneida Rosa, Assistant General Counsel, NASD, at (202) 728-8284.

RULES OF PRACTICE AND PROCEDURES FOR THE SMALL ORDER EXECUTION SYSTEM

(Note: New language is underlined.)

a) DEFINITIONS
10. The term "professional trading account" shall mean
(i) an account in which five or more day trades have been executed through SOES during any trading day; or
(ii) an account in which there has been a professional trading pattern in SOES as demonstrated by a pattern or practice of executing day trades, executing a high volume of day trades in relation to the total transactions in the account, or executing a high volume of day trades in relation to the amount and value of securities held in the account.
11. The term "day trade" or "day trading" shall mean the execution of offsetting trades in the same security for generally the same size during the same trading day.
c) PARTICIPATION OBLIGATIONS IN SOES
3. SOES Order Entry Firms
(E)
(i) No member or person associated with a member shall enter any order for execution in SOES on behalf of a professional trading account.
(ii) A member will be presumed to be in compliance with Subsection (i) if (a) the member instructs persons associated with the member that no such person shall knowingly accept any order for entry into SOES from a professional trading account, and (b) the Association has not notified the member that the account has been classified as a professional trading account pursuant to subsection (iii) hereof.
(iii) Upon receiving written notice from the Association, a member shall report to the Association information concerning transactions entered into SOES by the firm and such other information as the Association may request. Based upon such information, the Association may identify to the member specific accounts as professional trading accounts.

1 See NASD Notices to Members 88-61, August 25, 1988, Supplement.



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