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87-69 Front-Running of Blocks—Interpretation of the Board of Governors on Article III, Section 1 of the Rules of Fair Practice

TO: All NASD Members and Other Interested Persons

SUMMARY

The NASD Board of Governors believes it is necessary to clarify its policy with respect to trading in stock and index options by members or persons associated with a member while in possession of material, non-public market information concerning imminent transactions of block size. Under certain circumstances, this type of activity, generally described as "front-running," shall constitute conduct inconsistent with just and equitable principles of trade in violation of Article III, Section 1 of the NASD Rules of Fair Practice.

Pursuant to the provisions of Article VII, Section l(a)(2) of the NASD By-Laws and Article I, Section 3 of the NASD Rules of Fair Practice, the NASD Board of Governors has adopted an Interpretation of Article III, Section 1 of the NASD Rules of Fair Practice clarifying its position. The text of the Interpretation is attached.

Although the Board believes it is important to provide guidelines describing the kind of conduct that will not be permitted, members and persons associated with a member should be aware that any conduct that is not consistent with their fiduciary responsibilities in this area would be a violation of Article III, Section 1 of the Rules of Fair Practice. Members and persons associated with a member should also be aware that such prohibitions also apply when members or persons associated with a member provide material, non-public market information to customers who then trade on the basis of the information.

* * * * *

The NASD will continue to address possible front-running violations on a case-by-case basis, taking into consideration the facts in each situation.

Questions concerning this notice should be directed to James Cangiano, Director, NASD Market Surveillance, at (202) 728-8186, or Eneida Rosa, Assistant General Counsel, NASD Office of General Counsel, at (202) 728-8294.

Sincerely,

Frank J. Wilson
Executive Vice President and General Counsel

Attachment

ARTICLE III SECTION 1 OF THE NASD'S RULES OF FAIR PRACTICE

• • •Interpretation of the Board of Governors__________________________________

Front-Running Policy

It shall be considered conduct inconsistent with just and equitable principles of trade for a member or person associated with a member, for an account in which such member or person associated with a member has an interest, or for an account with respect to which such member or person associated with a member exercises investment discretion, or for certain customer accounts, to cause to be executed:

(1) an order to buy or sell an option when such member or person associated with a member causing such order to be executed has material, non-public market information concerning an imminent block transaction in the underlying security, or when a customer has been provided such material, non-public market information by the member or any person associated with a member, or
(2) an order to buy or sell an underlying security when such member or person associated with a member causing such order to be executed has material, non-public market information concerning an imminent block transaction in an option overlying that security, or when a customer has been provided such material, non-public market information by the member or any person associated with a member,
prior to the time information concerning the block transaction has been made publicly available.

The violative practice noted above may include transactions that are executed based upon knowledge of less than all of the terms of the block transaction, so long as there is knowledge that all of the material terms of the transaction have been or will be agreed upon imminently.

These general prohibitions shall not apply to transactions executed by member participants in automatic execution systems in instances where participants must accept automatic executions.

These prohibitions also do not include situations in which a member or person associated with a member receives a customer's order of block size relating to both an option and the underlying security. In such cases, the member and person associated with a member may position the other side of one or both components of the order. However, in these instances, the member and person associated with a member would not be able to cover any resulting proprietary position(s) by entering an offsetting order until information concerning the block transaction has been made publicly available.

The application of this front-running policy is limited to transactions that are required to be reported on the last-sale reporting systems administered by NASDAQ, CTA, or OPRA. Information as to a block transaction shall be considered to be publicly available when it has been disseminated via the tape or high-speed communications line of one of those systems or of a third-party newswire service.

A transaction involving 10,000 shares or more of an underlying security or options covering such number of shares is generally deemed to be a "block" transaction, although a transaction of less than 10,000 shares could be considered a block transaction in appropriate cases. A block transaction that has been agreed upon does not lose its identity as such by arranging for partial executions of the full transaction in portions which themselves are not of block size if the execution of the full transaction may have a material impact on the market. In this situation, the requirement that information concerning the block transaction be made publicly available will not be satisfied until the entire block transaction has been completed and publicly reported.


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