Thursday, July 07, 2011

Equity Trader Alert #2011 - 35
NASDAQ OMX U.S. Services Agreement Addendum Pursuant to the SEC Market Access Rule 15c3-5

What you need to know:


What is the SEC Market Access Rule?

The Securities and Exchange Commission (the “Commission”) has adopted Rule 15c3-5, “Risk Management Controls for Brokers or Dealers with Market Access” (“Market Access Rule” or “Rule”). The Market Access Rule requires broker-dealers to establish, document and maintain a system of risk management controls and supervisory procedures that are reasonably designed to systematically limit the financial exposure of the broker dealer that could arise as a result of market access and ensure compliance with all regulatory requirements that are applicable in connection with market access. The Rule becomes effective on July 14, 2011, subject to certain extensions of the effective date that have been approved by the Commission.

How is NASDAQ impacted by the Market Access Rule?

As routing broker-dealers, NASDAQ Execution Services and NASDAQ Options Services (collectively “NASDAQ”) are subject to the requirements of the Rule. Section 15c3-5(2) of the Rule requires that broker/dealer risk management controls and supervisory procedures be reasonably designed to ensure compliance with all regulatory requirements, including preventing the entry of orders unless such orders are in compliance with all regulatory requirements that must be satisfied on a pre-order entry basis. NASDAQ has a limited exemption to these provisions under the Market Access Rule for its routing of orders for the purpose of accessing other trading centers with protected quotations in compliance with Rule 611 of Regulation NMS for NMS stocks and the provisions of the Options Linkage Plan for listed options. However, for all other types of order routing, that exemption is not available. NASDAQ is required to perform checks on those orders employing routing strategies that are not within the exemption (“Non-Exempt Routing Strategies”).

How will the NASDAQ router change when the rule goes into effect?

  1. Consistent with the requirements of the rule, NASDAQ will apply additional erroneous and duplicative order checks to routable orders. Orders deemed by the NASDAQ router to be erroneous or duplicative will be cancelled or rejected.
  2. Use of non-exempt routing strategies and directed ISO orders will be restricted to firms that have completed the routing addendum and whose written policies and procedures have been satisfactorily reviewed and approved.
  3. If a firm has not completed the addendum and policy submission:
    • Orders for exempt routing strategies will route normally
    • Orders for non-exempt routing strategies will be treated as non-routable orders
    • Directed ISO orders will be rejected

Which NASDAQ routing strategies are considered “exempt”?

NASDAQ Execution Services, the routing broker for NASDAQ, has a limited exemption under the Market Access Rule for the purpose of accessing other trading centers with protected quotations in compliance with Rule 611 of Regulation NMS. Consequently, the following routing strategies are exempt from the regulatory risk checks:

  • CART
  • DOTI
  • DOTZ
  • LIST
  • MOPP
  • SKIP
  • SKNY
  • Directed orders that are not marked ISO

Which NASDAQ routing strategies are considered “non-exempt”?

All other routing strategies, including SCAN and STGY, are non-exempt.

What is the NASDAQ Routing Agreement Addendum?

Rule 15c3-5(d)(1) permits NASDAQ to allocate specific regulatory risk management controls and supervisory procedures to its broker/dealer customers where there is a reasonable basis for determining that the broker/dealer, based on its position in the transaction and relationship with the ultimate customer, has better access to that ultimate customer and its trading information such that it can more effectively implement the specified regulatory risk management controls and supervisory procedures. Such allocation must be made through a written contract and after a thorough due diligence review.

Accordingly, NASDAQ requests that members execute the Addendum to U.S. Services Agreement (the “Addendum”). Please check the appropriate boxes on the form where indicated and submit the signed form and the documents and information as enumerated in the attached request to NASDAQ OMX Membership at membership@nasdaqomx.com.

Do proprietary trading firms need to submit written policies and procedures?

Yes, proprietary trading firms seeking to use non-exempt routing strategies must submit relevant policies and procedures.

What do I need to do?

Please be advised that both receipt and acceptance of a signed Addendum, and a determination by NASDAQ that the member’s written supervisory policies and procedures are reasonably designed to permit allocation of the regulatory controls, must occur prior to July 14, 2011. To ensure adequate time to review the requested materials, please submit them no later than the close of business on Friday, July 8, 2011.

Where can I get additional information?


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