SEC Votes to Propose Large Trader Reporting System and Amendments to Regulation NMS Related to Access to Options Quotations

April 16, 2010

On April 14, 2010, the SEC unanimously voted to propose new rules, pursuant to Section 13(h) of the Securities Exchange Act of 1934 (the “Exchange Act”), that would require large traders, as defined under the proposed rule, to identify themselves to the SEC which would then assign each trader a unique identification number. Large traders would provide this number to their broker-dealers, who would be required to maintain transaction records for each large trader and report that information to the SEC upon request.1 The large trader reporting rule would require broker-dealers to change their trading systems to include large trader identifying numbers in their trading records, and to monitor customer trades to determine if those customers should be filing as large traders. The SEC also voted to propose an amendment to Rule 610 of Regulation NMS that would (1) prohibit unfairly discriminatory terms that inhibit efficient access to quotations on options exchanges and (2) place limits on fees for the execution of an order against any quotation in an options series that is the best bid or best offer of an exchange.2

The SEC noted that the actions proposed at the open meeting are part of the SEC’s ongoing effort to promote fairness and efficiency in the U.S. securities markets. The SEC already has proposed a series of other rules that it says are designed to increase fairness and efficiency, including a proposal to ban marketable flash orders, a proposal to bring greater transparency to dark pools, a proposal to prohibit unfiltered access to markets, and a concept release seeking comment on a variety of market structure issues.

I. Large Trader Reporting System


A. Background

The proposed large trader reporting system (“LTRS”) would enable the SEC to readily identify large traders operating in the U.S. securities markets, and obtain basic identifying information on each large trader, its affiliates, its accounts, and its transactions. The SEC noted that rapid technological advances have had an impact on trading strategies and on how some broker-dealers, including high frequency traders, handle the trading activity of those large traders. In particular, the SEC noted that in today’s securities markets trades are transacted in milliseconds and dispersed among many trading centers, which allows large market participants to employ sophisticated trading methods to trade electronically in substantial volumes at high speed in multiple venues. To keep pace with modern trading methods and so that it can better oversee the U.S. securities markets and support its regulatory and enforcement efforts, the SEC stated that it should have a mechanism to efficiently track and promptly obtain trading records concerning large traders.

Currently, the SEC collects trade information from broker-dealers through the electronic blue sheets system (“EBS”). Through the EBS the SEC collects through clearing firms basic trade information, such as the security traded, the trade date, price, transaction size, and a list of the parties involved.3 The SEC stated during the open meeting, however, that it believes that the EBS is too narrowly focused on investigations involving trading in particular securities to be generally conducive to larger-scale market reconstructions and analyses involving numerous stocks during periods of peak trading volume. Therefore, the SEC believes it needs additional tools, such as the large trader reporting rule, in order to more fully supervise the U.S. securities markets.

B. Requirements Under the Proposal

1. Filing a Form

Under the proposed LTRS, traders who engage in substantial levels of trade activity would be required to identify themselves to the SEC by filing a form with the agency. The proposed definition of a large trader is based on the definition of “large trader” in Section 13(h)(8)(A) of the Exchange Act. Generally, the proposed rule defines a “large trader” as any person that directly or indirectly, including through other persons controlled by such person, exercises investment discretion over one or more accounts and effects transactions for the purchase or sale of any NMS security for or on behalf of such accounts, by or through one or more registered broker-dealers, in an aggregate amount equal to or greater than (i) two million shares or $20 million during any calendar day, or (ii) 20 million shares or $200 million shares during any calendar month.4 When determining who would be subject to the proposed requirements as a “large trader,” the proposed definition is intended to focus, in more complex organizations, on the parent company of the entities that employ or otherwise control the individuals that exercise investment discretion. The SEC stated that the purpose of this focus is to narrow the number of persons that would need to self-identify as “large traders” while allowing the SEC to identify the primary institutions that conduct a large trading business. If a natural person or a subsidiary entity within a large organization independently qualifies as a large trader, but the parent company files to identify itself as the large trader, then the natural person or subsidiary entity would not be required to separately identify itself as a large trader, or be subject to the other requirements that would apply to large traders.

2. Getting an Identification Number

The SEC would assign each large trader a unique identification number (“LTID”), which would allow the SEC to efficiently identify and analyze trading activity conducted by the large trader. The SEC estimated that the requirement would capture the largest 400 or so market participants. A large trader would be required to disclose to its broker-dealers its LTID and highlight all of the accounts held by that broker-dealer through which the large trader trades. A broker-dealer also would be required to identify itself as a large trader if it effected transactions for a proprietary account (or other account over which it exercises investment discretion) at or above the identifying activity level. Further, the proposed rule would require large traders to provide, upon request, additional information to the SEC that would allow the SEC to further identify the large trader and all accounts through which the large trader effects transactions.

3. Recordkeeping and Reporting

The proposed LTRS would require broker-dealers to maintain and report data that is similar in scope to the information required under the current EBS, with the additional obligation that the firm report its LTID and note the time that a transaction occurs. This requirement will require broker-dealers to create a data field to track the LTIDs of its clients. The proposed LTRS contemplates that broker-dealers would use the same technology to report the information required by the proposed rule, that they use under the EBS system. In addition, the proposed rule would require broker-dealers to monitor whether their customers meet the threshold that define a “large trader” (based on transactions completed at the broker-dealer) in order to facilitate compliance by their customers with the requirement to identify themselves as large traders to the Commission.

4. Ready Access to Data

The proposed rule would require transaction data to be available to the SEC upon request the morning after the day on which the transactions were effected. The SEC could use this next-day access to reconstruct market activity promptly and perform other trading analyses, as well as to assist in investigations of potential manipulative, abusive, or otherwise-illegal trading activity.

The proposed rule would impose certain duties on broker-dealers. In particular, the proposed rule would impose recordkeeping and reporting requirements on the following: registered broker-dealers that are large traders; registered broker-dealers that, together with a large trader or unidentified large trader, exercise investment discretion over an account; and registered broker-dealers that carry accounts for large traders or unidentified large traders or, with respect to accounts carried by a non-broker-dealer, broker-dealers that execute transactions for large traders or unidentified large traders.5 Additionally, the proposed rule would require registered broker-dealers to implement procedures to encourage and foster compliance with the self-identification requirements of the proposed rule.

II. Amendments to Rule 610 of Regulation NMS — Options Quotations

In order to promote fair and efficient access to quotations, the SEC previously adopted Rule 610(a) of Regulation NMS to prohibit securities exchanges from imposing unfairly discriminatory terms that impede investor access to displayed quotations. The SEC’s proposal to amend Rule 610 of Regulation NMS (the “Proposed NMS Amendment”) would apply Rule 610(a)’s non-discriminatory standard to listed options.

The Proposed NMS Amendment also seeks to more closely align the actual cost of executing an options trade with the additional costs of accessing quotes on exchanges and the wide range of fees charged by different markets. The SEC noted that exchange-listed option prices often do not display the all-in cost of executing against an options quote. According to the SEC, in practice, the displayed quotation on an options exchange may not reflect the actual amount a person will pay to buy or sell the option. Instead, the person often incurs additional costs to conduct the transaction, including the cost of accessing the exchange’s quotation.

A. Extending Standards for Indirect Access

Currently, Rule 610(a) of Regulation NMS prohibits securities exchanges from imposing unfairly discriminatory terms that prevent or inhibit any person from obtaining efficient access to quotations in an NMS security displayed through an SRO trading facility. The Proposed NMS Amendment would extend this requirement to quotations in listed options traded through an options exchange. According to the SEC, the Proposed NMS Amendment is designed to remove barriers that an options exchange might establish to disadvantage non-members who seek to access listed options quotations on an exchange.

B. Limits on the Access Fees

In addition to extending the non-discriminatory standard to listed options, the SEC also is considering a proposal that would set limits on the fees that can be charged for accessing an exchange’s best bid or offer in a listed option. In particular, the proposed access fee limit seeks to (i) facilitate displayed quotations that are fair and useful; (ii) create more transparency in the cost of accessing quoted prices in listed options; and (iii) preclude an exchange from taking improper advantage of the requirement to protect displayed quotations by charging high access fees.

Under the Proposed NMS Amendment, the SEC would prohibit an options exchange from imposing, or permitting to be imposed, any access fees that exceed $0.30 per contract for the execution of an options order. The Proposed NMS Amendment would apply to any fee based on the incoming order against an exchange’s best bid or offer. Conversely, fees not triggered by the execution of orders against options quotations are not included in the fee limit imposed by the Proposed NMS Amendment. The SEC noted that the $0.30 fee cap is consistent with the current Regulation NMS, and was designed to ensure that the total cost of the transaction does not vary from the listed option price.

Comments on both the large trader reporting rule proposal and the options market rule proposal will be due in 60 days from publication of the proposals in the Federal Register, so by mid-June, 2010.

For additional information concerning this alert, please contact the following lawyers:

Amy Natterson Kroll, Partner, Broker-Dealer Group, 202.373.6118

David C. Boch, Partner, Broker-Dealer Group, 617.951.8485

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area, 617.951.8247

Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area, 617.951.8615

Timothy P. Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area, 617.951.8620

1 See Exchange Act Release No. 61908 (Apr. 14, 2010) available at:
2 See Exchange Act Release No. 61902 (Apr. 14, 2010) available at:
3 A good description of the EBS system can be found in Exchange Act Release No. 44494 (Jun. 29, 2001) available at:
4 This definition would exclude entities that trade non-NMS OTC equities, foreign securities, debt securities, options, or derivatives, unless those entities qualify as “large traders” based solely on their NMS equity trading activities.
5 The term “unidentified large trader” would be defined to mean “each person who has not complied with the identification requirements…of this rule that a registered broker-dealer knows or has reason to know is a large trader.”

This article was originally published by Bingham McCutchen LLP.