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FINRA Issues Guidance With Respect to Amendments to Trade Reporting Rules

May 19, 2009

FINRA recently published updates to its Trade Reporting Frequently Asked Questions to address, among other things, amendments to the Trade Reporting Rules that become effective on August 3, 2009. The amendments, which were approved by the SEC in November 2008,1 replace the decades-old, current market-maker based reporting structure for transactions in equity securities with an “executing party” structure and require firms with trade reporting obligations acting in a riskless principal or agency capacity to submit non-tape reports to identify the parties to a trade. As the effective date approaches, FINRA is providing guidance for determining which firm in a transaction is the “executing party” and the requirement to submit the newly required non-tape reports. The amendments and guidance raise serious considerations for member firms, including the potential need to re-program systems and to re-visit certain contractual arrangements. 

Determining the “Executing Party”

The amended rules require that, in a transaction between two member firms, the “executing party” is responsible for reporting the trade to FINRA. The “executing party” is the member firm that receives an order for handling or execution or is presented an order against its quote, does not subsequently re-route the order, and executes the transaction. In most instances, the “executing party” is readily identifiable. For instance, a member that receives an order and executes the order without any further action is deemed to be the “executing party.” Likewise, a member that matches as agent two orders and executes the transaction is deemed to be the “executing party” with the trade reporting obligation. 

In general, a member that is presented an order against its quote is deemed to be the “executing party.” In an electronically negotiated and accepted trade, however, the party that electronically accepts and executes the trade at the negotiated price is the “executing party” regardless of which firm displayed the initial quote. By way of example, Firm A displays a quote and Firm B electronically routes an order to Firm A at a price inferior to Firm A’s quote. Firm A, through the use of electronic means, communicates a different price that is accepted electronically by Firm B. In this instance, Firm B is the “executing party” and has the trade reporting obligation. 

The Trade Reporting FAQs provide guidance for determining the “executing party” in seven scenarios. The complete Trade Reporting FAQs is located at http://www.finra.org/Industry/Regulation/Guidance/p038942. The FAQs related to this issue are attached here to.

Sell-Side Trade Reporting Obligation

In those limited circumstances in which it is not clear which firm should be deemed the “executing party” for trade reporting purposes (e.g., manually negotiated trades between two members via telephone), the firm representing the sell-side must report the transaction. In this scenario, the firm representing the sell-side may by agreement shift the trade reporting obligation. To be clear, a firm may only shift its trade reporting obligation by agreement only in those instances in which it is unclear which firm is the “executing party.” In order to shift its trade reporting obligation, the sell-side firm must contemporaneously document the agreement by, for instance, preparing contemporaneous notes of a telephone conversation or making a notation on the order ticket. The mere acceptance of a trade through the trade comparison and acceptance functionality would not satisfy the requirement for contemporaneous documentation. 

If the trade reporting obligation is shifted pursuant to a contemporaneously documented agreement, the sell-side is not responsible for any reporting deficiencies (i.e., failure to report in a timely manner). A previously executed give-up agreement can satisfy the requirement of a contemporaneously documented agreement if the agreement expressly states that in a manually negotiated trade between Firm A and Firm B, where Firm A as the sell-side has the reporting obligation, the parties agree that Firm B will have the reporting obligation. Since most current give-up agreements do not contemplate this scenario, give-up agreements will likely need to be amended or re-executed. Absent a specific provision, the buy-side may continue to report on behalf of the sell-side, but the sell-side firm still has the trade reporting obligation and is responsible for the trade report submitted on its behalf.  

Non-Tape Reports

The amendments also require that any firm with the obligation to report the trade under FINRA rules (i.e., the “executing party”) that is acting in a riskless principal or agency capacity on behalf of one or more other member firms submit to FINRA a non-tape report(s) to identify such other member firm(s) as a party to the transaction. The non-tape reporting requirement applies only to the firm that has the responsibility under FINRA rules to report the trade to FINRA for tape purposes. This requirement is akin to the current requirement to submit a non-tape report to reflect the offsetting leg under the alternative approach to riskless principal trade reporting. Member firms’ obligations with respect to riskless principal transactions remain unchanged. 

A firm that is acting on behalf of another member firm would have no separate reporting obligation under the amendments if the other member firm is identified in the initial (tape) trade report. Moreover, the requirements do not apply when a firm acts as agent or riskless principal on behalf of a non-member firm, or to transactions that are executed on and reported through an exchange. The specific FAQs related to this issue are attached hereto.

As a reminder, the submission of non-tape reports is not subject to the 90-second reporting requirement under FINRA trade reporting rules. As a result, firms generally have until the end of the day on trade date to submit non-tape reports, unless other FINRA rules require a shorter reporting time. 

Conclusion

Firms need to be aware of these important changes and should begin making necessary modifications and perform testing in advance of the effective date. In addition, firms may need to revisit their existing give-up agreements to ensure that trade reporting obligations are properly delegated.

For assistance, please contact the following lawyers in the Securities Area: 

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Securities Area
roger.joseph@bingham.com, 617.951.8247

Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area
timothy.burke@bingham.com, 617.951.8620

Endnotes

1 See Securities Exchange Act Release No. 58903 (Nov. 5, 2008) (SR-FINRA-2008-011); Securities Exchange Act Release No. 58903A (Nov. 13, 2008).

Circular 230 Disclosure: Internal Revenue Service regulations provide that, for the purpose of avoiding certain penalties under the Internal Revenue Code, taxpayers may rely only on opinions of counsel that meet specific requirements set forth in the regulations, including a requirement that such opinions contain extensive factual and legal discussion and analysis. Any tax advice that may be contained herein does not constitute an opinion that meets the requirements of the regulations. Any such tax advice therefore cannot be used, and was not intended or written to be used, for the purpose of avoiding any federal tax penalties that the Internal Revenue Service may attempt to impose.

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