[Federal Register Volume 75, Number 78 (Friday, April 23, 2010)]
[Proposed Rules]
[Pages 21456-21498]
[FR Doc No: 2010-9025]

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Part III

Securities and Exchange Commission

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17 CFR Parts 240 and 249

Large Trader Reporting System; Proposed Rule

Federal Register / Vol. 75, No. 78 / Friday, April 23, 2010 /
Proposed Rules

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 249

[Release No. 34-61908; File No. S7-10-10]
RIN 3235-AK55

Large Trader Reporting System

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing new Rule 13h-1 and Form 13H under Section 13(h) of the
Securities Exchange Act of 1934 (``Exchange Act'') to establish a large
trader reporting system. The proposal is intended to assist the
Commission in identifying and obtaining certain baseline trading
information about traders that conduct a substantial amount of trading
activity, as measured by volume or market value, in the U.S. securities
markets. In essence, a ``large trader'' would be defined as a person
whose transactions in NMS securities equal or exceed two million shares
or $20 million during any calendar day, or 20 million shares or $200
million during any calendar month. The proposed large trader reporting
system is designed to facilitate the Commission's ability to assess the
impact of large trader activity on the securities markets, to
reconstruct trading activity following periods of unusual market
volatility, and to analyze significant market events for regulatory
purposes. It also should enhance the Commission's ability to detect and
deter fraudulent and manipulative activity and other trading abuses,
and should provide the Commission with a valuable source of useful data
to study markets and market activity.
    The proposed identification, recordkeeping, and reporting system
would provide the Commission with a mechanism to identify large traders
and their affiliates, accounts, and transactions. Specifically,
proposed Rule 13h-1 would require large traders to identify themselves
to the Commission and make certain disclosures to the Commission on
proposed Form 13H. Upon receipt of Form 13H, the Commission would issue
a unique identification number to the large trader, which the large
trader would then provide to its registered broker-dealers. Registered
broker-dealers would be required to maintain transaction records for
each large trader, and would be required to report that information to
the Commission upon request. In addition, registered broker-dealers
would be required to adopt procedures to monitor their customers for
activity that would trigger the identification requirements of the
proposed rule.

DATES: Comments should be submitted on or before June 22, 2010.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number S7-10-10 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F St., NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number S7-10-10. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and copying in the Commission's
Public Reference Room, 100 F St., NE., Washington, DC 20549 on official
business days between the hours of 10 a.m. and 3 p.m. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Richard R. Holley III, Senior Special
Counsel, at<PHONE_NUMBER>, Christopher W. Chow, Special Counsel, at
(202) 551-5622, or Gary M. Rubin, Attorney, at<PHONE_NUMBER>, Division
of Trading and Markets, Securities and Exchange Commission, 100 F
Street, NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

I. Introduction

    U.S. securities markets have experienced a dynamic transformation
in recent years. In large part, the changes reflect the culmination of
a decades-long trend from a market structure with primarily manual
trading to a market structure with primarily automated trading. Rapid
technological advances have produced fundamental changes in the
structure of the securities markets, the types of market participants,
the trading strategies employed, and the array of products traded. The
markets also have become even more competitive, with exchanges and
other trading centers offering innovative order types, data products
and other services, and aggressively competing for order flow by
reducing transaction fees and increasing rebates. These changes have
facilitated the ability of large institutional and other professional
market participants to employ sophisticated trading methods to trade
electronically in huge volumes with great speed. For example, high
frequency traders have become increasingly prominent at a time when the
markets are experiencing an increase in overall volume. Market analysts
have offered a wide range of estimates for the level of activity
attributable to high frequency traders, but these estimates typically
exceed 50% of total volume.\1\ Meanwhile, consolidated average daily
share volume and trades in NYSE-listed stocks increased from just 2.1
billion shares and 2.9 million trades in January 2005, to 5.9 billion
shares (an increase of 181%) and 22.1 million trades (an increase of
662%) in September 2009.\2\
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    \1\ See, e.g., Jonathan Spicer and Herbert Lash, Who's Afraid of
High-Frequency Trading?, Reuters.com, December 2, 2009, available at
http://www.reuters.com/article/idUSN173583920091202 (``High-
frequency trading now accounts for 60 percent of total U.S. equity
volume, and is spreading overseas and into other markets.''); Scott
Patterson and Goeffrey Rogow, What's Behind High-Frequency Trading,
Wall Street Journal, August 1, 2009 (``High frequency trading now
accounts for more than half of all stock-trading volume in the
U.S.''). See also Rob Iati, The Real Story of Trading Software
Espionage, Advanced Trading, July 10, 2009, available at http://advancedtrading.com/algorithms/showArticle.jhtml?articleID=218401501
(high frequency trading accounts for 73% of U.S. equity trading
volume). One source estimates that, five years ago, that number was
less than 25%. See Rob Curran & Geoffrey Rogow, Rise of the (Market)
Machines, Wall Street Journal, June 19, 2009, available at http://blogs.wsj.com/marketbeat/2009/06/19/rise-of-the-market-machines/.
The trend is clear that high frequency traders now play an
increasingly prominent role in the securities markets.
    \2\ See NYSE Euronext, Consolidated Volume in NYSE Listed Issues
2000-2009 (available at http://www.nyxdata.com/nysedata/NYSE/FactsFigures/tabid/115/Default.aspx). In addition, NYSE's average
speed of execution for small (100-499 shares) market orders and
marketable limit orders was 10.1 seconds in January 2005, compared
to 0.7 seconds in October 2009. See NYSE Euronext, Rule 605 Reports
for January 2005 and October 2009, available at http://www.nyse.com/equities/nyseequities/1201780422054.html. Consolidated average trade
size in NYSE-listed stocks was 724 shares in 2005, compared to 268
shares in January through October 2009. See NYSE Euronext,
Consolidated Volume in NYSE Listed Issues 2000-2009, available at
http://www.nyxdata.com/nysedata/NYSE/FactsFigures/tabid/115/Default.aspx.

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    With respect to market movements and volatility, 2008 marked the
third largest yearly decline for the Dow Jones Industrial Average
(``Dow'') since it was inaugurated in 1896, with the Dow finishing down
approximately 34% for the year. However, through the end of December
2009, the Dow had advanced approximately 19%.\3\ While such market
movements are pronounced in absolute terms, volatility and expectations
of volatility have fluctuated considerably. Notably, the CBOE VIX
volatility index (based on the S&P 500) marked a high of 80.86 on
November 20, 2008, but had fallen back to the low 20s by late 2009.\4\
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    \3\ Bloomberg L.P. ``Stock price graph for Dow Jones Industrial
Average 12/31/08 to 12/31/09.'' (2010) (18.82%).
    \4\ For purposes of comparison, the high in the VIX for 2007 was
31.09. See CBOE's Volatility Indexes (January 2009) available at
http://www.cboe.com/micro/vix/volatility_qrg.pdf. The VIX is a
measure of market expectations of near-term volatility conveyed by
stock index option prices. Specifically, VIX measures 30-day
expected volatility of the S&P 500 Index. The components of VIX are
near- and next-term put and call options, usually in the first and
second SPX contract months. See Chicago Board Options Exchange,
``The CBOE Volatility Index--VIX,'' at 1 and 4, available at http://www.cboe.com/micro/vix/vixwhite.pdf.
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    In light of the dramatic changes to the securities markets,
including increased volumes, volatility, and the growing prominence of
large traders, the Commission recently published a Concept Release to
solicit public comment on a broad range of market structure issues.\5\
Given the dramatic changes to the securities markets, the Commission
believes it is appropriate to exercise its authority under Section
13(h) of the Exchange Act and propose to establish a large trader
reporting system, so as to enhance the Commission's ability to identify
large market participants, collect information on their trading, and
analyze their trading activity.
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    \5\ See Securities Exchange Act Release No. 61358 (January 14,
2010), 75 FR 3594 (January 21, 2010) (File No. S7-02-10) (Concept
Release on Equity Market Structure).
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    Currently, to support its regulatory and enforcement activities,
the Commission collects transaction data from registered broker-dealers
through the Electronic Blue Sheets (``EBS'') system.\6\ The Commission
uses the EBS system to obtain securities transaction information for
two primary purposes: (1) To assist in the investigation of possible
Federal securities law violations, primarily involving insider trading
or market manipulation; and (2) to conduct market reconstructions.
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    \6\ See 17 CFR 240.17a-25 (Electronic Submission of Securities
Transaction Information by Exchange Members, Brokers, and Dealers).
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    The EBS system has performed relatively effectively as an
enforcement tool for analyzing trading in a small sample of securities
over a limited period of time. However, because the EBS system is
designed for use in narrowly-focused enforcement investigations that
generally involve trading in particular securities, it has proven to be
insufficient for large-scale market reconstructions and analyses
involving numerous stocks during peak trading volume periods.\7\
Further, it does not address the Commission's need to identify
important market participants and their trading activity. To enhance
the Commission's ability to identify large traders and collect
information on their trading activity, Congress passed the Market
Reform Act of 1990 (``Market Reform Act'').\8\
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    \7\ The shortcomings of the EBS system were noted by the Senate
Committee on Banking, Housing and Urban Affairs in the Senate Report
accompanying the Market Reform Act of 1990. See Senate Report, infra
note 9, at 48.
    \8\ Public Law 101-432 (HR 3657), October 16, 1990.
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A. The Market Reform Act

    Following declines in the U.S. securities markets in October 1987
and October 1989, Congress noted that the Commission's ability to
analyze the causes of a market crisis was impeded by its lack of
authority to gather trading information.\9\ To address this concern,
Congress passed the Market Reform Act, which, among other things,
amended Section 13 of the Exchange Act to add new subsection (h),
authorizing the Commission to establish a large trader reporting system
under such rules and regulations as the Commission may prescribe.
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    \9\ The legislative history accompanying the Market Reform Act
also noted the Commission's limited ability to analyze the causes of
the market declines of October 1987 and 1989. See generally Senate
Comm. on Banking, Housing, and Urban Affairs, Report to accompany
the Market Reform Act of 1990, S. Rep. No. 300, 101st Cong. 2d Sess.
(May 22, 1990) (reporting S. 648) (``Senate Report'') and House
Comm. on Energy and Commerce, Report to accompany the Securities
Market Reform Act of 1990, H.R. No. 524, 101st Cong. 2d Sess. (June
5, 1990) (reporting H.R. 3657).
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    The large trader reporting authority in section 13(h) of the
Exchange Act was intended to facilitate the Commission's ability to
monitor the impact on the securities markets of securities transactions
involving a substantial volume or large fair market value, as well as
to assist the Commission's enforcement of the federal securities
laws.\10\ In particular, the Market Reform Act provided the Commission
with the authority to collect broad-based information on large traders,
including their trading activity, reconstructed in time sequence, in
order to provide empirical data necessary for the Commission to
evaluate market movement and volatility and enhance its ability to
detect illegal trading activity.\11\
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    \10\ See 15 U.S.C. 78m(h)(1). See also Senate Report, supra note
9, at 42.
    \11\ See Senate Report, supra note 9, at 4, 44, and 71. In this
respect, though self-regulatory organization (``SRO'') audit trails
provide a time-sequenced report of broker-dealer transactions, those
audit trails generally do not identify the broker-dealer's
customers. Accordingly, the Commission is not presently able to
utilize existing SRO audit trail data to accomplish the objectives
of the Market Reform Act.
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    The large trader reporting system envisioned by the Market Reform
Act authorizes the Commission to require large traders \12\ to self-
identify to the Commission and provide information to the Commission
identifying the trader and all accounts in or through which the trader
effects securities transactions.\13\ The Market Reform Act also
contemplated that the Commission could require large traders to
identify their status as large traders to any registered broker-dealer
through whom they directly or indirectly effect securities
transactions.\14\
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    \12\ Section 13(h) of the Exchange Act defines a ``large
trader'' as ``every person who, for his own or an account for which
he exercises investment discretion, effects transactions for the
purchase or sale of any publicly traded security or securities by
use of any means or instrumentality of interstate commerce or of the
mails, or of any facility of a national securities exchange,
directly or indirectly by or through a registered broker or dealer
in an aggregate amount equal to or in excess of the identifying
activity level.'' See 15 U.S.C. 78m(h)(8)(A). The term ``identifying
activity level'' is defined in Section 13(h) as ``transactions in
publicly traded securities at or above a level of volume, fair
market value, or exercise value as shall be fixed from time to time
by the Commission by rule or regulation, specifying the time
interval during which such transactions shall be aggregated.'' See
15 U.S.C. 78m(h)(8)(C). The proposed ``identifying activity level''
is set forth in paragraph (a)(7) of proposed Rule 13h-1.
    \13\ See 15 U.S.C. 78m(h)(1)(A).
    \14\ See 15 U.S.C. 78m(h)(1)(B).
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    In addition to facilitating the ability of the Commission to
identify large traders, the Market Reform Act authorizes the Commission
to collect information on the trading activity of large traders. In
particular, the Commission is authorized to require every registered
broker-dealer to make and keep records with respect to securities
transactions of large traders that equal or exceed a certain
``reporting activity level'' and report such

transactions upon request of the Commission.\15\
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    \15\ See 15 U.S.C. 78m(h)(2). Section 13(h) also provides the
Commission with authority to determine the manner in which
transactions and accounts should be aggregated, including
aggregation on the basis of common ownership or control. See 15
U.S.C. 78m(h)(3). The term ``reporting activity level'' is defined
in Section 13(h)(8)(D) of the Exchange Act to mean ``transactions in
publicly traded securities at or above a level of volume, fair
market value, or exercise value as shall be fixed from time to time
by the Commission by rule, regulation, or order, specifying the time
interval during which such transactions shall be aggregated.'' See
15 U.S.C. 78m(h)(8)(D).
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    The Market Reform Act specifies that the information collected from
large traders and registered broker-dealers under a large trader
reporting system would be considered confidential, subject to limited
exceptions.\16\ In addition, the Market Reform Act provides the
Commission with the authority to exempt any person or class of persons
or any transaction or class of transactions from the large trader
reporting system requirements.\17\
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    \16\ See 15 U.S.C. 78m(h)(7).
    \17\ See 15 U.S.C. 78m(h)(6).
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B. Prior Rulemaking

    The Commission initially proposed to use its authority under
Section 13(h) of the Exchange Act to establish a large trader reporting
system in 1991.\18\ Similar to the current proposal, the earlier
proposed rulemaking would have required large traders to disclose to
the Commission their accounts and affiliations by filing Form 13H and
would have imposed recordkeeping and reporting requirements on broker-
dealers with respect to the activity of their large trader
customers.\19\
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    \18\ See Securities Exchange Act Release No. 29593 (August 22,
1991), 56 FR 42550 (August 28, 1991) (S7-24-91) (``1991 Proposal'').
    \19\ In 1991, the Commission proposed an ``identifying activity
level,'' the triggering level at which large traders would be
required to identify themselves to the Commission, of aggregate
transactions during any 24-hour period that equals or exceeds either
100,000 shares or fair market value of $4,000,000, or any
transactions that constitute program trading. See 1991 Proposal,
supra note 18, 56 FR at 42551.
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    After considering the comments received on the 1991 Proposal, the
Commission clarified and revised its proposed large trader system and
issued a re-proposal in 1994.\20\ Among other things, the re-proposal
sought to: clarify the definition of large trader and to increase the
reporting thresholds; \21\ streamline the filing requirements and
include provisions for an inactive filing status; \22\ and provide a
safe harbor for a broker-dealer's duty to monitor compliance with the
rule.\23\
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    \20\ See Securities Exchange Act Release No. 33608 (February 9,
1994), 59 FR 7917 (February 17, 1994) (S7-24-91) (``1994
Reproposal'').
    \21\ Specifically, the Commission proposed to increase the
``identifying activity level'' to aggregate transactions in publicly
traded securities that are equal to or greater than the lesser of
200,000 shares and fair market value of $2,000,000 or fair market
value of $10,000,000. The Commission left unchanged the provision
that captured transactions that constitute program trading. See 1994
Reproposal, supra note 20, 59 FR at 7922.
    \22\ See 1994 Reproposal, supra note 20, 59 FR at 7927.
    \23\ See id. at 7918.
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C. Rule 17a-25 and the Enhanced EBS System

    The Commission did not adopt the large trader reporting rule as re-
proposed in 1994. However, in 2001 the Commission adopted Rule 17a-25
to enhance the EBS system and facilitate the Commission's ability to
collect electronic transaction data to support its investigative and
enforcement activities.\24\
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    \24\ See Securities Exchange Act Release No. 44494 (June 29,
2001), 66 FR 35836 (July 9, 2001) (S7-12-00) (final rulemaking)
(``EBS Release''); 42741 (May 2, 2000), 65 FR 26534 (May 8, 2000)
(proposed rulemaking).
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    Rule 17a-25 enhanced the EBS system in three primary areas. First,
it requires broker-dealers to submit to the Commission securities
transaction information responsive to a Blue Sheets request in
electronic format.\25\ Second, the rule modified the EBS system to take
into account evolving trading strategies used primarily by
institutional and professional traders. Specifically, the rule requires
firms to supply three additional data elements--prime brokerage
identifiers,\26\ average price account identifiers,\27\ and depository
institution identifiers \28\--to assist the Commission in aggregating
securities transactions by entities trading through multiple accounts
at more than one broker-dealer.\29\ Finally, the rule requires broker-
dealers to update their contact person information to provide the
Commission with up-to-date information necessary for the Commission to
direct EBS requests to the appropriate staff.\30\
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    \25\ See 17 CFR 240.17a-25. Rule 17a-25 requires submission of
the same standard customer and proprietary transaction information
that SROs request in connection with their market surveillance and
enforcement inquiries. For a proprietary transaction, the broker-
dealer must include the following information: (1) Clearing house
number or alpha symbol used by the broker-dealer submitting the
information; (2) clearing house number(s) or alpha symbol(s) of the
broker-dealer(s) on the opposite side to the trade; (3) identifying
symbol assigned to the security; (4) date transaction was executed;
(5) number of shares, or quantity of bonds or options contracts, for
each specific transaction; whether each transaction was a purchase,
sale, or short sale; and, if an options contract, whether open long
or short or close long or short; (6) transaction price; (7) account
number; (8) identity of the exchange or market where each
transaction was executed; (9) prime broker identifier; (10) average
price account identifier; and (11) the identifier assigned to the
account by a depository institution. For customer transactions, the
broker-dealer also is required to include the customer's name,
customer's tax identification number, customer's address(es), branch
office number, registered representative number, whether the order
was solicited or unsolicited, and the date the account was opened.
If the transaction was effected for a customer of another member,
broker, or dealer, the broker-dealer must include information on
whether the other party was acting as principal or agent on the
transaction.
    \26\ The Commission requires prime brokerage identifiers to
avoid double-counting of transactions where EBS submissions reflect
the same trade by both the executing broker-dealer and the broker-
dealer acting as the prime broker. See EBS Release, supra note 24,
66 FR at 35838.
    \27\ Some broker-dealers use ``average price accounts'' as a
mechanism to buy or sell large amounts of a given security for their
customers. Under this arrangement, a broker-dealer's average price
account may buy or sell a security in small increments throughout a
trading session, and then transfer the accumulated long or short
position to one or more accounts for an average price or volume-
weighted average price after the market close. Similar to prime
brokerage identifiers, the Commission requires average price account
identifiers to avoid double-counting where the EBS submission
reflects the same transaction for both the firm's average price
account and the accounts receiving positions from the average price
account. See EBS Release, supra note 24, 66 FR at 35838-39.
    \28\ The inclusion of a depository identifier in EBS reports was
designed to expedite the Commission's efforts to aggregate trading
when conducting complex trading reconstructions. See EBS Release,
supra note 24, 66 FR at 35839.
    \29\ See 17 CFR 240.17a-25(b).
    \30\ This provision was designed to address the recurring
problem of frequent staff turnover and re-organizations at broker-
dealers to ensure the Commission directs EBS requests to the
appropriate personnel. See EBS Release, supra note 24, 66 FR at
35839.
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D. The Current Proposal

    While Rule 17a-25 enhanced the Commission's EBS system and improved
the Commission's ability to obtain electronic transaction records, it
is insufficient for large-scale investigations and market
reconstructions involving numerous stocks during peak trading volume
periods, and is therefore inadequate with respect to the Commission's
efforts to monitor the impact of large trader activity on the
securities markets.\31\
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    \31\ See 15 U.S.C. 78m(h)(1).
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    In particular, Rule 17a-25 does not specify a definitive deadline
by which EBS trade information must be furnished to the Commission and,
in the Commission's experience, data collected through the EBS system
often is subject to lengthy delays, particularly with respect to files
involving a large number of transactions over an extended time period.
Commission staff often must make multiple requests to broker-dealers to
obtain sufficient order information about the purchase or sale of a
specific security to be able to

adequately analyze the trading. These multiple requests and responses
can take a significant amount of time and delay the Commission's
efforts to analyze the data on a contemporaneous basis. Further, since
decimal trading has increased the number of price points for
securities, the volume of transaction data subject to reporting under
the EBS system, particularly in the case of active large traders, can
be significantly greater than the EBS system was intended to
accommodate in a typical request for data. Thus, the current EBS system
does not efficiently collect large volumes of data in a timely manner
that allows the Commission to perform contemporaneous analysis of
market events.
    Further, the data generated by the EBS system does not include
important information on the time of the trade or the identity of the
customer.\32\ While the Commission may be able to use price as a proxy
for execution time when reconstructing trading history in a particular
security, such analysis is extremely resource intensive and hinders the
Commission's ability to promptly analyze data on a contemporaneous
basis. Further, information to identify the large trader customer can
provide valuable information to permit the Commission to track large
trader activity across markets and through various broker-dealers. The
ability to track and analyze this information would facilitate the
Commission's efforts both to investigate potential manipulative
activity and to reconstruct a more accurate market history and would be
particularly useful when analyzing information on large traders, as
some large traders may trade through multiple accounts at multiple
broker-dealers and may trade using sponsored access.\33\
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    \32\ The Commission staff also is developing, for Commission
consideration, a proposal to establish a consolidated audit trail
for equities and options that would collect and consolidate detailed
information about orders entered and trades executed on any exchange
or in the over-the-counter market. As Commission staff is unable to
estimate when that proposal could potentially be operational, the
large trader reporting system proposed today is designed to address
in the near term the Commission's current need for access to more
information about large traders and their activities. Longer term,
the proposed large trader reporting system should continue to
provide a uniquely valuable tool for efficiently identifying the
most significant market participants, in particular with respect to
the requirement on large traders to self-identify to the Commission,
as this aspect is uniquely addressed by Section 13(h) of the
Exchange Act and proposed Rule 13h-1.
    \33\ The Commission recently proposed rules that would address
sponsored access to exchanges. See Securities and Exchange Act
Release No. 61379 (January 26, 2010), 75 FR 4713 (January 29, 2010)
(File No. S7-03-10).
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    In light of recent turbulent markets and the increasing
sophistication and trading capacity of large traders, the Commission
needs to enhance further its ability to collect and analyze trading
information more efficiently, especially with respect to the most
active market participants. In particular, the Commission needs a
mechanism to reliably identify large traders, and promptly and
efficiently obtain their trading information on a market-wide basis.
    The Commission believes a proposal for a large trader reporting
system is necessary because, as noted above, large traders appear to be
playing an increasingly prominent role in the securities markets. For
example, market observers have offered a wide range of estimates for
the percent of overall volume attributable to one potential subcategory
of large trader--high frequency traders--which are typically estimated
at 50% of total volume or higher.\34\ The proposed large trader
reporting system is intended to provide the Commission with an
efficient system for obtaining the information necessary to monitor
more effectively the impact on the securities markets of ``large
traders.'' As discussed in greater detail below, the Commission
proposes to define a ``large trader'' as a person who, in exercising
investment discretion, effects transactions in NMS securities \35\ in
an amount equal to or greater than (1) during a calendar day, either 2
million shares or shares with a fair market value of $20 million; or
(2) during a calendar month, either 20 million shares or shares with a
fair market value of $200 million.\36\
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    \34\ See supra note 1.
    \35\ 17 CFR 240.600(b)(46) (defining ``NMS security'' as ``any
security or class of securities for which transaction reports are
collected, processed, and made available pursuant to an effective
transaction reporting plan, or an effective national market system
plan for reporting transactions in listed options.''). The term
refers to all exchange-listed securities, including equities and
options.
    \36\ See infra notes 72-73 and accompanying text (discussing the
calculation of the identifying activity level when determining who
meets the definition of large trader).
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    Among other things, the Commission believes that a large trader
reporting system would enhance its ability to (1) reliably identify
large traders and their affiliates, (2) obtain far more promptly
trading data on the activity of large traders, including execution
time,\37\ and (3) aggregate and analyze trading data among affiliated
large traders.
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    \37\ See infra note 149 and accompanying text.
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II. Description of the Proposed Rule

A. Application and Scope

    As discussed in detail below, under proposed Rule 13h-1, any person
would be a ``large trader'' 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 the identifying activity level.'' \38\
All large traders would be required to identify themselves to the
Commission by filing Form 13H, and would be required to update their
Form 13H at least annually and more frequently as necessary.\39\
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    \38\ See proposed Rule 13h-1(a)(1).
    \39\ See proposed Rule 13h-1(b)(1).
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    Upon receiving an initial Form 13H, the Commission would assign
each large trader a unique Large Trader Identification Number
(``LTID''). The LTID is a critical component of the proposal, and is
intended, among other things, to enable the Commission to aggregate
accounts and transactions of large traders on an inter-broker-dealer
basis to capture a large trader's trading activity even where the large
trader executes trades through a number of different registered broker-
dealers. In particular, the LTID would allow the Commission to
efficiently sort trade information by large trader.
    A large trader would be required to disclose to each of its
registered broker-dealers its LTID and identify all of the accounts
held by that broker-dealer through which the large trader trades.\40\
By requiring the large trader to identify all applicable accounts to
its registered broker-dealer, the proposed rule would place the self-
identification requirement directly on the large trader, which should
assist the registered broker-dealer in easily identifying and marking
all of the large trader's accounts held by the broker-dealer. 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
Commission that would allow the Commission to further identify the
large

trader and all accounts through which the large trader effects
transactions.\41\
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    \40\ See proposed Rule 13h-1(b)(2).
    \41\ See proposed Rule 13h-1(b)(4). For example, the Commission
might request additional information regarding a response provided
in Schedule 6 to a large trader's Form 13H concerning the
identification of accounts.
---------------------------------------------------------------------------

    Proposed Rule 13h-1 also would impose recordkeeping and reporting
requirements on registered broker-dealers, and would require registered
broker-dealers to provide large trader transaction data to the
Commission upon request. Finally, the proposed rule would require
registered broker-dealers to establish and maintain systems and
procedures designed to help assure compliance with the identification
requirements of the proposed rule.
    Accordingly, the proposed rule would impose the following
obligations on a large trader: (1) Self-identify to the Commission by
filing and updating Form 13H; (2) disclose its LTID to its registered
broker-dealers and others with whom it collectively exercises
investment discretion; and (3) provide certain additional information
in response to a Commission request. The proposed rule would impose the
following obligations on registered broker-dealers: (1) Maintain
records of transactions effected for large traders that are identified
by the specific large trader; (2) electronically report large trader
transaction information to the Commission upon request; and (3) monitor
compliance with the proposed rule.

B. Defining Large Trader

    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.\42\ Specifically, paragraph (a)(1) of 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 the identifying activity level.''
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    \42\ See 15 U.S.C. 78m(h)(8)(A) (providing that ``the term
`large trader' means every person who, for his own account or an
account for which he exercises investment discretion, effects
transactions for the purchase or sale of any publicly traded
security or securities by use of any means or instrumentality of
interstate commerce or of the mails, or of any facility of a
national securities exchange, directly or indirectly by or through a
registered broker or dealer in an aggregate amount equal to or in
excess of the identifying activity level'').
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    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 purpose of this focus is to narrow the number of
persons that would need to self-identify as ``large traders'' while
allowing the Commission to identify the primary institutions that
conduct a large trading business. As discussed further below, the
proposed rule provides specific guidance as to who should self-identify
as a ``large trader.'' Paragraph (b)(3)(i) of the proposed rule
provides that a large trader shall not be required to separately comply
with the requirements of paragraph (b) if a person who controls the
large trader complies with all of the requirements under paragraphs
(b)(1), (b)(2), and (b)(4) applicable to such large trader with respect
to all of its accounts.\43\ The intent of this proposed provision is to
push the identification requirement up the corporate hierarchy to the
parent entity to identify the primary institutions that conduct a large
trading business. By focusing the identification requirements in this
manner, the Commission would be able to identify easily the controlling
persons that themselves, or through subsidiaries or employees, operate
as large traders, while limiting the filing and self-identification
burdens that would be imposed to a relatively small group of persons.
Accordingly, if a natural person or a subsidiary entity within a large
organization independently qualifies as a large trader, but the parent
company files Form 13H and identifies itself as the large trader, then
the natural person or subsidiary entity would not be required to
separately identify itself as a large trader, file Form 13H, or be
subject to the other requirements that would apply to large traders.
Importantly, this provision would require that the entity that self-
identifies as the ``large trader'' comply with the proposed rule with
respect to all accounts within the entity over which investment
discretion is exercised, directly or indirectly. Accordingly, if the
parent company files Form 13H, then all accounts over which any
controlled person exercises investment discretion should be tagged with
the parent company's LTID.\44\
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    \43\ Notably, the definition of ``investment discretion'' in
Section 3(a)(35) of the Exchange Act, 15 U.S.C. 78c(a)(35), applies
to a person that is ``authorized to determine what securities or
other property shall be purchased or sold by or for the account'' as
well as a person that ``makes decisions as to what securities or
other property shall be purchased or sold by or for the account even
though some other person may have responsibility for such investment
decisions* * *.'' To the extent that an entity employs a natural
person that individually, or collectively with others, would meet
the proposed definition of a ``large trader,'' then, for purposes of
proposed Rule 13h-1, the entity that controls that person or those
persons would be considered a ``large trader.''
    \44\ Although the proposed rule would relieve a controlled
person from separately reporting as a large trader so long as its
parent entity complies with the rule with respect to all of its
accounts, the Commission anticipates designing the large trader
reporting system to accommodate those large traders that wish to
voluntarily identify with more granularity the subsidiary, trading
desk, or other unit that is directly exercising investment
discretion over the account. For example, although the large trader
parent entity would be assigned a single LTID by the Commission, the
LTID could include a number of blank fields, so that the large
trader could elect to append additional characters to sub-identify
the relevant unit that directly controls the account. The large
trader could then use its generic LTID, along with the more
particularized information, when identifying its accounts to its
broker-dealers. Large traders voluntarily using these additional
characters on their LTID may choose to do so for internal
recordkeeping purposes and to facilitate responses to Commission
requests for information.
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    Conversely, paragraph (b)(3)(ii) of the proposed rule would apply
the same principle on a ``top down'' basis, providing that a large
trader shall not be required to comply with the requirements of
paragraph (b) if one or more persons controlled by such large trader
collectively comply with all of the requirements under paragraphs
(b)(1), (b)(2), and (b)(4) applicable to such large trader with respect
to all of its accounts. A controlling person of one or more large
traders would be required to comply with all of the requirements of
paragraph (b) unless the entities that it controls discharge all of the
responsibilities of the controlling person under paragraph (b). The
intent of this provision is to focus the identification requirement on
the parent company, and avoid the application of the requirement to
natural persons who may be controlling owners of the parent company.
This provision is designed to limit the reporting burden to a
relatively small group of persons and avoid redundant identification of
accounts, while allowing the Commission to identify the controlling
institutions that operate as large traders and obtain information on
their trading. As with paragraph (b)(3)(i), this provision would
require that the entities that self-identify as large traders (i.e., an
entity that is ``controlled by'' the non-filer) comply with the
proposed rule with respect to all accounts of the non-filer controlling
person. In other words, a controlling person would not be excused from
the large trader requirements under this provision if it directly or
indirectly exercises investment discretion over any other accounts,
including those of other large traders, unless all of those other large
traders have also self-identified

with respect to all of its accounts. The purpose of this proposed
provision is to make sure that the entity that self-identifies as a
large trader encompasses the full extent of the large trader activity
within its domain and those of its controlling person.
    For example, a parent holding company generally would file a Form
13H on behalf of itself and each of its large trader subsidiaries. So
long as the Form provides all of the relevant information (e.g.,
discloses contact information and all of the accounts through which it
and its affiliates trade), and the holding company makes the necessary
disclosures to its and its subsidiaries' broker-dealers, then the large
trader subsidiaries would not be required to individually file Forms
13H.\45\ Alternatively, if all of the large trader's subsidiaries
collectively comply with all of the requirements of proposed paragraphs
(b)(1), (b)(2), and (b)(4) with respect to all of the parent company's
trading activity, then the holding company would not be required to
file a Form 13H.\46\ If however, a holding company has two subsidiaries
that independently qualify as large traders, and only one elects to
file its own Form 13H, then the holding company still would be required
to file its own Form 13H that encompasses both subsidiaries.\47\ The
holding company's Form 13H therefore would include information on each
of its subsidiaries, and transactions of both subsidiaries would be
tagged with the parent company's LTID.\48\
---------------------------------------------------------------------------

    \45\ See proposed paragraph (b)(3)(i).
    \46\ See proposed paragraph (b)(3)(ii).
    \47\ Both the holding company and subsidiary that elected to
file its own Form 13H would identify the other as an affiliated
large trader in Item 5 of the Form.
    \48\ Transactions of the subsidiary that filed its own Form 13H
would also be tagged with its unique LTID. See infra text
accompanying note 113 (discussing multiple LTIDs).
---------------------------------------------------------------------------

    The examples above describe situations in which, for the limited
purpose of determining who should self-identify as a large trader,
investment discretion would be considered to be indirectly exercised by
a parent company by virtue of the direct or indirect power that the
parent company exercises over its subsidiaries. Those who do not
exercise investment discretion--either directly or indirectly through,
for example controlled persons--would not be large traders, and so mere
ownership of accounts--by trusts,\49\ custodians, or nominees, for
example--through which the requisite number of securities transactions
are effected would not trigger large trader status.
---------------------------------------------------------------------------

    \49\ Trustees exercising investment discretion on behalf of such
trusts would be large traders.
---------------------------------------------------------------------------

    The proposed rule focuses on entities that directly or indirectly
exercise investment discretion and are responsible for trading large
amounts of securities. As these entities can represent significant
sources of liquidity and overall trading volume, their trading may have
a direct impact on the markets. As such, the Commission believes that
the proposed rule, if adopted, would allow the Commission to more
readily identify these large traders and obtain current information on
their trading activity. The Commission also believes that the proposed
rule is tailored to achieve the objectives of section 13(h) of the
Exchange Act by allowing the Commission to monitor the impact of large
traders on the securities markets and assisting the Commission's
enforcement of the Federal securities laws, while at the same time
minimizing the burden on affected entities.
1. Definition of Person and Control
    Section 13(h)(8)(E) of the Exchange Act defines ``person'' as
having ``the meaning given in Section 3(a)(9) [of the Exchange Act] and
also includes two or more persons acting as a partnership, limited
partnership, syndicate, or other group, but does not include a foreign
central bank.'' \50\ Section 3(a)(9) of the Exchange Act defines person
as ``a natural person, company, government, or political subdivision,
agency, or instrumentality of a government.'' \51\ Paragraph (a)(2) of
the proposed rule defines ``person'' by reference to the definition
contained in Section 13(h)(8)(E) of the Exchange Act.'' \52\
Accordingly ``person,'' for purposes of proposed Rule 13h-1, would
include, among other things, two or more persons acting together for
the purpose of trading, acquiring, holding, or disposing of NMS
securities.\53\
---------------------------------------------------------------------------

    \50\ See 15 U.S.C. 78m(h)(8)(E).
    \51\ 15 U.S.C. 78c(a)(9).
    \52\ As required by Section 13(h)(8)(E) of the Exchange Act, the
proposed rule expressly excludes foreign central banks from the
definition of a person. See 15 U.S.C. 78m(h)(8)(E). See also Senate
Report, supra note 9, at 49 (noting that foreign central banks were
to be excluded in the interest of comity and due to the nature of
the specific functions of such entities).
    \53\ See, e.g., House Comm. on Energy and Commerce, Report to
Accompany the Securities Market Reform Act of 1990, H.R. No. 524,
101st Cong. 2d Sess. (June 5, 1990) (reporting H.R. 3657).
---------------------------------------------------------------------------

    In addition, paragraph (a)(3) of the proposed rule defines control
(including the terms ``controlling,'' ``controlled by,'' and ``under
common control with'') as ``the possession, direct or indirect, of the
power to direct or cause the direction of the management and policies
of a person, whether through the ownership of securities, by contract,
or otherwise. Any person that directly or indirectly has the right to
vote or direct the vote of 25% or more of a class of voting securities
of an entity or has the power to sell or direct the sale of 25% of more
of a class of voting securities of such entity, or in the case of a
partnership, has the right to receive, upon dissolution, or has
contributed, 25% or more of the capital, is presumed to control that
entity.'' The proposed definition of control is based on the definition
of control contained in Form 1 (Application for Registration or
Exemption from Registration as a National Securities Exchange). The
Commission preliminarily believes that the proposed definition of
control is sufficiently limited to capture only those persons with a
significant enough controlling interest to warrant identification as a
large trader.\54\
---------------------------------------------------------------------------

    \54\ In particular, the Commission notes that the definition of
control contained in Form 1 is among the least expansive definitions
of control referenced in Commission rules. Cf. Rule 19h-1(f)(2)
under the Exchange Act, 17 CFR 240.19h-1(f)(2) (featuring a 10%
threshold with respect to the right to vote 10 percent or more of
the voting securities or receive 10 percent or more of the net
profits). The Commission believes that this definition of control
represents a less burdensome option that still achieves the goal of
identifying persons who exert direct or indirect control over large
traders. Further, the Commission has not incorporated the provision
contained in the Form 1 definition of control that is applicable to
directors, general partners, or officers that exercise executive
responsibility. Rather, given the proposed rule's focus on parent
companies, the Commission's proposed definition focuses on the
existence of a corporate control relationship over the large trader
entity.
---------------------------------------------------------------------------

    While a natural person typically exercises investment discretion
over an account, the proposed large trader reporting system is intended
to capture the activity of the entity that employs the natural person
doing the trading.\55\ As discussed above, the proposed rule is
intended to push requirements triggered by the large trader definition
up the hierarchy of corporate control to the parent company, where
applicable. For example, a company that controls persons who,
collectively or individually, meet the definition of large trader would
file Form 13H and identify itself as the large trader, and all
transactions by its employee traders, as well as the employee traders
of entities under its control, would be marked with the parent's LTID
number.
---------------------------------------------------------------------------

    \55\ Where a firm trades through an algorithmic trading system
in which trading decisions are performed by a computer program
without the intervention of a natural person, the exercise of
investment discretion would be attributed to the firm by way of the
natural person or persons who are responsible for the design of the
trading engine.

---------------------------------------------------------------------------

    The following examples elaborate on which person would identify
itself as the ``large trader.'' For example, if a firm (e.g., a
corporation, limited liability company, partnership, limited
partnership) employs two natural persons who exercise investment
discretion and trade in an amount that would qualify them individually
as ``large traders,'' then the firm, as their employer, would file Form
13H and identify itself as a large trader, and the individual employees
would not file Form 13H. In addition, if a firm employs two natural
persons who exercise investment discretion and trade in an amount that
would not individually qualify them as ``large traders,'' but, when
taken together, the exercise of investment discretion and trading
effected by those two natural persons would qualify the firm as a large
trader, then the firm, as their employer, would file Form 13H and
identify itself as a large trader. This would be the case as long as
the firm, directly or indirectly, is the employer of the natural
persons and exercises control over them in the context of the employer
relationship.\56\
---------------------------------------------------------------------------

    \56\ The Commission notes that the proposed rule would require
the aggregation of accounts over which employees exercise investment
discretion in the scope of their employment. See proposed Rule 13h-
1(a)(4) (defining ``investment discretion''). Therefore, as an
entity determines whether it is a large trader, it would not count
transactions effected by employees in their personal (e.g., 401(k))
accounts.
---------------------------------------------------------------------------

    In the case of a large firm that is composed of numerous operating
subsidiaries, to accomplish the Commission's goals, the Commission
intends that the entity that is the ultimate parent company would file
Form 13H and identify itself as the large trader, not the individual
subsidiaries. For example, in the case of a large financial holding
company, if an adviser and a registered broker-dealer subsidiary both
employ persons who exercise investment discretion over accounts and
effect the requisite level of transactions (either collectively or
individually), the financial holding company could identify itself as
the large trader by filing Form 13H, and the adviser and broker-dealer
subsidiaries need not file Form 13H.
    The following additional examples are intended to provide further
clarity as to the party the Commission believes should self-identify as
a large trader under the proposed rule:
     In the case of a registered investment adviser that acts
as the adviser to several investment companies registered under the
Investment Company Act (e.g., mutual funds), even if each fund is
managed by one natural person that would meet the applicable large
trader threshold, the investment adviser would file Form 13H and
identify itself as a large trader and the individual fund manager would
not file Form 13H. For purposes of the proposed rule, the investment
company would not directly or indirectly exercise investment discretion
over one or more accounts and therefore would not file Form 13H.
     Where four individuals form a partnership and operate a
proprietary trading business through a computerized algorithmic trading
engine, the partnership entity would file Form 13H and identify itself
as a large trader, and the four individual partners would not file Form
13H, so long as the partnership covers all of the partners' trading
activity for the partnership.\57\
---------------------------------------------------------------------------

    \57\ See proposed Rule 13h-1(b)(3)(ii).
---------------------------------------------------------------------------

     If a natural person large trader is not employed by an
entity (e.g., the person is self-employed), then the natural person
would file Form 13H and identify itself as a large trader.
    By focusing on parent companies, the proposed rule requires large
traders to aggregate accounts over which persons they control exercise
investment discretion.\58\ Accordingly, even if any individual
employee, group, or subsidiary within a company would not effect
transactions that equal or exceed the identifying activity threshold by
itself, if collectively the ultimate parent company operates
subsidiaries or controls individuals that together effect transactions
that equal or exceed the identifying activity threshold, then the
parent company would need to identify itself as a large trader.
---------------------------------------------------------------------------

    \58\ See proposed Rule 13h-1(a)(1) (defining the term ``large
trader'' to include ``any person that directly or indirectly,
including through other persons controlled by such person, exercises
investment discretion * * *'').
---------------------------------------------------------------------------

    The Commission believes that the proposed focus on parent company-
level entities should reduce the burden of the proposed rule by
requiring self-identification by a concentrated group of parent
companies, while capturing those organizations that in the aggregate
are responsible for exercising investment discretion over the trading
of a substantial volume or fair market value of NMS securities.
Notably, companies would not be able to divide their trading among
employees, groups, or subsidiaries for the purpose of avoiding meeting
the definition of large trader under the proposed rule.
2. Definition of Investment Discretion
    Paragraph (a)(4) of proposed Rule 13h-1 states that the definition
of ``investment discretion'' shall have the meaning provided for in
Section 3(a)(35) of the Exchange Act. Section 3(a)(35) provides that
``[a] person exercises `investment discretion' with respect to an
account if, directly or indirectly, such person (A) is authorized to
determine what securities or other property shall be purchased or sold
by or for the account, (B) makes decisions as to what securities or
other property shall be purchased or sold by or for the account even
though some other person may have responsibility for such investment
decisions, or (C) otherwise exercises such influence with respect to
the purchase and sale of securities or other property by or for the
account as the Commission, by rule, determines, in the public interest
or for the protection of investors, should be subject to the operation
of the provisions of this title and the rules and regulations
thereunder.'' \59\ A person's employees would be deemed to exercise
investment discretion on behalf of that person when they act within the
scope of their employment. This provision is intended to clarify that
when an entity determines whether it meets the definition of large
trader, it would not count, for example, transactions effected by
employees in their personal accounts. The Commission preliminarily
believes that this proposed definition would identify those persons and
entities responsible for making trading decisions concerning securities
transactions involving a substantial volume or a large fair market
value consistent with the purposes of section 13(h) of the Exchange
Act.
---------------------------------------------------------------------------

    \59\ 15 U.S.C. 78c(a)(35)(B).
---------------------------------------------------------------------------

3. Definition of Transaction and NMS Security
    Paragraph (a)(6) of the proposed rule defines the term
``transaction'' to mean all transactions in NMS securities, including
exercises or assignments of option contracts, except for a limited
number of transactions that are specifically identified in that
paragraph, which are discussed below. The term ``NMS security'' is
defined in Rule 600(b)(46) under the Exchange Act.\60\ The proposed
rule would apply to trading in NMS securities that are traded through
any facility of a national securities exchange, as well as traded in
foreign or domestic over-the-counter markets and after-hours systems.
---------------------------------------------------------------------------

    \60\ 17 CFR 240.600(b)(46). An ``NMS security'' means ``any
security or class of securities for which transaction reports are
collected, processed, and made available pursuant to an effective
transaction reporting plan, or an effective national market system
plan for reporting transactions in listed options.''

---------------------------------------------------------------------------

    Section 13(h)(8)(B) defines the term ``publicly traded security''
to mean ``any equity security (including an option on individual equity
securities, and an option on a group or index of such securities)
listed, or admitted to unlisted trading privileges, on a national
securities exchange, or quoted in an automated interdealer quotation
system.'' \61\ The Commission preliminarily believes that the
definition of ``NMS security'' encompasses the universe of securities
that the term ``publicly traded security'' used in Section 13(h)(8)(B)
was intended to cover.\62\
---------------------------------------------------------------------------

    \61\ See 15 U.S.C. 78m(h)(8)(B).
    \62\ The Commission notes that the term ``NMS security'' was
adopted in 2005, fourteen years after the adoption of Section 13(h).
See Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR
37496 (June 29, 2005) (File No. S7-10-04) (Regulation NMS adopting
release).
---------------------------------------------------------------------------

    For purposes of determining whether a person effects the requisite
amount of transactions in NMS securities to meet the definition of
``large trader,'' paragraph (a)(6) of the proposed rule would exclude a
limited set of transactions from the term ``transaction'' and the
requirements of the proposed rule. The proposed exclusions are designed
to exempt certain small and otherwise infrequent traders from the
definition of a large trader as well as activity that is not
characterized by active investment discretion or is associated with
capital raising or employee compensation.
    Specifically, the Commission preliminarily believes that the
proposed excepted transactions are not effected with an intent that is
commonly associated with an arm's length purchase or sale of securities
in the secondary market and therefore do not fall within the types of
transactions that are characterized by the exercise of investment
discretion. While a large enough one-time transaction in the proposed
categories could have an impact on the market, the Commission would be
able to obtain information on that trade through other means, including
the EBS system. The Commission preliminarily believes that the benefit
to the Commission of identifying such person as a large trader solely
through one of the enumerated excepted transactions would not be
justified by the costs that would be imposed on the person and their
registered broker-dealer that accompany meeting the definition of large
trader. Accordingly, the Commission proposes to exclude the following
types of transactions, described below, from the proposed definition of
``transaction'':
     Any journal or bookkeeping entry made to an account to
record or memorialize the receipt or delivery of funds or securities
pursuant to the settlement of a transaction; \63\
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    \63\ The Commission notes that such activity is part of the
clearance and settlement process. Because proposed Rule 13h-1
focuses on effecting transactions for the purchase or sale of an NMS
security, the Commission does not believe that the capture of this
activity is useful in the context of a rule that is designed to
identify trading activity.
---------------------------------------------------------------------------

     Any transaction that is part of an offering of securities
by or on behalf of an issuer, or by an underwriter on behalf of an
issuer, or an agent for an issuer, whether or not such offering is
subject to registration under the Securities Act of 1933, provided,
however, that this exemption shall not include an offering of
securities effected through the facilities of a national securities
exchange;
     Any transaction that constitutes a gift;
     Any transaction effected by a court-appointed executor,
administrator, or fiduciary pursuant to the distribution of a
decedent's estate; \64\
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    \64\ This proposed exclusion draws a distinction between the
distribution and continuing administration of an estate. A court-
appointed fiduciary may be authorized to invest and reinvest in
securities for many years. Transactions effected pursuant to the
continuing administration or investment of an estate's assets would
fall outside the exclusion for transactions of a decedent or marital
estate, as they would indicate an on-going exercise of investment
discretion and extend beyond a one-time event. Only those
transactions effected pursuant to the distribution or liquidation of
such estates would be excluded.
---------------------------------------------------------------------------

     Any transaction effected pursuant to a court order or
judgment;
     Any transaction effected pursuant to a rollover of
qualified plan or trust assets subject to Section 402(c)(1) of the
Internal Revenue Code; \65\ and
---------------------------------------------------------------------------

    \65\ 26 U.S.C. 402(c)(1).
---------------------------------------------------------------------------

     Any transaction between an employer and its employees
effected pursuant to the award, allocation, sale, grant or exercise of
a NMS security, option or other right to acquire securities at a pre-
established price pursuant to a plan which is primarily for the purpose
of an issuer benefit plan or compensatory arrangement.

The Commission preliminarily believes that narrowing the definition of
a transaction should reduce the impact of the proposed rule on
infrequent traders and at the same time allow the Commission to focus
the proposed rule on those persons and activities that require large
trader identification.
4. Identifying Activity Level
    Section 13(h)(8)(C) defined the term ``identifying activity level''
to mean ``transactions in publicly traded securities at or above a
level of volume, fair market value, or exercise value as shall be fixed
from time to time by the Commission by rule or regulation, specifying
the time interval during which such transactions shall be aggregated.''
\66\ The ``identifying activity level'' is the threshold level of
transaction activity at which a market participant would be considered
a ``large trader'' and required to identify itself to the Commission.
The Commission proposes that ``identifying activity level'' mean
aggregate transactions in NMS securities that are equal to or greater
than: during a calendar day, either two million shares or shares with a
fair market value of $20 million; or (2) during a calendar month,
either twenty million shares or shares with a fair market value of $200
million.\67\
---------------------------------------------------------------------------

    \66\ See 15 U.S.C. 78m(h)(8)(C).
    \67\ See proposed Rule 13h-1(a)(7).
---------------------------------------------------------------------------

    The thresholds are designed to identify large traders that effect
transactions of a substantial magnitude relative to overall volume. In
formulating the proposed threshold, the Commission considered a level
that would identify those entities that effect transactions in an
amount corresponding to approximately 0.01% of the daily volume and
market value of trading in NMS stocks. The Commission staff estimates
that daily matched volume in NMS stocks traded on U.S. securities
exchanges or reported through a transaction reporting facility \68\ is
within a range of 7 to 10 billion shares in late 2009.\69\ Doubling
that matched volume figure to account for the two sides of every trade,
considering that the large trader proposal is focused on the aggregated
buy and sell activity of traders, results in a figure of between 14
billion and 20 billion shares. Given the Commission's objective to
define a ``large'' trader to be one who effects

transactions of approximately .01% of overall daily volume on the
equities markets, then a large trader would be a trader who effects
transactions involving 2 million shares daily. The Commission estimates
that, based on its experience with information gathered in connection
with transaction fees pursuant to Section 31 of the Exchange Act,\70\
the daily market value of trading in NMS stocks, also on a double-
counted basis, is approximately $200 billion. Applying the same 0.01%
standard to market value that was applied to daily volume results in a
threshold of approximately $20 million.
---------------------------------------------------------------------------

    \68\ Over-the-counter trades, including trades executed by
alternative trading systems, are reported to the consolidated trade
streams through one of the trade reporting facilities operated by
FINRA on behalf of exchanges, or through FINRA's ADF.
    \69\ While the proposed large trader definition would include
options trading in defining a large trader, the proposed threshold
was based on information for NMS stock trading. This figure does not
count transactions conducted on derivatives markets. Consequently,
the Commission believes that the 7 to 10 billion figure understates
overall volume relative to the proposed gross-up methodology for
calculating the identifying activity threshold. Nevertheless, the
Commission preliminarily believes that considering reported volume
in NMS stocks provides an appropriate and relevant benchmark, using
figures that are widely accessible, for determining the threshold
for large trader status. The Commission notes that several exchanges
provide daily and moving average volume figures on public Web sites.
See, e.g., http://www.nasdaqtrader.com.
    \70\ 15 U.S.C. 78ee.
---------------------------------------------------------------------------

    The first prong of the proposed threshold is designed to identify
large traders who effect transactions, on a daily basis, in a
substantial volume. The second prong of the proposed threshold is
intended to identify large traders who might not trigger the calendar-
day threshold but might nevertheless effect transactions in large
enough amounts over the course of a calendar month to warrant becoming
subject to the proposed requirements that would be applicable to large
traders. In addition, the second prong should allow the Commission to
establish a high enough first prong so as to not pick up small or
infrequent traders who might trigger identification based on a single
transaction.
    Section 13(h)(3) of the Exchange Act authorizes the Commission to
prescribe rules governing the manner in which transactions and accounts
shall be aggregated for purposes of determining who should be defined
as a large trader.\71\ The proposal would require market participants
to use a ``gross up'' approach in calculating their activity levels.
Offsetting or netting transactions among or within accounts, even for
hedged positions, would be added to a participant's activity level in
order to show the full extent of a trader's purchase and sale
activity.\72\ Specifically, paragraph (c)(1) of proposed Rule 13h-1
would specify that the volume or fair market value of equity securities
purchased and sold would be aggregated with the market value of
transactions in options or on a group or index of equity
securities.\73\ For purposes of the identifying activity level, with
respect to options, only purchases and sales, and not exercises, would
be counted. By considering only purchases and sales, the proposed rule
is intended to focus on the trading of options and avoid double-
counting towards the applicable identification threshold.
---------------------------------------------------------------------------

    \71\ See 15 U.S.C. 78m(h)(3).
    \72\ In particular, a trader that nets or hedges its positions,
e.g., one that seeks to achieve a net position of zero at the end of
a trading day, may nevertheless have transacted in a substantial
volume or fair market value during the course of the day. Through
the proposed rule, the Commission seeks to identify any person who
effects transactions in the requisite amount. Substantial trading
activity has the potential to impact the market regardless of the
person's net position.
    \73\ For example, 50,000 shares of XYZ stock and 500 XYZ call
options would count as aggregate transactions of 100,000 shares in
XYZ (i.e., 50,000 + 500 x 100 = 100,000). With respect to index
options, the market value would be computed by multiplying the
number of contracts purchased or sold by the market price of the
options and the applicable multiplier. For example, if ABC Index has
a multiplier of 100, a person who purchased 200 ABC call options for
$400 would have effected aggregate transaction of $8 million (i.e.,
200 x 400 x 100 = $8,000,000). Transactions in index options are not
required to be ``burst'' into share equivalents for each of the
underlying component equities.
---------------------------------------------------------------------------

    The Commission believes that this approach would accurately
identify those traders that effect purchase and sale transactions in a
large volume of securities in absolute terms and is designed to
minimize the burden on affected entities in calculating the applicable
thresholds by utilizing a bright line standard that is readily applied.
    To help prevent circumvention of the proposed rule, paragraph
(c)(2) further would prohibit a person from disaggregating accounts to
avoid identification and the accompanying proposed requirements of a
large trader. Accordingly, the proposal would prohibit, among other
things, persons from splitting activity among multiple registered
broker-dealers, accounts, or transactions for the purpose of evading
the large trader identification requirement. Additionally, where two
separate entities engage in a coordinated trading strategy that results
in the joint exercise of investment discretion over their individual
accounts, each entity must count the transactions in NMS securities
effected through those ``joint'' accounts toward its identifying
activity level.\74\
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    \74\ The definition of ``person'' includes two or more persons
acting as a partnership, limited partnership, syndicate, or other
group. As discussed infra, if a person meets the identifying
activity level, the person would be a large trader and would need to
list the applicable accounts in proposed Schedule 6 to Form 13H.
---------------------------------------------------------------------------

    The Commission believes that the capture of substantial trading
activity would be essential to accomplish the purposes of Section 13(h)
of the Exchange Act. The Commission has balanced this need against the
burden of capturing the information and preliminarily believes that the
proposed identifying activity level strikes an appropriate balance. In
particular, the Commission preliminarily believes that trading activity
in an amount corresponding to the proposed identifying activity level
effected during the applicable measuring periods is sufficiently
substantial to warrant identification as a large trader so that the
Commission can more readily obtain information about that trader and
its market activity. The Commission also preliminarily believes that
the proposed identifying activity level would establish a simple
bright-line threshold consistent with the activity-based threshold
contemplated by Section 13(h) of the Exchange Act.
5. Inactive Status
    Proposed Rule 13h-1(b)(3)(iii) would establish an optional inactive
status for large traders. Specifically, large traders previously
assigned an LTID whose aggregate transactions during the previous full
calendar year did not reach the identifying activity level at any time
during the year would be eligible to file for inactive status upon
checking a box on the cover page of a Form 13H filing. This status
would be available to traders that become less active and no longer
meet the threshold at which large trader status is realized. After a
large trader files for inactive status, it would be relieved from the
Form 13H filing requirements, as well as the requirement to inform its
registered broker-dealers and others with whom it shares investment
discretion, of its LTID.\75\
---------------------------------------------------------------------------

    \75\ In addition, a large trader on inactive status could inform
its broker-dealers of its inactive status and request that the
broker-dealer cease tagging its transactions with its LTID.
---------------------------------------------------------------------------

    As proposed, large traders on inactive status who once again reach
the identifying activity level would be required to reactivate their
large trader status by filing Form 13H promptly after effecting
transactions in an amount that equals or exceeds the large trader
identifying activity threshold.\76\ In submitting a ``Reactivated
Status'' Form 13H, the large trader would retain the LTID initially
assigned to it, and would be required to notify registered broker-
dealers and others of its status and LTID.
---------------------------------------------------------------------------

    \76\ See infra note 81 (discussing the ``promptly'' standard).
---------------------------------------------------------------------------

    The Commission believes that the proposed provision for an inactive
status should eliminate the ongoing costs of compliance with the
proposed rule, including the requirement to file amendments to Form 13H
with the Commission, for those entities that no longer trade in amounts
that would meet the definition of large trader. The Commission
preliminarily believes that

the provision for an inactive status is consistent with the objectives
of Section 13(h) of the Exchange Act.
    As a subset of inactive status, proposed Form 13H would allow a
large trader that discontinues operations to file an amended Form 13H
reflecting its ``Termination'' status. For example, this status would
be applicable in the event of certain mergers or acquisitions involving
a large trader, including a merger of two large traders. In that
instance, the non-surviving large trader would be required to submit a
``Termination Filing'' that specifies the effective date of the merger.
In Item 5b of the Form 13H, the surviving large trader would be
required to list as an affiliate the non-surviving company, note that
the company no longer exists, and provide the LTID of the non-surviving
company. The Commission believes that specifically allowing a large
trader to file an updated Form 13H indicating that it has discontinued
operations will allow large traders to accurately reflect their status
to the Commission and will enhance the utility of the proposed large
trader reporting system.

C. Large Trader Self-Identification

    Section 13(h)(1) of the Exchange Act authorizes the Commission to
prescribe identification requirements for large traders for the purpose
of monitoring the impact on the securities markets of securities
transactions involving a substantial volume, or a large fair market
value or exercise value, and to assist the Commission in the
enforcement of the Exchange Act.\77\ The Commission is specifically
authorized to require large traders to provide it with the information
deemed necessary or appropriate to identify large traders and all
accounts in or through which large traders effect transactions.\78\ The
Commission also is authorized to require large traders to disclose
their large trader status to the registered broker-dealers that carry
the accounts through which they effect transactions.\79\ The Commission
is proposing Rule 13h-1(b) and Form 13H to implement these provisions
of Section 13(h)(1) of the Exchange Act.
---------------------------------------------------------------------------

    \77\ See 15 U.S.C. 78m(h)(1).
    \78\ See 15 U.S.C. 78m(h)(1)(A).
    \79\ See 15 U.S.C. 78m(h)(1)(B).
---------------------------------------------------------------------------

    As discussed below, under the proposed rule, each large trader
would be required to identify itself to the Commission by filing
electronically with the Commission a Form 13H.\80\ Additionally, each
large trader would be required to identify itself to the broker-dealers
through which it effects transactions as well as to any other entity
with which it shares investment discretion over an account. Finally,
the proposed rule would require a large trader to promptly provide the
Commission with such other descriptive or clarifying information that
the Commission may request from time to time to further identify the
large trader and all accounts through which the large trader effects
transactions.\81\ Under this provision, the Commission would be able to
obtain, for example, clarifying information concerning information
provided in a Form 13H filing.
---------------------------------------------------------------------------

    \80\ The Commission is proposing an electronic filing system for
proposed Form 13H, and the proposed rule would require electronic
filing. See proposed Rule 13h-1(b)(1). If the Commission adopts the
proposed rule as proposed, it is possible that large traders might
be required to file Form 13H in paper until such time as an
electronic filing system is operational and capable of receiving the
Form. Large traders would be notified as soon as the electronic
system can accept filings of Form 13H.
    \81\ See proposed Rule 13h-1(b)(4). See also infra note 83
(referencing the ``promptly'' standard of Rule 15b3-1).''
---------------------------------------------------------------------------

1. Form 13H Filing Requirements
    Paragraph (b)(1) of the proposed rule would require large traders
to file Form 13H with the Commission promptly after first effecting
transactions that reach the identifying activity level.\82\ Thereafter,
large traders would be required to file an amended Form 13H promptly
following the end of a calendar quarter, but only if any of the
information contained in the Form 13H becomes inaccurate for any reason
(e.g., change of name or address, contact number, type of organization,
principal business, regulatory status, or accounts maintained).\83\ To
the extent none of the information contained in the Form became
inaccurate during the quarterly period, the large trader would not be
required to file an amended form. Regardless of whether it files any
amended Forms 13H, a large trader would still be required to file
proposed Form 13H annually, within 45 days after the calendar year-end,
in order to help ensure the accuracy and currency of all of the
information reported to the Commission.\84\
---------------------------------------------------------------------------

    \82\ See proposed Rule 13h-1(b)(1)(i).
    \83\ See proposed Rule 13h-1(b)(1)(iii) (requiring registered
broker-dealers to ``promptly file'' amendments to Form 13H as
necessary). See also 17 CFR 240.15b3-1 (concerning a similar
standard for Form BD).
    \84\ See proposed Rule 13h-1(b)(1)(ii).
---------------------------------------------------------------------------

    The Commission believes that the proposed requirement that large
traders keep current the information contained in their Form 13H
submissions will provide the Commission with up-to-date information
that the Commission could utilize promptly when needed. Unless the
Commission has up-to-date Forms 13H for each large trader, the
Commission could be impaired in its ability quickly to identify and
contact large traders, as well as identify their accounts, affiliates,
and trading activity. Given the limited amount of information proposed
to be collected on the Form 13H, the Commission believes the burden of
amending the form would be justified by the benefit to the Commission
of minimizing problems that could arise from otherwise stale
information.
2. Form 13H and Instructions
    Proposed Form 13H, and the Schedules and Instructions thereto, are
designed to capture basic information on each large trader consistent
with the Commission's authority under Section 13(h) of the Exchange
Act. The proposed Instructions to the proposed form provide all of the
pertinent definitions, examples of who would be a large trader, and
what information must be provided on Form 13H. The proposed
Instructions also provide guidance and cross-references to Rule 13h-1
and other related instructions. The Commission believes that a careful
review of the Instructions to Form 13H should assist large traders and
facilitate the completion and filing of Form 13H.
    The cover page to proposed Form 13H requires a large trader to
indicate the nature of the submission it is filing, including:
``Initial Filing,'' ``Annual Filing,'' ``Interim Filing,'' ``Inactive
Status,'' ``Reactivated Status,'' and ``Termination Filing.'' It also
requires that a large trader provide its LTID. For its ``Initial
Filing,'' a large trader would not be able to provide an LTID, as the
Commission would issue the LTID only after it receives the initial Form
13H submission. After receiving its LTID, the large trader would need
to file promptly an ``Interim Filing'' to include the LTID and any new
information.\85\ The cover page also would require contact information
for the large trader, and requires the signature of the large trader's
representative. The cover page contains a statement for the person
signing the form to acknowledge that all of the information contained
in the form

is true, correct, and complete. In addition, the cover page notes that
intentional misstatements or omissions of fact constitute a federal
crime and may result in civil penalties or other sanctions.
---------------------------------------------------------------------------

    \85\ Proposed Schedule 6 of Form 13H would require a large
trader to provide the LTID for all other large traders (if any) that
also exercise investment discretion over the accounts it identifies.
When large traders submit their ``Initial Filings'' after
implementation of this rule, large traders may not have the LTID of
these other large traders for the same reason: the Commission may
not have issued them yet. Therefore, as the Commission issues LTID
numbers, and as large traders disclose their LTIDs to each other as
required under proposed paragraph (b)(2), large traders would need
to file ``Interim Filings.''
---------------------------------------------------------------------------

    Proposed Item 1 to Form 13H would require large traders to identify
their business by checking the appropriate pre-populated categories or
by indicating ``other.'' In Item 2, a large trader would be required to
disclose whether it or any of its affiliates files forms with the
Commission and, if so, to indicate the types of forms and all
applicable SEC File and CRD numbers. The Commission anticipates that
some of the most common registrations or filings that large traders may
list in proposed Item 2 would include, for example, Form BD, Form ADV,
or Form 10-K. Identification of this information will allow the
Commission to readily ascertain the regulatory status of the large
trader and its controlled persons.
    Proposed Item 3 to Form 13H would require a large trader to
disclose whether it or any of its affiliates is: (1) A registered
trader or otherwise registered with the Commodity Futures Trading
Commission; (2) is a bank holding company, national bank, state member
bank of the Federal Reserve System, state non-member bank, savings bank
or association, credit union, or foreign bank; (3) an insurance
company; or (4) regulated by a foreign regulator. For each entity that
is, the form requires additional identifying information, which will
allow the Commission to readily ascertain the regulated status of the
large trader, and provide context for the Commission to understand the
large trader's operations. Such entities must be identified and, for
entities registered under the Commodity Exchange Act, the large trader
would be required to provide its registration type and number. For
other identified entities, a large trader would be required to disclose
the applicable regulator(s).
    Proposed Item 4 to Form 13H, and the corresponding Schedule 4,
would require the large trader to disclose basic business information.
For example, the large trader must disclose whether it exercises
investment discretion as a trustee, partnership, or corporation.
Natural person large traders would be required to disclose whether they
are self-employed or otherwise employed. Entities would be required to
disclose the jurisdiction in which they are organized and their
organization type: partnership, limited partnership, corporation,
limited liability company, or other. In addition, entities would be
required to identify those persons who own or control a large trader
corporation, partnership, limited partnership, or trust. The term
``executive officer,'' used in proposed Schedule 4, would mean
``policy-making officer'' and otherwise would be interpreted in
accordance with Rule 16a-1(f) under the Exchange Act.\86\ Further, each
large trader would be required to describe the nature of its business.
Identification of this information will help the Commission understand
the corporate structure of the large trader and the nature of its
business. Among other things, this information would be useful to the
Commission to provide context to a large trader's operations, and would
help the Commission understand the control relationships surrounding
the large trader. This information also would be useful to the
Commission in tailoring any requests for additional information that it
may send to a large trader.
---------------------------------------------------------------------------

    \86\ 17 CFR 240.16a-1(f).
---------------------------------------------------------------------------

    Proposed Item 5 to Form 13H would collect information about the
affiliates of large traders that either exercise investment discretion
over accounts that hold NMS securities or that beneficially own NMS
securities, if any. For purposes of this form, ``affiliate'' would be
defined to mean any person that directly or indirectly controls, is
under common control with, or is controlled by the large trader. This
proposed definition of affiliate is designed to allow the Commission to
collect comprehensive identifying information relating to the large
trader and is consistent with other similar definitions of the
term.\87\ The large trader would be required to identify each affiliate
that either exercises investment discretion over accounts that hold NMS
securities or that beneficially owns NMS securities, state the nature
of its affiliate's business, and explain the relationship to the large
trader (e.g., limited partner, direct subsidiary). Additionally, the
large trader would be required to provide any applicable LTID for its
large trader affiliates. Among other things, proposed Item 5 would
allow the Commission to more carefully tailor any request that it may
make to disaggregate large trader activity, and should also assist the
Commission in understanding the affiliate relationships of the large
trader and determine whether the correct entities had self-identified
with the Commission.
---------------------------------------------------------------------------

    \87\ This definition is similar to the definition of
``affiliate'' provided in the instructions to Form 1, 17 CFR 249.1.
See also supra note 54.
---------------------------------------------------------------------------

    Proposed Item 6, and the accompanying Schedule 6, are designed to
collect information concerning accounts over which the large trader
exercises investment discretion. Specifically, the proposed schedule
would require the large trader to identify all the accounts over which
it directly or indirectly (e.g., through controlled persons) exercises
investment discretion for purposes of the proposed rule. Proposed
Schedule 6 also would require a large trader to disclose the LTID of
any other large traders that exercise investment discretion over the
identified accounts. The Commission would use this information to
cross-reference accounts and avoid the double counting of transactions.
To reduce the burden on large traders, the proposed Instructions
specify that large traders may submit internally produced lists of
accounts, provided that such lists contain all required information in
a format substantially similar to the applicable Schedule. Finally,
Schedule 6 would require the identification of a designated contact
person at the large trader that the Commission could consult concerning
the accounts listed on Schedule 6.
3. Confidentiality
    Section 13(h)(7) of the Exchange Act provides that Section 13(h)
``shall be considered a statute described in subsection (b)(3)(B) of [5
U.S.C. 552]'', which is part of the Freedom of Information Act
(``FOIA'').\88\ As such, ``the Commission shall not be compelled to
disclose any information required to be kept or reported under [Section
13(h)].'' \89\ Accordingly, the information that a large trader would
be required to disclose on proposed Form 13H or provide in response to
a Commission request would be exempt from disclosure under FOIA. In
addition, any transaction information that a registered broker-dealer
would report under the proposed rule also would be exempt from
disclosure under FOIA.
---------------------------------------------------------------------------

    \88\ 5 U.S.C. 552(b)(3)(B) is now 5 U.S.C. 552(b)(3)(A)(ii).
    \89\ See section 13(h)(7) of the Exchange Act, 15 U.S.C.
78m(h)(7).
---------------------------------------------------------------------------

4. Self-Identification to Others
    Proposed paragraph (b)(2) of Rule 13h-1 would require each large
trader to disclose its LTID to those registered broker-dealers that
effect transactions on its behalf. In doing so, a large trader would be
required to identify all of the accounts held by such broker-dealer to
which its LTID applies. For example, a large trader would not be
required to disclose to Broker-Dealer A the large trader's accounts
held by Broker-Dealer B, but the large trader would need to

specifically highlight to Broker-Dealer A all of the accounts held by
Broker-Dealer A over which the large trader exercises investment
discretion. Requiring large traders to provide this information to
their broker-dealers would place the primary account identification
responsibilities on those who can most readily satisfy them--the large
traders themselves--and would facilitate the ability of registered
broker-dealers to fulfill their recordkeeping and reporting
requirements under the proposed rule by facilitating their ability to
identify and properly mark all applicable accounts through which a
large trader trades.
    Proposed paragraph (b)(2) of Rule 13h-1 also would require each
large trader to disclose its LTID to others with whom it collectively
exercises investment discretion. The purpose of this provision is to
enable large traders to provide all information required under Schedule
6 of Form 13H.\90\ In addition, the proposed requirement would
facilitate the ability of a large trader to provide a broker-dealer
with the LTID of all large traders that exercise investment discretion
over an account.\91\
---------------------------------------------------------------------------

    \90\ Specifically, Schedule 6 would require a large trader to
disclose the LTID of all other large traders who exercise investment
discretion over the accounts listed. Absent this requirement, large
traders would have no reason to know the LTIDs of the large traders
with whom they share investment discretion.
    \91\ For example, where two advisers co-manage an account,
Adviser A would inform Adviser B of its LTID, and Adviser B would
provide both its LTID and Adviser A's LTID to the broker-dealer
carrying the account.
---------------------------------------------------------------------------

D. Recordkeeping, Reporting, and Monitoring Responsibilities

    Section 13(h)(2) of the Exchange Act authorizes the Commission to
prescribe for registered broker-dealers recordkeeping requirements
related to large trader activity that it deems necessary or appropriate
in the public interest, for the protection of investors, or otherwise
in furtherance of the purposes of the Exchange Act.\92\ The Commission
also is authorized to conduct reasonable periodic, special, or other
examinations of registered broker-dealers of all records required to be
made and kept pursuant to the rule.\93\ Paragraph (d) of the proposed
rule would implement the recordkeeping provisions of Section 13(h)(2)
of the Exchange Act.
---------------------------------------------------------------------------

    \92\ See 15 U.S.C. 78m(h)(2).
    \93\ See 15 U.S.C. 78m(h)(4).
---------------------------------------------------------------------------

    In addition, Section 13(h)(2) of the Exchange Act specifically
authorizes the Commission to require registered broker-dealers to
report transactions that equal or exceed the reporting activity level
effected directly or indirectly by or through such broker-dealer for
persons who they know are large traders, or any persons who they have
reason to know are large traders on the basis of transactions effected
by or through such broker-dealers.\94\ The Commission is proposing
paragraph (e) of Rule 13h-1 to implement the transaction reporting
provisions of Section 13(h)(2) of the Exchange Act. The proposed rule
would mirror the statutory requirement that records and information
required to be made and kept pursuant to the proposed rule be available
for reporting to the Commission on the morning after the day the
transactions were effected.\95\ While such information must be
available for reporting to the Commission on the following day, the
proposed rule further clarifies that transaction data would be required
to be submitted to the Commission before the close of business on the
day specified in the request for such transaction information.\96\
Further, the Commission is authorized to require that such transaction
reports be transmitted in any format that it may prescribe, including
machine-readable form.\97\ The proposed rule mirrors this requirement
and, as discussed further below, the proposed rule would utilize the
general format applicable to the EBS system, as modified to accommodate
the specific requirements of the proposed rule, including the fields of
LTID and execution time.\98\
---------------------------------------------------------------------------

    \94\ See 15 U.S.C. 78m(h)(2).
    \95\ See proposed Rule 13h-1(d)(5). This requirement was
intended to include Saturdays or holidays. See Senate Report, supra
note 9, at 40.
    \96\ See proposed Rule 13h-1(e).
    \97\ See 15 U.S.C. 78m(h)(2).
    \98\ See infra note 104 and accompanying text.
---------------------------------------------------------------------------

    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.
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.
1. Broker-Dealer Recordkeeping
    Proposed paragraph (d)(1) of Rule 13h-1 would provide that
``[e]very registered broker-dealer shall maintain records of all
information required under paragraphs (d)(2) and (d)(3) for all
transactions effected directly or indirectly by or through (i) An
account such broker-dealer carries for a large trader or an
Unidentified Large Trader, (ii) an account over which such broker-
dealer exercises investment discretion together with a large trader or
an Unidentified Large Trader, or (iii) if the broker-dealer is a large
trader, any proprietary or other account over which such broker-dealer
exercises investment discretion. Additionally, where a non-broker-
dealer carries an account for a large trader or an Unidentified Large
Trader, the broker-dealer effecting transactions directly or indirectly
for such large trader or Unidentified Large Trader shall maintain
records of all of the information required under paragraphs (d)(2) and
(d)(3) for those transactions.''
    The term ``Unidentified Large Trader'' would be defined to mean
``each person who has not complied with the identification requirements
of paragraphs (b)(1) and (b)(2) of this rule that a registered broker-
dealer knows or has reason to know is a large trader.'' \99\ The
proposed ``reason to know'' standard is discussed in more detail below
in the context of a registered broker-dealer's responsibility to
monitor for Unidentified Large Traders.
---------------------------------------------------------------------------

    \99\ See proposed Rule 13h-1(a)(9).
---------------------------------------------------------------------------

    To help the Commission monitor the impact on the securities markets
of securities transactions involving a substantial volume or a large
fair market value, assist in the Commission's investigation of possible
Federal securities law violations, and allow the Commission to conduct
time-sequenced market reconstructions, the proposed rule would require
registered broker-dealers to maintain specified data that would be
relevant for these purposes. Notably, as discussed below, registered
broker-dealers already are required to maintain most of the proposed
fields of information for all of their customers pursuant to Rule 17a-
25 under the Exchange Act and the EBS system. In particular, the
proposed rule would require registered broker-dealers to maintain the
following information:
     Date the transaction was executed;
     Account number;
     Identifying symbol assigned to the security;

     Transaction price;
     Number of shares or option contracts traded in each
specific transaction; whether each transaction was a purchase, sale, or
short sale; and, if an option contract, whether the transaction was a
call or put option, an opening purchase or sale, a closing purchase or
sale, or an exercise or assignment
     Clearing house number of the entity maintaining the
information and the clearing house numbers of the entities on the
opposite side of the transaction;
     Designation of whether the transaction was effected or
caused to be effected for the account of a customer of such registered
broker-dealer, or was a proprietary transaction effected or caused to
be effected for the account of such broker-dealer;
     Identity of the exchange or other market center where the
transaction was executed;
     Time that the transaction was executed;
     LTID(s) associated with the account, unless the account is
for an Unidentified Large Trader;
     Prime broker identifier;
     Average price account identifier; and
     If the transaction was processed by a depository
institution, the identifier assigned to the account by the depository
institution.
    In addition, proposed paragraph (d)(3) broadens the list of
required broker-dealer records for transactions effected by
Unidentified Large Traders beyond those that would be required for a
self-identified large trader in order to assist the Commission in
identifying the Unidentified Large Trader. Specifically, for
Unidentified Large Traders, in addition to the above fields, the
registered broker-dealer also would be required to retain and report
such person's name, address, date the account was opened, and tax
identification number(s).
    The proposed rule would incorporate the requirement contained in
Section 13(h)(2) that transaction records be available for reporting to
the Commission on the morning of the day following the day the
transactions were effected.\100\ When the Commission makes a request
for data, the proposed rule specifies that registered broker-dealers
would be required to furnish it before the close of business on the day
specified in the request for such transaction information.\101\
Paragraph (d)(4) of the proposed rule would require that such records
be kept for a period of three years, the first two in an accessible
place, in accordance with Rule 17a-4(b) under the Exchange Act.\102\
---------------------------------------------------------------------------

    \100\ See proposed Rule 13h-1(d)(5). This time frame is
established in Section 13(h)(2) of the Exchange Act. See 15 U.S.C.
78m(h)(2).
    \101\ See proposed Rule 13h-1(e).
    \102\ 17 CFR 240.17a-4(b).
---------------------------------------------------------------------------

    Currently, broker-dealers already are required to provide most of
the proposed fields of information for all of their customers pursuant
to Rule 17a-25 under the Exchange Act and the EBS system.\103\ The only
additional items of information that this proposal would capture beyond
what is currently captured by the existing EBS system are: (1) LTID and
(2) transaction execution time.\104\ In this respect, the proposed rule
is intended to address the principal limitations of the EBS system when
applied to a large trader reporting system under Section 13(h) of the
Exchange Act, namely the EBS system's lack of transaction execution
time information and lack of a LTID to uniformly identify large traders
on a market-wide basis. The proposed rule also would require registered
broker-dealers to be able to report trading information for large
traders to the Commission much more promptly than the EBS system.\105\
The Commission preliminarily believes that the collection of current
trading information is necessary to allow it to monitor the impact on
the securities markets of large trader activity, particularly during
times of market stress when such analyses are particularly relevant, as
well as to support the Commission's efforts to detect and deter
fraudulent and manipulative activity and other trading abuses.
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    \103\ Rule 17a-25 requires that broker-dealers provide to the
Commission upon request the following information for proprietary
transactions: (1) Clearing house number or alpha symbol used by the
broker-dealer submitting the information; (2) clearing house
number(s) or alpha symbol(s) of the broker-dealer(s) on the opposite
side to the trade; (3) security identifier; (4) execution date; (5)
quantity executed; (6) transaction price; (7) account number; (8)
identity of the exchange or market where each transaction was
executed; (9) prime broker identifier; (10) average price account
identifier; and (11) the identifier assigned to the account by a
depository institution. For transactions effected for a customer
account, a broker-dealer must provide to the Commission upon request
the following information: The customer's name, customer's address,
the customer's tax identification number, and other related account
information. See Rule 17a-25(a)(2)(ii). Additionally, if the
transaction was effected for a customer of another firm or broker-
dealer, the broker-dealer must state whether the other broker-dealer
was acting as principal or agent on the transaction. See Rule 17a-
25(a)(2)(iii).
    \104\ While the recording of execution time is already required
of registered broker-dealers pursuant to Rule 17a-3, 17 CFR 240.17a-
3, and is currently captured by many SRO audit trails, see, e.g.,
CBOE Chapter VI, Rule 6.51 (Reporting Duties), with respect to the
proposed large trader reporting system, the reporting of execution
times within the specified period would constitute a new requirement
compared to the existing EBS system. Execution times would need to
be recorded and reported with the same degree of precision that is
required by applicable rules.
    \105\ See EBS Release, supra note 24, 66 FR at 35836 (noting
that firms are requested to submit the electronic bluesheets data
within 10 business days).
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    In particular, the capture of transaction execution times would
allow the Commission to reconstruct a more accurate and complete time-
sequenced market history and facilitate the Commission's ability to
more accurately assess the market impact of large traders, particularly
during times of peak activity and market stress. The Commission
preliminarily believes that capturing execution time would be essential
for accomplishing the purposes of Section 13(h) of the Exchange Act, as
the Market Reform Act intended a large trader system through which the
Commission could perform time-sequenced reconstruction of trading
activity.\106\
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    \106\ See Senate Report, supra note 9, at 38-40.
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    The Commission acknowledges that, in some instances, multiple LTIDs
may be disclosed to a registered broker-dealer for a single account.
For example, such a situation could arise where more than one large
trader exercises investment discretion over an account (e.g., where two
large trader investment managers co-manage an account), or where a
parent company and one of its subsidiaries both identify themselves as
large traders. Therefore, registered broker-dealers would need to
develop systems capable of tracking multiple LTIDs. The Commission
preliminarily believes that capturing the LTID of all large traders
that exercise investment discretion for an account would be essential
to adequately monitor the trading activity of each large trader that
exercises investment discretion over those transactions that are
reported to the Commission by broker-dealers and thereby accomplish the
purposes of Section 13(h) of the Exchange Act. Without that
information, the Commission could be hindered in its ability to readily
use large trader data as contemplated in Section 13(h), including to
support its regulatory and enforcement activities.
 2. Broker-Dealer Reporting
    Complementing the proposed recordkeeping requirements on brokers
and dealers, proposed paragraph (e) of Rule 13h-1 would implement the
transaction reporting provisions of Section 13(h)(2) of the Exchange
Act.
    a. General Requirements

    Under proposed paragraph (e) of proposed Rule 13h-1, the broker-
dealers required to keep records pursuant to paragraph (d)(1) also
would have a duty to report that information upon request. More
specifically, upon the request of the Commission, those broker-dealers
would be required to report electronically, in machine-readable form
and in accordance with a format specified by the Commission that is
based on the existing EBS system format, all required information for
all transactions effected directly or indirectly by or through accounts
carried by such broker-dealer for large traders and Unidentified Large
Traders if they equal or exceed the reporting activity level.\107\
Broker-dealers would need to report a particular day's trading activity
only if it equals or exceeds the ``reporting activity level,'' which is
defined and discussed below. Transaction reports, including data on
transactions up to and including the day immediately preceding the
request, would need to be furnished to the Commission before the close
of business on the day specified in the request for such transaction
information.\108\ In recognition of the value of using existing
reporting systems where practicable, the proposed rule would require
broker-dealers to utilize the existing technology and infrastructure of
the EBS system to the greatest degree possible to maintain large trader
data and transmit it to the Commission.\109\
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    \107\ Section 13(h)(2) requires that ``[s]uch records and
reports shall be in a format and transmitted in a manner prescribed
by the Commission (including, but not limited to, machine readable
form).'' See 15 U.S.C. 78m(h)(2).
    \108\ Section 13(h)(2) requires that ``[s]uch records shall be
available for reporting to the Commission, or any self-regulatory
organization that the Commission shall designate to receive such
reports, on the morning of the day following the day the
transactions were effected, and shall be reported to the Commission
or a self-regulatory organization designated by the Commission
immediately upon request by the Commission or such a self-regulatory
organization.'' See 15 U.S.C. 78m(h)(2).
    \109\ Section 13(h)(5)(A) of the Exchange Act directs the
Commission to take into account existing reporting systems in
exercising its authority under Section 13(h). See 15 U.S.C.
78m(h)(5)(A).
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b. Reporting Activity Level
    Consistent with Section 13(h)(2) of the Exchange Act, the proposed
rule would require a registered broker-dealer to report only those
transactions that equal or exceed the reporting activity level for that
particular day of trading being reported. Paragraph (a)(8) of Rule 13h-
1 would define the ``reporting activity level'' as: (i) Each
transaction in NMS securities, effected in a single account during a
calendar day, that is equal to or greater than 100 shares; (ii) any
other transaction in NMS securities, effected in a single account
during a calendar day, that a registered broker-dealer may deem
appropriate; or (iii) such other amount that may be established by
order of the Commission from time to time. While a registered broker-
dealer would be required to report for a given day data only if it
equals or exceeds the reporting activity level, the rule specifically
would allow a broker-dealer to voluntarily report a day's trading
activity that falls short of the applicable threshold. For example,
registered broker-dealers may consider it more appropriate, given the
low level of the proposed reporting activity level, to take this
approach if they prefer to avoid implementing systems to filter the
transaction activity and would rather utilize a ``data dump'' approach
to reporting large trader transaction information to the Commission.
    In proposing a reporting activity level of 100 shares, the
Commission notes that large traders often break-up large-size orders
and disburse their trading interest across multiple market centers in
an effort to maintain the confidentiality of the trade and minimize any
market impact it might otherwise have if it were revealed to its full
extent. Such large orders often are processed by algorithmic systems
that split the order into smaller orders of a hundred to a few hundred
shares. For example, high frequency traders often quote and trade in
round lots of 100 shares or a few hundred shares. By establishing a low
reporting activity level, the Commission intends for the proposed rule
to result in the reporting of substantially all large trader activity
in response to a request for data.\110\ Access to substantially all
trading data would allow the Commission to perform more complete and
accurate reconstructions of aggregate large trader activity.
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    \110\ See proposed Rule 13h-1(a)(6) (exceptions to the
definition of transaction).
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    The proposed rule also would implement the authority in Section
13(h)(8)(D) of the Exchange Act, allowing the Commission to establish,
from time to time, such reporting activity level that the Commission
shall specify by rule, regulation, or order, by proposing that the
Commission would be able to alter the reporting activity level by
order.\111\ The Commission could use this authority to change the
reporting activity level if necessary to assure, for example, the
quality of 13H Reports and the level of compliance with the
identification requirements.\112\
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    \111\ See proposed Rule 13h-1(a)(8). See also Senate Report,
supra note 9, at 73 (noting that this authority to act by order was
intended to provide the Commission with the flexibility necessary
for responding to changing market conditions).
    \112\ The Commission might, for example, consider whether an
alternative threshold amount would be more appropriate if large
traders were managing their account activity to avoid the proposed
100 share reporting activity level.
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    Unlike the identifying activity level, when considering the
reporting activity level, a registered broker-dealer would consider
only the trading activity for each of its large trader and unidentified
accounts, and would not need to aggregate transaction information on an
intra-broker-dealer basis solely for calculating the reporting activity
level. Thus, if a large trader maintains two separate accounts at a
registered broker-dealer under the same LTID, the broker-dealer would
be required to report activity in each account only if the activity in
such account equaled or exceeded the reporting activity level on the
specified day. A registered broker-dealer would report each account
separately and would not need to aggregate accounts with the same LTID.
By establishing a low reporting activity level, the Commission's
proposal eliminates the need to propose aggregation requirements to
assure that most large trader accounts would be reported in response to
a request for data. The Commission believes that most active large
trader accounts on any given day should contain sufficient transactions
(i.e., at least 100 shares traded) to make the accounts reportable in
response to a particular Commission request.
c. Multiple LTIDs
    Under the proposal, it is possible that more than one LTID could be
associated with a particular account. For example, such a situation
could arise where two or more large traders share investment discretion
over the account. For transactions involving these accounts, the
registered broker-dealer would be required to record each LTID for
every trade effected in such account.\113\ In response to a request for
records, the registered broker-dealer would report transaction
information containing each LTID associated with the account. For
identified large traders, the Commission could then use the LTID
information collected on Schedule 6 to proposed Form 13H to filter the
data and avoid double counting transactions.
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    \113\ Broker-dealers also would need to monitor for Unidentified
Large Traders that effect transactions through a shared account.

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 3. Broker-Dealer Monitoring and Safe Harbor
    The proposed rule places the principal burden of compliance with
the identification requirements on large traders themselves. The
Commission, however, believes that a limited monitoring requirement at
the broker-dealer level would provide a necessary backstop to encourage
compliance and fulfill the objectives of Section 13(h) of the Exchange
Act.
    Section 13(h) of the Exchange Act contemplates that registered
broker-dealers would assist in fostering compliance with a large trader
reporting system by monitoring their customers' compliance with the
large trader self-identification requirements. Specifically, Section
13(h)(2) of the Exchange Act authorizes the Commission to establish
rules for recordkeeping and reporting of transactions effected by
persons a registered broker-dealer ``knows or has reason to know'' is a
large trader, based on transactions effected directly or indirectly by
or through such broker-dealer. Proposed paragraphs (d) and (e) of Rule
13h-1 would implement that authority by requiring registered broker-
dealers to maintain records of and report to the Commission information
about transactions effected by Unidentified Large Traders.\114\
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    \114\ See supra text accompanying note 99 (discussing
recordkeeping requirements for Unidentified Large Traders). In
particular, proposed Rule 13h-1(d)(3) would broaden the list of
required elements for transactions effected by Unidentified Large
Traders, and would require broker-dealers to report for Unidentified
Large Traders such person's name, address, date the account was
opened, and tax identification number(s).
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    With respect to identifying large traders, the Commission
emphasizes that the principal burden of compliance with the proposed
identification requirements is placed squarely on large traders
themselves. However, the Commission also believes that requiring some
form of monitoring by the entities that are in the best position to
know the details of a large trader's account would help assure that the
objectives of the rule are met.
    The Commission acknowledges that the duty to monitor its large
trader customers would impose a burden on registered broker-dealers. To
minimize this burden, paragraph (f) of proposed Rule 13h-1 would
establish a ``safe harbor'' for the duty to monitor for Unidentified
Large Traders.\115\ Pursuant to proposed paragraph (a)(9), in the case
of an Unidentified Large Trader, a ``registered broker-dealer has
reason to know whether a person is a large trader based on the
transactions in NMS securities effected by or through such broker-
dealer.'' A registered broker-dealer would not be deemed to know or to
have reason to know that a person is an Unidentified Large Trader if:
(1) It does not have actual knowledge that a person is a large trader;
and (2) it established and maintained policies and procedures
reasonably designed to assure compliance with the identification
requirements of the proposed safe harbor. Paragraphs (f)(1) and (2) of
the proposed rule provide the specific elements that would be required
for the safe harbor.