Section 4 Trading Practices and Prohibited Activities

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1 The goal of this section is to Section 4 Trading Practices and Prohibited Activities Understand written supervisory procedures, application, and adherence thereto Understand the mechanics and ramifications of the tendering of exercise notices for options; exercise by exception and same day exercise Understand the effect of exercise prior to ex-dividend date Understand OCC assignment procedure and firm/market maker assignment Understand the compliance requirements for delivery, payment, and settlement Understand relevant position/exercise limits Understand reporting related to position limits 4.1 Supervisory Procedures All procedures of registered firms should be documented. Also, there are strict procedures spelled out that involve maintaining ongoing documentation. Many of these procedures apply to customer accounts, as well as the updating of Forms U4 and U SRO Rules Regarding Supervisory Procedures As a reminder SROs are the National Exchanges and FINRA. There are small differences in the registration requirements of SROs but the following is general guideline that adheres to the rules of the SROs. All registered persons shall be registered with an SRO. This is provided that the Exchange may waive this requirement or may permit a short-form registration or notification in the case of an individual who is properly registered with another selfregulatory organization. This alternate SRO will have registration and examination procedures acceptable to the Exchange. Every other employee and person associated with a Participant must also be acceptable to the Exchange. The acceptance often relates directly to a statutory disqualification in the past. Registered persons are Participants and persons associated with a Firm who are engaged or will be engaged in the securities business of a Participant. This may also include the management of such securities business, including the functions of supervision, solicitation, conduct of business or the training of persons associated with a Participant for any of these functions. Series 56 Section 4 1

2 The following is a list of persons to be registered: Sole Proprietors Officers Partners Principal Stockholders Directors Branch office managers Persons acting as Institutional Broker Representatives Persons acting as Market Maker Traders Representatives Persons engaged in any of the following functions on behalf of a Firm: 1. Underwriting, trading or sales of securities; 2. Research or investment advice, other than general economic information or advice. 3. Activities that involve communication, directly or indirectly, with public investors in securities in connection with activities described in above. The following persons associated with a Participant are not required to be registered with an SRO Persons associated with a Participant whose functions are solely and exclusively clerical or ministerial Persons associated with a Participant not actively engaged in the securities business. A Participant shall not make application for the registration of any person associated with the Participant where there is no intent to employ such person in the securities business of the Participant. Registration of an Option Principal No person shall be approved to transact options business with the public until those associated persons who are designated as Options Principals have been approved by and registered with an SRO. Persons engaged in the supervision of options sales practices or a person to whom the designated general partner or executive officer or another Registered Options Principal delegates the authority to supervise options sales practices shall be designated as Options Principals. Series 56 Section 4 2

3 Opening of Customer Accounts No firm shall accept an order from a customer to purchase or write an options contract unless the customer s account has been approved for options transactions. In approving a customer s account for options transactions, a firm shall exercise due diligence to learn the essential facts as to the customer and his investment objectives and financial situation, and shall make a record of such information. Based upon such information, the branch office manager or other Options Principal shall approve in writing the customer s account for options transactions; provided, that if the branch office manager is not an Options Principal, his approval shall within a reasonable time be confirmed by an Options Principal. Customers should also be furnished with a copy of the Options Disclosure Document. Branch Offices firms approved to do options business with the public under this shall file with the proper SRO and keep current a list of each of its branch offices showing the location of each such office and the name of the manager of each such office. No branch office shall transact options business with the public unless the manager of such branch office has been qualified as an Options Principal. This requirement shall not apply to branch offices in which not more than three representatives are located so long as the Member can demonstrate that the options activities of such branch offices are appropriately supervised by an Options Principal. Supervision of Accounts - The general partners or directors of each firm that conducts non-member customer business shall provide for appropriate supervisory control. The firm shall designate a general partner or executive officer, who shall be identified to an SRO, to assume overall authority and responsibility for internal supervision and control of the organization and compliance with securities laws and regulations. Additionally supervision may 1. Be delegated to qualified employees responsibilities and authority for supervision and control of each office, department or business activity, and shall provide for appropriate written procedures of supervision and control. 2. Be established as a separate system of follow-up and review to determine that the delegated authority and responsibility is being properly exercised. 3. Should involve developing and implementing written policies and procedures reasonably designed to independently supervise the activities of accounts serviced by branch office managers, sales managers, regional/district sales managers or any person performing a similar supervisory function. Series 56 Section 4 3

4 4.1.2 Options Price Reporting Authority The Options Price Reporting Authority (OPRA) provides, through Market Data Vendors, last sale information and current options quotations from a committee of Participant Exchanges. Current OPRA participants include: AMEX, ARCA, BATS, BSE, C2, CBOE, ISE, NASDAQ, NYSE, and PHLX. The participants act as a policy committee composed of representatives from each participant exchange and they implement and, subject to Commission approval, amend the policies and procedures set forth in the OPRA Plan. OPRA is not involved in the settlement of option trades. Also, OPRA has no role in the exercise and assignment process. 4.2 Applicable Federal Regulations Securities Exchange Act of 1934 The Securities Exchange Act of 1934 established laws governing the secondary trading of securities. Also, this act established the Securities and Exchange Commission (SEC) Section 3 Definitions and Application of Title The following terms are taken directly from the Securities Exchange Act of 1934 text. There are several other definitions that are not included in the outline provided by the examiners. These definitions come directly from the outline. Exchange - any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange. Series 56 Section 4 4

5 Member (Permit Holder) with respect to a national securities exchange a member means 1. Any natural person permitted to effect transactions on the floor of the exchange without the services of another person acting as broker 2. Any registered broker or dealer with which such a natural person is associated 3. Any registered broker or dealer permitted to designate as a representative such a natural person. 4. Any other registered broker or dealer which agrees to be regulated by such exchange and with respect to which the exchange undertakes to enforce compliance with the provisions of this title, the rules and regulations there under, and its own rules. Broker the term broker means any person engaged in the business of effecting transactions in securities for the account of others. Dealer The term dealer means any person engaged in the business of buying and selling securities (not including security-based swaps, other than security-based swaps with or for persons that are not eligible contract participants) for such person s own account through a broker or otherwise. Issuer The term issuer means any person who issues or proposes to issue any security. Security The term security means any note, stock, treasury stock, security future, security-based swap, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a security; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker s acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited. Series 56 Section 4 5

6 Equity Security The term equity security means any stock or similar security; or any security future on any such security; or any security convertible, with or without consideration, into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any other security which the Commission shall deem to be of similar nature and consider necessary or appropriate, by such rules and regulations as it may prescribe in the public interest Buy-Purchase The terms buy and purchase each include any contract to buy, purchase, or otherwise acquire. For security futures products, such term includes any contract, agreement, or transaction for future delivery. For security-based swaps, such terms include the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, or extinguishing of rights or obligations under, a security-based swap, as the context may require. Sale-Sell The terms sale and sell each include any contract to sell or otherwise dispose of. For security futures products, such term includes any contract, agreement, or transaction for future delivery. For security-based swaps, such terms include the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, or extinguishing of rights or obligations under, a security-based swap, as the context may require. Clearing Agency The term clearing agency means any person who acts as an intermediary in making payments or deliveries or both in connection with transactions in securities or who provides facilities for comparison of data respecting the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities. Such term also means any person, such as a securities depository, who 1. Acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry without physical delivery of securities certificates, or 2. Otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates Prohibition Against the Manipulation of Securities Prices The manipulation of securities prices shall be unlawful for any person, directly or indirectly, by the use of the mails or any means or instrumentality of interstate commerce, or of any facility of any national securities exchange, or for any member of a national securities exchange. The following examples of price manipulation come directly from Section 9 of the Securities and Exchange Act of Updated exchange related rules follow in the next section. Series 56 Section 4 6

7 Misleading Appearance of Active Trading For the purpose of creating a false or misleading appearance of active trading in any security other than a government security, or a false or misleading appearance with respect to the market for any such security 1. To effect any transaction in such security that involves no change in the beneficial ownership. 2. To enter an order or orders for the purchase of such security with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the sale of any such security, has been or will be entered by or for the same or different parties. 3. To enter any order or orders for the sale of any such security with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the purchase of such security, has been or will be entered by or for the same or different parties. Inducing Purchase or Sale by Others To effect, alone or with one or more other persons, a series of transactions in any security other than a government security, any security not so registered, or in connection with any security-based swap or securitybased swap agreement with respect to such security creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others. Dissemination of Information as to Rise or Fall of Securities Prices An attempt to manipulate or influence the price of a security through the circulation or dissemination of information. This would be in the ordinary course of business of information to the effect that the price of any such security will or is likely to rise or fall because of market operations of any one or more persons conducted for the purpose of raising or depressing the price of such security. Making False or Misleading Statements making any statement which was at the time and in the light of the circumstances under which it was made, false or misleading with respect to any material fact, and which that person knew or had reasonable ground to believe was so false or misleading. Dissemination of Information for Consideration For a consideration (payment), circulation or dissemination of information to the effect that the price of any such security will or is likely to rise or fall because of the market operations of any one or more persons conducted for the purpose of raising or depressing the price of such security. Series 56 Section 4 7

8 Pegging, Fixing, or Stabilizing Prices To effect either alone or with one or more other persons any series of transactions for the purchase and/or sale of any security other than a government security for the purpose of pegging, fixing, or stabilizing the price of such security in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors Use or Employment of Deceptive Devices It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange. The following example of deceptive devices comes directly from Section 10 of the Securities and Exchange Act of Updated exchange related rules follow in the next section. Employment of manipulative and deceptive devices by brokers or dealers To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors Tender Offers The following example of rules regarding tender offers comes directly from Section 14 of the Securities and Exchange Act of Updated exchange related rules follow in the next section. Prohibited transactions in connection with partial tender offers Any solicitation or recommendation to the holders of such a security to accept or reject a tender offer or request or invitation for tenders shall be made in accordance with such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. Series 56 Section 4 8

9 Regulation FD Regulation FD refers to Regulation Fair Disclosure. The basis is that when an issuer (public company) discloses material nonpublic information to certain persons (such as, securities market professionals and holders of the issuer s securities) who may well trade on the basis of the information, it must also make public disclosure of that information. With respect to Regulation to FD, if information may have been disclosed to a select number of individual erroneously, an issuer (company) should make every effort to publicly disclose this information as quickly as possible. 4.3 Prohibited Activities Anti-Manipulation Rules Each SRO has their own specific rules regarding manipulative practices. The following is a guideline of rules based on multiple SRO documents. No individual shall effect or induce the purchase, sale or exercise of any security for the purpose of creating or inducing a false, misleading, or artificial appearance of activity in such security or in the underlying security, or for the purpose of unduly or improperly influencing the market price of such security or of the underlying security or for the purpose of making a price which does not reflect the true state of the market in such security or in the underlying security. No person or organization shall directly or indirectly participate in or have any interest in the profit of a manipulative operation or knowingly manage or finance a manipulative operation. Specifics Applied to This Rule The creation of any pool, syndicate or joint account, whether in corporate form or otherwise, organized or used intentionally for the purpose of unfairly influencing the market price of any security by means of options or otherwise and for the purpose of making a profit thereby shall be deemed to be a manipulative operation; The soliciting of subscriptions to any such pool, syndicate or joint account or the accepting of discretionary orders from any such pool, syndicate or joint account shall be deemed to be managing a manipulative operation; and The carrying on margin of either a long or a short position in securities for, or the advancing of credit through loans of money or of securities to, any such pool, syndicate or joint account shall be deemed to be financing a manipulative operation. Series 56 Section 4 9

10 4.3.2 Anti-Money Laundering Rules Each SRO has their own anti-money laundering rules that are specific to the exchange or agency. All money laundering rules should be consistent with the Bank Secrecy Act rules on Money Laundering. The following is a compilation of those rules. Each firm shall develop and implement a written anti-money laundering program reasonably designed to achieve and monitor the firm or individual s compliance with the requirements of the Bank Secrecy Act and the implementing regulations promulgated thereunder by the Department of the Treasury. Each firm's antimoney laundering program must be approved, in writing, by the firm s senior management. The anti-money laundering programs shall, at a minimum 1. Establish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of potentially illegal transactions. 2. Establish and implement policies, procedures, and internal controls reasonably designed to achieve compliance with the Bank Secrecy Act. 3. Provide for independent testing for compliance to be conducted by the Member s personnel or by a qualified outside party. 4. Designate and identify to the Exchange (by name, title, mailing address, e- mail address, telephone number, and facsimile number) an individual or individuals responsible for implementing and monitoring the day-to-day operations and internal controls of the program, and provide prompt notification to the Exchange regarding any change in such designation(s). 5. Provide ongoing training for appropriate personnel. Series 56 Section 4 10

11 4.3.3 Insider Trading Every firm, other than a lessor that is neither registered, nor required to be registered, as a broker-dealer shall establish, maintain and enforce written policies and procedures reasonably designed, taking into consideration the nature of the firm s business, to prevent the misuse of material nonpublic information by such firm or persons associated with such firm in violation of the established rules. Material non-public information. Information is considered material if there is a substantial likelihood that a reasonable investor would consider it important in deciding to buy or sell a security. If this information would have a direct impact on a security s price it should be considered material. Misuse of material non-public information includes, but is not limited to 1. Direct trading in a security based on knowledge of material non-public information. 2. Trading in any derivative security that has value based on the security related to non-public information. 3. Disclosing to an individual any material non-public information or facilitating in the use of material non-public information. Each firm shall establish, maintain and enforce the following policies and procedures as appropriate for the nature of each firm s business 1. All associated persons must be advised in writing of the prohibition against the misuse of material nonpublic information; 2. Firm should have signed attestations from the member and all associated persons affirming their awareness of, and agreement to abide by, the aforementioned prohibitions must be maintained for at least three (3) years, the first two (2) years in an easily accessible place. 3. Records of all brokerage accounts maintained by the Member and all associated persons must be acquired and maintained for at least three (3) years, the first two (2) years in an easily accessible place, and such brokerage accounts must be reviewed periodically by the Member for the purpose of detecting the possible misuse of material nonpublic information. 4. Any business dealings the Member may have with any corporation whose securities are publicly traded, or any other circumstances that may result in the Member receiving, in the ordinary course of business, material nonpublic information concerning any such corporation, must be identified and documented. Series 56 Section 4 11

12 Firm that are required that are required to do so shall, contemporaneously with those submissions shall annually file attestations signed by firms stating that the procedures mandated have been established, enforced and maintained. Any Member or associated person who becomes aware of a possible misuse of material nonpublic information must promptly notify the Exchange. Firms should establish internal controls (Chinese Walls) that limit the flow of information that could result in confidential information being shared and possibly misused. Two types of Chinese Wall violations are a breach of an information barrier or lack of information barriers Anti-Competitive Trading Practices No individual or firm shall engage in acts or practices inconsistent with just and equitable principles of trade. The following specific definitions are cited Collusion A non-competitive agreement between rivals that attempts to disrupt the market's equilibrium. By collaborating with each other, rival firms look to alter the price of a good to their advantage. The parties may collectively choose to restrict the supply of a good, and/or agree to increase its price in order to maximize profits. Groups may also collude by sharing private information, allowing them to benefit from insider information Price/size/spread convention Any collusion by market participants to alter or control publicly quoted prices, indicated bid or offer sizes, or the width of the bid ask spreads shall be deemed conduct inconsistent with just and equitable principles of trade. Harassment and Intimidation Practices involving harassment, threats, intimidation, collusion, refusals to deal, or retaliation that have the intended purpose or effect of discouraging a member (permit holder) or other market participant from acting, or seeking to act, competitively are prohibited under this Rule and shall be deemed conduct inconsistent with just and equitable principles of trade. Series 56 Section 4 12

13 4.3.5 Additional Prohibited Activities The following are terms specifically pointed out by the material outline Front Running The illegal practice of a broker executing orders on a security for its own account while taking advantage of advance knowledge of pending orders from its customers. When orders previously submitted by its customers will predictably affect the price of the security, purchasing first for its own account gives the broker an unfair advantage, since it can expect to close out its position at a profit based on the new price level. The front running broker either buys for his own account (before filling customer buy orders that drive up the price), or sells (where the broker sells for its own account, before filling customer sell orders that drive down the price). Trading Ahead A practice that is similar to front running. This may be done by any market participant who has knowledge of a large order that may be pending in the marketplace and would influence the future price of a security. Marking-the-Close attempting to influence a security s closing price through buying or selling of that security near the market close. This may be done by placing a large number of buy or sell orders near the close of business. Painting-the-Tape An illegal action by a group of market manipulators buying and/or selling a security among themselves to create artificial trading activity, which, when reported on the ticker tape, lures in unsuspecting investors as they perceive an unusual volume. Spreading Market Rumors attempting to influence a security s price through the spreading of unsubstantiated or false information. Wash-Sale Rule An Internal Revenue Service (IRS) rule prohibiting taxpayers from claiming a loss on the sale of an investment. The long term benefit is not valid when the same investment was purchased within 30 days before or after the sale date. Also know as the "30-day wash-sale rule". Information Barriers Also known as a Chinese Wall. The goal of this barrier is keep non-public inside information within the proper division of a firm. If confidential work is being done by a banking division that would influence security prices it should solely remain in that division. Breach of Information Barriers A situation where non-public information has been shared with a division of a company where it may result in illegal trading activity. This information has been shared as the result of circumventing any information barrier that has been properly implemented. Series 56 Section 4 13

14 Lack of Information Barriers A situation where a company has not established proper procedures to avoid information being shared with a division that should not be privy to such information. The information has been shared with a department or individuals that should not have access in the regular course of business. If a firm has not implemented proper information barriers to avoid this occurring the result is a lack of information barriers. Pre-Arranged Trading Trading activity that may be the result of collusion. The pre-arranged trade may be agreed upon with the goal of creating the illusion of an increase in volume (painting the tape) or in order to manipulate the price of the security. Trade Shredding the practice of breaking orders into smaller, multiple trading solely for the purpose of generating market data revenue Short Sales and Mandatory Buy-Ins In 2005 Regulation SHO (Reg SHO) was implemented to update legislations concerning short sale practices. Regulation SHO established "locate" and "close-out" standards that are primarily aimed at preventing the opportunity for traders to engage in unethical naked short selling practices. Specific definitions that come under this section are Aggregation a broker dealer may aggregate all long and short positions to determine a net firm position. In order to qualify for aggregation regarding short selling a broker-dealer should meet the following requirements 1. The broker-dealer has a written plan of organization that identifies each aggregation unit, specifies its trading objective(s), and supports its independent identity. 2. Each aggregation unit within the firm determines at the time of each sale its net position for every security that it trades. 3. all traders in an aggregation unit pursue only the trading objectives or strategy(ies) of that aggregation unit. 4. Individual traders are assigned to only one aggregation unit at any time. Series 56 Section 4 14

15 Marking Requirements a sale should be correctly registered as a short sale if the seller does not have a legitimate long position in the security. Locate Requirements a short seller should have reasonable grounds that a security that is to be sold short may be borrowed and delivered by the date of delivery before a short sale is executed. Close-Out Requirement Regulation SHO imposes additional delivery requirements on broker-dealers for securities in which there are a relatively substantial number of extended delivery failures at a registered clearing agency. Additional short sales may not be enacted in these securities. Threshold Securities stocks that are on the Threshold Security List which is a daily public accounting of market settlement system failures (or 'fails') published daily. A market settlement failure occurs when delivery on a security is not made within the alloted settlement period. Threshold Security Lists are published daily by national securities exchanges. A security will make the threshold list if it meets the following criteria over five consecutive settlement days: 1. The total share number of fails to deliver exceed 10,000 shares. 2. The total number of shares that have failed to deliver exceed 0.5% of the outstanding shares. 3. The security is listed on a similar list by a self-regulatory organization (another exchange s threshold list). Once a company is added to the list it remains there until the 'fails' fall beneath the benchmark standards for five consecutive trading days. Buy-Ins A contract which has not been completed by the seller according to its terms may be closed by the buyer not sooner than the third business day following the date delivery was due Series 56 Section 4 15

16 Regulation SHO Short Sales Three Violations of Regulation SHO related to selling short 1. Selling stock short without having located stock for delivery at settlement. 2. Selling stock short and failing to deliver shares at the time of settlement. 3. Selling stock short and failing to deliver shares at the time of settlement with the purpose of driving down the security s price. A public customer should locate shares to borrow for delivery before executing a short sale. The following Reg SHO Rules are specifically cited in the outline Regulation SHO Rule 200 The term short sale shall mean any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller. A person shall be deemed to own securities only to the extent that he has a net long position in such securities. Aggregation independent trading units may aggregate positions to determine a net long or short position. In order to determine its net position, a broker or dealer shall aggregate all of its positions in a security unless it qualifies for independent trading unit aggregation, in which case each independent trading unit shall aggregate all of its positions in a security to determine its net position. Independent trading unit aggregation is available only if: 1. The broker or dealer has a written plan of organization that identifies each aggregation unit, specifies its trading objective(s), and supports its independent identity; 2. Each aggregation unit within the firm determines, at the time of each sale, its net position for every security that it trades; 3. All traders in an aggregation unit pursue only the particular trading objective(s) or strategy(s) of that aggregation unit and do not coordinate that strategy with any other aggregation unit; and 4. Individual traders are assigned to only one aggregation unit at any time. Series 56 Section 4 16

17 A broker or dealer must mark all sell orders of any equity security as "long, "short, or "short exempt." Marking of Sell Orders Long a sell order may be marked long sale only if the seller is an owner of the security. Short of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed. Short Exempt a sell order may be marked as short exempt if the seller is relying on an exception from the tick test or other rules in place that allow an exemption as spelled out under Regulation SHO Rule 201. Regulation SHO Rule 201 Definition of short sale and Marking Requirements Covered Security NMS stock means any NMS security other than an option. Effective Transaction Reporting Plan for a Covered Security any transaction reporting plan approved by the Commission pursuant to SEC rules. plan. Listing Market will be the market that is defined in the transaction reporting National Best Bid and National Best Offer with respect to quotations for an NMS security, the best bid and best offer for such security that are calculated and disseminated on a current and continuing basis by a plan processor pursuant to an effective national market system plan provided, that in the event two or more market centers transmit to the plan processor pursuant to such plan identical bids or offers for an NMS security, the best bid or best offer (as the case may be) shall be determined by ranking all such identical bids or offers (as the case may be) first by size (giving the highest ranking to the bid or offer associated with the largest size), and then by time (giving the highest ranking to the bid or offer received first in time). Odd Lot an order for the purchase or sale of an NMS stock in an amount less than a round lot. A stock round lot is considered 100 shares. Plan Processor any self-regulatory organization or securities information processor acting as an exclusive processor in connection with the development, implementation and/or operation of any facility contemplated by an effective national market system plan. Series 56 Section 4 17

18 Regular Trading Hours the time between 9:30 a.m. and 4:00 p.m. Eastern Time, or such other time as is set forth in the regulatory procedures. Riskless Principal a transaction in which a broker or dealer, after having received an order to buy a security, purchases the security as principal at the same price to satisfy the order to buy, exclusive of any explicitly disclosed markup or markdown, commission equivalent, or other fee, or, after having received an order to sell, sells the security as principal at the same price to satisfy the order to sell, exclusive of any explicitly disclosed markup or markdown, commission equivalent, or other fee. Trading Center means a national securities exchange or national securities association that operates an SRO trading facility, an alternative trading system, an exchange market maker, an OTC market maker, or any other broker or dealer that executes orders internally by trading as principal or crossing orders as agent. Short Sale Rules A trading center shall establish, maintain, and enforce written policies and procedures reasonably designed to: 1. Prevent the execution or display of a short sale order of a covered security at a price that is less than or equal to the current national best bid if the price of that covered security decreases by 10% or more from the covered security's closing price. 2. Impose the requirements of this section for the remainder of the day and the following day when a national best bid for the covered security is calculated and disseminated on a current and continuing basis by a plan processor pursuant to an effective national market system plan. 3. Provided, however, that the policies and procedures must be reasonably designed to permit the execution of a displayed short sale order of a covered security by a trading center if, at the time of initial display of the short sale order, the order was at a price above the current national best bid and the execution or display of a short sale order of a covered security marked "short exempt" without regard to whether the order is at a price that is less than or equal to the current national best bid. Series 56 Section 4 18

19 A trading center shall regularly surveil to ascertain the effectiveness of the policies and procedures required by rules and shall take prompt action to remedy deficiencies in such policies and procedures. The determination regarding whether the price of a covered security has decreased by 10% or more from the covered security's closing price as determined by the listing market for the covered security as of the end of regular trading hours on the prior day shall be made by the listing market for the covered security and, if such decrease has occurred, the listing market shall immediately notify the single plan processor responsible for consolidation of information for the covered security pursuant to rules. The single plan processor must then disseminate this information. Following any determination and notification pursuant to rules with respect to a covered security, a broker or dealer submitting a short sale order of the covered security in question to a trading center may mark the order "short exempt" if the broker or dealer identifies the order as being at a price above the current national best bid at the time of submission; provided, however 1. The broker or dealer that identifies a short sale order of a covered security as "short exempt" in accordance with rules must establish, maintain, and enforce written policies and procedures reasonably designed to prevent incorrect identification of orders for purposes of these rules 2. The broker or dealer shall regularly surveil to ascertain the effectiveness of the policies and procedures required by rules of this section and shall take prompt action to remedy deficiencies in such policies and procedures. Series 56 Section 4 19

20 Following any determination and notification pursuant to rules with respect to a covered security, a broker or dealer may mark a short sale order of a covered security "short exempt" if the broker or dealer has a reasonable basis to believe that 1. The short sale order of a covered security is by a person that is deemed to own the covered security, provided that the person intends to deliver the security as soon as all restrictions on delivery have been removed. 2. The short sale order of a covered security is by a market maker to offset customer odd-lot orders or to liquidate an odd-lot position that changes such broker's or dealer's position by no more than a unit of trading 3. The short sale order of a covered security is for a good faith account of a person who then owns another security by virtue of which he is, or presently will be, entitled to acquire an equivalent number of securities of the same class as the securities sold; provided such sale, or the purchase which such sale offsets, is effected for the bona fide purpose of profiting from a current difference between the price of the security sold and the security owned and that such right of acquisition was originally attached to or represented by another security or was issued to all the holders of any such securities of the issuer. 4. The short sale order of a covered security is for a good faith account and submitted to profit from a current price difference between a security on a foreign securities market and a security on a securities market subject to the jurisdiction of the United States, provided that the short seller has an offer to buy on a foreign market that allows the seller to immediately cover the short sale at the time it was made. For the purposes of this rule, a depository receipt of a security shall be deemed to be the same security as the security represented by such receipt. 5. The short sale order of a covered security is by a broker or dealer effecting the execution of a customer purchase or the execution of a customer "long" sale on a riskless principal basis. In addition, for purposes of these rules, a broker or dealer must have written policies and procedures in place to assure that, at a minimum 1. The customer order was received prior to the offsetting transaction; 2. The offsetting transaction is allocated to a riskless principal or customer account within 60 seconds of execution; and 3. The broker or dealer has supervisory systems in place to produce records that enable the broker or dealer to accurately and readily reconstruct, in a time-sequenced manner, all orders on which a broker or dealer relies pursuant to this exception. Series 56 Section 4 20

21 6. The short sale order is for the sale of a covered security at the volume weighted average price (VWAP) that meets the following criteria: 1. The VWAP for the covered security is calculated by: A. Calculating the values for every regular way trade reported in the consolidated system for the security during the regular trading session, by multiplying each such price by the total number of shares traded at that price; B. Compiling an aggregate sum of all values; and C. Dividing the aggregate sum by the total number of reported shares for that day in the security. 2. The transactions are reported using a special VWAP trade modifier. 3. The VWAP matched security: A. Qualifies as an "actively-traded security" B. The proposed short sale transaction is being conducted as part of a basket transaction of twenty or more securities in which the subject security does not comprise more than 5% of the value of the basket traded. 4. The transaction is not effected for the purpose of creating actual, or apparent, active trading in or otherwise affecting the price of any security. 5. A broker or dealer shall be permitted to act as principal on the contra-side to fill customer short sale orders only if the broker's or dealer's position in the covered security, as committed by the broker or dealer during the pre-opening period of a trading day and aggregated across all of its customers who propose to sell short the same security on a VWAP basis, does not exceed 10% of the covered security's relevant average daily trading volume. No self-regulatory organization shall have any rule that is not in conformity with, or conflicts with, these Rules. Upon written application or upon its own motion, the Commission may grant an exemption from the provisions of this section, either unconditionally or on specified terms and conditions, to any person or class of persons, to any transaction or class of transactions, or to any security or class of securities to the extent that such exemption is necessary or appropriate, in the public interest, and is consistent with the protection of investors. Series 56 Section 4 21

22 Regulation SHO Rules 203 Borrowing and Delivery Requirements Market Maker means any specialist permitted to act as a dealer, any dealer acting in the capacity of block positioner, and any dealer who, with respect to a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for his own account on a regular or continuous basis. Participant when used with respect to a clearing agency means any person who uses a clearing agency to clear or settle securities transactions or to transfer, pledge, lend, or hypothecate securities. Such term does not include a person whose only use of a clearing agency is (A) through another person who is a participant or (B) as a pledgee of securities. Registered Clearing Agency means any person who acts as an intermediary in making payments or deliveries or both in connection with transactions in securities or who provides facilities for comparison of data respecting the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities. Such term also means any person, such as a securities depository, who (i) acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry without physical delivery of securities certificates, or (ii) otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates. Security Future a contract of sale for future delivery of a single security or of a narrow-based security index, including any interest therein or based on the value thereof. Settlement Day any business day on which deliveries of securities and payments of money may be made through the facilities of a registered clearing agency. Series 56 Section 4 22

23 Threshold Security any equity security of an issuer that is registered and for which the issuer is required to file reports for which 1. There is an aggregate fail to deliver position for five consecutive settlement days at a registered clearing agency of 10,000 shares or more and that is equal to at least 0.5% of the issue s total shares outstanding 2. is included on a list disseminated to its members by a self regulatory agency (SRO exchange) and 3. provided that a security shall cease to be a threshold security if the aggregate fail to deliver position at a registered clearing agency does not exceed the level specified in rules for five consecutive settlement days. The Threshold List is published by respective exchanges. Short Sales of Security Futures do not fall under Regulation SHO Rules. For Threshold List Stocks Long Sales a broker or dealer knows or has reasonable grounds to believe that the sale of an equity security was or will be effected pursuant to an order marked "long," such broker or dealer shall not lend or arrange for the loan of any security for delivery to the purchaser's broker after the sale, or fail to deliver a security on the date delivery is due Short Sales A broker or dealer may not accept a short sale order in an equity security from another person, or effect a short sale in an equity security for its own account, unless the broker or dealer has: 1. Borrowed the security, or entered into a bona-fide arrangement to borrow the security; or 2. Resonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due 3. Documented compliance. Series 56 Section 4 23

24 If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for thirteen consecutive settlement days, the participant shall immediately thereafter close out the fail to deliver position by purchasing securities of like kind and quantity: Upon written application or upon its own motion, the Commission may grant an exemption from these provisions, either unconditionally or on specified terms and conditions, to any transaction or class of transactions, or to any security or class of securities, or to any person or class of persons. Reg SHO Rule 204 Close-Out Requirements A participant of a registered clearing agency must deliver securities to a registered clearing agency for clearance and settlement on a long or short sale in any equity security by settlement date, or if a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in any equity security for a long or short sale transaction in that equity security, the participant shall, by no later than the beginning of regular trading hours on the settlement day following the settlement date, immediately close out its fail to deliver position by borrowing or purchasing securities of like kind and quantity. Series 56 Section 4 24

25 4.4 Trading Practices Terms and Definitions Program Trading Computerized trading used primarily by institutional investors typically for large-volume trades. Orders from the trader's computer are entered directly into the market's computer system and executed automatically Best Execution Brokers are legally required to seek the best execution reasonably available for their customers' orders. To comply with this requirement, brokers evaluate the orders they receive from all customers in the aggregate and periodically assess which competing markets, market makers, or electronic communication networks (ECNs) offer the most favorable terms of execution. Some of the factors a broker must consider when seeking best execution of customers' orders include: the opportunity to get a better price than what is currently quoted, the speed of execution, and the likelihood that the trade will be executed. Unlisted Trading Privilege (UTP) An Exchange may determine to extend unlisted trading privileges ("UTP") to an NMS Stock that is listed on another national securities exchange. Unlisted trading privileges may be extended by an Exchange by the Chief Executive Officer or his designee, with the approval of the Board of Governors, upon such terms and conditions as the Board may prescribe and in compliance with the Securities Exchange Act of 1934 and the rules and regulations of the Securities and Exchange Commission. Price-Time Priority Under this method, resting orders in the System are prioritized according to price and time. If there are two or more orders at the best price then priority is afforded among these orders in the order in which they were received by the System Customer or Public Customer A Public Customer order is an order for an account in which no Participant, non-participant in a joint-venture with a Participant, or non-participant broker-dealer (including a foreign broker-dealer) has an interest (a public customer order). Public customer orders shall have priority over nonpublic customer interest. If there are two or more public customer orders at the same price, priority shall be afforded to such public customer orders in the sequence in which they are received by the System. Nondisplayed public customer orders shall not have priority over displayed orders. Series 56 Section 4 25

26 Pro Rata Priority Under this method, resting orders in the System are prioritized according to price. If there are two or more orders at the best price then trades are allocated proportionally according to size (in a pro rata fashion). The executable quantity is allocated to the nearest whole number, with fractions ½ or greater rounded up and fractions less than ½ rounded down. If there are two market participants that both are entitled to an additional ½ contract and there is only one contract remaining to be distributed, the additional contract will be distributed to the participant whose quote or order has time priority. Do-Not-Trade Lists lists of stocks that may be restricted from trading by a firm due to the possession of material non-public inside information. As a general rule customer orders often have priority on an Exchange. An Exchange will determine a procedure for allocating executions among Professional Orders and market maker quotes in cases where all customer orders have been executed and there are two or more professional orders or market maker quotes at the best price Position and Exercise Limits Each exchange has specific position limit rules that vary from exchange to exchange. There are common threads among the exchanges that will be addressed in this section. Except with the proper prior permission, no member or permit holder shall make, for any account in which it has an interest or for the account of any customer, an opening transaction on any exchange if the member or permit holder has reason to believe that as a result of such transaction the member or its customer would, acting alone or in concert with others, directly or indirectly: 1. Control an aggregate position in an options contract traded on the Exchange in excess of the designated position limit in options contracts (whether long or short) of the put type and the call type on the same side of the market respecting the same underlying security, combining for purposes of this position limit long positions in put options with short positions in call options, and short positions in put options with long positions in call options, or such other number of options contracts as may be fixed from time to time by the Exchange as the position limit for one or more classes or series of options; or 2. Exceed the applicable position limit fixed from time to time by another exchange for an options contract not traded on the Exchange, when the member or permit holder is not a member or permit holder of the other exchange on which the transaction was effected. Series 56 Section 4 26

27 Should a Member have reason to believe that a position in any account in which it has an interest or for the account of any customer is in excess of the applicable limit, such Member shall promptly take the action necessary to bring the position into compliance. Reasonable notice shall be given of each new position limit fixed by the Exchange Every six (6) months, an Exchange will review the status of underlying securities to determine which limit should apply. A higher limit will be effective on the date set by the Exchange, while any change to a lower limit will take effect after the last expiration then trading, unless the requirement for the same or a higher limit is met at the time of the intervening six (6) month review. If, however, subsequent to a six (6) month review, an increase in volume and/or outstanding shares would make a stock eligible for a higher position limit prior to the next review, the Exchange in its discretion may immediately increase such position limit. The equity hedge exemption is in addition to the standard limit and other exemptions available under Exchange Rules. Where each option contract is hedged or covered by 100 shares of the underlying security or securities convertible into such underlying security, or, in the case of an adjusted option contract, the same number of shares represented by the adjusted contract; 1. Long call and short stock 2. Short call and long stock 3. Long put and long stock 4. Short put and short stock. A long call position accompanied by a short put position, where the long call expires with the short put, and the strike price of the long call and short put is equal, and where each long call and short put position is hedged with 100 shares (or other adjusted number of shares) of the underlying security or securities convertible into such stock ( reverse conversion ). A short call position accompanied by a long put position where the short call expires with the long put, and the strike price of the short call and long put is equal, and where each short call and long put position is hedged with 100 shares (or other adjusted number of shares) of the underlying security or securities convertible into such stock ( conversion ). A short call position accompanied by a long put position, where the short call expires with the long put, and the strike price of the short call equals or exceeds the long put, and where each short call and long put position is hedged with 100 shares of the underlying security (or other adjusted number of shares). Neither side of the short call, long put position can be in-the-money at the time the position is established ( collar ). Series 56 Section 4 27

28 A long call position accompanied by a short put position where the long call expires with the short put and the strike price of the long call equals or exceeds the short put and where each long call and short put position is hedged with 100 shares of the underlying security (or other adjusted number of shares). Neither side of the long call, short put position can be in-the-money at the time the position is established ( reverse collar ). A long call position accompanied by a short put position with the same strike price and a short call position accompanied by a long put position with a different strike price ( box spread ). An equity option position is delta neutral, subject to the following: The term delta neutral refers to an equity options position that is hedged, in accordance with a permitted pricing model as defined in paragraph below, by a position in the underlying security or one or more instruments relating to the underlying security, for the purpose of offsetting the risk that the value of the options position will change with incremental changes in the price of the security underlying the option position. In the case of an equity option position for which the underlying security is an ETF that is based on the same index as an index option, the equity option position and any position in the underlying ETF may be combined with such an index option position and/or correlated instruments, Delta-Based Index Hedge Exemption, for calculation of the delta-based equity hedge exemption. Series 56 Section 4 28

29 4.4.3 Cabinet Trading Cabinet Trade a trade in a deep out of the money option contract. Cabinet trading shall be available for each series of options open for trading on the Exchange under the following terms and conditions: Trading shall be conducted in accordance with other Exchange Rules except as otherwise provided herein or unless the context otherwise requires. The specialist registered in each class of option contracts shall supervise the operation of the cabinet for that class. Only closing limit orders at a price of $1 (0.01) per option contract for the accounts of customer, firm, specialists and ROTs may be placed in the cabinet. Such orders must be submitted to the specialist in writing. All orders placed in the cabinet shall be assigned priority based upon the sequence in which such orders are received by the specialist. All closing bids and offers must be submitted to the specialist in writing, and the specialist shall effect all closing cabinet transactions by matching such orders placed with him. Bids or offers on orders to open for the accounts of customer, firm, specialists and ROTs may be made at $1 per option contract, but such orders may not be placed in and must yield to all orders in the cabinet. Specialists shall effect all cabinet transactions by matching closing purchase or sale orders which have been placed in the cabinet or, provided there is no matching closing purchase or sale order in the cabinet, by matching a closing purchase or sale order in the cabinet with an opening purchase or sale order. Cabinet transactions shall not be reported on the ticker. All cabinet transactions shall be reported to the Exchange following the close of each business day. Any member, member organization, or other person who is a non-member broker or dealer and who directly or indirectly controls, is controlled by, or is under common control with, a member or member organization (any such other person being referred to as an affiliated person) may effect any transaction as principal in the over-the-counter market in any class of option contracts listed on the Exchange for a premium not in excess of $1.00 (0.01) per contract. Series 56 Section 4 29

30 4.5 Regulation NMS Regulation of the National Market System Regulation NMS or Reg NMS is a regulation promulgated and described by the SEC as "a series of initiatives designed to modernize and strengthen the national market system for equity securities." It was established in It seeks to foster both "competition among individual markets and competition among individual orders" in order to promote efficient and fair price formation across securities markets. In 1972, before the SEC began its pursuit of a national market system, the market for securities was quite fragmented. The same stock sometimes traded at different prices at different trading venues, and the NYSE ticker tape did not report transactions in NYSE-listed stocks that took place on regional exchanges or on other over-the-counter securities markets. This fragmentation made it difficult for traders to comparison shop. In 1975, Congress authorized the SEC to facilitate a national market system. Rule 600 NMS security designation and definitions National market system security means any NMS security. Aggregate quotation size means the sum of the quotation sizes of all responsible brokers or dealers who have communicated on any national securities exchange bids or offers for an NMS security at the same price Automated quotation means a quotation displayed by a trading center that: 1. Permits an incoming order to be marked as immediate-or-cancel; 2. Immediately and automatically executes an order marked as immediateor-cancel against the displayed quotation up to its full size; 3. Immediately and automatically cancels any unexecuted portion of an order marked as immediate-or-cancel without routing the order elsewhere; 4. Immediately and automatically transmits a response to the sender of an order marked as immediate-or-cancel indicating the action taken with respect to such order; and 5. Immediately and automatically displays information that updates the displayed quotation to reflect any change to its material terms. Series 56 Section 4 30

31 Automated trading center means a trading center that: Has implemented such systems, procedures, and rules as are necessary to render it capable of displaying quotations that meet the requirements for an automated quotation set forth in applicable rules. 1. Identifies all quotations other than automated quotations as manual quotations; 2. Immediately identifies its quotations as manual quotations whenever it has reason to believe that it is not capable of displaying automated quotations; and 3. Has adopted reasonable standards limiting when its quotations change from automated quotations to manual quotations, and vice versa, to specifically defined circumstances that promote fair and efficient access to its automated quotations and are consistent with the maintenance of fair and orderly markets. Average effective spread means the share-weighted average of effective spreads for order executions calculated, for buy orders, as double the amount of difference between the execution price and the midpoint of the national best bid and national best offer at the time of order receipt and, for sell orders, as double the amount of difference between the midpoint of the national best bid and national best offer at the time of order receipt and the execution price. Average realized spread means the share-weighted average of realized spreads for order executions calculated, for buy orders, as double the amount of difference between the execution price and the midpoint of the national best bid and national best offer five minutes after the time of order execution and, for sell orders, as double the amount of difference between the midpoint of the national best bid and national best offer five minutes after the time of order execution and the execution price; provided, however, that the midpoint of the final national best bid and national best offer disseminated for regular trading hours shall be used to calculate a realized spread if it is disseminated less than five minutes after the time of order execution. Best bid and best offer mean the highest priced bid and the lowest priced offer. Bid or offer means the bid price or the offer price communicated by a member of a national securities exchange or member of a national securities association to any broker or dealer, or to any customer, at which it is willing to buy or sell one or more round lots of an NMS security, as either principal or agent, but shall not include indications of interest. Series 56 Section 4 31

32 Block size with respect to an order means it is: 1. Of at least 10,000 shares; or 2. For a quantity of stock having a market value of at least $200,000. Categorized by order size means dividing orders into separate categories for sizes from 100 to 499 shares, from 500 to 1999 shares, from 2000 to 4999 shares, and 5000 or greater shares. Categorized by order type means dividing orders into separate categories for market orders, marketable limit orders, inside-the-quote limit orders, at-the-quote limit orders, and near-the-quote limit orders. Categorized by security means dividing orders into separate categories for each NMS stock that is included in a report Consolidated display means: 1. The prices, sizes, and market identifications of the national best bid and national best offer for a security; and 2. Consolidated last sale information for a security. Consolidated last sale information means the price, volume, and market identification of the most recent transaction report for a security that is disseminated pursuant to an effective national market system plan. Covered order means any market order or any limit order (including immediateor- cancel orders) received by a market center during regular trading hours at a time when a national best bid and national best offer is being disseminated, and, if executed, is executed during regular trading hours, but shall exclude any order for which the customer requests special handling for execution, including, but not limited to, orders to be executed at a market opening price or a market closing price, orders submitted with stop prices, orders to be executed only at their full size, orders to be executed on a particular type of tick or bid, orders submitted on a not held basis, orders for other than regular settlement, and orders to be executed at prices unrelated to the market price of the security at the time of execution. Series 56 Section 4 32

33 Customer (Public Customer) means any person that is not a broker or dealer. Customer limit order means an order to buy or sell an NMS stock at a specified price that is not for the account of either a broker or dealer; provided, however, that the term customer limit order shall include an order transmitted by a broker or dealer on behalf of a customer. Customer order means an order to buy or sell an NMS security that is not for the account of a broker or dealer, but shall not include any order for a quantity of a security having a market value of at least $50,000 for an NMS security that is an option contract and a market value of at least $200,000 for any other NMS security. Directed order means a customer order that the customer specifically instructed the broker or dealer to route to a particular venue for execution. Dynamic market monitoring device means any service provided by a vendor on an interrogation device or other display that: 1. Permits real-time monitoring, on a dynamic basis, of transaction reports, last sale data, or quotations with respect to a particular security; and 2. Displays the most recent transaction report, last sale data, or quotation with respect to that security until such report, data, or quotation has been superseded or supplemented by the display of a new transaction report, last sale data, or quotation reflecting the next reported transaction or quotation in that security. 3. Effective national market system plan means any national market system plan approved by the Commission. 4. Effective transaction reporting plan means any approved transaction reporting plans. Series 56 Section 4 33

34 Electronic Communications Network (ECN) means, any electronic system that widely disseminates to third parties orders entered therein by an exchange market maker or OTC market maker, and permits such orders to be executed against in whole or in part; except that the term electronic communications network shall not include: Any system that crosses multiple orders at one or more specified times at a single price set by the system (by algorithm or by any derivative pricing mechanism) and does not allow orders to be crossed or executed against directly by participants outside of such times; or Any system operated by, or on behalf of, an OTC market maker or exchange market maker that executes customer orders primarily against the account of such market maker as principal, other than riskless principal. Exchange market maker means any member of a national securities exchange that is registered as a specialist or market maker pursuant to the rules of such exchange. Exchange-traded security means any NMS security or class of NMS securities listed and registered, or admitted to unlisted trading privileges, on a national securities exchange; provided, however, that securities not listed on any national securities exchange that are traded pursuant to unlisted trading privileges are excluded. Executed at the quote means, for buy orders, execution at a price equal to the national best offer at the time of order receipt and, for sell orders, execution at a price equal to the national best bid at the time of order receipt. Executed outside the quote means, for buy orders, execution at a price higher than the national best offer at the time of order receipt and, for sell orders, execution at a price lower than the national best bid at the time of order receipt. Executed with price improvement means, for buy orders, execution at a price lower than the national best offer at the time of order receipt and, for sell orders, execution at a price higher than the national best bid at the time of order receipt. Inside-the-quote limit order, at-the-quote limit order, and near-the-quote limit order mean non-marketable buy orders with limit prices that are, respectively, higher than, equal to, and lower by $0.10 or less than the national best bid at the time of order receipt, and nonmarketable sell orders with limit prices that are, respectively, lower than, equal to, and higher by $0.10 or less than the national best offer at the time of order receipt. Series 56 Section 4 34

35 Intermarket sweep order (ISO) means a limit order for an NMS stock that meets the following requirements: When routed to a trading center, the limit order is identified as an intermarket sweep order; and Simultaneously with the routing of the limit order identified as an intermarket sweep order, one or more additional limit orders, as necessary, are routed to execute against the full displayed size of any protected bid, in the case of a limit order to sell, or the full displayed size of any protected offer, in the case of a limit order to buy, for the NMS stock with a price that is superior to the limit price of the limit order identified as an intermarket sweep order. These additional routed orders also must be marked as intermarket sweep orders. Interrogation device means any securities information retrieval system capable of displaying transaction reports, last sale data, or quotations upon inquiry, on a current basis on a terminal or other device. Joint self-regulatory organization plan means a plan as to which two or more self-regulatory organizations, acting jointly, are sponsors. Last sale data means any price or volume data associated with a transaction. Listed equity security means any equity security listed and registered, or admitted to unlisted trading privileges, on a national securities exchange. Listed option means any option traded on a registered national securities exchange or automated facility of a national securities association. Make publicly available means posting on an Internet Web site that is free and readily accessible to the public, furnishing a written copy to customers on request without charge, and notifying customers at least annually in writing that a written copy will be furnished on request. Manual quotation means any quotation other than an automated quotation. Market center means any exchange market maker, OTC market maker, alternative trading system, national securities exchange, or national securities association. Marketable limit order means any buy order with a limit price equal to or greater than the national best offer at the time of order receipt, or any sell order with a limit price equal to or less than the national best bid at the time of order receipt. Series 56 Section 4 35

36 Moving ticker means any continuous real-time moving display of transaction reports or last sale data (other than a dynamic market monitoring device) provided on an interrogation or other display device. Nasdaq security means any registered security listed on The Nasdaq Stock Market, Inc. National best bid and national best offer means, with respect to quotations for an NMS security, the best bid and best offer for such security that are calculated and disseminated on a current and continuing basis by a plan processor pursuant to an effective national market system plan; provided, that in the event two or more market centers transmit to the plan processor pursuant to such plan identical bids or offers for an NMS security, the best bid or best offer (as the case may be) shall be determined by ranking all such identical bids or offers (as the case may be) first by size (giving the highest ranking to the bid or offer associated with the largest size), and then by time (giving the highest ranking to the bid or offer received first in time). National market system plan means any joint self-regulatory organization plan in connection with: The planning, development, operation or regulation of a national market system (or a subsystem thereof) or one or more facilities thereof; or The development and implementation of procedures and/or facilities designed to achieve compliance by self-regulatory organizations and their members with any section of this Regulation NMS and part 240, subpart A of this chapter promulgated pursuant to section 11A of the Act. National securities association means any association of brokers and dealers registered pursuant to section 15A of the Act. National securities exchange means any exchange registered pursuant to section 6 of the Act. 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. NMS stock means any NMS security other than an option. Non-directed order means any customer order other than a directed order. Odd-lot means an order for the purchase or sale of an NMS stock in an amount less than a round lot. Series 56 Section 4 36

37 Options class means all of the put option or call option series overlying a security. Options series means the contracts in an options class that have the same unit of trade, expiration date, and exercise price, and other terms or conditions. OTC market maker means any dealer that holds itself out as being willing to buy from and sell to its customers, or others, in the United States, an NMS stock for its own account on a regular or continuous basis otherwise than on a national securities exchange in amounts of less than block size. Participants, when used in connection with a national market system plan, means any self-regulatory organization which has agreed to act in accordance with the terms of the plan but which is not a signatory of such plan. Payment for order flow the payment to a broker for the directing of trades to a particular exchange Plan processor means any self-regulatory organization or securities information processor acting as an exclusive processor in connection with the development, implementation and/or operation of any facility contemplated by an effective national market system plan. Profit-sharing relationship means any ownership or other type of affiliation under which the broker or dealer, directly or indirectly, may share in any profits that may be derived from the execution of non-directed orders. Protected bid or protected offer means a quotation in an NMS stock that: 1. Is displayed by an automated trading center; and 2. Is disseminated pursuant to an effective national market system plan; 3. Is an automated quotation that is the best bid or best offer of a national securities exchange, the best bid or best offer of The Nasdaq Stock Market, Inc., or the best bid or best offer of a national securities association other than the best bid or best offer of The Nasdaq Stock Market, Inc. Series 56 Section 4 37

38 Protected quotation means a protected bid or a protected offer. Published aggregate quotation size means the aggregate quotation size calculated by a national securities exchange and displayed by a vendor on a terminal or other display device at the time an order is presented for execution to a responsible broker or dealer. Published bid and published offer means the bid or offer of a responsible broker or dealer for an NMS security communicated by it to its national securities exchange or association pursuant to Rule and displayed by a vendor on a terminal or other display device at the time an order is presented for execution to such responsible broker or dealer. Published quotation size means the quotation size of a responsible broker or dealer communicated by it to its national securities exchange or association pursuant to Rule and displayed by a vendor on a terminal or other display device at the time an order is presented for execution to such responsible broker or dealer. Quotation means a bid or an offer. Quotation size, when used with respect to a responsible broker s or dealer s bid or offer for an NMS security, means: The number of shares (or units of trading) of that security which such responsible broker or dealer has specified, for purposes of dissemination to vendors, that it is willing to buy at the bid price or sell at the offer price comprising its bid or offer, as either principal or agent; or In the event such responsible broker or dealer has not so specified, a normal unit of trading for that NMS security. Regular trading hours means the time between 9:30 a.m. and 4:00 p.m. Eastern Time, or such other time as is set forth in the procedures established. Series 56 Section 4 38

39 Responsible broker or dealer means: When used with respect to bids or offers communicated on a national securities exchange, any member of such national securities exchange who communicates to another member on such national securities exchange, at the location (or locations) or through the facility or facilities designated by such national securities exchange for trading in an NMS security a bid or offer for such NMS security, as either principal or agent. Revised bid or offer means a market maker s bid or offer which supersedes its published bid or published offer. Revised quotation size means a market maker s quotation size which supersedes its published quotation size. Self-regulatory organization means any national securities exchange or national securities association. Specified persons, when used in connection with any notification required to be provided means: 1. Each vendor; 2. Each plan processor; and 3. The processor for the Options Price Reporting Authority (in the case of a notification for a subject security which is a class of securities underlying options admitted to trading on any national securities exchange). Sponsor, when used in connection with a national market system plan, means any self-regulatory organization which is a signatory to such plan and has agreed to act in accordance with the terms of the plan. SRO display-only facility means a facility operated by or on behalf of a national securities exchange or national securities association that displays quotations in a security, but does not execute orders against such quotations or present orders to members for execution. SRO trading facility means a facility operated by or on behalf of a national securities exchange or a national securities association that executes orders in a security or presents orders to members for execution. Series 56 Section 4 39

40 Subject security means: With respect to a national securities exchange: Any exchange-traded security other than a security for which the executed volume of such exchange, during the most recent calendar quarter, comprised one percent or less of the aggregate trading volume for such security as reported pursuant to an effective transaction reporting plan or effective national market system plan; and Any other NMS security for which such exchange has in effect an election, to collect, process, and make available to a vendor bids, offers, quotation sizes, and aggregate quotation sizes communicated on such exchange; and With respect to a member of a national securities association: Any exchange-traded security for which such member acts in the capacity of an OTC market maker unless the executed volume of such member, during the most recent calendar quarter, comprised one percent or less of the aggregate trading volume for such security as reported pursuant to an effective transaction reporting plan or effective national market system plan; and Any other NMS security for which such member acts in the capacity of an OTC market maker and has in effect an election, to communicate to its association bids, offers, and quotation sizes for the purpose of making such bids, offers, and quotation sizes available to a vendor. Time of order execution means the time (to the second) that an order was executed at any venue. Time of order receipt means the time (to the second) that an order was received by a market center for execution. Time of the transaction has the meaning provided in Rule b-10 of this chapter. Trade-through means the purchase or sale of an NMS stock during regular trading hours, either as principal or agent, at a price that is lower than a protected bid or higher than a protected offer. Trading center means a national securities exchange or national securities association that operates an SRO trading facility, an alternative trading system, an exchange market maker, an OTC market maker, or any other broker or dealer that executes orders internally by trading as principal or crossing orders as agent. Series 56 Section 4 40

41 Trading rotation means, with respect to an options class, the time period on a national securities exchange during which: Opening, re-opening, or closing transactions in options series in such options class are not yet completed; and Continuous trading has not yet commenced or has not yet ended for the day in options series in such options class. Transaction report means a report containing the price and volume associated with a transaction involving the purchase or sale of one or more round lots of a security. Transaction reporting association means any person authorized to implement or administer any transaction reporting plan on behalf of persons acting jointly under Rule (a). Transaction reporting plan means any plan for collecting, processing, making available or disseminating transaction reports with respect to transactions in securities filed with the Commission pursuant to, and meeting the requirements of, Rule Vendor means any securities information processor engaged in the business of disseminating transaction reports, last sale data, or quotations with respect to NMS securities to brokers, dealers, or investors on a real-time or other current and continuing basis, whether through an electronic communications network, moving ticker, or interrogation device. Series 56 Section 4 41

42 Rule Dissemination of quotations in NMS securities Dissemination requirements for national securities exchanges and national securities associations. Every national securities exchange and national securities association shall establish and maintain procedures and mechanisms for collecting bids, offers, quotation sizes, and aggregate quotation sizes from responsible brokers or dealers who are members of such exchange or association, processing such bids, offers, and sizes, and making such bids, offers, and sizes available to vendors, as follows: Each national securities exchange shall at all times such exchange is open for trading, collect, process, and make available to vendors the best bid, the best offer, and aggregate quotation sizes for each subject security listed or admitted to unlisted trading privileges which is communicated on any national securities exchange by any responsible broker or dealer, but shall not include: A. Any bid or offer executed immediately after communication and any bid or offer communicated by a responsible broker or dealer other than an exchange market maker which is cancelled or withdrawn if not executed immediately after communication; and B. Any bid or offer communicated during a period when trading in that security has been suspended or halted, or prior to the commencement of trading in that security on any trading day, on that exchange. Each national securities association shall, at all times that last sale information with respect to NMS securities is reported pursuant to an effective transaction reporting plan, collect, process, and make available to vendors the best bid, best offer, and quotation sizes communicated otherwise than on an exchange by each member of such association acting in the capacity of an OTC market maker for each subject security and the identity of that member (excluding any bid or offer executed immediately after communication), except during any period when over-the-counter trading in that security has been suspended. Series 56 Section 4 42

43 Obligations of responsible brokers and dealers. Each responsible broker or dealer shall promptly communicate to its national securities exchange or national securities association, pursuant to the procedures established by that exchange or association, its best bids, best offers, and quotation sizes for any subject security. Each responsible broker or dealer shall be obligated to execute any order to buy or sell a subject security, other than an odd-lot order, presented to it by another broker or dealer, or any other person belonging to a category of persons with whom such responsible broker or dealer customarily deals, at a price at least as favorable to such buyer or seller as the responsible broker s or dealer s published bid or published offer (exclusive of any commission, commission equivalent or differential customarily charged by such responsible broker or dealer in connection with execution of any such order) in any amount up to its published quotation size. Transactions in listed options. A national securities exchange or national securities association: Shall not be required to collect from responsible brokers or dealers who are members of such exchange or association, or to make available to vendors, the quotation sizes and aggregate quotation sizes for listed options, if such exchange or association establishes by rule and periodically publishes the quotation size for which such responsible brokers or dealers are obligated to execute an order to buy or sell an options series that is a subject security at its published bid or offer. Series 56 Section 4 43

44 Thirty second response. Each responsible broker or dealer, within thirty seconds of receiving an order to buy or sell a listed option in an amount greater than the quotation size established by a national securities exchange s or national securities association s rules pursuant to this section, or its published quotation size must: Execute the entire order; or Execute that portion of the order equal to at least: 1. The quotation size established by a national securities exchange s or national securities association s rules, pursuant to paragraph (c)(1) of this section, to the extent that such exchange or association does not collect and make available to vendors quotation size and aggregate quotation size under paragraph (a) of this section; or 2. Its published quotation size; and revise its bid or offer. Exemptions. The Commission may exempt from the provisions of this section, either unconditionally or on specified terms and conditions, any responsible broker or dealer, electronic communications network, national securities exchange, or national securities association if the Commission determines that such exemption is consistent with the public interest, the protection of investors and the removal of impediments to and perfection of the mechanism of a national market system. Series 56 Section 4 44

45 Rule Display of customer limit orders. Specialists and OTC market makers. For all NMS stocks: Each member of a national securities exchange that is registered by that exchange as a specialist, or is authorized by that exchange to perform functions substantially similar to that of a specialist, shall publish immediately a bid or offer that reflects: The price and the full size of each customer limit order held by the specialist that is at a price that would improve the bid or offer of such specialist in such security; and The full size of each customer limit order held by the specialist that: 1. Is priced equal to the bid or offer of such specialist for such security; 2. Is priced equal to the national best bid or national best offer; and 3. Represents more than a de minimis change in relation to the size associated with the specialist s bid or offer. Series 56 Section 4 45

46 Each registered broker or dealer that acts as an OTC market maker shall publish immediately a bid or offer that reflects: The price and the full size of each customer limit order held by the OTC market maker that is at a price that would improve the bid or offer of such OTC market maker in such security; and The full size of each customer limit order held by the OTC market maker that: Is priced equal to the bid or offer of such OTC market maker for such security; A. Is priced equal to the national best bid or national best offer; and B. Represents more than a de minimis change in relation to the size associated with the OTC market maker s bid or offer. Exceptions. The requirements for order display shall not apply to any customer limit order: That is executed upon receipt of the order. That is placed by a customer who expressly requests, either at the time that the order is placed or prior thereto pursuant to an individually negotiated agreement with respect to such customer s orders, that the order not be displayed. That is an odd-lot order. That is a block size order, unless a customer placing such order requests that the order be displayed. That is delivered immediately upon receipt to a national securities exchange or national securities association-sponsored system, or an electronic communications network that complies with requirements. That is delivered immediately upon receipt to another exchange member or OTC market maker that complies with the requirements of this section with respect to that order. That is an all or none order. Series 56 Section 4 46

47 Exemptions. The Commission may exempt from the provisions of this section, either unconditionally or on specified terms and conditions, any responsible broker or dealer, electronic communications network, national securities exchange, or national securities association if the Commission determines that such exemption is consistent with the public interest, the protection of investors and the removal of impediments to and perfection of the mechanism of a national market system. The Manning Rule prohibits an NASD member firm from placing the firm s interest before the financial interests of clients. Series 56 Section 4 47

48 Rule Disclosure of order execution information. Monthly electronic reports by market centers. Every market center shall make available for each calendar month, in accordance with the procedures established a report on the covered orders in NMS stocks that it received for execution from any person. Such report shall be in electronic form; shall be categorized by security, order type, and order size; and shall include the following columns of information: For market orders, marketable limit orders, inside-the-quote limit orders, at-the-quote limit orders, and near-the-quote limit orders: A. The number of covered orders; B. The cumulative number of shares of covered orders; C. The cumulative number of shares of covered orders cancelled prior to execution; D. The cumulative number of shares of covered orders executed at the receiving market center; E. The cumulative number of shares of covered orders executed at any other venue; F. The cumulative number of shares of covered orders executed from 0 to 9 seconds after the time of order receipt; G. The cumulative number of shares of covered orders executed from 10 to 29 seconds after the time of order receipt; H. The cumulative number of shares of covered orders executed from 30 seconds to 59 seconds after the time of order receipt; I. The cumulative number of shares of covered orders executed from 60 seconds to 299 seconds after the time of order receipt; J. The cumulative number of shares of covered orders executed from 5 minutes to 30 minutes after the time of order receipt; and K. The average realized spread for executions of covered orders; and Series 56 Section 4 48

49 For market orders and marketable limit orders: A. The average effective spread for executions of covered orders B. The cumulative number of shares of covered orders executed with price improvement; C. For shares executed with price improvement, the shareweighted average amount per share that prices were improved; D. For shares executed with price improvement, the shareweighted average period from the time of order receipt to the time of order execution; E. The cumulative number of shares of covered orders executed at the quote; F. For shares executed at the quote, the share-weighted average period from the time of order receipt to the time of order execution; G. The cumulative number of shares of covered orders executed outside the quote; H. For shares executed outside the quote, the share-weighted average amount per share that prices were outside the quote; and I. For shares executed outside the quote, the share-weighted average period from the time of order receipt to the time of order execution Series 56 Section 4 49

50 Every national securities exchange on which NMS stocks are traded and each national securities association shall act jointly in establishing procedures for market centers to follow in making available to the public the reports readily accessible, and usable electronic form. In the event there is no effective national market system plan establishing such procedures, market centers shall prepare their reports in a consistent, usable, and machine-readable electronic format, and make such reports available for downloading from an Internet Web site that is free and readily accessible to the public. A market center shall make available the report required by this section within one month after the end of the month addressed in the report. Exemptions. The Commission may, by order upon application, conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of this section, if the Commission determines that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors. Series 56 Section 4 50

51 Rule Disclosure of order routing information. Quarterly report on order routing. Every broker or dealer shall make publicly available for each calendar quarter a report on its routing of non-directed orders in NMS securities during that quarter. For NMS stocks, such report shall be divided into three separate sections for securities that are listed on the New York Stock Exchange, Inc., securities that are qualified for inclusion in The Nasdaq Stock Market, Inc., and securities that are listed on the American Stock Exchange LLC or any other national securities exchange. Such report also shall include a separate section for NMS securities that are option contracts. Each of the four sections in a report shall include the following information: 1. The percentage of total customer orders for the section that were non-directed orders, and the percentages of total non-directed orders for the section that were market orders, limit orders, and other orders; 2. The identity of the ten venues to which the largest number of total non-directed orders for the section were routed for execution and of any venue to which five percent or more of non-directed orders were routed for execution, the percentage of total nondirected orders for the section routed to the venue, and the percentages of total non-directed market orders, total non-directed limit orders, and total non-directed other orders for the section that were routed to the venue; and 3. A discussion of the material aspects of the broker s or dealer s relationship with each venue identified pursuant to this section, including a description of any arrangement for payment for order flow and any profit-sharing relationship. 4. A broker or dealer shall make the report required by this section publicly available within one month after the end of the quarter addressed in the report. Series 56 Section 4 51

52 Customer requests for information on order routing. 1. Every broker or dealer shall, on request of a customer, disclose to its customer the identity of the venue to which the customer s orders were routed for execution in the six months prior to the request, whether the orders were directed orders or non-directed orders, and the time of the transactions, if any, that resulted from such orders. 2. A broker or dealer shall notify customers in writing at least annually of the availability on request of this order routing information. The Manning Rule prohibits an NASD member firm from placing the firm s interest before the financial interests of clients. Exemptions. The Commission may, by order upon application, conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of this section, if the Commission determines that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors. Series 56 Section 4 52

53 Rule Access to quotations. Quotations of SRO trading facility. A national securities exchange or national securities association shall not impose unfairly discriminatory terms that prevent or inhibit any person from obtaining efficient access through a member of the national securities exchange or national securities association to the quotations in an NMS stock displayed through its SRO trading facility. Quotations of SRO display-only facility. Any trading center that displays quotations in an NMS stock through an SRO display-only facility shall provide a level and cost of access to such quotations that is substantially equivalent to the level and cost of access to quotations displayed by SRO trading facilities in that stock. Any trading center that displays quotations in an NMS stock through an SRO display-only facility shall not impose unfairly discriminatory terms that prevent or inhibit any person from obtaining efficient access to such quotations through a member, subscriber, or customer of the trading center. Fees for access to quotations. A trading center shall not impose, nor permit to be imposed, any fee or fees for the execution of an order against a protected quotation of the trading center or against any other quotation of the trading center that is the best bid or best offer of a national securities exchange, the best bid or best offer of The Nasdaq Stock Market, Inc., or the best bid or best offer of a national securities association other than the best bid or best offer of The Nasdaq Stock Market, Inc. in an NMS stock that exceed or accumulate to more than the following limits: If the price of a protected quotation or other quotation is $1.00 or more, the fee or fees cannot exceed or accumulate to more than $0.003 per share; or If the price of a protected quotation or other quotation is less than $1.00, the fee or fees cannot exceed or accumulate to more than 0.3% of the quotation price per share. Series 56 Section 4 53

54 Locking or crossing quotations. Each national securities exchange and national securities association shall establish, maintain, and enforce written rules that: Require its members reasonably to avoid: Displaying quotations that lock or cross any protected quotation in an NMS stock; and Displaying manual quotations that lock or cross any quotation in an NMS stock disseminated pursuant to an effective national market system plan; Are reasonably designed to assure the reconciliation of locked or crossed quotations in an NMS stock; and Prohibit its members from engaging in a pattern or practice of displaying quotations that lock or cross any protected quotation in an NMS stock, or of displaying manual quotations that lock or cross any quotation in an NMS stock disseminated pursuant to an effective national market system plan, other than displaying quotations that lock or cross any protected or other quotation as permitted by an exception contained in its rules established pursuant to paragraph (d)(1) of this section. Exemptions. The Commission, by order, may exempt from the provisions of this section, either unconditionally or on specified terms and conditions, any person, security, quotations, orders, or fees, or any class or classes of persons, securities, quotations, orders, or fees, if the Commission determines that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors. Series 56 Section 4 54

55 Rule Order protection Rule Reasonable policies and procedures. Exceptions. A trading center shall establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs on that trading center of protected quotations in NMS stocks that do not fall within an exception displayed below, if relying on such an exception, that are reasonably designed to assure compliance with the terms of the exception. A trading center shall regularly surveil to ascertain the effectiveness of policies and procedures and shall take prompt action to remedy deficiencies in such policies and procedures. The transaction that constituted the trade-through was effected when the trading center displaying the protected quotation that was traded through was experiencing a failure, material delay, or malfunction of its systems or equipment. The transaction that constituted the trade-through was not a regular way contract. The transaction that constituted the trade-through was a single-priced opening, reopening, or closing transaction by the trading center. The transaction that constituted the trade-through was executed at a time when a protected bid was priced higher than a protected offer in the NMS stock. The transaction that constituted the trade-through was the execution of an order identified as an intermarket sweep order. The transaction that constituted the trade-through was effected by a trading center that simultaneously routed an intermarket sweep order to execute against the full displayed size of any protected quotation in the NMS stock that was traded through. The transaction that constituted the trade-through was the execution of an order at a price that was not based, directly or indirectly, on the quoted price of the NMS stock at the time of execution and for which the material terms were not reasonably determinable at the time the commitment to execute the order was made. Series 56 Section 4 55

56 The trading center displaying the protected quotation that was traded through had displayed, within one second prior to execution of the transaction that constituted the trade-through, a best bid or best offer, as applicable, for the NMS stock with a price that was equal or inferior to the price of the trade-through transaction. The transaction that constituted the trade-through was the execution by a trading center of an order for which, at the time of receipt of the order, the trading center had guaranteed an execution at no worse than a specified price (a stopped order ), where: 1. The stopped order was for the account of a customer; 2. The customer agreed to the specified price on an order-by-order basis; and 3. The price of the trade-through transaction was, for a stopped buy order, lower than the national best bid in the NMS stock at the time of execution or, for a stopped sell order, higher than the national best offer in the NMS stock at the time of execution. Intermarket sweep orders. The trading center, broker, or dealer responsible for the routing of an intermarket sweep order shall take reasonable steps to establish that such order meets the requirements set forth in rules. Exemptions. The Commission, by order, may exempt from the provisions of this section, either unconditionally or on specified terms and conditions, any person, security, transaction, quotation, or order, or any class or classes of persons, securities, quotations, or orders, if the Commission determines that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors. Series 56 Section 4 56

57 Rule 612 Minimum pricing increment. No national securities exchange, national securities association, alternative trading system, vendor, or broker or dealer shall display, rank, or accept from any person a bid or offer, an order, or an indication of interest in any NMS stock priced in an increment smaller than $0.01 if that bid or offer, order, or indication of interest is priced equal to or greater than $1.00 per share. No national securities exchange, national securities association, alternative trading system, vendor, or broker or dealer shall display, rank, or accept from any person a bid or offer, an order, or an indication of interest in any NMS stock priced in an increment smaller than $ if that bid or offer, order, or indication of interest is priced less than $1.00 per share. Exemptions. The Commission, by order, may exempt from the provisions of this section, either unconditionally or on specified terms and conditions, any person, security, quotation, or order, or any class or classes of persons, securities, quotations, or orders, if the Commission determines that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors. 4.6 Third Party Trades Step Out A step-out allows a member to allocate all or part of a client's position from a previously executed trade to the client's account at another broker-dealer. In other words, a step-out functions as a client's position transfer, rather than a trade; there is no exchange of shares and funds and no change in beneficial ownership. The step-out function was designed and implemented as a service to facilitate the clearing process for members involved in these types of transfers. For example, member BD1 buys 1000 shares of ABCD security on behalf of its client and reports that trade to the FINRA/NASDAQ TRF and then submits a clearingonly report to the FINRA/NASDAQ TRF to allocate those shares at the same price to that client's account at member BD2. Series 56 Section 4 57

58 Give-up (clearing) - A procedure in securities or commodities trading where the executing broker places a trade on behalf of another broker as if he/she actually executed the trade. This is usually done because a broker is too busy to place a trade for a client and asks another broker to place the trade for him/her. On the record books, the trade will not show the executing broker's information, but the broker to whom the client belongs. Thus, the broker of the client and the broker on the other side of the trade will receive the commission, while the executing trader will get nothing. Be aware of the difference between a Give Up and Step Out transaction. Prime Broker Prime Brokerage is the generic name for a bundled package of services offered by investment banks and securities firms to hedge funds and other professional investors needing the ability to borrow securities and cash to be able to invest on a netted basis and achieve an absolute return. The business advantage to a hedge fund of using a Prime Broker is that the Prime Broker provides a centralized securities clearing facility for the hedge fund, and the hedge fund's collateral requirements are netted across all deals handled by the Prime Broker. Series 56 Section 4 58

59 4.7 Exercise/Assignment of Options Tender of Exercise Notices Exercise of Equity Options Special procedures apply to the exercise of standardized equity options on the last business day before expiration ( expiring options ). Unless waived by The Options Clearing Corporation, expiring standardized equity options are subject to the Exercise-by-Exception ( Ex-by-Ex ) procedure under the Options Clearing Corporation Rule 805. This rule provides that, unless contrary instructions are given, standardized equity option contracts that are in the money shall be automatically exercised. Option holders desiring to exercise or not exercise expiring options must either: 1. Take no action and allow exercise determinations to be made in accordance with the Clearing Corporation s Ex-by-Ex procedure where applicable; or 2. Submit a "Contrary Exercise Advice" to the Exchange as specified. Exercise cut-off time. Option holders have until 5:30 p.m. Eastern Time on the business day immediately prior to the expiration date or, in the case of Quarterly Options Series, on the expiration date, to make a final decision to exercise or not exercise an expiring option. Members may not accept exercise instructions for customer or non-customer accounts after 5:30 p.m. Eastern Time. Contrary Exercise Advice is a form approved by the national options exchanges, FINRA, or The Options Clearing Corporation for use by a member to submit a final exercise decision. Submission of Contrary Exercise Advices. A Contrary Exercise Advice is a communication either: 1. To not exercise an option that would be automatically exercised under the Clearing Corporation's Ex-by-Ex procedure, or 2. To exercise an option that would not be automatically exercised under the Clearing Corporation s Ex-by-Ex procedure. A Contrary Exercise Advice would basically instruct the Clearing Corp to do opposite of what would be done automatically. Series 56 Section 4 59

60 For customer accounts members have until 7:30 pm Eastern Time to submit a Contrary Exercise Advice. For non-customer accounts members have until 7:30 pm Eastern Time to submit a Contrary Exercise Advice provided the member employs an electronic submission procedure with time stamp. Members are required to manually submit a Contrary Exercise Advice by 5:30 PM Eastern Time for non customer accounts if such members do not employ an electronic submission procedure with time stamp. Effect of Exercise Prior to Ex-Dividend Date A call holder becomes entitled to the dividend if he exercises the option prior to the ex-dividend date even though assigned writer may not be notified that he was assigned an exercise until after the ex-dividend date. Because call holders may seek to 'capture' an impending dividend by exercising, a call writer s chances of being assigned an exercise may increase as the ex-date for a dividend on the underlying security approaches. Exercise of Index Options Firm must follow the procedures of the Clearing Corporation when exercising American-style cash-settled index option contracts issued or to be issued in any account at the Clearing Corporation. Trading Permit Holders must also follow the procedures set forth below with respect to American-style cash-settled index options: For all contracts exercised by the firm or by any customer, an "Exercise Advice" must be delivered to a place designated by the Exchange no later than 3:20 p.m. (CT), or if trading hours are extended or modified in the applicable option class, no later than five (5) minutes after the close of trading on that day. Subsequent to the delivery of an "Exercise Advice", should the firm or a customer of the firm determine not to exercise all or part of the advised contracts, the firm must also deliver an "Advice Cancel" in such form or manner prescribed by the Exchange to a place designated by the Exchange no later than 3:20 p.m. (CT), or if trading hours are extended or modified in the applicable option class, no later than five (5) minutes after the close of trading on that day. Series 56 Section 4 60

61 The procedures set forth in this section do not apply 1. On the business day prior to expiration in series expiring on a day other than a business day or 2. On the expiration day in series expiring on a business day. In other words these do not apply on the final day that an option contract would be trading. Exercises of American-style, cash-settled index options (and the submission of corresponding "Exercise Advice" and "Advice Cancel" forms) shall be prohibited during any time when trading in such options is delayed, halted, or suspended, subject to the following exceptions: 1. The exercise of an American-style, cash-settled index option may be processed and given effect in accordance with and subject to OCC rules while trading in the option is delayed, halted, or suspended if it can be documented, in a form prescribed by the Exchange, that the decision to exercise the option was made during allowable time frames prior to the delay, halt, or suspension. Acceptable documentation shall ordinarily be limited to an "Exercise Advice" previously transmitted via OCC's electronic communications system or a Trading Permit Holder's copy of an "Exercise Advice" previously submitted to the Exchange. 2. Exercises of expiring American-style, cash-settled index options shall not be prohibited on the last business day prior to their expiration. 3. Exercises of American-style, cash-settled index options shall not be prohibited during a trading halt that occurs at or after 3:00 p.m. (CT). In the event of such a trading halt, exercises may occur through 3:20 p.m. (CT). In addition, if trading resumes following such a trading halt (such as by closing rotation), exercises may occur during the resumption of trading and for five (5) minutes after the close of the resumption of trading. The provisions of this subparagraph (iii) are subject to the authority of the Board to impose restrictions on transactions and exercises pursuant to rules.. 4. A market official with proper authority may determine to permit the exercise of American-style, cash-settled index options while trading in such options is delayed, halted, or suspended. Series 56 Section 4 61

62 In the case of an American-style, cash-settled FLEX Index Option, the references in this section to a trading delay, halt, suspension, resumption, or closing rotation shall mean the occurrence of the applicable condition in the standardized option on the index underlying the FLEX Index Option (rather than the occurrence of the applicable condition in the FLEX Index Option itself). Series 56 Section 4 62

63 4.7.2 Assignment of Exercise Notices Effect of Exercise Prior to Ex-Dividend Date A call holder becomes entitled to the dividend if he exercises the option prior to the ex-dividend date even though assigned writer may not be notified that he was assigned an exercise until after the ex-dividend date. Because call holders may seek to 'capture' an impending dividend by exercising, a call writer s chances of being assigned an exercise may increase as the ex-date for a dividend on the underlying security approaches. OCC Assignment Procedure The option holder has the right to exercise his or her options position prior to expiration regardless of whether the options are in- or out-of-the-money. You can be assigned if an investor or market professional holding calls of the same series as your short position submits an exercise notice to his or her brokerage firms, which in turn, submitted an exercise notice to OCC (or if the brokerage firm is not an OCC Clearing Member, then it would submit the notice to a firm that is an OCC Clearing Member, and that Member would then submit the notice to OCC). OCC randomly assigns exercise notices to Clearing Members in whose accounts have short positions of the same series. The Clearing Member then assigns the exercise to one of its short positions using a fair assignment method, though not necessarily random. You should ask your brokerage firm how it assigns exercise notices to its customers. OCC's Clearing Members can submit exercise notices, on a daily basis, up to 7:00 p.m. Central Time, and in general each Clearing Member will establish its own (earlier) deadline for its customers. (There is a different set of procedures for expiring options.) As part of its nightly processing, OCC randomly assigns its Clearing Members based on the days exercises. This processing is completed at approximately 1:00 a.m. Central Time. OCC transmits the assignments to its Clearing Members and as part of the Member's nightly processing, they allocate the assignments to their customers on either a random basis or a first in - first out basis. For expirations, OCC process all exercise/assignments on Saturday. OCC's processing is completed and transmitted to its Clearing Members late Saturday night. Clearing Members will process expiration exercises and assignments on Sunday and then notify their customers the next business day. Series 56 Section 4 63

64 Each firm may have their own threshold for automatic exercise, OCC's auto exercise threshold is 1 cent (.01) in the customers account. (The automatic exercise threshold in firms and market makers accounts is 1 cent (.01).) Customers and Brokers should check with their firm's Operations Department to determine their company's policies regarding exercise thresholds. An option holder has the right to exercise their option regardless of the price of the underlying security. It might be a good practice for all option holders to express their exercise - or non-exercise - instructions to their broker. Is there a magic number that ensures that option writers will not be assigned? The answer would be 'NO'. Although unlikely, an investor may choose to exercise a slightly out of the money option or choose not to exercise an option that is in the money by greater than 1 cent (.01). Delivery of the underlying security upon the exercise of an option contract, and payment of the aggregate exercise price in respect thereof, shall be in accordance with the Rules of the Clearing Corporation. As promptly as possible after the exercise of an option contract by a customer, the customer should make full cash payment of the aggregate exercise price in the case of a call option contract, or to deposit the underlying security in the case of a put option contract, or to make the required margin deposit in respect thereof if the transaction is effected in a margin account, in accordance with the Rules of the Exchange and the applicable regulations of the Federal Reserve Board. As promptly as practicable after the assignment to a customer of an exercise notice a firm shall require the customer to deposit the underlying security in the case of a call option contract if the underlying security is not carried in the customer's account, or to make full cash payment of the aggregate exercise price in the case of a put option contract, or in either case to deposit the required margin in respect thereof if the transaction is effected in a margin account, in accordance with the specific exchange rules and the applicable regulations of the Federal Reserve Board. Series 56 Section 4 64

65 4.8 Clearance, Transaction Review, and Settlement Procedures Clearance and Settlement When entering orders on an Exchange, each firm shall submit trade information in such form as may be prescribed by the Exchange in order to allow the Exchange to properly prioritize and match orders and quotations pursuant to applicable rules and report resulting transactions to the Clearing Corporation. All listed option transactions made on an Exchange shall be submitted for clearance to the Options Clearing Corporation, and all such transactions shall be subject to the rules of the Clearing Corporation. Every Clearing Member shall be responsible for the clearance of the Exchange Transactions of such Clearing Member and of each Member who gives up such Clearing Member s name pursuant to a letter of authorization, letter of guarantee or other authorization given by such Clearing Member to such Member, which authorization must be submitted to the Exchange. On each business day at or prior to such time as may be prescribed by the Clearing Corporation, the Exchange shall furnish the Clearing Corporation a report of each Clearing Member s matched trades. Series 56 Section 4 65

66 4.8.2 Leverage and Associated Risk The Risk Based Haircut methodology may be used to calculate theoretically based capital charges as set forth within the SEC net capital rule. It applies options price theory and portfolio theory to positions involving listed options for the computation of capital charges. Under the risk based method, options price theory is utilized to project portfolio liquidating values under various potential market scenarios. Portfolios may consist of positions in options, stocks, futures and options on futures based on the same underlying instrument or on different highly correlated underlying instruments. Option positions include equity, index and currency products. OCC utilizes a proprietary derivation of the Cox-Ross-Rubinstein binomial option pricing model to calculate projected liquidating prices. Projected prices are calculated based upon the closing underlying asset price for each day plus and minus price moves at ten equidistant data points over a broad range of market movements: For broker-dealers other than non-clearing specialists and/or market makers, the appropriate percentages of the daily market price of the underlying are +/- 15% for equities, narrow-based indexes, and non-high capitalization diversified indexes, +/-10% for high capitalization diversified indexes, +/-6% for major market foreign currencies and +/-20% for all other currencies. For non-clearing specialists and market makers, the percentages of the daily market price of the underlying are +6/-8% for high capitalization diversified indexes, +/- 10% for non-high capitalization indexes and +/-4.5% for major market foreign currencies. The implied volatility curve specific to an option's underlying security and maturity is matched to the potential market scenarios in the calculation of projected prices for that option. Interest rates reflect current swap rates, and dividend amounts are input as reported by an outside vendor. Prices for all instruments are projected, and the resulting profits and losses of the portfolio are summed to estimate the projected aggregate gain or loss at the underlying price move. Within a class group (all products with the same underlying instrument), 100% of a position's gain at any one valuation point is allowed to offset another position's loss at the same valuation point. Other offsets are provided to instruments based on product groups and portfolio groups. Product groups are comprised of closely related broad-based indexes, sector indexes and currencies. Portfolio groups consist of closely related product groups. Series 56 Section 4 66

67 In the case of index options and related instruments offset by a qualified stock basket, there will be a 95% offset with a minimum charge of 5% of the market value of the basket for high capitalization diversified and narrow-based indexes and 7.5% of the market value of the basket for non-high capitalization diversified indexes. To account for liquidation risk, a minimum charge of 1/4 point per contract times the appropriate multiplier is applied when the class, product or portfolio group reflects little or no market exposure (or $25.00 per option contract assuming that option contract covers 100 shares). The largest projected loss for the entire class, or group in the case of the offseteligible products, over the range of ten potential market scenarios is the required capital charge for this portfolio. OCC computes and makes available theoretical profit and loss values for each option series and for the related and underlying instruments on a daily basis. Firms' open positions and the theoretical values can be combined to compute the appropriate capital charge. Customer Portfolio Margin System ("CPM") was developed by The Options Clearing Corporation ("The OCC") to support portfolio-based margining of customer accounts. Based on the TIMS margin methodology, CPM takes an OCC generated master file of profit and loss values and a user generated position file as input. The TIMS methodology is then applied to generate a margin computation that can be viewed via hypertext pages from the account down to the position level. Positions eligible for a portfolio margining account include margin equity securities (including foreign equity securities and options on foreign equity securities provided the foreign equity is deemed to have a ready market ), listed options on an equity security or index of equity securities, security futures products, unlisted derivatives on an equity security or index of equity securities, warrants on an equity security or index of equity securities, broad-based index futures, and options on broadbased index futures. If transactions in security futures are to be included in the account, approval for such transactions is also required. And, an eligible participant may not establish or maintain positions in unlisted derivatives unless minimum equity of at least five million dollars, aggregated across all accounts under identical ownership at the clearing broker, is established and maintained with the member organization. Series 56 Section 4 67

68 4.8.3 Account Designations The following transfers involving a Trading Permit Holder's positions may be effected off the floor: (i) the dissolution of a joint account in which the remaining Trading Permit Holder assumes the positions of the joint account; (ii) the dissolution of a corporation or partnership in which a former nominee of the corporation or partnership assumes the positions; (iii) positions transferred as part of a Trading Permit Holder's capital contribution to a new joint account, partnership, or corporation; (iv) the donation of positions to a not-for-profit corporation; (v) the transfer of positions to a minor under the "Uniform Gifts to Minor" law; and (vi) a merger or acquisition where continuity of ownership or management results. Each firm which maintains a joint back office ("JBO" arrangement with a clearing broker-dealer subject to the requirements of Regulation T Section of the Federal Reserve System shall comply with the requirements below: Each JBO participant must be registered as a broker-dealer pursuant to Section 15 of the Securities Exchange Act of Each JBO participant must meet and maintain a minimum account equity requirements of $1,000,000 the carrying organization must issue a call for additional funds or securities which shall be obtained within five business days. If funds or securities sufficient to eliminate the deficiency are not received within five (5) business days, the carrying organization must margin the account in accordance with the requirements prescribed for a customer in Regulation T and Exchange Rule 722. Each JBO participant must meet and maintain the ownership standards. Each JBO participant must employ or have access to a qualified Series 27 (financial and operations) principal. Series 56 Section 4 68

69 4.9 Transaction Review The price at which an order is executed shall be binding notwithstanding that an erroneous report in respect thereto may have been rendered, or no report rendered. A report shall not be binding if an order was not actually executed but was reported to have been executed in error. Obvious Error An Obvious Error will be deemed to have occurred when the execution price of a transaction is higher or lower than the Theoretical Price for the series by an amount equal to at least the amount shown below: Theoretical Price Minimum Amount Below $2.25 $2 to $5.40 Above $5 to $10.50 Above $10 to $20.80 Above $ Catastrophic Error - A Catastrophic Error will be deemed to have occurred when the execution price of a transaction is higher or lower than the Theoretical Price for the series by an amount equal to at least the amount shown below: Theoretical Price Minimum Amount Below $2 $1 $2 to $5 $2 Above $5 to $10 $5 Above $10 to $50 $10 Above $50 to $100 $20 Above $100 $30 \ Series 56 Section 4 69

70 Unmatched Trade Reports and Reconciliation of Unmatched Trades On each business day the Exchange shall match the trade information submitted by member firms on that day and shall issue Unmatched Trade Reports to each clearing firm, which shall contain a list 1. Of Clearing Firm trades on such day for which the Exchange did not receive matching trade data from another Clearing Firm (called "unmatched trades") and 2. Of all trades reported by other Clearing Members for which such Clearing Members submitted no matching trade data (called "advisory trades"). Promptly upon receipt of an Unmatched Trade Notification or Report, a Firm or Member shall be obligated to reconcile all unmatched trades and advisory trades shown thereon and to report all reconciliations and corrections to the Exchange or the Clearing Trading Permit Holder responsible for submission to the Exchange, in accordance with such procedures as may be established by the Exchange from time to time. If an option trade remains unmatched after trade day, it must be resolved no later than fifteen minutes prior to the opening of trading on the following business day. If an unmatched options trade cannot be resolved by mutual agreement, the transaction shall be promptly closed out by the parties pursuant to exchange rules. If an unmatched options trade is not resolved by fifteen minutes prior to the opening of trading on the following business day, due to one of the executing brokers not being present or represented on the Exchange floor, the trade shall be submitted to The Options Clearing Corporation pursuant to the terms presented by the executing broker who is in attendance or who is represented during the trade resolution process. Under unusual conditions the Exchange may prescribe a different schedule for the resolution of unmatched trades. Series 56 Section 4 70

71 4.10 Order Tickets A firm shall submit requested trade data elements, in such automated format as may be prescribed by the Exchange from time to time, in regard to a transaction(s) that is the subject of the particular request for information. If the transaction was a proprietary transaction effected or caused to be effected by the firm for any account in which such firm, or any approved person, partner, officer, director, or employee thereof, is directly or indirectly interested, the firm shall submit or cause to be submitted, any or all of the following information as requested by the Exchange: (1) Clearing house number or alpha symbol as used by the Member submitting the data; (2) Clearing house number(s) or alpha symbol(s) as may be used from time to time, of the Member(s) on the opposite side of the transaction; (3) Identifying symbol assigned to the security and where applicable for the options month and series symbols; (4) Date transaction was executed; (5) Number of option contracts for each specific transaction and whether each transaction was an opening or closing purchase or sale, as well as: (i) the number of shares traded or held by accounts for which options data is submitted; (ii) where applicable, the number of shares for each specific transaction and whether each transaction was a purchase, sale or short sale; (6) Transaction price; (7) Account number; and (8) Market center where transaction was executed. Series 56 Section 4 71

72 If the transaction was effected or caused to be effected by the firm for any customer account, such firm shall submit or cause to be submitted any or all the following information as requested by the Exchange: (1) Data elements (1) through (8) of from above and including; (2) Customer name, address(es), branch office number, Representative number, whether the order was discretionary, solicited or unsolicited, date the account was opened and employer name and tax identification number(s); and (3) If the transaction was effected for a Member broker-dealer customer, whether the broker-dealer was acting as a principal or agent on the transaction or transactions that are the subject of the Exchange s request. In addition to the above trade data elements, a firm shall submit such other information in such automated format as may be prescribed by the Exchange, as may from time to time be required. The firm may grant exceptions, in such cases and for such time periods as it deems appropriate, from the requirement that the data elements prescribed above be submitted in an automated format Settlement Practices Settlement and Delivery Requirements Delivery of the underlying security upon the exercise of an options contract, and payment of the aggregate exercise price in respect thereof, shall be in accordance with the Rules of the Clearing Corporation. As promptly as possible after the exercise of an options contract by a customer, the Member shall require the customer to make full cash payment of the aggregate exercise price in the case of a call options contract, or to deposit the underlying security in the case of a put options contract, or to make the required margin deposit in respect thereof if the transaction is effected in a margin account, in accordance with the Rules of the Exchange and the applicable regulations of the Federal Reserve Board. As promptly as practicable after the assignment to a customer of an exercise notice the Member shall require the customer to deposit the underlying security in the case of a call options contract if the underlying security is not carried in the customer s account, or to make full cash payment of the aggregate exercise price in the case of a put options contract, or in either case to deposit the required margin in respect thereof if the transaction is effected in a margin account, in accordance with the Rules of the Exchange and the applicable regulations of the Federal Reserve Board. Series 56 Section 4 72

73 Clearing Members must follow the procedures of the Clearing Corporation when exercising American-style cash-settled index options contracts issued or to be issued in any account at the Clearing Corporation. Members must also follow the procedures set forth below with respect to American-style cash-settled index options: (1) For all contracts exercised by the Member or by any customer of the Member, an "exercise advice" must be delivered by the Member in such form or manner prescribed by the Exchange no later than 4:20 p.m. Eastern time (3:20 Central), or if trading hours are extended or modified in the applicable options class, no later than five (5) minutes after the close of trading on that day. (2) Subsequent to the delivery of an "exercise," should the Member or a customer of the Member determine not to exercise all or part of the advised contracts, the Member must also deliver an "advice cancel" in such form or manner prescribed by the Exchange no later than 4:20 p.m. Eastern time (3:20 Central), or if trading hours are extended or modified in the applicable options class, no later than five (5) minutes after the close of trading on that day. (3) An Exchange official designated by the Board may determine to extend the applicable deadline for the delivery of "exercise advice" and "advice cancel" notifications pursuant to this paragraph (h) if unusual circumstances are present. (4) No Member may prepare, time stamp or submit an "exercise advice" prior to the purchase of the contracts to be exercised if the Member knew or had reason to know that the contracts had not yet been purchased. (5) The failure of any Member to follow these procedures may result in the assessment of a fine, which may include but is not limited to disgorgement of potential economic gain obtained or loss avoided by the subject exercise, as determined by the Exchange. (6) Preparing or submitting an "exercise advice" or "advice cancel" after the applicable deadline on the basis of material information released after such deadline, in addition to constituting a violation of this Rule, is activity inconsistent with just and equitable principles of trade. (7) These procedures do not apply on the business day prior to expiration in series expiring on a day other than a business day (AM Settled) or on the expiration day in series expiring on a business day (PM Settled). Series 56 Section 4 73

74 (8) Exercises of American-style, cash-settled index options (and the submission of corresponding "exercise advice" and "advice cancel" forms) shall be prohibited during any time when trading in such options is delayed, halted, or suspended, subject to the following exceptions: (i) The exercise of an American- style, cash-settled index option may be processed and given effect in accordance with and subject to the rules of the Clearing Corporation while trading in the option is delayed, halted, or suspended if it can be documented, in a form prescribed by the Exchange, that the decision to exercise the option was made during allowable time frames prior to the delay, halt, or suspension. (ii) Exercises of expiring American-style, cash-settled index options shall not be prohibited on the last business day prior to their expiration. (iii) Exercises of American-style, cash-settled index options shall not be prohibited during a trading halt that occurs at or after 4:00 p.m. Eastern time. In the event of such a trading halt, exercises may occur through 4:20 p.m. Eastern time. In addition, if trading resumes following such a trading halt (such as by closing rotation), exercises may occur during the resumption of trading and for five (5) minutes after the close of the resumption of trading. The provisions of this subparagraph (iii) are subject to the authority of the Board to impose restrictions on transactions and exercises pursuant to Rule 417. (iv) An Exchange official designated by the Board may determine to permit the exercise of American-style, cash-settled index options while trading in such options is delayed, halted, or suspended Clearance Procedures Applicable OCC By-Laws Any person registered as a broker-dealer under the Securities Exchange Act of 1934, as amended, or any Non-U.S. Securities Firm, shall be eligible to become a Clearing Member; and in addition, a futures commission merchant registered under the Commodity Exchange Act shall be eligible to become a Clearing Member for the purpose of clearing transactions in commodity futures, futures options and commodity options. Each applicant to become a Clearing Member must meet the initial Clearing Member financial requirements then in effect and maintain facilities and personnel adequate for the expeditious and orderly transaction of business with the Corporation and other Clearing Members. Every applicant must meet such additional non-discriminatory standards of financial responsibility, operational capability, experience and competence as may from time to time be prescribed in the statutory rules of the Corporation. The Corporation may, and in cases in which the Securities and Exchange Commission, by order, directs as appropriate in the public interest, shall disapprove the application for clearing membership of any person subject to a statutory disqualification. Series 56 Section 4 74

75 Applications for clearing membership s1hall be in such form and contain such information as the Board of Directors shall from time to time prescribe. The Membership/Risk Committee shall review applications for clearing membership and shall recommend, approval or disapproval to the Board of Directors. The Membership/Risk Committee or the Board of Directors, or their designated delegates or agents, may examine the books and papers of any applicant, take such evidence as they may deem necessary or employ such other means as they may deem desirable or appropriate to ascertain relevant facts bearing upon the applicant's qualifications. If the Membership/Risk Committee proposes to recommend to the Board of Directors that an application for clearing membership be disapproved, it shall first furnish the applicant with a written statement of its proposed recommendation and the specific grounds therefor, and afford the applicant an opportunity to be heard and to present evidence on its own behalf. All Exchange transactions shall be cleared through the Corporation, and no other transaction shall be cleared through the Corporation without its consent. Applicable OCC Rules Trade Reporting and Matching Each business day each Exchange shall report to the Corporation information with respect to each Exchange transaction made on such Exchange during said business day (or on a previous day and reconciled on said business day) and as to which matching trade information has been submitted by or on behalf of the Purchasing Clearing Member and the Writing or Selling Clearing Member. Such matching trade information shall also include a Customer CMTA Indicator, a CMTA Customer Identifier, and an IB Identifier to the extent required under applicable Exchange rules. If a give-up service provider reports to the Corporation the information required for Exchange transactions effected on an affiliated futures market, matched trade information from the give-up service provider shall be deemed to have been submitted to the Corporation by such affiliated futures market for all purposes of the By-Laws and Rules. Series 56 Section 4 75

76 Options. If the relevant transaction is in options, the matching trade information for such transaction shall include: 1. The identity of the Purchasing Clearing Member and the Writing Clearing Member and of the accounts in which the transaction was effected. 2. The underlying interest, 3. The exercise price (or in the case of packaged spread options, the base exercise price and the spread interval or in the case of delayed start options that do not yet have a set exercise price, the exercise price setting formula and exercise price setting date), 4. The currency in which the option is denominated, 5. The cap price, if any, 6. The expiration date, 7. The number of option contracts, 8. The premium per unit, 9. Except for a transaction in a Market-Maker s account, whether an opening or closing transaction, 10. The type of option, 11. The ticker symbol, 12. Any other information as may be required by the Corporation. In the case of futures options, such matching trade information shall also include a notation identifying any transaction that is a block trade, exchange-for-physical, or any other trade designated by the futures market or security futures market reporting the trade as a noncompetitively executed trade. Series 56 Section 4 76

77 Futures. If the relevant transaction is in futures, the matching trade information for such transaction shall include 1. the identity of the Purchasing Clearing Member and the Selling Clearing Member and of the accounts in which the transaction was effected. 2. the underlying interest. 3. the currency in which the future is denominated (if other than US dollars), 4. the maturity date, 5. the number of contracts, 6. the contract price, 7. except for a transaction in a Market Maker s account or as otherwise agreed between the Corporation and an Exchange, whether an opening or closing transaction, 8. if a stock future, whether it is physically-settled or cash-settled, 9. the series marker, if any, 10. if an exchange-for-physical or block trade or any other trade designated by the futures market or security futures market reporting the trade as a non-competitively executed trade, a notation to that effect, and 11. such other information as may be required by the Corporation. Daily Cash Settlement Report Prior to 9:00 A.M. Central Time (10:00 A.M. Eastern Time) of each business day, the Corporation shall make available to each Clearing Member a Daily Position Report for each account maintained by the Clearing Member with the Corporation. The Daily Position Report shall list, among other things, all Exchange transactions of the Clearing Member in such account settling on such business day and shall show the net daily premiums due to or from the Corporation in such account as a result of such Exchange transactions. Net daily premiums shall be further combined and netted with net variation payments due to or from the Corporation in respect of positions and transactions in futures in such accounts as calculated by the Corporation in accordance with specific rules. Series 56 Section 4 77

78 Delivery of Underlying Securities and Payment Delivery Advices made available to a Clearing Member by the Corporation shall identify the designated settlement method, the quantity and description of each underlying security to be delivered against receipt of payment therefor, the quantity and description of each underlying security to be received against payment therefor, the delivery date, the event resulting in the obligation to deliver, receive or make payment, the exercise price (in the case of options), the final settlement price (in the case of stock futures), the allocation percentage of the exercise price or final settlement price, and, for settlements to be effected on a broker-to-broker basis, the contra Clearing Member to the settlement obligation. In the event that the Corporation directs that settlement be effected by a method different than a previously designated method, the Corporation shall provide notice thereof to the affected Clearing Members, but shall not revise any outstanding Delivery Advice. In the event that more than one underlying security is deliverable upon the exercise or maturity of a contract, the Corporation shall have the discretion to allocate a percentage of the exercise price or final settlement price to each underlying security to be delivered or received to determine the amount to be paid or received in respect of such security. Such allocation shall reflect the value of the underlying security relative to the aggregate value of the contract as determined by the Corporation. When a Delivery Advice or the Corporation directs that settlement be made on a broker-to-broker basis, the Delivering Clearing Member shall deliver each underlying security specified in the Delivery Advice against payment of the aggregate purchase price therefor on the delivery date specified therein, which, in the case of options, shall be the third business day following the day on which the exercise notice was, or is deemed to have been, properly tendered to the Corporation pursuant to Rules, and, in the case of security futures, shall be the third business day following the maturity date, provided that: 1. The Corporation may designate a different delivery date for property that is deliverable as a result of an adjustment of a contract pursuant to the By-Laws and Rules; and 2. The Chairman, Management Vice Chairman or President or delegate of such officer may extend or postpone the time for delivery whenever, in such person s opinion, such action is required in the public interest or to meet unusual conditions. Series 56 Section 4 78

79 Unless the Corporation directs otherwise, broker-to-broker settlements shall be made on a delivery-versus-payment basis through the facilities of The Depository Trust Company. If the Corporation directs that a broker-to-broker settlement be made otherwise than as provided in subsection (a), the Delivering Clearing Member and Receiving Clearing Member shall mutually agree upon the location and method for effecting delivery of each underlying security and payment therefor. Clearing Members shall make appropriate arrangements for the payment of any applicable stock transfer or similar taxes in the manner prescribed by the applicable laws and regulations of the taxing jurisdiction, and shall jointly and severally hold the Corporation harmless from any liability in respect thereof. Clearing Members shall furnish to the Corporation upon request such evidence as the Corporation may require with respect to the payment of such taxes. Any stock transfer or similar tax payable in accordance with applicable laws and regulations of a taxing jurisdiction upon the transfer of securities pursuant to the exercise of an option contract shall be the responsibility of the Delivering Clearing Member except where the incidents of the tax are attributable solely to the Receiving Clearing Member (or his customer or customers), in which case the tax will be the responsibility of the Receiving Clearing Member. Securities required to be delivered shall be delivered by book-entry through the facilities of a securities depository registered as a clearing agency with the Securities and Exchange Commission or by delivery of a certificate or certificates in good deliverable form. A certificate shall be deemed to be in good deliverable form for the purposes hereof only if the delivery of the certificate in such form would constitute good delivery under the rules of the primary market for the security. The Receiving Clearing Member shall accept a partial delivery if tendered in round lots or multiples thereof, or, if the unit of trading is or includes an odd lot, in such odd lot or multiples thereof. The acceptance of a delivery prior to the delivery date shall be at the option of the Receiving Clearing Member. When settlement is made the Delivering Clearing Member shall have the right to require the allocable purchase price of the delivered units of the underlying security to be paid by customary means in immediately available funds. Unless settlement is made through the correspondent clearing corporation the Delivering Clearing Member and the Receiving Clearing Member shall each promptly submit notices to the Corporation, in accordance with the procedures and within the timeframes periodically specified by the Corporation, as to the number of units of the underlying security delivered (received) and the amount received (paid) therefor. Series 56 Section 4 79

80 During times to be specified by the Corporation, the Corporation shall make available to the affected Delivering Clearing Member and Receiving Clearing Member reports reflecting the notices submitted by each such Clearing Member regarding delivery, payment, or receipt of delivery or payment in respect of an underlying security. If the reported number of units of the underlying security delivered equals the reported number of units received, the delivery obligation with respect to such number of units shall be deemed discharged. If an equal number of units of such underlying security are reported to have been delivered and received, but such number is less than the total delivery obligation in respect of the underlying security, the remaining portion of such obligation shall be deemed outstanding. The delivery obligation in respect of such underlying security shall be deemed to be fully discharged when the total number of units reported to be delivered and received equals the total quantity of the underlying security to be delivered (received) as set forth in the applicable Delivery Advice. Once the total delivery obligation in respect of an underlying security has been fully discharged, the Delivering Clearing Member, the Receiving Clearing Member and the Corporation shall have no further obligation in respect thereof. If the reported payment amount received equals the reported amount paid in respect of an underlying security, then the payment obligation with respect to such amount shall be deemed discharged. If equal amounts are reported to have been paid and received, but such amount is less than the total payment obligation, the remaining portion of the payment obligation shall be deemed outstanding. The payment obligation in respect of such underlying security shall be deemed to be fully discharged when the total amount reported to be paid and received equals the aggregate purchase price for such underlying security in the applicable Delivery Advice. Once the total payment obligation has been fully discharged, the Delivering Clearing Member, the Receiving Clearing Member and the Corporation shall have no further obligation in respect thereof. In the event a Delivering Clearing Member or a Receiving Clearing Member (as applicable) submits to the Corporation notice of a delivery, payment, or receipt of delivery or payment, and the contra Clearing Member to the settlement obligation does not respond to such notice two business days after such notice was made available to such Clearing Member, the contraparty s failure to respond shall constitute its acknowledgment to the Corporation that particular obligation has been settled as indicated in the notice furnished by the submitting Clearing Member, provided that the designated delivery date has occurred. In the event that the notice submitted by the Delivering Clearing Member and the notice submitted by the Receiving Clearing Member regarding a delivery (receipt) of units of an underlying security, or payment (receipt of payment) therefor, contain contradictory information as to such delivery (receipt) or payment (receipt of payment), each such notice shall be deemed null and void and given no effect. Series 56 Section 4 80

81 If the Delivering Clearing Member has not completed a required delivery by the close of business on the delivery date, the Receiving Clearing Member shall issue a buy-in notice, in paper format or in automated format through the facilities of a selfregulatory organization that provides an automated communications system, with respect to the undelivered units of the underlying security, within 20 calendar days following the delivery date, and shall thereupon buy in the undelivered securities. Except as otherwise directed by the Corporation, the buy-in shall be effected, as nearly as may be, in accordance with the then current procedures and interpretations of the correspondent clearing corporation for buy-ins of receive balance orders, and the Delivering Clearing Member and the Receiving Clearing Member shall have the rights and obligations set forth therein, provided that (i) buy-in notices shall not be retransmitted except to other Delivering Clearing Members, and (ii) extensions of time may be granted only by the Corporation (and not by the correspondent clearing corporation). The Clearing Member executing a buy-in shall as promptly as possible on the day of execution notify the Corporation and the Delivering Clearing Member, in such manner as the Corporation shall specify, as to the quantity purchased and the price paid. The defaulting party shall promptly, and in any event prior to 10:00 A.M. Central Time (11:00 A.M. Eastern Time) of the following business day, pay the Receiving Clearing Member the excess of 1. The price paid on such buy-in over or, 2. the settlement amount of the securities bought-in less any portion thereof already paid by the Receiving Clearing Member. Notwithstanding any other provision of the By-Laws and Rules, from and after the time when the Receiving Clearing Member has received payment of such difference, if any, the settlement obligation in respect of the undelivered units of the underlying security shall be deemed fulfilled and the Delivering Clearing Member and the Corporation shall have no further obligation in respect thereof. As used herein, the term defaulting party shall mean the Corporation when the buy-in notice is issued in respect of a call option contract and shall mean the Delivering Clearing Member when the buy-in notice is issued in respect of a put option contract. When the buy-in notice is issued in respect of a call option contract, the Delivering Clearing Member shall be obligated to pay to the Corporation the amount specified in subparagraph (b) not later than settlement time on the business day following the execution of the buy-in and the Corporation shall be authorized to withdraw such amount from such Clearing Member s bank account established in respect of its firm account. Series 56 Section 4 81

82 The failure of the Receiving Clearing Member to issue a buy-in notice within the time specified or to execute the buy-in in a timely manner shall not affect the contract rights of the parties except that the defaulting party may limit the amount which it is obligated to pay pursuant to the highest amount it would have been required to pay if the buy-in notice had been issued and executed on a timely basis. The protect procedures set forth in this Rule apply to deliveries of securities that are effected on a broker-to-broker basis pursuant to Rules and such procedures shall not apply to any delivery to be made through the correspondent clearing corporation. A delivery to be made through the correspondent clearing corporation shall be subject to the protect procedures, if any, provided by the rules or procedures of the correspondent clearing corporation. If a Receiving Clearing Member is entitled to receive warrants, rights, convertible securities or other securities which have been called for redemption or are due to expire or with respect to which a call or expiration date is impending or which are subject to a tender or exchange offer or other offer which will expire, and if the expiration time (as hereafter defined) is on or after the delivery date, such Receiving Clearing Member may deliver a notice (a Liability Notice ) to the Delivering Clearing Member not later than 9:00 a.m. Central Time on the business day preceding the expiration date. If a Liability Notice is so delivered to the Delivering Clearing Member, and the Delivering Clearing Member fails to deliver the securities by the expiration time, the defaulting party shall be liable for any damages which may accrue thereby. All claims for such damage shall be made promptly. For the purposes of this paragraph, the term expiration time means the latest time and date on which securities must be delivered or surrendered up to and including the last day of the protect period, if any. As used herein, the term "defaulting party" shall mean the Corporation when the Liability Notice is issued in respect of a call option contract or a security future and shall mean the Delivering Clearing Member when the buy-in notice is issued in respect of a put option contract. When the Liability Notice is issued in respect of a call option contract or a security future, the Delivering Clearing Member shall be obligated to pay to the Corporation the amount of the damages referred promptly upon notice from the Corporation that the Corporation has paid such amount to the Receiving Clearing Member. Once a Liability Notice is issued by a Receiving Clearing Member, unless subsequently withdrawn, no buy-in notice may be issued. Series 56 Section 4 82

83 If a Receiving Clearing Member shall refuse to receive all of the units of the underlying security duly delivered to it in fulfillment of a delivery obligation, and such refusal shall continue beyond the close of business on the delivery date, the Delivering Clearing Member may, without notice, sell out in the best available market, for the account and liability of the defaulting party, all or any part of the undelivered units. Notice of such sell-out, including the quantity sold and the price received, shall be submitted as promptly as possible on the date of execution, in such manner as the Corporation shall specify, to the Corporation and the Receiving Clearing Member. As used in this Rule 911, the term defaulting party shall mean the Receiving Clearing Member in the case of a call option contract and the Corporation in the case of a put option contract or a security future. The defaulting party shall be obligated to pay promptly, and in any event prior to 10:00 A.M. Central Time (11:00 A.M. Eastern Time) of the business day following the sell-out, to the Delivering Clearing Member the excess, if any, of the aggregate purchase price of the undelivered units over the price at which such units were sold out; and if the Corporation is the defaulting party, the Receiving Clearing Member shall pay such amount to the Corporation not later than settlement time on the business day immediately following the sell-out and the Corporation shall be authorized to withdraw such amount from the bank account established by the Receiving Clearing Member in respect of its firm account. Notwithstanding any other provision of the By-Laws and Rules, from and after the time when the Delivering Clearing Member has received payment of such difference, if any, the settlement obligation in respect of the units of the underlying security for which there was a refusal to receive shall be deemed fulfilled and the Receiving Clearing Member and the Corporation shall have no further obligation in respect thereof. If a Receiving Clearing Member shall fail to pay the aggregate purchase price for all of the units of the underlying security duly delivered to it in fulfillment of a delivery obligation, and such failure shall continue beyond the close of business on the delivery date, the defaulting party shall be obligated to pay such aggregate purchase price to the Delivering Clearing Member promptly, and in any event prior to 10:00 A.M. Central Time (11:00 A.M. Eastern Time), on the following business day, and if the Corporation is the defaulting party, the Receiving Clearing Member shall pay such amount to the Corporation not later than settlement time on such following business day and the Corporation shall be authorized to withdraw such amount from the bank account established by the Receiving Clearing Member in respect of its firm account. Notwithstanding any other provision of the By-Laws and Rules, from and after the time when the Delivering Clearing Member has received payment of such aggregate purchase price, the settlement obligation in respect of the units of the underlying security for which there was a refusal to pay shall be deemed fulfilled and the Receiving Clearing Member and the Corporation shall have no further obligation in respect thereof. Series 56 Section 4 83

84 When an exercise notice is properly tendered to the Corporation, or when the maturity date of a physically-settled stock future occurs, prior to an ex date (as fixed by the primary market for the underlying security) for a distribution that causes an adjustment to be made pursuant to the By-Laws, the Delivering Clearing Member shall make delivery as required by such adjustment unless the parties otherwise agree. When an exercise notice is properly tendered to the Corporation, or when the maturity date of a physically-settled stock future occurs, prior to such an ex date for a distribution that does not cause an adjustment to be made pursuant to the By-Laws, and delivery of the underlying security is made too late to enable the Receiving Clearing Member to transfer the security into its name and to receive such distribution, the Delivering Clearing Member shall, at the time of delivery, issue its due bill check to the Receiving Clearing Member for the amount of the distribution, which check shall be payable on the payment date of such distribution. Series 56 Section 4 84