FINRA's proposed amendments to its trade reporting rules for OTC equity securities have been released for comment;  the comment period expires 3/26/12.  The changes specifically relate to instances where a member firm acts in a mixed trading capacity - e.g., a single trade execution by a firm as both principal and agent). FINRA is considering alternative approaches, such as:  (i) requiring firms to report a mixed-capacity trade as multiple trade executions with the firm’s capacity properly identified in each trade report;  or (ii) permitting a mixed-capacity trade to be reported in a single trade report and requiring firms to submit a non-tape report linked to the original trade report, identifying the portions of the trade executed in each different capacity - agent, principal, riskless principal. Introduction. FINRA rules generally require that reports of OTC transactions in equity securities accurately reflect the trading capacity - i.e., agent, principal or riskless principal - of the reporting firm and any member firm on the contra side of the trade.  The information can be provided in a single report, if the reporting firm submits trade information for both sides of the trade, or it can be provided in a combination of reports, if the reporting firm and contra side each submit its own trade information. In some instances, a firm may act in different capacities with respect to a single trade execution - e.g., the firm combines multiple orders in different capacities at the same price and executes the combined orders as a single trade (referred to as a “mixed-capacity” trade). However, trade reports submitted to FINRA can only accommodate one capacity code, and, as a result, a trade executed by a firm in a mixed capacity of agent and principal is reported as either agent or principal; the trade report cannot reflect that the firm acted in both capacities. In December 2001, FINRA published Notice to Members (NtM) 01-85, which provides relief to firms with respect to reporting the capacity code for mixed-capacity trades.  As indicated in NTM 01-85, a mixed-capacity trade can be reported in a single trade report, with a single capacity code, and firms have the option of submitting a non-tape report to FINRA to accurately reflect the capacity for a mixed-capacity trade.

e.g. - if a firm executes an OTC trade for 10,000 shares in a mixed capacity of 6,000 shares as principal and 4,000 shares as agent, and reports the trade with a capacity of principal, NtM 01-85 provides that the firm may - but is not required to - submit a non-tape report to FINRA to show that it executed 4,000 of those shares as agent.

Based on a review of trade report data, FINRA has determined that firms rarely submit the voluntary non-tape reports. As such, mixed-capacity trade reporting provides less than optimal information for FINRA’s regulatory surveillance systems that rely on capacity codes. Request for Comment. FINRA is proposing to amend its trade reporting rules to ensure that FINRA receives accurate trade data for trades executed in a mixed capacity and is considering at least 2 alternative approaches, which are described below.  FINRA notes that the relief granted to firms in NtM 01-85 was intended to address technological constraints that existed at the time - but no longer are applicable. Thus, under both approaches, firms would no longer be able to rely on the relief provided in NtM 01-85 and would no longer have the option of reporting a mixed-capacity trade in a single trade report and submitting a nontape report to correct the capacity. Proposal One - Reporting Mixed-Capacity Trades as Multiple Trade Executions. Here, FINRA would expressly require firms to report a mixed capacity trade as multiple trade executions with the firm’s capacity properly identified in each trade report. Unless the trade qualifies for an exclusion from reporting for public dissemination purposes under FINRA trade reporting rules, each trade report would be submitted for dissemination (a “tape report”).

e.g. - Firm A executes a trade for 10,000 shares in a mixed capacity of 6,000 shares as principal and 4,000 shares as agent;  Firm A would be required to report the trade in 2 reports: one tape report for 6,000 shares with a capacity of principal and a second tape report for 4,000 shares with a capacity of agent.

This requirement would apply whether the party acting in a mixed capacity is the reporting firm or a member firm on the contra side of the trade.

e.g. - Firm A routes an order to Firm B for 10,000 shares in a mixed capacity of 6,000 shares as principal and 4,000 shares as agent, and Firm B has the reporting obligation under FINRA trade reporting rules, Firm B would be required to report the trade in two reports: one tape report for 6,000 shares with Firm A’s capacity identified as principal and a 2nd tape report for 4,000 shares with Firm A’s capacity identified as agent.

In both of the above examples, it would not be permissible to report the entire 10,000 share mixed-capacity trade in a single trade report identifying a single capacity of either agent or principal. A member firm that routes a mixed-capacity order to a firm for execution would be required to identify the individual components of the order so that the firm executing and reporting the trade could properly report the trade. If the firm cannot do so, then it would need to route the components of the order separately - e.g., rather than routing a mixed principal and agency order, the firm would route an agency order and a separate principal order. Proposal Two - Mandatory Submission of Non-Tape Reports. Here, FINRA would continue to permit firms to report mixed capacity trades in a single trade report and to mandate the submission of the non-tape reports that are currently voluntary, as provided in NtM 01-85.

e.g. - Firm A executes an OTC trade for 10,000 shares in a mixed capacity of 6,000 shares as principal and 4,000 shares as agent and reports the trade to FINRA in a single tape report with a capacity of principal;  Firm A would be required to submit a non-tape report to FINRA to show that it executed 4,000 of those shares as agent.

e.g. - Firm A routes an order to Firm B for 10,000 shares in a mixed capacity of 6,000 shares as principal and 4,000 shares as agent, and Firm B has the reporting obligation under FINRA trade reporting rules, if Firm B reports the trade in a single tape report with Firm A’s capacity identified as principal, under this proposed approach, Firm A would be required to submit a non-tape report to FINRA to show that it executed 4,000 of those shares as agent.

This proposed approach is similar to current FINRA trade reporting rules that allow firms to report OTC riskless principal transactions in 2 separate reports: (i) a tape report to reflect the initial leg of the transaction, with the capacity marked as principal;  and, (ii) a non-tape report to reflect the offsetting, “riskless” leg of the transaction, with the correct capacity of riskless principal. If FINRA were to mandate the submission of non-tape reports to correct the capacity for a member firm acting in a mixed capacity, firms would be required to link the tape and nontape reports by providing the same unique identifier in both reports to enable FINRA staff to identify related reports in the audit trail. FINRA welcomes comments ... on all aspects of the proposals discussed in this Notice, and specifically encourages comments on the following:

• What percentage of your firm’s trading is done in a mixed capacity?
• What are the technological implications and burdens associated with each of the proposed approaches described above?
• How much time would firms need to make the necessary systems changes to implement each of the proposed approaches described above?
• Is there another approach or variation on the 2 approaches described above that FINRA should consider?
• If FINRA were to mandate the submission of non-tape reports - which would  require the use of a unique identifier to link tape and non-tape reports - should the identifier be:

1. a unique identifier that is generated and submitted by the firm - e.g., as a new field in both the tape and non-tape reports; 2. a control number assigned by the trade reporting facility on the  confirmation of receipt of the tape report that would then be entered by the firm submitting the non-tape report; or 3. some other linkage mechanism?

FINRA Staff Contacts. Direct questions to:   Legal Section, Market Reg. - (240) 386-5126; Office of General Counsel - (202) 728-8071. For further details:  [FINRA RegNote 12-07, February 2012].