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August 9, 2006

Dealing with OATS Phase III: It will change the process and culture of trading

By Deborah Mittelman

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  • Dealing with OATS Phase III: It will change the process and culture of trading

Phase three of the NASD's Order Audit Trail System (OATS) was scheduled to go into effect on July 10. OATS applies to all orders for Nasdaq securities received or originated by an OATS reporting member, whether the order is received electronically or manually. For firms, their primary focus will be on implementing the right technology and

processes to meet OATS compliance. Still, there also will need to be a more subtle cultural shift on the part of traders as they implement these new technologies and processes.

Trading Culture Shift

Traders at large and small brokerage firms alike will have to adjust how, when, and even where they receive orders to comply with the ruling. OATS members must capture and report both the time the order is received from the customer and the time the order is received by the member's trading desk or trading department, if those times are different. Many trades are handled by phone, over email and even via instant messaging and in-person (on the golf course, for example), with OATS Phase III specifically addressing these scenarios.

The challenge is in the fact that phone orders are typically the most complex, with many parameters, and not quickly or easily punched into an OMS or order capture system. Also outlined under the directive is that any time lag between when a manual order is received and when it is sent to the trading desk must be accounted for. Any stops between the point of receipt and the trading desk must be entered. Manual-order cancellations must also be captured, as well as whether those orders were directed to a specific execution venue.

OATS is driven by the 1996 settlement between the SEC and the NASD after the Nasdaq price-fixing scandal. The NASD was charged with lax regulation of the Nasdaq market. The OATS ruling was designed to enable the NASD to improve monitoring of brokerage firms and to spot breakdowns in controls and operations. These breakdowns could lead to possible violations of NASD rules or federal securities regulations. With the third and most recent phase of the rule, the NASD will be equipped with sufficient information to perform highly sophisticated surveillance on a more broad set of order flow than it has had access to up until now. The big question is whether firms are up to the task of conducting equally comprehensive self-surveillance as the NASD. Fundamental to compliance will be the ability to perform robust internal surveillance, across the complete compliance lifecycle.

To make sure that internal surveillance is up to par with that of the NASD, all firms will have some work to do around OATS Phase III. Small and large firms will bear the brunt of the burden. In addition to ensuring trader diligence, implementing the right technology and processes present the greatest challenge. Very few firms have streamlined their technology and operations processes so that they can effectively comply with OATS Phase III.

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