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Tim Quast
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February 16, 2007

The Over-theCounter Market Braces for OATS

By Peter Chapman

Over-the-counter dealers have four months to comply with new NASD rules that require them to report trades to the NASD's Order Audit Trail System, or OATS. Heretofore OATS applied only to Nasdaq securities. But last fall the SEC approved an NASD plan to extend compliance to OTC equities, notably OTC Bulletin Board and Pink Sheets securities. Compliance kicks in June 11.

Sources say compliance is no easy task. "A lot of firms aren't geared up for it," says Steven Nelson, an attorney and Security Traders of New York member who represents several trading houses. "I don't know what system they can use to help them." Trading in the OTC market is largely a manual process. Telephones and paper tickets are still used to capture incoming orders. Most dealers have systems to report orders for Nasdaq securities to OATS. But many don't have systems that can automatically report orders in OTC equities.

Traders say SunGard/Brass is working to automate the process, but they aren't sure where the vendor stands on the project. Brass is one of the more popular order management systems used by market makers.

The NASD provides a Web-based system, traders say, but it has limitations. It is used to report the occasional order for a Nasdaq security that comes by phone.

The NASD uses OATS to track an order from the time it hits a broker's desk to the time it is executed. Market makers must enter data into OATS twice: when they first receive the order and when they fill it.

NASD compares that data against quote and trade data in the market during the time the order is being handled. The object is to determine if the customer received best execution. The NASD first proposed the expansion of OATS to the OTC market in 2004. The industry was not supportive.

The Securities Industry and Financial Markets Association (SIFMA) complained to the SEC that installing the technology to comply was an "enormous undertaking."

SIFMA said: "The markets for OTC equity securities are inherently manual by nature and virtually all order information would have to be captured by new front-end systems."