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May 16, 2007

Stung By Ruling, NASD to Review OATS

By Peter Chapman

The NASD, after losing a legal challenge brought by one of its members, plans to review its OATS rules.

NASD chairman and chief executive Mary Schapiro announced recently that the regulator is creating a pilot program to review some of its rules. The plan is a response to criticism that some NASD rules do not justify the burdens they impose.

OATS-which stands for Order Audit Trail System, and requires broker-dealers to submit order and trade data-is on the list of rules to review.

"We plan to analyze the OATS rules to determine how they have worked and whether changes are appropriate," Schapiro said at the Securities Industry and Financial Markets Association compliance and legal division's annual seminar. "Our goal is to revisit certain rules...to ensure they are working the way they should be" and not be burdensome.

Many broker-dealers maintain that the burden of OATS is not warranted. Sam Lek, who heads Lek Securities and brought the legal challenge against the NASD, is one of them.

"I don't think it has any benefit," Lek told Traders Magazine. "Anytime the NASD does an investigation, the first thing they ask for is the [trade] tickets."

Lek won his challenge over accusations that his firm failed to comply with OATS in a timely manner.

OATS requires broker-dealers to submit start-to-finish order and trade information to an NASD database daily. The NASD wants to know when an order hit various desks and when it was executed. Lek maintains that the database is so huge and unwieldy that NASD enforcement officials don't even bother to use it.

The regulator first established OATS in the late 1990s, following the Nasdaq market-maker price collusion scandal. The NASD has gradually expanded coverage of OATS over the years. The most recent iteration of the rule would require coverage of OTC securities (see related article below).

OATS is very technical and difficult to comply with, say legal professionals. It also guarantees the NASD a steady source of fees because of the high degree of noncompliance among member firms.

"Whenever you see something in the industry where there is a lot of disciplinary action, there are two conclusions you can draw," said Mike Wolk, an attorney with Foley & Lardner in Washington. "Either the industry doesn't get it and they are not complying, or the regulators have not made compliance easy. In this case, you have a little bit of both."

Lek, who took his case before an NASD judiciary panel, attempted to shape the case into a referendum on the legality of OATS. The trader maintains that the NASD did not comply with the federal Paperwork Reduction Act when it originally passed the rule. Lek managed to beat the NASD's charges, but failed to broaden his case.