[Federal Register Volume 61, Number 14 (Monday, January 22, 1996)]
[Notices]
[Pages 1655-1660]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-737]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36719; File No. SR-NASD-95-60]
Self-Regulatory Organizations; Notice of Proposed Rule Change by
the National Association of Securities Dealers, Inc. Relating to a Six-
Month Extension of the SOES Minimum Exposure Limit Rule and the SOES
Automated Quotation Update Feature
January 16, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on December
19, 1995, the National Association of Securities Dealers, Inc.
(``NASD'' or ``Association'') filed with the Securities and Exchange
Commission (``Commission'' or ``SEC'') the proposed rule change as
described in Items I, II, and III below, which Items have been prepared
by the NASD. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD proposes to extend, until July 31, 1996, the effectiveness
of certain rules governing the operation of The Nasdaq Stock Market,
Inc.'s (``Nasdaq'') Small Order Execution System (``SOES'').
Specifically, these SOES rules, which were previously approved by the
Commission on a pilot basis on December 23, 1993 1 and recently
extended through January 31, 1996,2 provide for: (1) A reduction
in the minimum exposure limit for unpreferenced SOES orders from five
times the maximum order size to two times the maximum order size, and
for the elimination of exposure limits for preferenced orders (``SOES
Minimum Exposure Limit Rule''); and (2) implementation of an automated
function for updating market maker quotations when the market maker's
exposure limit has been exhausted (``SOES Automated Quotation Update
Feature''). These rules are part of a set of SOES rules approved by the
SEC on a pilot basis known as the Interim SOES Rules.3
\1\ See Securities Exchange Act Release No. 33377 (December 23,
1993), 58 FR 69419 (December 30, 1993) (``Interim SOES Rules
Approval Order'').
\2\ See Securities Exchange Act Release No. 36311 (September 29,
1995), 60 FR 52438 (October 6, 1995) (``Interim SOES Rules Extension
Order'').
\3\ As first approved by the Commission on December 23, 1993,
the Interim SOES Rules had four components: (1) The SOES Minimum
Exposure Limit; (2) the Automated Quotation Update; (3) a reduction
in the maximum size order eligible for execution through SOES from
1,000 shares to 500 shares (``SOES Maximum Order Size''); and (4)
the prohibition of short sales through SOES. The SOES Maximum Order
Size Rule lapsed effective March 28, 1995, and the rule prohibiting
the execution of short sales through SOES lapsed effective January
26, 1995.
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II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The NASD has prepared summaries, set forth in Sections
(A), (B), and (C) below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
The Commission originally approved the SOES Minimum Exposure Limit
Rule and the SOES Automated Quotation Update Feature on a one-year
pilot basis in December 1993, along with two other SOES rules which
have since lapsed.4 Since December 1993, the SEC has approved
three NASD proposals to extend the effectiveness of the rules, with the
most recent approval extending the rules through January 31,
1996.5 With this filing the NASD proposes to further extend the
effectiveness of the SOES Minimum Exposure Limit Rule and the SOES
Automated Quotation Update Feature until July 31, 1996, so that the
rules can continue on an uninterrupted basis until the SEC has had an
opportunity to
[[Page 1656]]
consider Nasdaq's proposed NAqcess system.
\4\ See Interim SOES Rules Approval Order, supra note 1.
\5\ See Interim SOES Rules Extension Order, supra note 2, and
Securities Exchange Act Release Nos. 35275 (January 25, 1995), 60 FR
6327 (February 1, 1995); 35535 (March 27, 1995), 60 FR 16690 (March
31, 1995).
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As described in more detail below, because the NASD believes
implementation of the SOES Minimum Exposure Limit Rule and the SOES
Automated Quotation Update Feature have been associated with positive
developments in the markets for Nasdaq securities and clearly have not
had any negative effects on market quality, the NASD believes it is
appropriate and consistent with the maintenance of fair and orderly
markets and the protection of investors for the Commission to approve a
further limited extension of the effectiveness of these rules. The NASD
believes the SOES Minimum Exposure Limit Rule and the SOES Automated
Quotation Update Feature reflect a reasoned approach by the NASD to
address the adverse effects on market liquidity attributable to active
intra-day trading activity through SOES, while at the same time not
compromising the ability of small, retail investors to receive
immediate executions through SOES. Specifically, these rules are
designed to address concerns that concentrated, aggressive use of SOES
by a growing number of order entry firms has resulted in increased
volatility in quotations and transaction prices, wider spreads, and the
loss of liquidity for individual and institutional investor orders.
The NASD believes that the same arguments and justifications made
by the NASD in support of approval of the SOES Minimum Exposure Limit
Rule and the SOES Automated Quotation Update Feature and three
extensions of these rules are just as compelling today as they were
when the SEC relied on them to initially approve these rules. In sum,
the NASD continues to believe that concentrated bursts of SOES activity
by active order-entry firms contribute to increased short-term
volatility, wider spreads, and less market liquidity on Nasdaq and that
the SOES Minimum Exposure Limit Rule and the SOES Automated Quotation
Update Feature are an effective means to minimize these adverse market
impacts. In addition, given the increased utilization of SOES since the
SOES Maximum Order Size Rule lapsed at the end of March 1995, the NASD
believes it is even more imperative that the SOES Minimum Exposure
Limit Rule and the SOES Automated Quotation Update Feature remain in
effect to help to ensure the integrity of the Nasdaq market and prevent
waves of SOES orders from a handful of SOES order-entry firms from
degrading market liquidity and contributing to excessive short-term
market volatility.
The NASD notes that the SEC made specific findings in the Interim
SOES Rules Approval Order that the SOES Minimum Exposure Limit Rule and
the SOES Automated Quotation Update Feature were consistent with the
Act. In particular, the SEC stated in its approval order that:
a. Because the benefits for market quality of restricting SOES
usage outweigh any potential decrease in pricing efficiency, the
Commission concludes that the net effect of the proposal is to
remove impediments to the mechanism of a free and open market and a
national market system, and to protect investors and the public
interest, and that the proposed rule changes are designed to produce
accurate quotations, consistent with Sections 15A(b)(6) and
15A(b)(11) of the Act. In addition, the Commission concludes that
the benefits of the proposal in terms of preserving market quality
and preserving the operational efficiencies of SOES for the
processing of small size retail orders outweigh any potential burden
on competition or costs to customers or broker-dealers affected
adversely by the proposal. Thus, the Commission concludes that the
proposal is consistent with Section 15A(b)(9) of the Act in that it
does not impose a burden on competition which is not necessary or
appropriate in furtherance of the purposes of the Act.6
\6\ Interim SOES Rules Approval Order, supra note 1, 58 FR at
69423.
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b. The Commission also concludes that the proposal advances the
objectives of Section 11A of the Act. Section 11A provides that it
is in the public interest and appropriate for the protection of
investors and the maintenance of fair and orderly markets to assure
economically efficient execution of securities transactions, fair
competition among market participants, and the practicality of
brokers executing orders in the best market. The Commission
concludes that the proposal furthers these objectives by preserving
the operational efficiencies of SOES for the processing of small
orders from retail investors.7
\7\ Id.
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c. The Commission believes that it is appropriate to restrict
trading practices through SOES that impose excessive risks and costs
on market makers and jeopardize market quality, and which do not
provide significant contributions to liquidity or pricing efficiency
* * * The Commission believes that it is more important to ensure
that investors seeking to establish or liquidate an inventory
position have ready access to a liquid Nasdaq market and SOES than
to protect the ability of customers to use SOES for intra-day
trading strategies.8
\8\ Id. at 69424-25.
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d. The Commission believes that there are increased costs
associated with active intra-day trading activity through SOES that
undermine Nasdaq market quality. * * * Active intra-day trading
activity through SOES can also contribute to instability in the
market.9
\9\ Id.
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e. In addition, these waves of executions can make it difficult
to maintain orderly markets. Given the increased volatility
associated with these waves of intra-day trading activity, market
makers are subject to increased risks that concentrated waves of
orders will cause the market to move away. As a result, individual
market makers may be unwilling to narrow the current spread and
commit additional capital to the market by raising the bid or
lowering the offer. When market makers commit less capital and quote
less competitive markets, prices can be expected to deteriorate more
rapidly. Accordingly, the Commission believes that it is appropriate
for the NASD to take measured steps to redress the economic
incentives for frequent intra-day trading inherent in SOES to
prevent SOES activity from having a negative effect on market prices
and volatility.10
\10\ Id. at 69425-26.
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f. The Commission does not believe that intra-day trading
strategies through SOES contribute significantly to market
efficiency in the sense of causing prices to reflect information
more accurately.11
\11\ Id.
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g. The Commission has evaluated each of the proposed
modifications to SOES, and concludes that each of the modifications
reduces the adverse effects of active trading through SOES and
better enables market makers to manage risk while maintaining
continuous participation in SOES. In addition, the Commission does
not believe that any of the modifications will have a significant
negative effect on market quality. To the extent that any of the
modifications may result in a potential loss of liquidity for small
investor orders, the Commission believes that these reductions are
marginal and are outweighed by the benefits of preserving market
maker participation in SOES and increasing the quality of executions
for public and institutional orders as a result of the
modifications.12
\12\ Id.
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h. The Commission * * * has determined that the instant
modifications to SOES further objectives of investor protection and
fair and orderly markets, and that these goals, on balance, outweigh
any marginal effects on liquidity for small retail orders, and any
anti-competitive effects on order entry firms and their customers.
The Commission concludes that the ability of active traders to place
trades through a system designed for retail investors can impair
market efficiency and jeopardize the level of market making capital
devoted to Nasdaq issues. The Commission believes that the rule
change is an appropriate response to active trading through SOES,
and that the modifications will reduce the effects of concentrated
intra-day SOES activity on the market.13
\13\ Id. at 69429.
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The NASD believes these significant statutory findings by the SEC
regarding the SOES Minimum Exposure Limit Rule and the SOES Automated
Quotation Update Feature and the SEC's assessment of the likely
benefits to the marketplace that would result from the rules have been
confirmed and substantiated by econometric studies on
[[Page 1657]]
the effectiveness of the Interim SOES Rules conducted by the NASD's
Economic Research Department 14 and an independent economist
commissioned by the NASD.15 When the SEC approved the Interim SOES
Rules, it stated that ``[a]ny further action the NASD seeks with
respect to SOES--extension of these modifications upon expiration, or
introduction of other changes--will require an independent
consideration under Section 19 of the Act.'' 16 In addition, the
SEC stated that, should the NASD desire to extend these SOES changes or
modify SOES, the Commission would expect ``the NASD to monitor the
quality of its markets and assess the effects of [the approved SOES]
changes on market quality for Nasdaq securities.'' Also, if feasible,
the SEC instructed the NASD to provide a quantitative and statistical
assessment of the effects of the SOES changes on market quality; or, if
an assessment is not feasible, the SEC stated that the NASD should
provide a reasoned explanation supporting that determination.
\14\ See letter from Gene Finn, Vice President & Chief
Economist, NASD, to Katherine England, Assistant Director, National
Market System & OTC Regulation, SEC, dated October 24, 1994 (letter
submitted in connection with the NASD's NPROVE filing, SR-
NASD-94-13).
\15\ See The Association Between the Interim SOES Rules and
Nasdaq Market Quality, Dean Furbush, Ph.D., Economists, Inc.,
Washington D.C., December 30, 1994 (``Furbush Study'').
\16\ Interim SOES Rules Approval Order, supra note 1, 59 FR at
69429.
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In sum, the NASD's study found that:
Since the SOES changes went into effect in January 1994,
the statistical evidence indicated that when average daily volume,
stock price, and stock price volatility are held constant through
regression techniques, quoted percentage spreads in Nasdaq securities
experienced a decline in the immediate period following implementation
of the changes and have continued to decline since then. The
statistical evidence also showed that the narrowing of quoted
percentage spreads became more pronounced and robust the longer the
Interim SOES Rules were in effect. In particular, quoted spreads in
cents per share for the 500 largest Nasdaq National Market (``NNM'')
securities experienced a sharp decline from April 28 to May 12 and from
June 23 to July 18; 17
\17\ Some press reports have attributed the recent decline in
spreads for Nasdaq stocks to the publication, on May 26 and 27,
1994, of newspaper articles in The Wall Street Journal, The Los
Angeles Times and other publications reporting the results of an
economic study conducted by two academicians that illustrated the
lack of odd-eighth quotes for active Nasdaq stocks. Contrary to
these press reports, this study shows that spreads had indeed
narrowed before publication of these articles (from April 28 to May
12), stabilized at these narrower levels from mid-May until June 23,
and declined again from June 23 to July 18.
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With the exception of a brief, market-wide period of
volatility experienced by stocks traded on Nasdaq, the New York Stock
Exchange, and the American Stock Exchange during the Spring, the
volatility of Nasdaq securities appears to be unchanged in the period
following implementation of the changes; and
A smaller percentage of Nasdaq stocks experienced extreme
relative price volatility after implementation of the rules and that
these modifications, in turn, suggest a reduction in relative
volatilities since the rules were put into effect.
The Furbush Study found that there was a statistically significant
improvement in effective spreads for the top 100 Nasdaq stocks (based
on dollar volume) during the three month period following
implementation of the rules. Moreover, the study also found that the
most significant improvement in effective spreads for the top 100
stocks occurred for trade sizes between 501 and 1,000 shares, precisely
the level that was made ineligible for SOES trading by the Interim SOES
Rules. In addition, the study found that the average number of market
makers for the top ten Nasdaq-listed stocks increased from 44.3 to
46.0, or 3.8 percent, and from 30.2 to 30.9 for the top 100 stocks, or
2.3 percent. Although correlation does not necessarily imply causation,
as noted by the SEC when it approved the Interim SOES Rules and
extensions of the Interim SOES Rules, the NASD believes that positive
market developments clearly have been associated with implementation of
the Interim SOES Rules.
The NASD also believes that these studies of the effectiveness of
the Interim SOES Rules lend credence to another NASD study that was
submitted to the SEC in support of approval of the Interim SOES
Rules.18 In the May 1993 SOES Study, the NASD found that
concentrated waves of orders entered into SOES by active order-entry
firms resulted in discernible degradation to the quality of the Nasdaq
market. Specifically, the study found, among other things, that: (1)
Bursts of orders entered into SOES by active order entry firms
frequently result in a decline in the bid price and a widening of the
bid-ask spread; (2) that there is a significant positive relationship
between increases in spreads and volume attributable to active order-
entry firms as it related to total SOES volume per security; and (3)
activity by active order-entry firms resulted in higher price
volatility and less liquidity--higher price changes are associated with
high active trading firm volume, even after controlling for normal
price fluctuations.
\18\ See NASD Department of Economic Research: Impact of SOES
Active Trading Firms on Nasdaq Market Quality (May 12, 1993) (``May
1993 SOES Study''). See also Securities Exchange Act Release No.
32313 (May 17, 1993), 58 FR 29647 (publication of the study for
comment).
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The NASD also believes market activity since the SOES Maximum Order
Size Rule lapsed on March 28, 1995, provides further support for the
effectiveness of the SOES Minimum Exposure Limit Rule and the SOES
Automated Quotation Update Feature and the NASD's economic rationale
for these rules. In particular, an analysis prepared by the NASD's
Economic Research Department clearly illustrates that there has been a
dramatic increase in SOES volume since the SOES Maximum Order Size Rule
lapsed and that many market maker positions have been abandoned. These
two phenomena appear to be linked. Those Nasdaq stocks that have
experienced the greatest decline in the number of market makers are the
ones that have experienced the greatest increase in SOES volume since
the rule lapsed.19 The NASD believes these figures indicate that
the relaxation of one of the Interim SOES Rules may have contributed to
some of the adverse market developments that the NASD was seeking to
avoid through implementation of the Interim SOES Rules (e.g.,
degradation in market maker participation and market liquidity).20
Accordingly, the NASD believes that any further relaxation of the
Interim SOES Rules by permitting the SOES Minimum Exposure Limit Rule
or the SOES Automated Quotation Update Feature to lapse would further
harm the Nasdaq market. In light of the significance of these figures
and their indicated adverse ramifications upon the Nasdaq market, the
NASD also believes that SEC reconsideration of its position with
respect to the entry of 1,000-share orders into SOES is warranted.
\19\ See letter from Richard G. Ketchum, Executive Vice
President & Chief Operating Officer, NASD, to Brandon Becker,
Director, Division of Market Regulation, SEC, dated August 1, 1995.
\20\ The NASD believes that elimination of the ban against short
sales through SOES did not have a dramatic negative market effect
because the NASD's short sale rule was approved during the time that
the ban was in effect.
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In addition, the NASD has recently prepared another report that the
NASD believes illustrates that the SOES Minimum Exposure Limit Rule and
the
[[Page 1658]]
SOES Automated Quotation Update Feature have had no adverse impact on
the market for Nasdaq securities.21 This report was in response to
the Commission's request in the Interim SOES Rules Extension Order that
the NASD: monitor the extent to which exposure limits are exhausted,
the extent to which the automated quotation update feature is used, and
the effects these two aspects have on liquidity. Moreover, the
Commission expects the NASD to consider the possibility of enhancements
to eliminate the potential for delayed and/or inferior
executions.22
\21\ See Monitoring Report of Exhaustion of SOES Exposure Limits
and the Usage of Nasdaq Automated Quotation Update Feature, NASD
Economic Research Department, December 18, 1995. This report is
available for inspection and copying in the Commission's Public
Reference Room.
\22\ Interim SOES Rules Extension Order, supra note 2, 60 FR at
52439, n. 12 (``December 1995 Monitoring Report'').
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In sum, the December 1995 Monitoring Report found that it is a very
infrequent occurrence for a market maker to have its exposure limit
exhausted in a NNM security. In particular, from the period October 2,
1995 to November 22, 1995, there were, on average, 83 instances per day
where a market maker's exposure limit in NNM securities was
exhausted.23 Thus, given the fact that there was an average of
44,062 market making positions in NNM securities and 3,932 NNM
securities trading per day during this time period, the impact of these
individual exposure limit exhaustions on the availability of SOES to
investors throughout the trading day was infinitesimal. Each market
making position experienced .0019 exposure limit exhaustions per day
over this time period and each NNM security experienced .0211
exhaustions per day. Moreover, while Nasdaq could not readily determine
the extent to which the exposure limit exhaustions occurred
simultaneously in the same security, given the stark infrequency with
which the exposure limit exhaustions occurred, the NASD believes it is
extremely improbable that a NNM security would experience a situation
where the SOES exposure limits for all market makers in that stock were
exhausted at the same time. Indeed, this conclusion is borne out by the
extremely short time-span in which SOES orders are executed.
Specifically, the report shows that, on average, SOES orders are
executed 1.62 seconds after entry and that 98.5 percent of all SOES
orders are executed within three seconds.24
\23\ The highest number of exposure limits exhausted on any day
during this period was 119 on November 21, 1995 and the lowest
number was 47 on October 4, 1995.
\24\ The report also found that SOES orders can experience brief
execution delays in isolated instances, as one order took as long as
87 seconds to be executed. While the NASD could not readily identify
the reasons for these infrequent execution delays, the NASD believes
these delays are likely the result of two factors. First, consistent
with the NASD's short-sale rule, short sales entered into SOES
cannot be executed on down bids. Second, waves of SOES orders
transmitted by active SOES order-entry firms cause queues to develop
in the processing of SOES orders, which, in turn, causes execution
delays.
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The report also shows that SOES exposure limit exhaustions tend to
cluster in active NNM securities with high numbers of market makers.
This further illustrates the extremely low probability that all market
makers in the same security would ever have their exposure limits
exhausted simultaneously. Lastly, examining one trading day, the report
shows that active SOES order entry firms accounted for 92 percent of
the exposure limit exhaustion, as might be expected given that these
firms account for 89 percent of SOES dollar volume. Accordingly, the
NASD and Nasdaq believe that the SOES Minimum Exposure Limit Rule has
had a very negligible, if any, impact on the availability of SOES to
small, retail investors.
The report also found that the Automated Quotation Update Feature
appears to be used extensively by some market making firms.
Specifically, the report shows that the quote update feature is used by
126 market makers for 10,644 market making positions. Thus, this
feature is currently being used by 26 percent of the market makers and
for 24 percent of all market making positions. In addition the report
shows that, on average, 3,394 quotations a day were generated by the
quote update feature from October 2, 1995 to November 21, 1995.
Accordingly, the NASD and Nasdaq believe that the Automated Update
Feature has effectively served its intended purpose helping to maintain
continuous quotations in Nasdaq, minimize ``closed quote'' conditions,
and avoid unexcused market maker withdrawals, thereby promoting market
liquidity.
Accordingly, the NASD believes the Commission should properly view
these two SOES rules as strictures that are highly correlated with
improvements in market liquidity, not as rules that have had or could
have a damaging effect on liquidity. The NASD and Nasdaq also believe
the monitoring report illustrates that implementation of the Automated
Quotation Update Feature and the SOES Minimum Exposure Limit Rule have
not diminished the significant benefits provided to investors through
the automatic execution capabilities of SOES. Simply put, these two
SOES rules have in no way altered the operation of SOES as an automatic
execution system that affords small, retail investors immediate
executions at the inside market. However, as noted in the NASD's
proposed NAqcess filing, the NASD believes the limit order processing
capabilities and order execution algorithm of SOES could be
significantly improved upon for the benefit of small investors and the
marketplace as a whole.
Moreover, in the Interim SOES Rules Extension Order, an order
approving a proposal identical to the NASD's instant proposal, the SEC
found that the continued effectiveness of the SOES Minimum Exposure
Limit Rule ``provides customers fair access to the Nasdaq market and
reasonable assurance of timely executions.'' 25 With respect to
the SOES Automated Quotation Update Feature, the SEC also stated that
it believes ``that extending the automated update function is
consistent with the Firm Quote Rule. The update function provides
market makers the opportunity to update their quotations automatically
after executions through SOES; under the Commission's Firm Quote Rule,
market makers are entitled to update their quotations following an
execution and prior to accepting a second order at their published
quotes.'' 26
\25\ Interim SOES Rules Extension Order, supra note 2, 60 FR at
52439.
\26\ Id. (footnotes omitted).
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Therefore, in light of the above-cited statutory findings made by
the SEC when it first approved the SOES Minimum Exposure Limit Rule and
the SOES Automated Quotation Update Feature and extensions of these
rules, coupled with the NASD's findings that these rules have been
associated with positive market developments in terms of lower spreads
on Nasdaq and less stocks with extreme relative price volatility, the
NASD believes it would be consistent with the Act for the Commission to
extend the effectiveness of the SOES Minimum Exposure Limit Rule and
the SOES Automated Quotation Update Feature for a six-month period.
Moreover, even if the Commission is unwilling to find positive
significance in the NASD's statistical analyses, at the very least,
these studies indicate that the market has not been harmed by
implementation of these rules.27 Indeed, the Commission
[[Page 1659]]
clearly stated in the Interim SOES Rules Extension Order that the SOES
Minimum Exposure Limit Rule and the SOES Automated Quotation Update
Feature have not had a detrimental effect on the Nasdaq market: ``the
Commission * * * continues to believe that the data submitted by the
NASD demonstrates * * * [no] serious deterioration in the quality of
the Nasdaq market subsequent to the adoption of the January 1994
amended SOES Rules.'' 28
\27\ Even if the Commission concludes that the SOES Minimum
Exposure Limit Rule and the SOES Automated Quotation Update Feature
have had no impact on market quality, the NASD believes the
Commission's approval of New York Stock Exchange (``NYSE'') Rule 80A
on a permanent basis illustrates that the Commission would still
have a sufficient basis to approve an extension of the rules for a
four-month period. In particular, the SEC's discussion of the
statutory basis for approval of NYSE Rule 80A focused in large part
on the fact that Rule 80A did not have any adverse impacts on market
quality on the NYSE and that, as a result, the NYSE should be given
the latitude to take reasonable steps to address excessive
volatility in its marketplace. See Securities Exchange Act Release
No. 29854 (October 24, 1994), 56 FR 55963 (October 30, 1994).
Accordingly, the NASD believes the SEC should afford the NASD the
same regulatory flexibility that it afforded the NYSE to implement
rules reasonably designed to enhance the quality of Nasdaq and
minimize the effects of potentially disruptive trading practices.
\28\ Interim SOES Rules Extension Order, supra note 2, 60 FR at
52439.
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The NASD believes that the proposed rule change is consistent with
Sections 15A(b)(6), 15A(b)(9), 15A(b)(11) and 11A(a)(1)(C) of the Act.
Among other things, Section 15A(b)(6) requires that the rules of a
national securities association be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system and in general to
protect investors and the public interest. Specifically, the NASD is
proposing to extend the effectiveness of the SOES Minimum Exposure
Limit Rule and the SOES Automated Quotation Update Feature for six
months because of concerns that concentrated, aggressive use of SOES by
a growing number of order entry firms has resulted in increased
volatility in quotations and transaction prices, wider spreads, and the
loss of liquidity for individual and institutional investor orders, all
to the detriment of public investors and the public interest. The NASD
believes the SOES Minimum Exposure Limit Rule and the SOES Automated
Quotation Update Feature have operated to rectify this situation while
continuing to provide an effective opportunity for the prompt, reliable
execution of small orders received from the investing public.
Accordingly, in order to protect investors and the public interest, the
NASD believes the SEC should approve an additional six-month extension
of the SOES Minimum Exposure Limit Rule and the SOES Automated
Quotation Update Feature through July 31, 1996, so that small
investors' orders will continue to receive the fair and efficient
executions that SOES was designed to provide.
Section 15A(b)(9) provides that the rules of the Association may
not impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act. The SOES Minimum Exposure Limit
Rule and the SOES Automated Quotation Update Feature apply across the
board and do not target any particular user or participant, as all
dealers may set their exposure limits at two times the tier size and
all dealers may elect to utilize the automated quote update feature.
Accordingly, the NASD believes that these rule changes are not anti-
competitive, as they are uniform in application and they seek to
preserve the ability of SOES to provide fair and efficient automated
executions for small investor orders, while preserving market maker
participation in SOES and market liquidity.
Section 15A(b)(11) empowers the NASD to adopt rules governing the
form and content of quotations relating to securities in the Nasdaq
market. Such rules must be designed to produce fair and informative
quotations, prevent fictitious and misleading quotations, and promote
orderly procedures for collecting and distributing quotations. The NASD
is seeking to continue the effectiveness of the SOES Minimum Exposure
Limit Rule and the SOES Automated Quotation Update Feature so that SOES
activity may not result in misleading quotations in the Nasdaq market.
Market makers place quotes in the Nasdaq system and these quotes
comprise the inside market and define the execution parameters of SOES.
When volatility in the SOES environment causes market makers to widen
spreads or to change quotes in anticipation of waves of SOES orders,
quotes in the Nasdaq market become more volatile and may be misleading
to the investing public. Accordingly, absent continuation of the SOES
Minimum Exposure Limit Rule and the SOES Automated Quotation Update
Feature, the quotations published by Nasdaq may not reflect the true
market in a security and, as a result, there may be short-term
volatility and loss of liquidity in Nasdaq securities, to the detriment
of the investing public. Further, the continuation of the automated
refresh feature will ensure that a market maker's quotation is updated
after an exposure limit is exhausted. Uninterrupted use of this
function will maintain continuous quotations in Nasdaq as market makers
exhausting their exposure limits in SOES will not be subject to a
``closed quote'' condition or an unexcused withdrawal from the market.
Finally, the NASD believes that the proposed rule change is
consistent with significant national market system objectives contained
in Section 11A(a)(1)(C) of the Act. This provision states it is in the
public interest and appropriate for the protection of investors and the
maintenance of fair and orderly markets to assure, among other things:
(i) Economically efficient execution of securities transactions; (ii)
fair competition among brokers and dealers; and (iii) the practicality
of brokers executing investor orders in the best market. Specifically,
the SOES Minimum Exposure Limit Rule and the SOES Automated Quotation
Update Feature advance each of these objectives by preserving the
operational efficiencies of SOES for the processing of small investors'
orders, by maintaining current levels of market maker participation
through reduced financial exposure from unpreferenced orders, and by
reducing price volatility and the widening of market makers' spreads in
response to the practices of order entry firms active in SOES.
In addition, for the same reasons provided by the SEC when it
approved the Interim SOES Rules that are cited above in the text
accompanying footnotes 6 through 13, the NASD believes that the
proposed rule change is consistent with Sections 15A(b)(6), 15A(b)(9),
15A(b)(11) and 11A(a)(1)(C) of the Act.
B. Self-Regulatory Organization's Statement on Burden on Competition
The NASD believes that the proposed rule change will not result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Comments were neither solicited nor received.
[[Page 1660]]
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the NASD consents, the Commission will:
A. by order approve such proposed rule change, or
B. institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to file number SR-NASD-95-60 and
should be submitted by January 26, 1996. The SOES Minimum Exposure
Limit Rule and the SOES Automated Quotation Update Feature expire after
January 31, 1996 and, therefore, the Commission requests that
interested parties comment by January 26, 1996, so as to allow the
Commission sufficient time to consider the views of interested persons
prior to the expiration of the rules.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.29
\29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-737 Filed 1-19-96; 8:45 am]
BILLING CODE 8010-01-P
