[Federal Register Volume 62, Number 16 (Friday, January 24, 1997)]
[Notices]
[Pages 3725-3727]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-1681]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38180; File No. SR-NASD-96-50]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Granting Accelerated Temporary Approval and Notice
of Filing and Accelerated Approval of Amendment No. 1 of Proposed Rule
Change Relating to Amendments to the NASD's Excess Spread Rule
Applicable to Market Maker Quotations Through July 1, 1997
January 16, 1997.
I. Introduction
On December 16, 1996, the National Association of Securities
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities
and Exchange Commission (``SEC'' or ``Commission'') a proposed rule
change pursuant to Section 19(b)(1) of the Securities Exchange Act of
1934 (``Exchange Act'') \1\ and Rule 19b-4 thereunder.\2\ The NASD
proposed to amend NASD Rule 4613(d) on a pilot basis through January
31, 1998, to provide that a registered market maker in a security
listed on The Nasdaq Stock Market (``Nasdaq'') shall be precluded from
being a registered market maker in that issue for twenty business days
if its average spread in the security over the course of any full
calendar month exceeds 150 percent of the average of all dealer spreads
in such issue for the month.\3\
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\1\ 15 U.S.C. Sec. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ The NASD requested accelerated approval of its proposed rule
change.
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Notice of the proposed rule change was published in the Federal
Register.\4\ No comments have been received in response to the
Commission release.
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\4\ Securities Exchange Act Release No. 38089 (December 27,
1996), 62 FR 436 (January 3, 1997).
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Subsequent to publication of the NASD filing, on January 9, 1997,
the NASD filed with the Commission Amendment No. 1, which proposes to
shorten the length of the pilot period from January 31, 1998, to July
1, 1997.\5\ This order approves the proposed rule change, including
Amendment No. 1, on an accelerated basis.
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\5\ See Letter from Robert E. Aber, Vice President and General
Counsel, Nasdaq, to David Oestreicher, Esq., Division of Market
Regulation, SEC, dated January 8, 1997. A copy of this amendment is
available for inspection and copying in the Commission's Public
Reference Room.
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II. Description
NASD Rule 4613(d), which is commonly known as the NASD's ``excess
spread rule,'' presently provides that registered market makers in
Nasdaq securities shall not enter quotations that exceed the NASD's
parameter for maximum allowable spreads. Specifically, the rule
provides that the maximum allowable spread for any Nasdaq security is
125 percent of the average of the three narrowest market maker spreads
in that issue (``125 percent test''), provided, however, that the
maximum allowable spread shall never be less than \1/4\ of a point.\6\
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\6\ Unrelated to the excess spread rule, there is also a dealer
spread test that is part of the NASD's Primary Market Maker
(``PMM'') standards that are used to determine the eligibility of
market makers for an exemption from the NASD's short sale rule for
short sales effected during the course of bona fide market making
activity. Specifically, the market maker spread component of the PMM
standards provides that a market maker must maintain a spread no
greater than 102 percent of the average dealer spread. The NASD
recently filed a proposed rule change related to the PMM standards.
See Securities Exchange Act Release No. 38091 (December 27, 1996),
62 FR 778 (January 6, 1997).
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In its filing with the Commission, the NASD stated that the
proposed rule change is an attempt to strike a reasonable balance
between the need to eliminate any disincentive that the excess spread
rule places on firms to improve their quotations and the need to avoid
fostering a market environment where registered market makers can
maintain inordinately wide spreads and still receive the benefits of
market maker status. Under the amendment, a registered market maker
will be required to maintain an average spread over the course of any
full calendar month equal to or less than 150 percent of the average
spread of all market makers in the issue over the course of the month
(``150 percent test''). If a market maker fails to satisfy this
standard with respect to a particular Nasdaq security, it will be
forced to withdraw from market making in that issue for at least 20
business days.
Amended Rule 4613(d) will afford market makers that opportunity to
request reconsideration of their withdrawal notices. Requests for
reconsideration will be reviewed by the Market Operations Review
Committee, whose decisions will be final and
[[Page 3726]]
binding on the members. The grounds for reconsideration will be limited
to claims that Nasdaq's calculation of the market maker's average
spread for the month was in error.
This rule change will be operational for a pilot period beginning
on January 20, 1997, and ending at the close of business on July 1,
1997.
III. Discussion
In its filing, the NASD stated that the excess spread rule was
originally designed to enhance the quality of the Nasdaq market by
preventing firms from holding themselves out as market makers without
having a meaningful quote in the system. Despite the regulatory
objectives underlying the excess spread rule, however, many market
participants believe the rule has produced a variety of unintended
consequences that have undermined the quality of Nasdaq quotations.\7\
Indeed, the Commission during its investigation of the NASD found that
the NASD's excess spread rule had undesirable effects.\8\ In
particular, the rule created disincentives for any given market maker
to narrow its spread because to do so would reduce the maximum
allowable spreads for all market makers. The Commission concluded that
the rule interferes with the free flow of prices in the market and
impedes attempts by the market to reach the optimal competitive
spread.\9\ The Commission also noted that the rule may create
incentives for market makers to collaborate or harass each other to
dissuade a market maker from changing its quote if such a change would
narrow one of the three smallest spreads in the stock.\10\ As part of
its settlement with the Commission, the NASD agreed to modify the
excess spread rule to eliminate its undesirable effects, or to
eliminate the rule in its entirely, within one year of the Commission's
Order.\11\
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\7\ Some market participants claim that one such consequence is
an increase in locked and crossed markets during periods of market
turbulence because of the constraints on quote movements created by
the rule.
\8\ See Report Pursuant to Section 21(a) of the Securities
Exchange Act of 1934 Regarding the NASD, the Nasdaq Market, and
Nasdaq Market Makers, Securities Exchange Act Release No. 37542
(August 8, 1996) (``21(a) Report''), and Appendix thereto.
\9\ Id.
\10\ Id.
\11\ Order Instituting Public Proceedings Pursuant to Section
19(h)(1) of the Securities Exchange Act of 1934, Making Findings and
Imposing Remedial Sanctions, Securities Exchange Act Release No.
37538 (August 8, 1996) (``Order'').
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The NASD submitted its proposal to amend the current excess spread
rule as an initial step to comply with the Commission's Order. The NASD
also believes that the proposed rule change is necessary in light of
changes to the Nasdaq market that will be brought about by
implementation of the SEC's new limit order display on January 20,
1997.\12\ In particular, because spreads in Nasdaq securities likely
will narrow due to the display of customer limit orders, the average of
the three narrowest market maker spreads also will narrow. As a result,
the Commission's concerns with the current excess spreads rule will be
exacerbated; application of the current rule under these circumstances
may increase the incentive for market maker collaboration. Application
of the current excess spread rule after the effective date of the order
Execution Rules could have other consequences. For example, the current
rule may lead market makers to decide not to accept customer limit
orders or only accept those limit orders priced at the inside bid or
offer so as not to narrow the maximum allowable spread parameters.
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\12\ SEC Rule 11Acl-4 requires the display of customer limit
orders that are placed better than a market maker's quote or that
add to the size associated with a market maker's quote when the
market maker is at the best price in the market. See Securities
Exchange Act Release No. 37619A (September 6, 1996), 61 FR 48290
(September 12, 1996) (``Order Execution Rules Adopting Release'').
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The NASD has tried to reduce the anticompetitive effects of the
excess spread rule by broadening the calculations used to determine the
maximum allowable spread. The NASD recognizes that its proposal is only
an interim step. Consequently, the NASD has proposed that the rule
operate on a temporary basis while it studies the effects of the rule
and examines other alternatives.
The Commission has determined to approve the proposed rule change
on a pilot basis through July 1, 1997. The amended rule may reduce, to
some degree, the Commission's concerns regarding the current excess
spread rule. For example, the new spread parameters are based on the
average of all market makers in an issue, rather than only the three
market makers quoting the narrowest spreads. Moreover, this average
will be based on a full calendar month. Further, the NASD has increased
the current 125 percent test to a 150 percent test. These changes limit
the effect that one market maker's quote change will have on the
obligations of other market makers, and thereby will limit the
incentives toward improper behavior or harassment.
Although the amended excess spread rule may reduce some of the
anticompetitive concerns outlined in the 21(a) Report, the Commission
believes that the amendment approved today may not completely satisfy
the NASD's obligations under the Commission's Order with regard to the
excess spread rule. Specifically, it may not remove completely the
anticompetitive incentives for market makers to refrain from narrowing
quotes because the market makers' quotation obligation continues to be
dependent to some extent upon quotations of other market makers in the
stock. Nonetheless, the Commission recognizes that the NASD needs to
amend its excess spread rule quickly in light of the implementation of
the Commission's Order Execution Rules. Although the proposal does not
present a permanent solution, it is preferable to the current rule. As
a result, the Commission has approved the amendment on a pilot basis
only through July 1, 1997.\13\ During this time period, the NASD should
monitor the effects of the pilot, as well as study alternative methods
that would enhance market making performance while completely
fulfilling the NASD's obligation regarding the excess spread rule
before the August 8, 1997 deadline contained in the Commission's
Order.\14\
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\13\ In the Securities Acts Amendments of 1975, Congress
directed the Commission to use its authority under the Exchange Act,
including its authority to approve self-regulatory organization
(``SRO'') rule changes, to foster the establishment of a national
market system and promote the goals of fair competition and best
execution. See S. Rep. No. 75, 94th Cong., 1st Sess. (1975)
(``Senate Report''). Congress granted the Commission broad
discretionary authority and maximum flexibility to carry out the
objectives outlined in the 1975 Amendments. Id.
\14\ The Commission notes that one possible approach is to
delete entirely the excess spread methodology and instead develop
alternative measures to ensure adequate market maker performance.
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Accordingly, the Commission finds that the rule change is
consistent with the Exchange Act and the rules thereunder applicable to
the NASD and, in particular, Sections 15A(b)(6), 15A(b)(9), and
15A(b)(11). The Commission finds good cause for approving the proposed
rule change and Amendment No. 1 prior to the 30th day after the date of
publication of notice of filing thereof in the Federal Register. The
Commission believes that accelerated approval of the NASD's proposal is
appropriate given the fact that the Order Execution Rules become
effective on January 20, 1997. These rules will likely result in a more
order driven environment in which market makers' quotes frequently
reflect customer limit orders. This could make compliance with the
current excess spread rule difficult and thus exacerbate the concerns
outlined by the Commission in its 21(a) Report
[[Page 3727]]
regarding the current excess spread rule's effect on price competition
in the Nasdaq market.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 1 to the proposed rule change.
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 Amendment No. 1 that
are filed with the Commission, and all written communications relating
to Amendment No. 1 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-96-50 and should be submitted by February 14, 1997.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act, that the proposed rule change SR-NASD-96-50 be, and
hereby is, approved effective January 20, 1997 through July 1, 1997.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
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\15\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 97-1681 Filed 1-23-97; 8:45 am]
BILLING CODE 8010-01-M
