[Federal Register Volume 62, Number 17 (Monday, January 27, 1997)]
[Notices]
[Pages 3935-3936]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-1868]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38185; File No. SR-NASD-97-01]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Granting Accelerated Partial Temporary Approval of
Proposed Rule Change Relating to Entry of Certain SelectNet Orders
January 21, 1997.
I. Introduction
On January 8, 1997, the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association'') filed with the Securities and
Exchange Commission (``Commission'' or ``SEC'') pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule
19b-4 thereunder \2\ a proposed rule change to clarify members'
obligations regarding the use of the SelectNet Service as it will
operate under the Commission's new limit order display rule, Rule
11Ac1-4 (``Display Rule'') and amendments to Rule 11Ac1-(c)(5) (``ECN
Amendment''). The proposed rule change was published for comment in
Securities Exchange Act Release No. 38149 (January 10, 1996), 62 FR
1942 (January 14, 1997) (``Notice of Proposed Rule Change''). This
order temporarily approves the proposed rule change, in part, on an
accelerated basis.
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\1\ 15 U.S.C. 78s (b)(1).
\2\ 17 CFR 240.19b-4.
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II. Description of the Proposal
The NASD has proposed a new Conduct Rule to prohibit members from
cancelling or attempting to cancel a broadcast or preferenced order
entered into SelectNet until a minimum period of ten seconds has
elapsed, and to prohibit the entry of a preferenced order to electronic
communications networks that have conditions regarding responses to the
order.\3\
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\3\ Rule 3380 is proposed to read (a) Cancellation of a Select
Net Order: No member shall cancel or attempt to cancel an order,
whether preferenced to a specific market maker or electronic
communications network, or broadcast to all available members, until
a minimum time period of ten seconds has expired after the order to
be cancelled was entered. Such ten second time period shall be
measured by the Nasdaq processing system processing the SelectNet
order; (b) Prohibition Regarding The Entry of Conditional Orders: No
member shall enter an order into SelectNet that is preferenced to an
electronic communications network covered by Rule 4623 that has any
conditions regarding responses to the order, e.g., preferenced
SelectNet orders sent to an electronic communications networks shall
not be all or none, or subject to minimum execution size above a
normal unit of trading, or deemed non-negotiable.
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III. Discussion
In August 1996, the Commission adopted a new rule and amendments to
an existing rule that went into effect on January 20, 1997.\4\ Upon
commencement of the Order Execution Rules, over-the-counter (``OTC'')
market makers began representing certain customer limit orders in their
quotations in manner significantly different from previously. Moreover,
under an amendment to the Quote Rule, electronic communications
networks (``ECNs'') began entering quotations in the Nasdaq Stock
Market in a manner which heretofore was reserved for registered market
makers.\5\
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\4\ See Securities Exchange Act Release No. 37619A (September 6,
1996), 61 FR 48290 (September 12, 1996) adopting Rule 11Ac1-4
(``Limit Order Display Rule'') and amendments to Rule 11Ac1-1
(``Quote Rule'') (collectively the ``Order Execution Rules''). See
also Securities Exchange Act Release Nos. 38110 (January 2, 1997),
62 FR 1279 (January 9, 1997) (revising the effective date of the
Order Execution Rules to January 13, 1997); and 38139 (January 8,
1997) (revising the effective of the Order Execution Rules until
January 20, 1997).
\5\ Rule 11Ac1-1(c)(5) requires a market maker to display in its
quote any better priced order the market maker places into an
electronic communications network (``ECN Amendment'').
Alternatively, the ECN Amendment provides an exception to the market
maker's display obligation that depends upon the ECN itself
displaying into the consolidated system the best-priced orders
entered therein by a market maker or specialist, and allowing
brokers and dealers to access such orders (``ECN Display
Alternative'').
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To facilitate the ECN Display Alternative envisioned by the Order
Execution Rules, Nasdaq has established linkages with four ECNs,\6\
which provide these ECNs a means to display their best market makers'
and specialists' quotes and certain customer quotes in the Nasdaq
system.\7\ A critical portion of Nasdaq's linkage mechanism involves
Nasdaq's SelectNet Service (``SelectNet''). The SelectNet linkage
allows NASD members that are not subscribers to a particular ECN to
access the ECN's orders that are being displayed in the Nasdaq quote
montage via a preferenced order in SelectNet directed to a particular
ECN at its displayed price.\8\
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\6\ The four ECNs are B-Trade; Instinet; Island; and Terra Nova.
\7\ ECNs must provide the best prices and sizes that market
makers and specialists have entered in the ECN to the public
quotation system for inclusion in the consolidated quotation. See
Order Execution Rules Adopting Release at 121.
\8\ See Order Execution Rules Adopting Release at 121, noting
that the ability of nonsubscribers to access market makers' and
specialists' orders entered into an ECN is a fundamental requirement
of the ECN Display Alternative.
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Each ECN is required, pursuant to an Agreement signed with Nasdaq
and conditions of letters from Commission staff recognizing the ECN as
a Display Alternative, to have an automated system designed to respond
to a preferenced order received via SelectNet within a few seconds.
Consequently, the ECN has only seconds to accept a preferenced order,
send the Nasdaq processor an acknowledgement that the order has been
accepted, and notify its customer of the order's execution. Although an
ECN, upon accepting a preferenced order, notifies its customer of an
execution obtained via SelectNet, the execution does not actually occur
when the ECN accepts the order but rather when the Nasdaq system
processor receives the ECN acknowledgement that it has accepted the
order. During the time the Nasdaq
[[Page 3936]]
processor is awaiting the ECN's acknowledgement, Nasdaq could presently
receive a cancellation message from the broker-dealer that sent the
preferenced order to the ECN. This will result in the Nasdaq processor
accepting a cancellation message that was first in time and rejecting
the ECN's acknowledgment message. Consequently, the ECN would be
exposed to executions to its counterpart when the SelectNet order is
cancelled.
The Commission believes that it is important for the operation of
the SelectNet linkage with ECNs and the ECN Display Alternative that
ECNs have a reasonable opportunity to respond to orders preferenced
through SelectNet before the orders are cancelled. Because of the
structure of the linkage as currently designed, ECNs are potentially
exposed to internal customer executions when a cancellation of a
SelectNet order occurs. The Commission notes that, on the first day of
the Order Execution Rules, there were instances where ECNs experienced
delays due to the acceptance of SelectNet preferenced orders that were
immediately cancelled. Moreover, the cancellation of SelectNet orders
immediately after entry creates significant additional message traffic
that can potentially slow the linkage. With respect to SelectNet orders
not using the ECN linkage, the Commission also notes that SelectNet
orders preferenced to a particular market maker as a practical matter
need to be accessible for a minimal length of time in order for
responses to be generated by that market maker. Otherwise, if the order
may be in the process of being cancelled, market makers will have less
incentive to attempt to accept SelectNet orders directed to them. The
Commission believes it is important that ECNs, as well as market
makers, have a reasonable basis to conclude that when they accept a
preferenced order it will not be cancelled during the transmission of
their response. Therefore, the Commission is approving the proposal for
preferenced SelectNet orders on a temporary basis, until July 1, 1997,
to evaluate the effects of the proposal on ECNs, market makers, and
order entry firms.
In addition to preferenced orders, orders that are sent to ECNs
with conditions imposed also create response difficulties on the part
of ECNs.\9\ Therefore, Nasdaq has proposed to prohibit members from
entering conditional orders into SelectNet when the orders are
preferenced to an ECN.\10\ The Commission recognizes that conditional
preferenced orders involve difficult programming issues in electronic
trading systems. As a result, the ECNs have been unable to modify their
systems in preparation for the SelectNet linkage to accept conditional
orders via SelectNet. Nonetheless, conditional orders are being routed
to ECNs through the linkage, and these orders are subsequently being
rejected, causing confusion and unnecessary message traffic. The
Commission believes that prohibiting members from preferencing
conditional orders to ECNs will eliminate impediments to the operation
of the linkage with ECNs. Accordingly, the Commission is temporarily
approving proposed Rule 3380(b) until July 1, 1997, to reduce the
immediate impact of these orders to the linkage and allow the
Commission to better evaluate the impact of the proposal before
considering the rule change on a permanent basis.
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\9\ The Commission recently approved an NASD Rule change to
prohibit the entry of all-or-none orders in the Small Order
Execution System. See Securities Exchange Act Release No. 38156.
\10\ For example, an all or none order, an order subject to a
minimum execution size above a normal unit or trading, or an order
deemed non-negotiable.
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For the foregoing reasons, the Commission finds that the proposed
rule change is consistent with the Act and the rules and regulations
thereunder applicable to the NASD, and in particular Sections
15A(b)(6), 15A(b)(9), and 15A(b)(11). In addition, the Commission finds
that the rule change is consistent with the Congressional objectives
for the National Market System, set out in Section 11A of the Exchange
Act, of achieving more efficient and effective market operations, fair
competition among brokers and dealers, and the economically efficient
execution of investor orders in the best market. The Commission further
believes that allowing preferenced orders to be entered into SelectNet
and immediately cancelled impedes the operation of the Order Execution
Rules, specifically the ECN Display Alternative. Accordingly, the
Commission finds good cause for approving the proposed rule change, in
part, on a temporary basis until July 1, 1997, prior to the thirtieth
day after date of publication of notice of filing thereof in the
Federal Register.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\11\ that the proposed rule change (NASD-97-01) be and hereby is
approved on a temporary basis, in part, effective January 21, 1997,
until July 1, 1997.
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\11\ 15 U.S.C. 78s(b)(2)( 1998).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\12\
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\12\ 17 CFR 200.30-3(a)(12) (1996).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-1868 Filed 1-24-97; 8:45 am]
BILLING CODE 8010-01-M
