[Federal Register Volume 63, Number 4 (Wednesday, January 7, 1998)]
[Notices]
[Pages 897-899]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-290]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 39490, File No. SR-NASD-97-50]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Approving Proposed Rule Change By the NASD To
Extend From 15 Seconds to 17 Seconds the Amount of Time a Market Maker
Has To Update Its Quote After an Order Execution in SOES Before Being
Required To Execute a Subsequent Order
December 24, 1997.
On July 14, 1997, the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association''), filed with the Securities and
Exchange Commission (``Commission'' or ``SEC'') 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 proposal
amends NASD Rule 4730(b)(1) to indicate that once the Nasdaq Stock
Market, Inc.'s (``Nasdaq'') Small Order Execution System (``SOES'')
executes an unpreferenced market order or a marketable limit order
against a SOES market maker, that market maker is not required to
execute another unpreferenced SOES order at the same bid or offer in
the same security until 17 seconds have elapsed, absent a quotation
update by the market maker within such 17-second period. On July 24,
1997, notice of the proposed rule change, including the substance of
the proposal, was published for comment in the Federal Register.\3\ The
Commission received 64 comment letters, which are discussed below. The
Commission is hereby approving the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 38849 (July 17, 1997) 62
FR 39883 (July 24, 1997).
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I. Description
The proposed rule change specifies the obligations of SOES market
makers during non-locked and non-crossed market situations. As amended,
NASD Rule 4730(b)(1) would provide that once SOES executes an
unpreferenced market order or a marketable limit order against a SOES
market maker, that market maker is not required to execute another
unpreferenced SOES order at the same bid or offer in the same security
until 17 seconds have elapsed, absent a quotation update by the market
maker within that 17-second period.
Currently, NASD Rule 4730(b)(1) provides that:
Market Makers shall have a period of time following their
receipt of an execution report in which to update their quotation in
the security in question before being required to execute another
unpreferenced order at the same bid or offer in the same security.
This period of time shall initially be established as 15 seconds,
but may be modified upon appropriate notification to SOES
participants.
This language was originally added to the NASD's rules in October
1991 to give a SOES market maker a brief opportunity to update its
quotations in response to executions it received through SOES (``15-
Second SOES Execution Response Period''). As the current language of
NASD Rule 4730(b) reflects, the ``15-Second SOES Execution Response
Period'' commences when a market maker has received notification of a
SOES execution through the system.\4\ Because SOES does not have the
capability to determine the exact time when a market maker receives a
SOES execution report, at the time this rule was implemented Nasdaq
estimated that it took up to five seconds for SOES to execute an order
against a market maker and for the market maker to receive a report of
the execution (the ``SOES Execution Report Communication Period''). As
a result, SOES was programmed to add uniformly a five-second period to
the ``15-Second SOES Execution Response Period,'' with the effect that
the system executes unpreferenced market orders against a market maker
in twenty-second intervals, absent a quotation update by the market
maker.
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\4\ See Exchange Act Release No. 29810 (October 10, 1991) 56 FR
52098, 52099 (October 17, 1991) (order approving file no. SR-NASD-
91-18) (``[f]ollowing receipt of an execution report of an
unpreferenced purchase or sale through SOES, a market maker will
have a period of time (15 seconds) to update its quote prior to
executing any subsequent transaction on the same side of the market
at the same price.'' [Footnote omitted].).
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Nasdaq now estimates that on average, the SOES Execution Report
Communication Period is between two and three seconds, although the
actual time may vary depending on activity and communications traffic
during different periods of the day. Based on this data, the NASD
determined that it was appropriate to assign a two-second period to the
SOES Execution Report Communications Period for purposes of the rule.
The NASD proposes to incorporate explicitly this two-second period
into NASD Rule 4730. The proposed rule change is designed to retain the
ability of a market maker to respond to SOES executions while
recognizing that,
[[Page 898]]
under normal circumstnaces, a minimal period of time is necessary for
reports of those executions to be received by the market maker. The
proposed amendments to NASD Rule 4730(b) also would clarify that:
(1) A market maker becomes immediately eligible to receive
another execution through SOES if it updates its quote (its bid,
offer, or size) during the 17-second period,\5\ and
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\5\ The proposed amendments to NASD Rule 4730(b) do not change
in any way the current functionality of SOES whereby preferenced
orders are continuously executed against a market maker without any
delay between executions. In addition, as is presently the case
during locked and crossed markets, SOES will execute orders (both
preferenced and unpreferenced against a market maker that is locked
or crossed in five second intervals. See NASD Rule 4730(b)(3).
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(2) The 17-second period arises regardless of whether the market
maker executes an unpreferenced market order or an unpreferenced
marketable limit order.
This rule change is intended to eliminate ambiguities in Nasdaq's
implementation of this rule and among market participants concerning
the manner in which unpreferenced orders are executed in SOES.
II. Summary of Comments
The Commission received 64 comment letters from the public. Of
these, 58 letters concerned other NASD filings, and thus were
irrelevant and one comment letter was submitted twice. Of the five
remaining comment letters, three were in favor of the proposed rule
change and two were against it. None of these comment letters contained
any reason for the positions taken.
III. Discussion
The Commission finds the proposed rule change, by helping to ensure
that market makers stand willing to buy and sell securities at all
times, is consistent with the Exchange Act and in particular with
Sections 15A(b)(6), 15A(b)(9), 15A(b)(11) and 11A(a)(1)(C) of the
Exchange 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, and processing
information with respect to, and facilitating transactions in
securities. Section 15A(b)(6) also requires that the rules of a
national securities association be designed 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. 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 Exchange Act. Section 15A(b)(11)
requires the NASD, as an association, 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, distributing, and publishing quotations.
Section 11A(a)(1)(C) provides that, among other things, it is in the
public interest to assure the economically efficient execution of
securities transactions and the availability to brokers, dealers, and
investors of information with respect to quotations for and
transactions in securities.
The Commission believes that the proposed amendments will help to
ensure that a market maker has no more time than necessary after
execution--i.e., 17 seconds--before it must update its quotes. This
requirement will help ensure that a market maker cannot attempt to
avoid its market making obligations by waiting a lengthy period of time
after a SOES execution before entering an updated quote.\6\ As a
result, the proposed rule change should increase a market maker's
compliance with its obligation to make continuous, two-sided markets
and promote quote competition among market makers. Such competition
among market makers should, in turn, enhance the integrity of the
Nasdaq market by helping to ensure the best execution of customer
orders and improving the price discovery process for Nasdaq securities.
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\6\ A market maker that can avoid updating its quote for a
period of time can take advantage of its temporary ability to avoid
SOES executions and wait to see how other market makers update their
quotes. This delay could serve to lessen competition among market
makers.
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The Commission also notes that the NASD filed the proposed rule
change in response to concerns about the rule the Commission raised in
its Report Pursuant to Section 21(a) of the Securities Exchange Act of
1934 Regarding the NASD and the Nasdaq Market (``SEC Report''). In
relevant part, the SEC Report notes that the
October 1991 SOES rule amendments as filed with the Commission also
allowed for the modification of the SOES operating software to
provide for a fifteen-second delay between executions by a
particular market maker. The purpose of this delay was to give the
SOES market maker an opportunity to update its quotations after
receiving a report of a trade executed through SOES. In fact, the
NASD implemented an effective delay of twenty seconds, which reduced
the ability of SOES users to obtain executions.\7\ The purported
rationale for the additional five-second delay was to allow for the
time taken for the electronic transmission of execution reports and
quote updates. According to internal NASD studies, however, any
delays in transmission occurred only at the opening of busy trading
days and the vast majority of any such delays were no more than two
to three seconds in length. The NASD should have set forth in its
filings with the Commission seeking approval for the delay that the
time between executions had been set at twenty seconds, but did not
do so. The existence of the additional five second delay was
discovered by the Commission staff during the investigation [that
led to the issuance of the SEC Report].\8\
\7\ The Release by the Commission approving the proposed rule
changes explicitly noted that the delay function was set at fifteen
seconds and stated that ``[a]ny change in the time period must be
submitted to the Commission for review pursuant to Section 19(b) of
the [Exchange] Act.'' Exchange Act Release No. 29810 (October 10,
1991) 56 FR 52098 (October 17, 1991) n.10. The NASD had never made
any such submission. (This footnote conforms to footnote 160 in the
Appendix to the SEC Report.)
\8\ Appendix to SEC Report at A-62-63.
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The proposed rule change addresses the concerns of the SEC Report
by clearly establishing the time delay between SOES executions against
a market maker. Moreover, the delay includes, in addition to the
previously established 15-second period, only the time measured by the
NASD for electronic transmission of an execution report.
Thus, the proposal to change NASD Rule 4730 is consistent with the
Exchange Act and in particular with the following sections of that Act:
(1) Section 15A(b)(6), because it is designed to prevent a
market maker from failing to meet its obligation to make a
continuous, two-sided market;
(2) Section 11A(a)(1)(C)(i)-(iii), because it assures:
economically efficient execution of securities transactions; fair
competition among brokers and dealers by encouraging timely, fair,
and accurate quotations; and the availability to brokers, dealers,
and investors of timely information concerning these fair and
accurate quotations.
Further, the proposed change to NASD Rule 4370 is consistent with
Section 15A(b)(9) of the Exchange Act, because it does not impose any
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act, but merely alters, slightly, a timing
requirement for market makers.
Finally, the Commission believes that the proposal is consistent
with Exchange Act Section 15A(b)(11). In particular, by helping to
ensure that
[[Page 899]]
SOES market makers update their quotes promptly after executions, the
proposal should help to produce fair and informative quotations and
prevent fictitious and misleading quotations.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act, that the proposed rule change (SR-NASD-97-50) be, and
hereby is, approved.\9\
\9\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. The proposed rule change likely will enhance
the efficiency and fairness of the process by which market makers
update their quotes. It likely also will enhance the ability of
investors to obtain updated market maker quotes quickly, thus
increasing Nasdaq's transparency. The net effect of approving the
proposed rule change will be positive. 15 U.S.C. 78c(f).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\10\
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\10\ 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-290 Filed 1-6-98; 8:45 am]
BILLING CODE 8010-01-M
