[Federal Register Volume 64, Number 202 (Wednesday, October 20, 1999)]
[Notices]
[Pages 56554-56560]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-27308]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-42003; File No. SR-NASD-99-57]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change and Amendment No.
1 by National Association of Securities Dealers, Inc. Relating to the
Extension of Certain Nasdaq Services and Facilities Until 6:30 p.m.
Eastern Time
October 13, 1999.
Pursuant to Section 19(b)(1) of the Securities Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on October 5, 1999, the National Association of Securities Dealers,
Inc. (``NASD''), through its wholly-owned subsidiary, The Nasdaq Stock
Market, Inc. (``Nasdaq'') filed with the Securities and Exchange
Commission (``SEC'' or ``Commission'') the proposed rule change as
described in Items I and II below, which Items have been prepared by
Nasdaq. On October 13, 1999, Nasdaq submitted Amendment No. 1 to the
proposed rule change.\3\ The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
For the reasons discussed below, the Commission is granting accelerated
approval of the proposed rule change and Amendment No. 1 on a pilot
basis through March 1, 2000.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Letter to Belinda Blaine, Associate Director, Division of
Market Regulation (``Division''), Commission, from Thomas P. Moran,
Assistant General Counsel, Nasdaq, dated October 12, 1999
(``Amendment No. 1''). In Amendment No. 1, Nasdaq proposes to amend
the initial filing to request that the Commission approve its
proposed extended hours trading session on a pilot basis beginning
on October 25, 1999, through March 1, 2000. Nasdaq also explains in
Amendment No. 1 how certain concerns regarding calculation of a 4
p.m. closing price will be addressed and how the Manning Rule will
apply.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
Pursuant to the provisions of Section 19(b)(1) under the Act,\4\
Nasdaq is filing a proposed rule change to establish a pilot program
extending the availability of several Nasdaq services and facilities
until 6:30 p.m. Eastern Time. In addition, Nasdaq is proposing to
extend the applicability of NASD Interpretive Material 2110-2 (the
``Manning Rule'') until 6:30 p.m. Eastern Time. Below is the text of
the proposed rule change.
[[Page 56555]]
Proposed new language is italicized; proposed deletions are in
brackets.
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\4\ 15 U.S.C. 78s(b)(1).
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* * * * *
IM-2110-2. Trading Ahead of Customer Limit Order
(a) General Application \5\
To continue to ensure investor protection and enhance market
quality, the Association's Board of Governors is issuing an
interpretation to the Rules of the Association dealing with member
firms' treatment of their customer limit orders in Nasdaq securities.
This interpretation, which is applicable from 9:30 a.m. to 6:30 p.m.
Eastern Time, will require members acting as market makers to handle
their customer limit orders with all due care so that market makers do
not ``trade ahead'' of those limit orders. Thus, members acting as
market makers that handle customer limit orders, whether received from
their own customers or from another member, are prohibited from trading
at prices equal or superior to that of the limit order without
executing the limit order. [,provided that, prior to September 1, 1995,
this prohibition shall not apply to customer limit orders that a member
firm receives from another member firm and that are greater than 1,000
shares.] Such orders shall be protected from executions at prices that
are superior but not equal to that of the limit order. In the interests
of investor protection, the Association is eliminating the so-called
disclosure ``safe harbor'' previously established for members that
fully disclosed to their customers the practice of trading ahead of a
customer limit order by a market-making firm.1
\5\ On September 9, 1999, the NASD filed a proposed rule
change (SR-NASD-99-44), which became effective upon filing pursuant
to Section 19(b)(3)(A) of the Act and Rule 19b-4(f)(1) thereunder,
modifying IM-2110-2 (exclusion of limit orders marketable at the
time of receipt). A non-substantive amendment was filed on September
24, 1999. This filing incorporates the amendments filed in SR-NASD-
99-44.
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1 ``For purposes of the pilot program expanding the
operation of certain Nasdaq transaction and quotation reporting
systems and facilities in SR-NASD-99-57 during the period from 4
p.m. to 6:30 p.m. Eastern Time, members may generally limit the life
of a customer limit order to the period of 9:30 a.m. to 4 p.m.
Eastern Time. If a customer does not formally assent (``opt-in'') to
processing of their limit order(s) during the extended hours period
commencing after the normal close of the Nasdaq market, limit order
protection will not apply to that customer's order(s).''
* * * * *
(b) Exclusion for Limit Orders That Are Marketable at Time of Receipt
No Change.
4617. Normal Business Hours
A Nasdaq market marker shall be open for business as of 9:30 a.m.
Eastern Time and shall close no earlier than 4 p.m. Eastern Time.
Should a market maker wish to voluntarily remain open for business
later than 4 p.m. Eastern Time, it shall so notify the Nasdaq Market
Operations via a Nasdaq terminal and shall close only on the hour or
the half hour, but no later than 6:30 p.m. Eastern Time. Nasdaq market
makers whose quotes are open after 4 p.m. Eastern Time shall be
obligated to comply, while their quotes are open, with all NASD Rules
that are not by their express terms, or by an official interpretation
of the Association, inapplicable to any part of the 4 p.m. to 6:30 p.m.
Eastern Time period.
4630. Reporting Transactions in Nasdaq National Market Securities
4632. Transaction Reporting
(a) When and How Transactions Are Reported
(1)-(3) No Change.
(4) Transaction Reporting Outside Normal Market Hours. (A) Last
sale reports of transactions in designated securities executed between
8 a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT
within 90 seconds after execution and shall be designated as ``.T''
trades to denote their execution outside normal market hours.
Additionally, last sale reports of transactions in designated
securities executed between the hours of 4 p.m. and [5:15] 6:30 p.m.
Eastern Time shall be transmitted through ACT within 90 seconds after
execution; trades executed and reported after 4 p.m. Eastern Time shall
be designated as ``.T'' trades to denote their execution outside normal
market hours. Transactions not reported within 90 seconds must include
the time of execution on the trade report.
(B) Last sale reports of transactions in designated securities
executed outside the hours of 8 a.m. and [5:15] 6:30 p.m. Eastern Time
shall be reported as follows:
(i) No Change.
(ii) Last sale reports of transactions executed between [5:15] 6:30
p.m. and midnight Eastern Time shall be transmitted through ACT on the
next business day (T+1) between 8 a.m. and [5:15] 6:30 p.m. Eastern
Time, be designated ``as/of'' trades to denote their execution on a
prior day, and be accompanied by the time of execution. The party
responsible for reporting on T+1, the trade details to be reported, and
the applicable procedures shall be governed, respectively, by
paragraphs (b), (c), and (d) below.
(5)-(8) No Change.
4640. Reporting Transactions in Nasdaq Small Cap--Market Securities
4642. Transaction Reporting
(a) When and How Transactions Are Reported
(1)-(3) No Change.
(4)(A) Last sale reports of transactions in designated securities
executed between 8 a.m. and 9:30 a.m. Eastern Time shall be transmitted
through ACT within 90 seconds after execution and shall be designated
as ``.T'' trades to denote their execution outside normal market hours.
Additionally, last sale reports of transactions in designated
securities executed between the hours of 4 p.m. and [5:15] 6:30 p.m.
Eastern Time shall be transmitted through ACT within 90 seconds after
execution; trades executed and reported after 4 p.m. Eastern Time shall
be designated as ``.T'' trades to denote their execution outside normal
market hours. Transactions not reported within 90 seconds must include
the time of execution on the trade report.
(B) Last sale reports of transactions executed outside the hours of
8 a.m. and [5:15] 6:30 p.m. Eastern Time shall be reported as follows:
(i) No Change.
(ii) Last sale reports of transactions executed between [5:15] 6:30
p.m. and midnight Eastern Time shall be transmitted through ACT on the
next business day (T+1) between 8 a.m. and [5:15] 6:30 p.m. Eastern
Time, be designated ``as/of'' trades to denote their execution on a
prior day, and be accompanied by the time of execution. The party
responsible for reporting on T+1, the trade details to be reported, and
the applicable procedures shall be governed, respectively, by
paragraphs (b), (c), and (d) below.
(5)-(8) No Change.
4650. Reporting Transactions in Nasdaq Convertible Debt Securities
4652. Transaction Reporting
(a) When and How Transactions Are Reported
(1)-(3) No Change.
(4) Transactions Reporting Outside Normal Market Hours. (A) Last
sale reports of transactions in designated securities executed between
8 a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT
within 90 seconds after execution and shall be designated as ``.T''
trades to denote their
[[Page 56556]]
execution outside normal market hours. Additionally, last sale reports
of transactions in designated securities executed between the hours of
4 p.m. and [5:15] 6:30 p.m. Eastern Time shall be transmitted through
the ACT system within 90 seconds after execution; trades reported after
4 p.m. Eastern Time shall be designated as ``.T'' trades to denote
their execution outside normal market hours. Transactions not reported
within 90 seconds must include the time of execution on the trade
report.
(B) Last sale reports of transactions in designated securities
executed outside the hours of 8 a.m. and [5:15] 6:30 p.m. Eastern Time
shall be reported as follows:
(i) No Change.
(ii) Last sale reports of transactions executed between [5:15] 6:30
p.m. and midnight Eastern Time shall be transmitted through ACT on the
next business day (T+1) between 8 a.m. and [5:15] 6:30 p.m. Eastern
Time, be designated ``as/of'' trades to denote their execution on a
prior day, and be accompanied by the time of execution. The party
responsible for reporting on T+1, the trade details to be reported, and
the applicable procedures shall be governed, respectively, by
paragraphs (b), (c), and (d) below.
(5)-(7) No Change.
6600. Reporting Transactions in Over-the-Counter Equity Securities
6620. Transaction Reporting
(a) When and How Transactions Are Reported
(1)-(2) No Change.
(3) Transaction Reporting Outside Normal Market Hours. (A) Last
sale reports of transactions in OTC Equity Securities executed between
8 a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT
within 90 seconds after execution and shall be designated as ``.T''
trades to denote their execution outside normal market hours. Last sale
reports of transactions in OTC Equity Securities executed between the
hours of 4 p.m. and [5:15] 6:30 p.m. Eastern Time shall also be
transmitted through ACT within 90 seconds after execution; trades
executed and reported after 4 p.m. Eastern Time shall be designated as
``.T'' to denote their execution outside normal market hours.
Transactions not reported within 90 seconds must include the time of
execution on the trade report.
(B) Last sale reports of transactions ins OTC Equity Securities
executed outside the hours of 8 a.m. and [5:15] 6:30 p.m. Eastern Time
shall be reported as follows:
(i) No Change.
(ii) Last sale reports of transactions ins ADRs, Canadian issues,
or domestic OTC Equity Securities that are executed between [5:15] 6:30
p.m. and midnight Eastern Time shall be transmitted through ACT on the
next business day (T+1) between 8 a.m. and [5:15] 6:30 p.m. Eastern
Time, be designated ``as/of'' trades to denote their execution on a
prior day, and be accompanied by the time of execution. The party
responsible for reporting on T+1, the trade details to be reported, and
the applicable procedures shall be governed, respectively, by
paragraphs (b), (c), and (d) below; and
(iii) No Change.
(4)-(6) No Change.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, Nasdaq 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 III below. Nasdaq 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
Trading securities outside of normal market hours is not a new
phenomenon. Nasdaq presently makes available several systems until
until 5:15 p.m. Eastern Time to facilitate trading after the close of
the Nasdaq market at 4 p.m. Eastern Time. Recently, however, several
alternative trading systems have initiated their own after-hours
trading sessions. As such, there are now several different market
venues available for trading after 4:00 p.m. Eastern Time. Presently
there is no facility available to aggregate the activity in these
various markets, making it difficult for market participants to
determine the best prices available. Furthermore, information regarding
transactions executed on these different markets is currently not
widely available to investors, depriving them and other market
participants of full, verifiable information on which to base trading
decisions.
To remedy this situation, Nasdaq is proposing to establish a pilot
program to extend, effective October 25, 1999 through March 1, 2000,
the availability of its trade reporting and quotation dissemination
facilities until 6:30 p.m. Eastern Time to encourage the collection and
public dissemination of securities transactions taking place after the
4 p.m. close of the Nasdaq market. these facilities are presently
available until 5:15 p.m. Eastern Time. At the outset, Nasdaq wishes to
stress that the above proposals are made in response to requests from
other market participants that wish to expand their trading activity in
the hours after the regular close of the Nasdaq market. It is Nasdaq's
view that the importance of bringing increased transparency in the form
of more visible quotes and transaction reports to the time period after
the Nasdaq market's close imposes an obligation on Nasdaq to make
available these systems and services as quickly as possible. Nasdaq
remains committed to working with the Commission and other primary
markets to carefully evaluate the complex issues surrounding any future
expansion of regular market trading hours. Under the pilot proposal,
Nasdaq will extend to 6:30 p.m. Eastern Time the operating hours of the
following services: (1) SelectNet Service (``SelectNet''); (2)
Automated Confirmation Transaction Service (``ACT''); (3) Nasdaq
Quotation Dissemination Service (``NQDS''); and (4) Nasdaq Trade
Dissemination Service (``NTDS''). The posting of quotations and trading
of securities by NASD members during the period of time after Nasdaq's
normal market close and before 6:30 p.m. Eastern Time shall be
voluntary.
Under the pilot, any Nasdaq market maker that chooses to post
quotations and trade during the 4 p.m. to 6:30 p.m. Eastern Time period
shall be obligated to post firm two-sided quotations when opening and
making its market, but may enter or leave the market on the hour or
half-hour up to 6:30 p.m. Eastern Time. NASD member firms that do not
choose to open their market and instead send customer or proprietary
orders to other market participants for display and/or execution (or
that choose to hold those orders until the next day's regular trading
session) will likewise not be obligated to post firm two-sided
quotes.\6\ Regardless of an NASD member's quotation activity, all
transactions in Nasdaq National Market, SmallCap, Convertible Debt and
over-the-counter equity securities executed between the hours 8 a.m.
and 6:30 p.m. Eastern Time
[[Page 56557]]
must be reported to ACT within 90 seconds.
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\6\ Nasdaq market makers that do not elect to open their quotes
would still be obligated to trade report transactions during the 4
p.m. to 6:30 p.m. Eastern Time period consistent with current trade
reporting rules applicable during regular market hours.
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Along with the expanded operating times of the above systems and
services, Nasdaq also wishes to make clear to members which NASD Rules
will be in force during the extended SelectNet and ACT sessions. Except
as modified by this filing, only those rules that are limited by their
express terms, or by an official interpretation of the Association, to
a specific time period outside of the 4 p.m. to 6:30 p.m. Eastern Time
period shall not be in force during the extended SelectNet/ACT/NQDS/
NTDS sessions. Towards that end, Nasdaq is proposing to modify NASD
rule 4617 (Normal Business Hours) to make clear to Nasdaq market makers
who voluntarily open their markets after the close that, except as
modified by this filing, they are obligated to conduct their business
during the extended SelectNet/ACT/NQDS/NTDS sessions in conformity with
all NASD Rules whose applicability is not limited to specific times
outside the 4 p.m. to 6:30 p.m. Eastern Time period. In addition,
Nasdaq's Board of Directors, at its meeting on October 6, 1999,
approved a proposal to amend NASD IM-2110-2 (also known as the
``Manning Rule'') to extend its applicability until 6:30 p.m. Eastern
Time. The Manning Rule prohibits an NASD member firm which is holding a
customer limit order from trading from that member's market making
proprietary account at a price that would satisfy the customer's limit
order without executing that customer limit order. This interpretation
previously applied only during regular Nasdaq market hours.\7\
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\7\ See NASD Notice to Members 95-67.
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NASD's Short Sale Rule,\8\ however, will not initially be
applicable beyond normal market hours. In NASD Notice to Members 94-68,
the NASD limited the Short Sale Rule's applicability to normal market
hours (9:30 a.m. to 4 p.m. Eastern Time). In addition, technological
constraints currently prevent Nasdaq from calculating a best bid/offer
during the period between 4 p.m. and 6:30 p.m. Eastern Time. As a
result, Nasdaq cannot provide the last bid directional arrow that is
relied on by market participants to remain in compliance with the rule.
Nasdaq believes that it will be technologically possible to calculate
and provide an inside quote for the extended SelectNet session by on or
about December 6, 1999. During the interim, Nasdaq will evaluate after-
the-close trading activity to determine whether an extension of the
Short Sale Rule to the 4 p.m. to 6:30 p.m. Eastern Time period is
appropriate. Prior to the provision of an inside quote, NASD members
will, however, continue to be required to make affirmative
determinations that they will receive delivery of a security from their
customers or that the member can borrow the security on behalf of the
customer for delivery by settlement date before accepting short sale
orders during the extended SelectNet and ACT sessions.\9\
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\8\ NASD Rule 3350.
\9\ See NASD Rule 3370.
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Finally, given the importance of timely trade reporting for
transparency purposes, Nasdaq's trade reporting rules for NMS,
SmallCap, Convertible Debt, and over-the-counter equity securities
(Rules 4632, 4642, 4652, 6620) will be modified to mandate 90 second
ACT trade reporting for all transactions in these securities executed
after Nasdaq's regular market close and before 6:30 p.m. Eastern Time.
Nasdaq staff will continue to initiate trading halts \10\ and
adjudicate clearly erroneous trade disputes in the extended SelectNet
and ACT sessions using the same standards and methods as employed
during normal market hours.\11\ Nasdaq's MarketWatch and NASD
Regulation's Market Regulation Department will be staffed to provide
oversight of trading and quotation activity up to 7 p.m. Eastern Time.
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\10\ Nasdaq notes that this trading halt authority will be
limited to individual stocks only and will be undertaken in
consultation with other primary markets operating after 4 p.m.
Eastern Time. Market-wide trading halt rules currently in effect
rely solely on percentage-based declines in the Dow Jones Industrial
Average (``DJIA''), a narrow index that does not contain any Nasdaq
stocks and which will not be calculated after the 4 p.m. close. In
the event that a circuit breaker halt, triggered during regular
market hours, prevents a normal close of U.S. primary markets,
Nasdaq proposes that no extended SelectNet or ACT sessions be
commenced that day.
\11\ Nasdaq has also been informed by the staff of NASD
Regulation, Inc. of its view that nothing in the instant proposals
modifies or limits an NASD member's obligation to comply with the
rules of NASD Regulation's Order Audit Trail System (``OATS'') when
reporting trading activity taking place between 4 p.m. and 6:30 p.m.
Eastern Time. Nasdaq's MarketWatch and NASD Regulation's Market
Regulation Department will be staffed to provide oversight of
trading and quotation activity up to 7 p.m. Eastern Time.
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Amendment No. 1. Among other things, Nasdaq's Amendment No. 1
addresses issues concerning the dissemination of regular session
closing price reports under the pilot program. Specifically, the
Amendment confirms that systems operations until 6:30 p.m. Eastern Time
will not interfere with the ability of investors to obtain 4 p.m.
closing prices in Nasdaq securities. Closing prices are currently
disseminated by vendors shortly after the 4 p.m. close even though the
Nasdaq systems operate until 5:15 p.m. Eastern Time; systems operations
until 6:30 p.m. Eastern Time will not change this practice. Trades
effected after 4 p.m. Eastern Time will continue to be designated as
``.T'' trades that do not affect closing price in the relevant
security.
Amendment No. 1 also describes how Nasdaq will address issues
involving the use of closing prices for NAV calculations by mutual
funds. In particular, under the Nasdaq proposal, certain specialized
closing price reports for non-OTC Bulletin Board and foreign ordinary
issues, as well as some American Depository Receipts (``ADRs''), will
not be issued by Nasdaq in time to permit funds to report their NAVs to
Nasdaq's Mutual Fund Quotation Service (``MFQS'') by that system's 5:50
p.m. Eastern Time deadline. Accordingly, Nasdaq has indicated that it
will post an electronic file with this closing price information on the
OTC Bulletin Board web site between 5:20 p.m. and 5:40 p.m. Eastern
Time (with an internal goal of posting by 5:30 p.m. Eastern Time).
In addition, some funds and vendors have raised general concerns
about what they perceived to be lack of time to modify and test their
systems before the planned introduction of inside quotations up to 6:30
p.m. Eastern Time. Amendment No. 1 indicates that, in response to these
concerns, Nasdaq has pushed back the planned start-up date for
distributing after-hours inside quotations from November 1 to December
6, 1999. While Nasdaq acknowledges that this later start-up date will
not satisfy every concern raised by vendors and funds, Nasdaq believes
that the delay until December 6 should provide sufficient time for
essential systems modifications and testing. Nasdaq states that it will
continue to work with vendors and the mutual fund industry on these
issues.
Amendment No. 1 also clarifies how the Manning Rule will apply
during the extended hours of the pilot from 4 p.m. to 6:30 p.m. Eastern
Time. Nasdaq confirms in Amendment No. 1 that, on October 6, 1999, the
Board of Directors of Nasdaq approved the expansion of the
applicability of the Manning Rule to 6:30 p.m. Eastern Time. Nasdaq
also clarifies the application of the Manning Rule after 4 p.m. Eastern
Time by adding a footnote to IM-2100-2(a) discussing the handling of
customer limit orders if the customer does not formally opt-in to
processing limit orders during the extended hours period.
Based on the above, Nasdaq believes that the proposed rule changes
are consistent with the provisions of Section 15A(b)(b) of the Act in
that they are designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of
[[Page 56558]]
trade, and to foster cooperation and coordination with persons engaged
in regulating, clearing, settling, and processing information with
respect to, and facilitating transactions in securities.
B. Self-Regulatory Organization's Statement on Burden on Competition
Nasdaq does not believe that the proposed rule change will result
in any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.
C. SRO's Statement on Comments on the Proposed Rule Change Received
From Members, Participants, or Others
Although written comments were not solicited, Nasdaq has received
four letters from market participants expressing concerns relating to
the proposed rule change.\12\ Nasdaq has addressed these comment
letters in Amendment No. 1.
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\12\ Letter to Richard G. Ketchum, President, NASD, from Craig
S. Tyle, General Counsel, Investment Company Institute, dated
September 24, 1999; Letter to Richard G. Ketchum, President, NASD,
and Patrick J. Campbell, Chief Operating Officer and Executive Vice
President, The Nasdaq-Amex Market Group, Inc., from Jenni Neumann,
Senior Vice President, Global Database Management, Bridge
Information Systems, dated September 27, 1999; Letter to Richard G.
Ketchum, President, NASD, from David Byrnes, Senior Vice President,
Americas Information Management Group, Reuters Information, dated
September 28, 1999; and Letter to Richard G. Ketchum, President,
NASD, from Thomas J. Higgins, Principal and Treasurer of the
Vanguard Funds, The Vanguard Group, dated September 29, 1999.
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III. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing including whether the proposed rule
change, as amended, is consistent with the Act. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW, Washington,
DC 20549-0609. 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 No.
SR-NASD-99-57 and should be submitted by November 10, 1999.
IV. Commission's Findings and Order Granting Accelerated Approval
of the Proposed Rule Change
For the reasons discussion below, the Commission finds that the
proposed rule change, as amended, is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to the
NASD and, in particular, the requirements of Sections 11A and 15A.\13\
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\13\ In approving this rule, the Commission has considered the
proposed rule's impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
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Specifically, the Commission believes that the proposed rule change
as amended furthers the goals of the national market system as
reflected in Sections 11A(a)(1)(C)(iii) and (iv) of the Act.\14\
Congress found in those provisions that it is in the public interest
and appropriate for the protection of investors and the maintenance of
fair and orderly markets to assure the availability to brokers,
dealers, and investors of information with respect to quotations for
and transactions in securities, and to assure the practicability of
brokers executing investors' orders in the best market. Section
11A(a)(1) further found that the linking of all markets for qualified
securities through communication and data processing facilities would
foster efficiency, enhance competition, increase the information
available to brokers, dealers, and investors, facilitate the offsetting
of investors' orders, and contribute to best execution of such
orders.\15\ The proposed rule change as amended will assure the
availability of information with respect to quotations and transactions
because it makes Nasdaq's systems, which are used by market
participants to communicate quotes and orders and to report trades,
available until 6:30 p.m. Eastern Time. Currently, there is not
consolidated source of information on trades and quotations after 5:15
p.m. Eastern Time, making it difficult for investors to determine the
best prices available. Nasdaq's proposal will enhance transparency by
requiring that transactions in NMS, SmallCap, Convertible Debt, and
over-the-counter equity securities that take place up to 6:30 p.m.
Eastern Time be reported within 90 seconds. In addition, to the extent
that a market maker chooses to participate in the after-hours session,
its quotations will be disseminated through NQDS. As a result,
investors will be better able to evaluate prices before entering their
order after primary trading hours. In sum, by providing the
consolidated quotation display and last sale tape for transactions
taking place between 4 p.m. and 6:30 p.m. Eastern Time, Nasdaq's
proposal should enhance investor protection and confidence because it
will give market participants more complete information upon which to
base trading decisions.
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\14\15 U.S.C. 78k-1(a)(1)(C) (iii) and (iv).
\15\ 15 U.S.C. 78k-1(a).
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The Commission also believes that the proposed rule change is
consistent with Section 15A of the Act \16\ in that it is 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. The proposed rule change
accomplishes these objectives by making Nasdaq's systems available to
market participants who choose to offer trading to customers outside of
traditional market hours, by providing for greater transparency, and by
linking the various market participants engaged in trading during those
hours through SelectNet.
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\16\ 15 U.S.C. 78o-3.
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Amendment No. 1 also confirms that the extended trading pilot will
not interfere with the ability of investors to obtain 4 p.m. closing
prices in Nasdaq securities. Moreover, Nasdaq has outlined measures
that it has taken to address specific concerns of vendors and the
mutual fund industry concerning the availability of closing prices for
NAV calculations and the need for sufficient time to modify and test
their systems before the planned introduction of inside quotations
after 4 p.m. Eastern Time. While Nasdaq acknowledges that these
measures will not satisfy every concern raised by vendors and funds,
the delay until December 6th for the dissemination of after-hours
inside quotations should provide sufficient time for essential systems
modifications and testing. Nasdaq has indicated that it will continue
to work with vendors and the mutual fund industry on these issues. In
light of the need for improved transparency during the after-hours
session, and Nasdaq's willingness to continue to work with vendors and
mutual funds to ensure an orderly extension of price reporting, the
Commission believes that Nasdaq's
[[Page 56559]]
determination to proceed with its pilot on schedule is reasonable.
In addition, the proposed rule change as amended furthers the
objectives of Section 15A of the Act by specifically extending rules
designed to protect investors beyond the traditional market hours while
Nasdaq's systems are operating. For example, the Manning Rule
previously did not apply after 4 p.m. Eastern Time. Originally, the
NASD believed Manning obligations should not apply after 4 p.m. Eastern
Time because the after-hours market was fundamentally different from
the regular market.\17\ With the advent of on-line retail trading and
other technological advances, however, the nature of the after-hours
market is changing. In particular, the increasing presence of retail
customers during the after-hours market has led the NASD to reconsider
the application of the Manning Rule between 4 p.m. and 6:30 p.m.
Eastern Time. Accordingly, upon approval of the pilot, members acting
as market makers during these hours will be required to handle their
customer limit orders with due care so that they do not trade ahead of
those limit orders. Members acting as market makers that handle
customer limit orders, whether received from their own customers or
from another member, will be prohibited from trading at prices equal or
superior to that of the limit order without executing the limit order.
The Commission believes that the application of the protections of the
Manning and other NASD rules during after-hours trading will
significantly enhance investor protection.\18\
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\17\ See, e.g., NASD Notice to Members 95-67.
\18\ The Commission believes that the clarification of the
application of the Manning Rule in Amendment No. 1 provides further
enhancement of investor protection. In addition, the Nasdaq staff
has indicated that a rule proposal is being developed for
consideration by the appropriate Boards that would require that
member firms establish procedures to have customers ``opt-in'' to
having their order(s) processed during any period outside of the
9:30 a.m. to 4 p.m. regular trading session for Nasdaq.
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Commission Rules
The Commission has received inquiries from market participants
seeking clarification regarding which Commission rules apply to NASD
members who choose to trade after 4 p.m. Eastern Time while Nasdaq's
systems are in operation. The Commission wishes to clarify that, by
their terms, SEC Rules 11Ac1-1(c)(2) (the ``Firm Quote Rule''), 11Ac1-
1(c)(5) (the ``ECN Display Alternative''), 11Ac1-4 (the ``Limit Order
Display Rule'') and Rule 301(b) (``Regulation ATS'') apply to NASD
member firms that choose to trade between 4 p.m. and 6:30 p.m. Eastern
Time.\19\
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\19\ 17 CFR 240.11Ac1-1(c)(2), 17 CFR 240.11Ac1-1(c)(5), 17 CFR
240.11Ac1-4, 17 CFR 242.301(b). For a complete discussion of these
rules and the definitions of the terms used in the following
discussion, see the applicable Commission releases.
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In general, SEC Rule 11Ac1-1(b)(1)(ii) requires an association to
disseminate the best bid, offer, and quotation sizes for subject
securities whenever ``last sale information with respect to reported
securities is reported [by a member acting in the capacity of an OTC
market maker] pursuant to an effective transaction reporting plan.''
\20\ NASD members, including OTC market makers, who choose to trade
from 4 p.m. to 6:30 p.m. Eastern Time will be required to report last
sale information pursuant to the NASD's rules, and the NASD will
disseminate quotes during this time period. These procedures, in turn,
trigger the Commission's Firm Quote Rule, which generally obligates OTC
market makers to execute any order to buy or sell a subject security,
other than an odd-lot order, presented to it by another broker or
dealer, or any other person belonging to a category of persons with
whom such responsible broker or dealer customarily deals, at a price at
least as favorable to such buyer or seller as the responsible broker's
or dealer's published bid or published offer.
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\20\ 17 CFR 240.11Ac1-1(b)(1)(ii).
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Similarly, the reporting of last sale information to the NASD
triggers the ECN Display Alternative. Under the ECN Display
Alternative, an order entered by a market maker into an electronic
communications network (``ECN'') that widely disseminates the order is
deemed to be a bid or offer to be communicated to the market maker's
association for at least the minimum quotation size required by the
Association's rules if the priced order is for the account of the
market maker, or the actual size of the order up to the minimum
quotation size required if the priced order is for the account of a
customer. The ECN Display Alternative deems the market maker to be in
compliance with this requirement if the ECN displays the market maker's
order in Nasdaq.\21\
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\21\ Therefore, if an ECN is receiving OTC market maker orders
before 6:30 p.m. Eastern Time, the ECN must transmit those orders
through SelectNet for display in the Nasdaq montage, or the OTC
market maker must post the quote separately in its own quote line in
the montage in order to be in compliance with the ECN Display
Alternative.
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In addition, the Limit Order Display Rule is not limited to regular
trading hours, but also applies to OTC market makers that choose to
participate in after-hours trading sessions. Simply put, the Limit
Order Display Rule requires an OTC market maker to publish immediately
a bid or offer that reflects the price and full size of each customer
limit order that improves the bid or offer of the OTC market marker, or
that reflects the full size of the customer limit order that is priced
equal to the bid or offer of the OTC market maker or the national best
bid or offer, and represents more than a de minimis change in the size
of the OTC market maker's bid or offer.\22\
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\22\ There are certain exceptions to the Limit Order Display
Rule. Those exceptions would continue to apply during an after-hours
trading session. See SEC Rule 11Ac1-4(c), 17 CFR 240.11Ac1-4(c).
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Regulation ATS also applies to market participants who choose to
operate from 4 p.m. to 6:30 p.m. Eastern Time. Currently, any
alternative trading system that has five percent or more of the average
daily trading volume in a security must display its best orders in that
security in the public quotation stream during regular trading hours.
Although there may be some confusion as to whether average ``daily''
trading volume includes trades executed outside of normal market hours,
the calculation alternative trading systems must make regarding volume
includes all trades executed during the twenty-four hours that
constitute a day. Any alternative trading system that meets the five
percent threshold must therefore display its orders in the public
quotation stream whenever the public quotation systems make display
possible.
The Commission is aware that there has been confusion among market
participants as to the applicability of these rules after 4 p.m.
Eastern Time. Consequently, the Commission has issued a no-action
letter to the NASD relieving market participants from complying with
Rules 11Ac1-1(c)(5) (the ECN Display Alternative), 11ac1-4 (the Limit
Order Display Rule), Rule 301(b) (Regulation ATS), and the NASD's
Manning Rule until November 2, 1999.\23\ This temporary relief is
designed to give market participants (including ECNs) time to make the
system changes necessary to comply with these rules during the 4 p.m.
to 6:30 p.m. Eastern Time period.\24\ The Commission emphasizes,
however, that broker-dealers continue to have a duty of best execution
for their customer's orders during these hours.
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\23\ Under the terms of this no-action letter, firms are not
relieved from their obligation to comply with the Firm Quote Rule
(Rule 11Ac1-1(c)(5), 17 CFR 240.11Ac1-1(c)(5)).
\24\ See Letter to Robert E. Aber, General Counsel, Nasdaq, from
Robert L.D. Colby, Deputy Director, Division, Commission, dated
October 12, 1999.
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[[Page 56560]]
Nasdaq has requested that the Commission find good cause pursuant
to Section 19(b)(2) of the Act \25\ for approving the proposed rule
change prior to the 30th day after publication in the Federal Register.
The Commission finds good cause for granting accelerated approval for
the proposed rule change because the Nasdaq pilot will benefit
investors by improving the transparency of the current after-hours
market and assisting broker-dealers in fulfilling their duty of best
execution for their customer orders.
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\25\ 15 U.S.C. 78s(b)(2).
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The Commission further believes that good cause exists for
approving Amendment No. 1 to the proposed rule change prior to the
thirtieth day after the date of publication of notice thereof in the
Federal Register. The first item covered in Amendment No. 1 merely
changes the date for implementation of the after-hours trading session
as a pilot program from October 11, 1999 to October 25, 1999. The
Commission believes that delaying the implementation date will provide
Nasdaq and its member firms with additional time to make any necessary
systems changes. The second and third items of Amendment No. 1 address
how the Manning Rule will apply during the extended hours of the pilot
from 4 p.m. to 6:30 p.m. Eastern Time. In the second item, Nasdaq
confirmed that, on October 6, 1999, the Board of Directors of Nasdaq
approved the expansion of the applicability of the Manning Rule to 6:30
p.m. Eastern Time. In the third item, Nasdaq clarified the application
of the Manning Rule after 4 p.m. Eastern Time by adding a footnote to
IM-2110-2(a) discussing the handling of customer limit orders if the
customer does not formally opt-in to processing limit orders during the
extended-hours period. The Commission believes that the Manning Rule's
customer limit order protections should be provided to customers who
opt-in to having their orders processed in the extended-hours period,
and that, therefore, there is good cause for accelerating the approval
of these items in Amendment No. 1. The Commission notes that the
remaining items discussed in Amendment No. 1 clarify how Nasdaq will
continue to make certain trade information available to the mutual fund
industry. These clarifications further ensure that the pilot program
will provide protection to investors who participate in the market
through mutual funds. Accordingly, the Commission believes that there
is good cause for accelerating the approval of all of the items in
Amendment No. 1.
While extended operation of some key Nasdaq trade reporting and
quotation dissemination systems will significantly improve the current
trading environment after the major markets close, the Commission
recognizes that Nasdaq's pilot program does not yet include some
features that would be essential for a full after-hours trading
session. Specifically, Nasdaq's pilot does not require registered
market makers in Nasdaq securities to participate in after-hours
trading from 4 p.m. to 6:30 p.m. Eastern time and does not envision the
use of the Small Order Execution System (``SOES'') during this period.
In Nasdaq's view, its market will not be open during the hours of the
pilot. The Commission believes that, before Nasdaq opens its market for
extended trading, it would need to incorporate additional market
integrity and investor protection features.\26\
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\26\ See, e.g., n. 18, supra.
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In addition, the Commission has expedited approval of this proposal
with the understanding that the systems limitations that currently
prevent the calculation of the best bid and offer for Nasdaq stocks
after 4 p.m. Eastern Time will be addressed expeditiously. Such
calculations will be necessary for the Nasdaq's Short Sale Rule to
apply to trading during the 4:30 p.m. to 6:30 p.m. Eastern Time period.
The Commission expects that Nasdaq will make every reasonable effort to
work with the vendors and the mutual fund community to implement the
systems enhancements needed for calculating the inside quote as soon as
possible.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\27\ that the proposed rule change (SR-NASD-99-57), including
Amendment No. 1, is approved as a pilot program through March 1, 2000.
\27\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\28\
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\28\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-27308 Filed 10-19-99; 8:45 am]
BILLING CODE 8010-01-M
