[Federal Register Volume 60, Number 204 (Monday, October 23, 1995)]
[Notices]
[Pages 54398-54401]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-26184]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36374; File No. SR-NASD-95-41]
Self-Regulatory Organizations; Notice of Proposed Rule Change by
National Association of Securities Dealers, Inc. Relating to an
Expansion of the NASD's Short-Sale Rule to Include Nasdaq SmallCap
Market Securities
October 16, 1995.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on September 22, 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.
\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD is proposing to expand the scope of its short-sale rule to
include Nasdaq SmallCap Market (``SCM'') securities.
Consistent with the current short-sale rule applicable to Nasdaq
National Market (``NNM'') securities, the NASD proposes to
implement the short-sale rule for SCM securities on a pilot basis until
June 3, 1996.
The text of the proposed rule change is available at the Office of
the Secretary of the NASD and at the Commission.
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
On June 29, 1994, the SEC approved a new short sale rule for NNM
securities traded on The Nasdaq Stock MarketSM (``Nasdaq'').\2\
The NASD's short sale rule, which became effective on September 6, 1994
for an eighteen-month pilot period,\3\ prohibits member firms from
effecting short sales \4\ at or below the current inside bid as
disseminated by the Nasdaq system whenever that bid is lower than the
previous inside bid.
\2\ See Securities Exchange Act Release No. 34277 (June 29,
1994), 59 FR 34885 (July 7, 1994).
\3\ The Commission subsequently approved a NASD proposal
extending the pilot period until June 3, 1996. Securities Exchange
Act Release No. 36171 (Aug. 30, 1995), 60 FR 46651 (Sept. 7, 1995).
\4\ A short sale is a sale of a security which the seller does
not own or any sale which is consummated by the delivery of a
security borrowed by, or for the account of, the seller. To
determine whether a sale is a short sale members must adhere to the
definition of a ``short sale'' contained in SEC Rule 3b-3, which
rule is incorporated into Nasdaq's short sale rule by Article III,
Section 48(l)(1) of the NASD Rules of Fair Practice.
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Nasdaq calculates the best bid from all market makers in the
security (including bids on behalf of exchanges trading Nasdaq
securities on an unlisted trading privileges basis), and disseminates
symbols to denote whether the current inside bid is an ``up bid'' or a
``down bid.'' Specifically, and ``up bid'' is denoted by a green ``up''
arrow symbol and a ``down bid'' is denoted by a red ``down'' arrow.
Accordingly, absent and exemption from the rule, a member can not
effect a short sale of or below the inside bid in a security in its
proprietary account or an account of a customer if there is a red arrow
next to
[[Page 54399]]
the security's symbol on the screen. In order to effect a ``legal''
short sale on a down bid, the short sale must be executed at a price at
least a \1/16\th of a point above the current inside bid. Conversely,
if the security's symbol has a green up arrow next to it, members can
effect short sales in the security without any restrictions. The rule
is in effect during normal domestic market hours (9:30 a.m. to 4:00
p.m., Eastern Standard Time).
In order to ensure that market maker activities that provide
liquidity and continuity to the market are not adversely constrained
when the short sale rule is invoked, the rule provides an exemption to
``qualified'' Nasdaq market makers. Even if a market maker is able to
avail itself of the qualified market maker exemption, it can only
utilize the exemption from the short sale rule for transactions that
are made in connection with bona fide market making activity. If a
market maker does not satisfy the requirements for a qualified market
maker, it can remain a market maker in the Nasdaq system, however, it
can not take advantage of the exemption from the rule.
Until December 1, 1995, a ``qualified'' Nasdaq market maker is
defined to be a registered market maker that has entered quotations in
the relevant security into the Nasdaq system on an uninterrupted basis
for the preceding 20 business days (the ``20-day'' test). The ``20-
day'' test is applied to initial public offerings, secondary offerings,
and merger and acquisition situations in the following manner:
for initial public offerings, a market maker may
immediately become a qualified market maker in an IPO by immediately
registering (by 9:30 of the business day after completion of the
offering) and entering quotations in the issue. However, if the market
maker withdraws from the security on an unexcused basis within the
first 20 days after the offering, it will not be eligible for
designation as a qualified market maker in any subsequent IPO for the
next 10 business days following the unexcused withdrawal.
For secondary offerings, unless a market maker was
registered in a security prior to the time a secondary offering in that
stock has been publicly announced or a registration statement has been
filed, it cannot become a qualified market maker in the stock unless
the secondary offering has become effective and the market maker has
been registered in the security and maintained quotations without
interruption for 40 calendar days.
In merger and acquisition situations, after a merger or
acquisition involving an exchange of stock has been publicly announced
and not yet consummated or terminated, a market maker may register and
begin entering quotations in either or both of the two affected
securities and immediately become a qualified market maker in either or
both of the issues. However, if the market maker withdraws on an
unexcused basis from any stock in which it has so registered within 20
days of so registering, the market maker will not be eligible for
immediate designation as a qualified market maker for any merger or
acquisition announced within three months subsequent to such unexcused
withdrawal.
From December 1, 1995 to June 3, 1996, a ``qualified'' market maker
must satisfy the criteria for a ``Primary Nasdaq Market Maker''
(``PMM'') found in new Section 49 of the NASD Rules of Fair
Practice.\5\ After December 1, 1995, a ``P'' indicator will be
displayed next to ever qualified market maker that is exempt from the
rule according to the PMM standards. To qualify as a PMM, market makers
must satisfy at least two of the following four criteria:
\5\ The PMM standards were originally scheduled to go into
effect on September 6, 1995; however, the implementation date for
the standards was postponed to December 1, 1995. Securities Exchange
Act Release No. 36171 (Aug. 30, 1995), 60 FR 46651 (Sept. 7, 1995).
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(1) The market maker must be at the best bid or best offer as shown
on the Nasdaq system no less than 35 percent of the time;
(2) The market maker must maintain a spread no greater than 102
percent of the average dealer spread;
(3) No more than 50 percent of the market maker's quotation updates
may occur without being accompanied by a trade execution of at least
one unit of trading; or
(4) The market maker executes 1\1/2\ times its ``proportionate''
volume in the stock.\6\
\6\ For example, if there are 10 market makers in a stock, each
dealer's proportionate share volume would be 10 percent; therefore,
1\1/2\ times proportionate share volume would mean 15 percent of
overall volume.
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The review period for satisfaction of the Primary Market Maker
performance standards is one calendar month. If a Primary market maker
has not satisfied the threshold standards after a particular review
period, the Primary Market Maker designation will be removed commencing
on the next business day following notice of failure to comply with the
standards. Market makers may requalify for designation as a Primary
Market Maker by satisfying the threshold standards for the next review
period.
If a market maker is a PMM in 80 percent or more of the securities
in which it has registered, it may immediately become a PMM (i.e., a
qualified market maker) in a NNM security by registering and entering
quotations in that issue. If the market maker is not a PMM in at least
80 percent of its stocks, it may qualify as a PMM in that stock if the
market maker registers in the stock but does not enter quotes for five
days or the market maker registers in the stock as a regular Nasdaq
market maker and satisfies the qualification criteria for the next
review period. In addition, the PMM standards are applied to initial
public offerings, secondary offerings, and merger and acquisition
situations in the following manner:
For initial public offerings, a market maker may
immediately become a PMM in an IPO issue by immediately registering and
entering quotations in the issue, provided it has obtained status in 80
percent or more of the stocks in which it has registered. However, if
at the end of the first review period a market maker has failed to
satisfy the qualification criteria or has withdrawn on an unexcused
basis from the security, it is prohibited from becoming a PMM in any
other IPO for the next 10 business days.
For secondary offerings, unless market maker was
registered in a security prior to the time a secondary offering in that
stock has been publicly announced or a registration statement has been
filed, it cannot become a PMM in the stock unless the secondary
offering has become effective and the market maker has satisfied the
PMM standards between the time the market maker registered in the
security and the time the offering became effective or the market maker
has satisfied the PMM standards for 40 calendar days.
In merger and acquisition situations, after a merger or
acquisition is announced, a market maker that is a PMM in one stock may
immediately become a PMM in the other stock by registering and entering
quotations in that issue. In addition, if a market maker is a PMM is 80
percent of the stocks it makes a market in, it may register and
immediately become a PMM in both issues.
In order to reduce compliance burdens for members, the NASD's short
sale rule also incorporates the exemptions in SEC Rule 10a-1 that are
relevant to trading on Nasdaq. Specifically the rule exempts:
Sales by a broker-dealer for an account in which it has no
interest and that are marked long;
[[Page 54400]]
Any sale by a market maker to offset odd-lot orders of
customers;
Any sale by any person, for an account in which he has an
interest, if such person owns the security sold and intends to deliver
such securities as soon as possible without undo inconvenience or
expense;
Sales by a member to liquidate a long position which is
less than a round lot, provided the sale does not change the member's
position by more than one unit of trading (100 shares);
Short sales effected by a person in a special arbitrage
account if the person effecting the short sale then owns another
security by virtue of which the person is, or presently will be,
entitled to acquire an equivalent number of securities of the same
class of securities sold; provided such sale, or the purchase which
such sale offsets, is effected for the bona fide purpose of profiting
from a current difference between the price of the security sold and
the security owned and that such right of acquisition was originally
attached to or represented by another security or was issued to all the
holders of any such class of securities of the issuer;
Short sales effected by a person in a special
international arbitrage account for the bona fide purpose of profiting
from a current difference between the price of such security on a
securities market not within or subject to the jurisdiction of the
United States and on such a securities market subject to the
jurisdiction of the United States; provided the person at the time of
such sale knows or, by virtue of information currently received, has
reasonable grounds to believe that an offering enabling a person to
cover such sale is then available to the person in such foreign
securities markets and intends to accept such offer immediately; and
Short sales by an underwriter or any member of the
distribution syndicate in connection with the over-allotment of
securities, or any lay-off sale by such a person in connection with a
distribution of securities rights pursuant to SEC Rule 10b-18 or a
standby underwriting commitment.
The rule also provides that a member not currently registered as a
Nasdaq market maker in a security that has acquired the security while
acting in the capacity of a block positioner shall be deemed to own
such security for the purposes of the rule notwithstanding that such
member may not have a net long position in such security if and to the
extent that such member's short position in such security is subject to
one or more offsetting positions created in the course of bona fide
arbitrage, risk arbitrage, or bona fide hedge activities.\7\ The rule
also contains certain limited exemptions for options market makers and
warrant market makers.
\7\ The NASD also has interpreted its short-sale rule to provide
exemptions consistent with SEC staff interpretations of SEC Rule
10a-1 dealing with the liquidation of index arbitrage positions and
trading in foreign securities (the so-called ``international
equalizing exemption''). See Securities Exchange Act Release No.
30772 (June 3, 1992), 57 FR 26891 (June 16, 1992).
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As with the short-sale rule for NNM securities, which the
Commission has approved on a pilot basis, the NASD believes imposing a
short-sale rule on SCM securities will promote the maintenance of fair
and orderly markets and the protection of investors. Specifically, by
helping to prevent speculative short selling in SCM securities from
rapidly accelerating a decline in the price of a security and a form of
manipulation known as ``bear raiding'' or ``piling on,'' \8\ the NASD
believes its proposal will enhance the market for SCM securities. The
NASD also is concerned that in instances of extreme intra-day
volatility in SCM securities that the ability of existing shareholders
to sell their stock may be inhibited because professional short sellers
are in the market before them, exacerbating downward pressure on stocks
and reducing overall liquidity in the marketplace. The NASA believes
that expanding the scope of its short-sale rule to include SCM
securities will help to curb abusive short selling, reducing the
exposure of the Nasdaq market to manipulation and excessive intra-day
volatility. Without a short-sale rule for SCM securities, the NASD also
believes issuers of SCM securities may be disadvantaged in offerings on
Nasdaq because the increased potential for short selling may
artificially affect the prices at which such offerings are conducted.
In this regard, members report that their investment banking
departments may recommend exchange listings for SCM securities because
of the lack of adequate short sale regulation in the Nasdaq market.
Accordingly, the NASD believes that the proposed modification to the
NASD's short-sale rule will assure both issuers and investors in SCM
securities that they are subject to at least equivalent protection from
predatory short selling in the Nasdaq market as they are on an
exchange.
\8\ ``Piling on'' occurs all when short sellers exert
substantial selling pressure on a stock with the intent to dominate
and demoralize the market for that sotck, forcing the price to drop
precipitiously, frequently with a single trading day.
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In addition, because the short-sale rule applicable to SCM
securities will be identical to the short-sale rule applicable to NNM
securities, the NASD believes its proposal is structured in a manner to
best prevent abusive short sales while also preserving the depth and
liquidity of the markets for SCM securities. In this connection, the
NASD notes that the Nasdaq Stock Market provides an efficient and
liquid trading environment through quote competition among competing
market makers. Crucial to the maintenance of this competitive market
structure is the requirement for market makers to display firm two-
sided quotations. Moreover, the very nature of the competitive market
maker system requires dealers to take substantial inventory positions.
Accordingly, the NASD believes application of a short-sale rule to SCM
securities without an exemption for qualified market makers would
result in degradation of the accuracy and reliability of quotations.
The NASD also believes qualified market makers in SCM securities
must be permitted the flexibility to sell short when necessary so that
they will be able to adjust quickly to market movements and control the
risks associated with market making, while continuing to provide the
maximum possible liquidity. The ability to manage risk with short
positions is fundamental to market maker performance. Market makers
need the constant ability to effect short sales to ``reliquefy'' their
positions throughout the trading day. If a short-sale rule were to
impact adversely their ability to manage risk, dealers may be forced to
reduce their market making support for the SCM securities in which they
currently make markets.\9\
\9\ Based on data for the month of August 1995, 73 percent of
the market making positions in Nasdaq SmallCap securities would have
satisfied the PMM standards.
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Finally, the NASD believes that adoption of a short-sale rule for
SCM securities will enhance the Nasdaq Stock Market's ability to
compete with exchange primary markets for listings of SCM securities.
From a competitive standpoint, the primary exchanges regularly use the
lack of a short-sale rule for SCM securities as an argument to try to
persuade companies to list on their exchange. Adoption of a short-sale
rule for SCM securities will further emphasize to shareholders that
Nasdaq provides equivalent short-sale protection to the investing
public through rules that are fair, equitable, and consistent with the
operation of a quality marketplace.
The NASD believes the proposed rule change is consistent with
Sections 15A(b) (6) and (9), Section 11A(a)(1)(C)(i), and Section
11A(c)(1)(F)
[[Page 54401]]
of the Act. 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 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 NASD believes that
the proposed short-sale rule for SCM securities is consistent with each
of these requirements. First, the NASD's proposal is premised on the
same anti-manipulation concerns that were relied upon by the SEC to
promulgate a short-sale rule for exchange-listed securities, SEC Rule
10a-1. Second, the short-sale rule for SCM securities will promote just
and equitable principles of trade by permitting long sellers access to
market prices at any time, while requiring short sellers in a declining
market to execute their short sales above the bid or wait for an up
bid, similar to the constraints placed upon short sellers of exchange-
listed securities. Third, the proposal removes impediments to a free
and open market for long sellers and ensures liquidity at bid prices
that might otherwise be usurped by short sellers. Finally, since the
immediate beneficiaries of a short-sale rule for SCM securities are the
shareholders who own stock, the NASD believes its proposal is
consistent with the protection of investors and the public interest.
Section 15A(b)(9) of the Act requires that the NASD's rules not
impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act. The NASD acknowledges that a
short-sale rule applicable to SCM securities does impose burdens and
restrictions on members and their customers where there were none
before, but believes that these burdens and restrictions are
appropriate and necessary to ensure the standing of long sellers in the
marketplace and the integrity of the Nasdaq market. This concern with
market integrity for existing shareholders has always been paramount in
exchange markets and the NASD believes it is now appropriate to extend
the same protections to shareholders in SCM securities as well.
Section 11A(a)(1)(C)(i) sets out the economically efficient
execution of securities transactions as an objective of a national
market system for securities. The NASD's proposed short-sale rule for
SCM securities would operate to level the playing field between
investors and short sellers by enabling those investors with long
positions in a security to liquidate their positions at any time, at
any price, while permitting short sellers access to bid prices when
that access will not exacerbate downward pressure in the stock, thus
promoting the efficiency of the Nasdaq market. Moreover, the NASD
believes that the primary market maker qualifications are critical to
ensuring that the proposed rule operates effectively and should have
the additional benefit of providing incentives for improved market
maker performance in SCM securities.
Section 11A(c)(1)(F) assures ``equal regulation of all markets for
qualified securities and all exchange members, brokers, and dealers
effecting transactions in such securities.'' \10\ The NASD believes
that approval of the proposed short-sale rule for SCM securities will
result in equivalent short sale regulation for exchange-listed
securities and SCM securities.
\10\ 15 U.S.C. Sec. 78k-1(c)(1)(F).
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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 purposes of the Act. The NASD believes the PMM standards
that would be applicable to market makers in Nasdaq SmallCap securities
are designed in a manner to permit market makers of all sizes to meet
the standards. Moreover, it is important to note that market makers in
Nasdaq SmallCap securities that do not meet the standards will still be
permitted to remain registered market makers in these securities.
Finally, the NASD is hopeful that the proposed criteria will raise
overall the quality of market maker participation in Nasdaq SmallCap
securities, thereby promoting competition in the market for these
securities.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The NASD has neither solicited nor received comments on the
proposed rule change.
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-95-41 and
should be submitted by November 13, 1995.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\11\
\11\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-26184 Filed 10-20-95; 8:45 am]
BILLING CODE 8010-01-M
