[Federal Register Volume 59, Number 241 (Friday, December 16, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-30915]
[[Page Unknown]]
[Federal Register: December 16, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35080; File Nos. SR-NASD-94-13 and SR-NASD-94-68]
Self-Regulatory Organizations; Notice of Amendment of Proposed
Rule Change by National Association of Securities Dealers, Inc.
Relating to the Small Order Execution System and the Proposed Nasdaq
Primary Retail Order View and Execution System
December 9, 1994.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that in connection with File Nos.
SR-NASD-94-13\2\ and SR-NASD-94-68,\3\ on October 24, 1994 the National
Association of Securities Dealers, Inc. (``NASD'') filed with the
Securities and Exchange Commission (``SEC'' or ``Commission'') an
econometric analysis conducted by the NASD's Economic Research
Department. In addition, in connection with File No. SR-NASD-94-13\4\
on December 2, 1994 the NASD filed with the Commission an analysis of
the potential for order queues to develop in its proposed Nasdaq
Primary Retail Order View and Execution System (``NPROVE'').
The econometric analysis and the NPROVE order queuing analysis
are set forth in Items I and II below respectively, which Items have
been prepared by the NASD. Accompanying Nasdaq's analyses were certain
graphs, charts and tables which are not included in this notice, but
are available for inspection in the Commission's Public Reference Room.
The Commission is publishing this notice to solicit comments from
interested persons.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\See Securities Exchange Act Release No. 34145 (June 1, 1994),
59 FR 29649 (June 8, 1994) (notice of File No. SR-NASD-94-13,
incorporating Amendment No. 1), Securities Exchange Act Release No.
34453 (July 28, 1994), 59 FR 39808 (Aug. 4, 1994) (notice of
Amendment No. 2) and Securities Exchange Act Release No. 35024 (Nov.
29, 1994), 59 FR 62755 (Dec. 6, 1994) (notice of Amendment No. 3).
\3\See Securities Exchange Act Release No. 35077 (Dec. 9, 1994)
(notice of File No. SR-NASD-94-68).
\4\See supra note 2.
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I. Impact of the SOES Interim Changes on the Quality of The Nasdaq
Stock Market
In SEC Release No. 34-33377\5\ (the ``Release''), the SEC approved
certain changes to the NASD's Small Order Execution System (``SOES'')
on a pilot basis. Specifically, the SEC approved the following changes
to SOES: (1) A reduction in the maximum size order eligible for SOES
execution to 500 shares from 1,000 shares;\6\ (2) a reduction in the
minimum exposure limit for ``unpreferenced'' SOES orders to two times
the maximum exposure limit from five times the maximum exposure; (3)
the elimination of exposure limits for ``preferenced'' orders; (4) the
implementation of an automated function for updating market maker
quotations when the market maker's exposure limit has been exhausted;
and (5) the prohibition of short sale transactions through SOES. These
changes, collectively referred to hereinafter as the ``SOES changes,''
went into effect on January 31, 1994.
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\5\Securities Exchange Act Release No. 33377 (Dec. 23, 1993), 58
FR 69419 (Dec. 30, 1993) (approval of File No. SR-NASD-93-16 on a
one-year pilot basis).
\6\Thus with this change, the SOES maximum order size for Nasdaq
National Market (NNM) securities is 200 shares or 500 shares,
depending upon the trading characteristics of the particular
security. All Nasdaq SmallCap securities are subject to a SOES
maximum order size of 500 shares.
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Due to the pilot nature of these changes, the Commission stated
that ``[a]ny further action the NASD seeks with respect to SOES--
extension of these modifications upon expiration, or introduction of
other changes--will require independent consideration under Section 19
of the Act.'' In addition, the SEC stated that, should the NASD desire
to extend these SOES changes or modify SOES, the Commission would
expect, ``the NASD to monitor the quality of its markets and assess the
effects of the approved SOES changes on market quality for Nasdaq
securities.'' Also, if feasible, the SEC instructed the NASD to provide
a quantitative and statistical assessment of the effects of the SOES
changes on market quality; or, if an assessment is not feasible, the
SEC stated that the NASD should provide a reasoned explanation
supporting that determination.\7\
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\7\The SEC also expressed the view that it is not possible to
determine from the correlation and regression analyses submitted in
support of the SOES changes whether increased stock price volatility
definitely leads to trading by SOES active trading (SAT) firms or
trading by SAT firms results in additional stock price volatility.
The SEC further determined that it is not possible to differentiate
between the effects on spreads and stock price volatility
attributable to active SOES trading and the effects attributable to
other factors such as stock-specific news or volatility.
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Accordingly, in order to facilitate and support approval of the
Nasdaq Stock Market's Nasdaq Primary Order View and Execution
(NPROVE) system, or an extension of the SOES changes, should
the Commission not approve NPROVE before termination of the
SOES changes, the NASD is submitting this economic study conducted by
the NASD's Economic Research Department on the impacts of the SOES
changes on the quality of the markets for Nasdaq securities.
In sum, the study found that:
Since the SOES changes went into effect in January 1994,
quoted spreads in Nasdaq securities experienced a decline in the
immediate period following implementation of the changes and have
continued to decline since then. In particular, quoted spreads for the
500 largest Nasdaq National Market securities experienced a sharp
decline from April 28 to May 12 and from June 23 to July 18.\8\
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\8\Some press reports have attributed the recent decline in
spreads for Nasdaq stocks to the publication, on May 26 and 27,
1994, of newspaper articles in The Wall Street Journal, The Los
Angeles Times and other publications reporting the results of an
economic study conducted by two academicians that illustrated the
lack of odd-eighth quotes for active Nasdaq stocks. Contrary to
these press reports, this study shows that spreads had indeed
narrowed before publication of these articles (from April 28 to May
12), stabilized at these narrower levels from mid-May until June 23,
and declined again from June 23 to July 18.
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With the exception of a brief, market-wide period of
volatility experienced by stocks traded on Nasdaq, the New York Stock
Exchange, and the America Stock Exchange during the Spring, the
volatility of Nasdaq securities appears to be unchanged in the period
following implementation of the changes.
The SOES changes were designed to correct a major market quality
problem caused by the establishment in mid-1988 of: (1) a requirement
that market makers in NNM securities must participate in SOES and (2)
minimum market maker exposure limits of 5000 shares for the most active
group of NNM securities (1988 SOES changes). While the 1988 SOES
changes were intended to ensure that order entry firms could obtain
executions for their customers in volatile markets, the changes also
had the unintended consequence of dramatically changing the dynamics
and economics of intra-day trading by investors in Nasdaq.
Specifically, the assurance of automatic order execution afforded
investors through SOES spawned trading by SAT firms that resulted in
market makers receiving multiple executions in brief periods of time
without the ability to update their quotes. This rapid-fire, intra-day
trading by SAT firms increased the cost of market making and, in turn,
resulted in a dramatic widening of displayed quotation spreads as
market makers avoided the trading risks associated with the mandated
5,000-share exposure limit in SOES.
The SOES changes noted above were an attempt by the NASD to
preserve the benefits of SOES for small retail investors and eliminate
the negative market impacts created by abuses of SOES. As detailed
below, the NASD's analysis illustrates that the SOES changes have been
associated with substantive improvements in the quality of the markets
for Nasdaq securities and that these positive improvements have become
more pronounced the longer the changes have been in effect, as market
makers have adjusted their trading practices to reflect the lower costs
and risks associated with SOES trading.
As the SEC stated in the release, market factors other than SOES
changes may be jointly or singly responsible for changes in market
quality. However, market quality measures are useful in indicating
whether the SOES changes have been associated with non-negative or
positive changes in market quality. Even though cause and effect cannot
be statistically proven, as pointed out succinctly in the Release, the
absence of negative market developments associated with the
implementation of the SOES changes, coupled with the apparent positive
market improvements associated with the SOES changes, provides useful
support for the SEC's evaluation of its decision to approve the SOES
changes.
Given the SEC's prior determination that it is virtually impossible
to measure the impacts on market quality of changes in SAT firm
activity and given the applicability of the SOES changes to all NNM
securities, NASD monitoring has focused on a before-and-after analysis
of commonly accepted measures of market quality, without trying to
distinguish the impacts of trading by SAT firms. The SOES changes are
treated as a partial reversal of a microstructure change made in mid-
1988 (the 1988 SOES changes) and analyzed on a before-and-after basis.
The impacts of such structural changes do not occur completely on
the immediate day after their introduction. For example, spreads did
not widen immediately after the mandatory SOES exposure limits were put
in place in mid-1988. Rather, adjustments to such changes and their
impacts are gradual and distributed out over a period of time.
Competitive forces cannot be expected to reverse instantaneously the
quality of market conditions that evolved from microstructure
restrictions and related arrangements that were in place for nearly six
years.
Moreover, the SOES changes impact indirectly the measures of market
quality. Each change, while important, can be expected to have
different adjustment time periods. While a change in the maximum size
order permitted to be entered into SOES is immediate, changes to
market-maker exposure limits require adjustments by traders, as they
reevaluate their quotation and inventory management procedures and
their use of order-driven systems (rather than displayed quotations) to
adjust inventories. Also the new automated quotation update, permitted
after a transaction, cannot be implemented without varying time lapses
by the many different market makers.
Nonetheless some improvement in the quality of the market for
Nasdaq stocks has occurred in the period following the SOES changes.
The analysis of the impact of the SOES changes on market quality
focuses on the associated movements in Nasdaq market spreads, stock-
price volatility, volume of SOES trading, the average size of SOES
trades, and other indicators of market quality. The objective is to
determine whether any apparent changes in market quality measures
followed the reduced SOES regulations on market makers.
To evaluate the impact of these changes, the NASD established a
data set for the one-year pilot, beginning with November 11, 1993, and
including complete audit trail information for a sample of days that
includes approximately two days each month during the pilot. Although
the pilot period is not over, enough data is available to derive some
findings as to the changes in market quality that followed these SOES
changes.
Impact of the SOES Change on the Level of SOES Activity
The average daily share volume of SOES transactions and the number
of SOES trades declined sharply following the SOES changes (see Chart
1). The immediate decline in average daily SOES volume approximated 52
percent from January to February, and the decline in the number of SOES
trades was 17 percent. Moreover, the average SOES trade size declined
43 percent from January to February. The average trade size, which had
risen from 310 shares in mid-1988, when the mandatory minimum exposure
limits were instituted (see Chart 2) to 581 shares in January 1994,
dropped sharply to 332 in February.
It is the average trade size in SOES that appears to best reflect
SOES activist trader presence in the data. It is apparent from Chart 2
that SOES activists entered the market as proprietary traders
immediately after the imposition of the mandatory SOES exposure limits
in mid-1988. Because this activity violated SOES rules however, the
NASD took action to preclude such trading through SOES and they
withdrew as proprietary traders. Later, in 1989, these SAT firms began
coaching individuals to trade through SOES in a similar fashion. As a
result the average size of a SOES trade began its long uptrend in 1989,
ending in January 1994, with a resulting substantial widening of
spreads of large, actively traded stocks (See Chart 6).
Whether some SOES activist volume merely shifted to one of the many
alternative execution systems following the January 1994 SOES changes
or whether some trading activities ceased because they were only
profitable in a regulatory environment with higher market-maker
exposure requirements has not been determined. Some traders apparently
have resumed using SOES at the 500 share level even with the lower
exposure limits. This is suggested by the fact that the SOES average
trade size continues above the mid-1988 level and the decline in the
number of SOES trades was much less than the decline in SOES share
volume. SOES activist traders generally trade in the maximum order size
permitted in SOES.
Displayed Quotation Spreads
Displayed Quotation Spreads declined in the six months following
the January 31 SOES changes. The improvement in displayed spreads\9\ is
evident in the pattern of average bid/ask spreads of the largest NNM
stocks (see Chart 3). Average spreads of the largest 500 NNM stocks,
those most affected by SOES trading, appear flat immediately following
the SOES changes; but they then decline sharply (see Chart 4) as market
makers became aware of the lower risks involved in moving their
displayed spreads closer to the actual trade-to-trade price changes
that were occurring in the order-driven segments of the market. The
first sharp decline in spreads is evident between the April 28 and May
12 sample days (see Chart 4). A second sharp break occurred between the
June 23 and July 18 sample days. However spreads appear to be narrowing
throughout the post-SOES change period.
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\9\Measure of spread used is the average of the observed market
displayed spread each time a trade occurs.
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Confirmation of the improvement in displayed quotation is the
proportion of share volume occurring in stocks with closing displayed
bid/ask spreads of one-quarter or less. The percentage of volume
accounted for by such stocks fluctuated around 61 percent until May
1994, when it rose to 62.5 percent, another clear indication that
spreads were tightening (see Table 1). It rose further to 65.6 percent
in June, to 66.2 percent in July, and to 68.7 percent by September.
Additional supporting information, in Charts 5 and 6, shows SOES
average trade size and the number and percentage of NNM stocks with
end-of-day quotation spreads less than 50 cents. SOES average trade
size reflects the entry and activity of SOES activist traders. Firms
effecting proprietary trades through SOES caused the average to rise
briefly in 1988, but SOES volume attributable to individual traders
active in SOES started in 1989 and expanded until January 1994. A major
decline in the percentage of NNM stocks with end-of-month spreads less
than 50 cents per share is apparent as SOES traders took advantage of
the mid-1988 institution of the 5,000-share minimum exposure limit for
SOES active stocks. An uptrend in that percentage has emerged following
the January reduction in market-maker exposure minimums.
To examine further these quotation spread patterns, regressions
were prepared using NNM stocks grouped by various characteristics. The
regressions controlled for market factor influences on spread including
volume, stock price, and intra-day price volatility. A dummy variable
(0,1) was used to reflect the periods before (0) and after (1) the SOES
changes. Regressions were run using all NNM stocks, the largest 500 NNM
stocks, 1,000- share tier, 500-share tier and 200-share tier stocks and
stocks with a proportionate decline in SOES activity after the January
1994 changes. These regressions confirm that spreads narrowed in the
six months following the SOES changes for all groups of stocks except
for those stocks in the 500- and 200-tier categories, even after
controlling for volume, price and intra-day price volatility. For the
500-and 200-tier groups the before and after changes overall were not
statistically significant.
A negative beta coefficient for the dummy variable indicates a
decrease in spreads from the period before the changes to the periods
after the SOES changes. For the first three months after the changes,
the beta coefficient for the dummy variable is generally negative but
statistically insignificant. However, by the second three-month period
the coefficients were negative and statistically significant for all
NNM stocks, the 1,000 share tier group and the largest 500 group,
indicating that quotation spreads were indeed narrowing. Because SOES
volume for the largest 500 NNM stocks represents 65 percent to 75
percent of the total SOES volume, the significance of the statistical
results is critical for this group.
Successive regressions then were for the largest 500 group using
for each stock the average of the pre-change days, and separately the
average for each of the post-change days to observe changes in the beta
coefficient of the dummy variable. The negative value of beta depicts a
negative difference between the pre-change average spreads and the
post-change individual day observation sets for every day in the post-
change period. Beta coefficients are negative for each day and
statistically significant for each day except for February 17, April
14, April 28, and May 26, 1994.
It is clear that the changes is SOES reduced uncontrollable or
mandated market-maker risk exposure across all NNM stocks and the
changes appear to have resulted in significantly lower spreads for the
largest 500 group.
Volatility
As the SEC pointed out in the release, differentiating between the
effects on spreads and stock-price volatility attributable to active
SOES traders and the effects attributable to other factors may not be
possible. Market volatility, in particular, surges and recedes. This
makes exceedingly difficult measurement of temporary impacts on price
volatility of unnecessary market-maker risk exposures that provide
profitable trading situations to opportunistic traders.
It is apparent from the volatility of the various indexes (see
Chart 7) that dramatic changes occurred in market volatility during the
six months following the SOES changes. The average absolute value of
daily percent changes of the Nasdaq Composite Index fluctuates from
over 0.03 percent in January 1994 to practically no change in February
and March. Then it jumps to nearly 0.07 percent in April.
Substantial effort would be required to empirically sort out the
effects on volatility of the SOES changes, if indeed it is possible to
sort them out. NASD attempts to isolate these effects statistically
have not been successful. Nonetheless an analysis was performed of
stock volatility distributions on the sample days. Valatilty is
calculated by taking the standard deviation of the absolute percent
changes in the bid price. A frequency distribution of each stock's bid
volatility was constructed for each day in the analysis, and the
skewness of these distribution curves was computed.
Skewness is a measure that describes to what extent a curve
deviates from a normally distributed bell shape. The distribution of
stock volatilities is found a contain a smaller right tail in the post-
change period than in the pre-change period as evidenced from the
declining measure of skewness (see Chart 8). The smaller right tail
reflects a smaller percentage of stocks with extreme relative price
volatility in the post-change period. Also the measures of dispersion
of the individual stock volatilities are smaller for the post-change
days. These distributional differences suggest a reduction in relative
volatilities in the post-change period.
Other Considerations
Major improvements, other than the SOES changes in January 1994,
are being instituted in Nasdaq trading to enhance market quality. New
requirements affecting the handling of customer limit orders were
adopted on July 9, 1994; a shore-sale bid test took effect in early
September; and the proposed NPROVE system to replace SOES is
awaiting SEC action.
As a result, identifying the delayed impacts of the SOES changes
may not be possible beyond the first few months included here.
Conclusion
The reduction in the mandatory minimum exposure limits and SOES
order sizes, which in turn decrease market-maker risk exposure, clearly
have been associated with positive changes in market quality. In
particular, displayed spreads have narrowed. More importantly, there is
no evidence of negative impacts on market quality.
While the impacts of the SOES changes cannot be precisely
segregated from the impacts of other factors with 100 percent
certainty, the absence of negative changes in measures of market
quality and the presence of positive changes in such measures following
the introduction of the SOES changes in late January 1994 support a
conclusion that the changes resulted in improved market quality. The
higher mandated exposure requirements and larger order sizes in place
from mid-1988 to January 31, 1994, in retrospect, were not necessary
and appear to have caused wider spreads as market makers adjusted their
activities to avoid the transactions of active traders in SOES.
II. Analysis of Potential for Order Queues to Develop in
NPROVE
In a letter dated August 16, 1994, Commission staff requested that
Nasdaq provide an assessment of the potential for queues to develop and
the basis for this assessment.\10\ In a letter dated December 7, 1994,
Nasdaq responded in writing to the request. The relevant portions of
Nasdaq's letter are as follows:
\10\Letter from Katherine A. England, Assistant Director, SEC,
to Robert E. Aber, Vice President and General Counsel, Nasdaq (Aug.
16, 1994).
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In sum, as the attached graphs and tables indicate, Nasdaq
believes the potential for sustained, lengthy order queues to
develop in NPROVE for any given security is minimal.\11\ In
fact, for the days analyzed by the staff, the data shows that over
98 percent of the orders transmitted by non-SOES activist firms\12\
would have received an execution within 30 seconds. In addition,
while our analysis illustrates that queues for a given security will
develop for brief periods of time, our analysis also indicates that
these occasional queues appear likely to abate in a matter of
minutes. Moreover, and perhaps most importantly, our analysis
demonstrates that, to the extent that there would be noticeable
queues in NPROVE, these queues would be directly
attributable to a narrow segment of orders originating from SOES
activists that were transmitted in waves during discreet, short
periods of time. When these queues do develop, however, a small
percentage of retail customer orders (2 percent) may be delayed by
the queue created by the SOES activists' orders. Aside from these
episodic queues attributable to SOES activists, the data indicates
that lengthy queues in NPROVE would be rare. Accordingly,
Nasdaq does not believe it is very likely that significant, on-going
order queues will develop in NPROVE during peak volume days.
\11\To analyze the potential for order queuing in NPROVE
Nasdaq staff used actual trading data for Nasdaq's Small Order
Execution System (``SOES'') for certain trading days. To simulate
trading in NPROVE with this SOES data, the staff ``spaced
out'' the SOES orders so that, at a minimum there was at least a 15
second interval between the execution of these orders. For example,
if three orders in the same security were sent simultaneously into
SOES, fifteen seconds were inserted between the orders. In light of
the recent amendments to NPROVE submitted to the Commission
on December 1, 1994, Nasdaq notes that fifteen seconds will be the
maximum length of time it will take for an order to be executed in
NPROVE once that order becomes subject to NPROVE's
order execution methodology, although in very limited circumstances
NPROVE orders directed to a priority market maker may take
between fifteen and thirty seconds to be executed. Moreover, market
makers will have the ability to affirmatively execute against market
orders any time during the fifteen-second display period. See
Securities Exchange Act Release No. 35024 (November 29, 1994). Thus,
the insertion of fifteen seconds between SOES orders facilitates an
extremely conservative replication of how such orders would have
been processed through NPROVE.
\12\See text accompanying note 16 for the definition of a SOES-
activist firm for purposes of this study.
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In addition, Nasdaq notes that the recent proposed amendments to
NPROVE will further help to ensure that significant, on-going
order queues will not develop in NPROVE.\13\ Specifically,
under the proposed order processing methodology for NPROVE,
unpreferenced market orders entered into the system will be broadcast
to all NPROVE market makers at the applicable inside market for
acceptance within 15 seconds, with the market next in rotation for an
NPROVE execution receiving an indicator that the system will
execute the order against him should he fail to reject the order or if
no other market maker accepts the order (market orders with such
notifications appended to them are referred to as ``designated,
unpreferenced orders'' and orders without such a notification are
referred to as ``undesignated, unpreferenced orders'').\14\ If a market
maker rejects a designated, unpreferenced NPROVE order and no
other market maker accepts the order within the 15-second period, the
system will automatically execute the order against the market maker
next in rotation that has not rejected the order upon expiration of the
15 second period. If all market makers decline the order consistent
with Rule 11Ac1-1 under the Act, the order will be automatically
executed against the market maker next in rotation at the new inside
quotation. Thus, with this proposal, Rounds 1 and 2 are effectively
collapsed into one round and Round 3 is eliminated because orders
rejected by all market makers would be executed automatically at the
new inside market. Accordingly, with this one-round order processing
format, the NASD believes even more strongly that significant order
queues will not occur in NPROVE, during normal trading days or
peak volume days, and that investors will receive timely executions at
prices at or superior to the quotes displayed when they entered their
orders into NPROVE.
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\13\Id. As previously designed, the execution of unpreferenced
market and marketable limit orders through NPROVE may have
involved up to three 15-second rounds. In Round 1, an unpreferenced
order would have been routed to the market maker at the inside bid
or offer that was next in line for an NPROVE execution. The
market maker could have manually executed the order or allowed the
system to automatically execute the order after 15 seconds. If the
market maker had effected a trade (or was in the process of
executing a trade in that security) and had updated its quotation
(or was in the process of updating), it could have rejected the
unpreferenced NPROVE order. When, consistent with the
requirements of Rule 11Ac1-1 under the Act, an order was rejected by
the first market maker in rotation, the order would have entered
Round 2 and would have been automatically displayed to all remaining
market makers at the inside quote. All of these market makers would
have had the opportunity to execute the order during a 15 second
period. If no market maker manually accepted the order, it would
have been automatically executed against the first market maker in
rotation. In the unlikely event that all of these market makers had
rejected the order during Round 2 pursuant to a valid exception from
Rule 11Ac1-1, the system would have automatically executed the order
against the first market maker in rotation quoting at the new inside
market after fifteen seconds. This was called Round 3.
\14\Market orders matched against limit orders (preferenced or
unpreferenced) priced between the inside bit or offer also will be
processed pursuant to this one-round order processing procedure.
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It is important to note that our response is not intended to be a
subjective commentary on the activities of SOES activists; rather it is
an objective reflection of the source of potential order queues in
NPROVE. It is axiomatic that episodic surges in order volume on
one or the other side of the market will impact the timing and price of
execution of these orders by virtue of fundamental economic principles
of supply and demand.
Following is a more detailed description of the attached graphs and
tables and the analytical process Nasdaq used to reach its conclusion
that significant order queuing likely will not occur with
NPROVE.
To analyze potential order queuing in NPROVE, the staff
examined SOES activity on two trading days--February 4, 1994 and July
13, 1994\15\ Exhibit 1 contains charts that provide aggregate data on
the extent to which order queuing would have occurred in NPROVE
on these days. Specifically, the charts identify all NASD members that
transmitted more than 50 orders into SOES on these days, with a
breakdown of how many of these orders would have been executed within
30 seconds, between 30 and 45 seconds, between 45 seconds and one
minute, and longer than a minute if NPROVE were in operation.
On February 4, 93 percent of these orders would have been executed with
30 seconds, and on July 13, 77 percent of the orders would have been
executed within 30 seconds. The staff also used these charts to
identify firms that are considered to be SOES activists. Specifically,
if a firm's ``OLIM'' percentage was greater than 75 percent it was
identified as a SOES activist.\16\ By differentiating between SOES
activists and non-activists, the staff was able to produce the summary
statistics at the bottom of the charts in Exhibit 1. These statistics
demonstrate that orders entered by SOES activists would have
experienced greater delays in execution than orders entered by non-
activists. Specifically, on February 4, 99.3 percent of all orders
entered by non-activists would have been executed within 30 seconds,
while 80.7 percent of all orders entered by SOES activists would have
been executed within 30 seconds. Similarly, on July 13, 98.4 percent of
all orders entered by non-activists would have been executed with 30
seconds, and 63.7 percent of all SOES activists' orders would have been
executed within 30 seconds.
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\15\On February 4, 1994, total Nasdaq share volume was
376,034,700 shares and on July 13, 1994, total Nasdaq share volume
was 342,162,600 shares. Both of these days were identified in your
August 16, 1994 letter as high volume days.
\16\``OLIM'' indicates the percentage of the firm's SOES order
that were entered at the maximum order size.
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Based on the finding illustrated in the charts in Exhibit 1 that
orders entered by SOES activists constitute the vast majority of orders
that would experience queues, the staff then identified those stocks
that received the highest number of orders from SOES activists that
would have been queued. Specifically, the tables in Exhibit 2 identify
those stocks that received more than 20 orders from SOES activists that
would have been queued. The staff then conducted a more detailed,
stock-by-stock analysis of the four ``top'' stocks on each of these
days.\17\ This analysis, as reflected in the NPROVE Order
Traffic & NPROVE Order Queues'' graphs contained in Exhibit 3,
reveals that the queues in these stocks would have occurred in
discreet, short-term clusters throughout the day, not in a random
fashion. The multi-colored bars in these graphs also illustrate that
orders entered by non-activists would only experience queuing when they
are tangled up in a queue created by a SOES activist. With the
exception of these isolated queues, the graphs also clearly illustrate
that orders entered by non-activists and activists would not have
experienced queuing throughout the remainder of the day. In addition,
as would be expected, the ``NPROVE Order Traffic'' graphs in
Exhibit 3 illustrate that these queues would have coincided with spikes
in transaction volume.
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\17\Specifically, the four stocks identified on February 4, 1994
were: (1) Lotus Development (LOTS); (2) DSC Communications Corp.
(DIGI); (3) 3COM Corp. (COMS); and (4) Cisco Systems, Inc. (CSCO).
The four days identified on July 13, 1994 were: (1) COMS; (2) Altera
Corp. (ALTR); (3) Adobe Systems, Inc. (ADBE); and (4) Microsoft
Corp. (MSFT).
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Accordingly, Nasdaq believes this information, along with the
NASD's proposed revisions to NPROVE to collapse the three
rounds of NPROVE order processing into one, illustrate that
queuing in NPROVE will not occur for sustained periods of time
in any one security and that only a very small percentage of retail
customer orders will be exposed to the risk that the market could move
against them while they are pending in NPROVE. In sum Nasdaq
believes the benefits that will be afforded small retail investors
through the price improvement and limit order protection features of
NPROVE, as well as the improvements to the integrity,
liquidity, and stability of Nasdaq that NPROVE likely will
produce, far outweight the potential costs to investors that may arise
from sporadic, short-lived order queues in NPROVE.\18\
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\18\Letter from Robert E. Aber, Vice President and General
Council, Nasdaq, to Katherine England, Assistant Director, SEC (Dec.
7, 1994).
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III. 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, DC 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 Numbers SR-NASD-94-13 and/or
SR-NASD-94-68 and should be submitted by January 6, 1995.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\19\
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\19\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-30915 Filed 12-15-94; 8:45 am]
BILLING CODE 8010-01-M
