[Federal Register Volume 64, Number 233 (Monday, December 6, 1999)]
[Notices]
[Pages 68125-68136]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-31527]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-42166; File No. SR-NASD-99-53]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc. and
Amendment Nos. 1 and 2 Thereto Relating to the Establishment of the
Nasdaq Order Display Facility and Modifications of the Nasdaq Trading
Platform
November 22, 1999.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'' or ``Exchange Act''),\1\ and Rule 19b-4
[[Page 68126]]
thereunder,\2\ notice is hereby given that on October 1, 1999, the
National Association of Securities Dealers, Inc. (``NASD'' or
``Association''), 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, II, and III below, which Items have been
prepared by Nasdaq. On October 26, 1999, Nasdaq filed Amendment No. 1
to the proposal.\3\ On October 29, 1999, Nasdaq filed Amendment No. 2
to the proposal.\4\ The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Thomas P. Moran, Assistant General Counsel,
NASD Regulation, to Richard Strasser, Assistant Director, Division
of Market Regulation (``Division''), Commission (October 26, 1999)
(``Amendment No. 1''). In Amendment No. 1, the NASD makes technical
and clarifying amendments to the proposed which are incorporated in
this notice. Additionally, the NASD amended the proposed rule
language to clarify that certain provisions of the proposal are
contingent upon other proposals that are pending before the
Commission.
\4\ See letter from John F. Malitzis, Assistant General Council,
NASD Regulation, to Richard Strasser, Assistant Director, Division,
Commission (October 29, 1999) (``Amendment No. 2''). Amendment No. 2
clarifies that the Nasdaq staff has consulted the NASD Regulation
staff with respect to the proposal rule change pursuant to the Plan
of Allocation and Delegation of Functions by NASD to Subsidiaries.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
Nasdaq proposes to enhance its quotation montage by creating a new
venue for the display of trading interest, called the Nasdaq Order
Display Facility. Additionally, this proposed rule change would
substantially modify the proposed Nasdaq National Market System
(``NNMS'').\5\
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\5\ See Exchange Act Release No. 41296 (April 15, 1999), 64 FR
19844 (April 22, 1999) (Notice for File No. SR-NASD-99-11 proposing
to functionally integrate the Small Order Execution System
(``SOES'') and SelectNet to become the foundation of the NNMS.)
(hereafter ``SR-NASD-99-11'' or ``SOES/SelectNet Integration'').
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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 my be examined at the places specified in Item
IV 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
1. Purpose
Nasdaq proposes to enhance its quotation montage and current
trading platforms, SelectNet and SOES. This proposed rule change is
contingent, and would expand upon Nasdaq's proposals to (1) establish
agency quotations;\6\ and (2) functionally integrate SOES and SelectNet
that are currently pending before the Commission.\7\ In particular,
Nasdaq proposes the following changes.
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\6\ See Exchange Act Release No. 41128 (March 2, 1999), 64 FR
12198 (March 11, 1999) (Notice for SR-NASD-99-09 proposing to permit
market makers to have a second market maker ID (``MMID'') for the
purpose of separately displaying agency and proprietary quotes.)
(Hereafter ``SR-NASD-99-09'' or ``Agency Quote Proposal'').
\7\ See note 5, above.
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A. New Nasdaq Order Display Facility
Under the proposal, Nasdaq will add a new display to the Nasdaq
Workstation II (``NWII'') called the Nasdaq Order Display Facility,
which would show the best bid/best offer in Nasdaq and two price levels
away, accompanied by the aggregate size at each price level of the
``displayed'' trading interest of market makers, electronic
communication networks (``ECN''), and Unlisted Trading Privilege
(``UTP'') Exchanges.\8\ As explained in greater detail below, Nasdaq
market makers and ECN's that are NASD members (``Nasdaq Quoting Market
Participants'') will be able to display their quotes/orders anonymously
at these price levels in the Nasdaq Order Display Facility, which
should encourage the display of greater trading interest.
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\8\ A ``UTP Exchange'' is an exchange that is a signatory to the
Joint Self-Regulatory Organization Plan Governing the Collection,
Consolidation and Dissemination Of Quotation and Transaction
Information For Exchange-Listed Nasdaq/National Market System
Securities Traded On Exchanges On An Unlisted Trading Privilege
Basis (``UTP Plan'' or ``Nasdaq UTP Plan''). As of September 1,
1999, there were four members of the Nasdaq UTP Plan. In addition to
the NASD, the UTP Plan participants included the Boston Stock
Exchange, the Chicago Stock Exchange (``CHX''), and the Philadelphia
Stock Exchange. Of these, only the CHX has established an interface
with the NASD/Nasdaq. The Cincinnati Stock Exchange is currently in
the process of becoming a member of the UTP Plan and the Pacific
Exchange has indicated its intent to commence this process.
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B. Enhanced Electronic Access to the Best Price in Nasdaq
Under the proposal, market participants would be able to
electronically access the best prices in the Nasdaq Order Display
Facility using a substantially modified and enhanced version of
Nasdaq's proposed NNMS trading platform. Specifically, Nasdaq would
provide order delivery or automatic execution against the best prices
displayed in the Nasdaq Order Display Facility based on the manner in
which the market participant receiving the order participates in
Nasdaq. Nasdaq would continue to offer market participants the ability
to electronically negotiate transactions with specific market makers.
C. Delivery of Multiple Quotes/Orders to Nasdaq
Under the proposal, Nasdaq would allow (but not require) Nasdaq
Quoting Market Participants to give the Nasdaq system multiple quotes/
orders at single as well as multiple price levels. These markets
participants may submit multiple agency and principal quotes/orders at
multiple price levels, instead of a single quote at one price level.
The proposed system will be able to accommodate the Agency Quote
concept proposed in SR-NASD-99-09.\9\ Nasdaq would display such trading
interest on the NWII consistent with the parameters (price, anonymity/
attribution) of the quotes/orders and the current market. Although
Nasdaq would accept multiple quotes/orders at various price levels
which may be displayed on a non-attributed basis in the Nasdaq Order
Display Facility if within the top three price levels in Nasdaq, the
Nasdaq Quotation Montage would display one MMID per ECN and market
maker.\10\ This functionality should allow Nasdaq to assist market
participants with the management of their back book. Nasdaq believes
that this functionality should, in turn, make it easier for ECNs to
participate in automatic execution, and will assist Nasdaq Quoting
Market Participants in complying with the SEC's Order Handling Rules
(``Order Handling Rules'' or ``OHR''). Nasdaq also believes that this
functionality will reduce the potential for the market to trade through
orders that a market maker or ECN is holding in its back book.
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\9\ See note 6, above.
\10\ If SR-NASD-99-09 is approved, however, a market maker would
also be able to display one Agency Quote MMID in the Nasdaq
Quotation Montage. UTP Exchanges would continue to transmit to, and
display in, Nasdaq a single, two-sided quotation.
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D. Order Collector Facility
Under the proposal, Nasdaq will create an Order Collector Facility
(``OCF''), which would serve as a single
[[Page 68127]]
point of order entry and single point of delivery of Liability Orders
and executions.\11\ Specifically, to access the best-priced quotes/
orders, a market participant would be required to enter an order into
the OCF, which would deliver either an automatic execution or a
Liability Order to the next market maker, ECN, or UTP Exchange
(``Quoting Market Participant'') in the queue. The OCF would determine
whether to deliver an order or an execution based on the manner in
which the market participant receiving the order participates in the
Nasdaq market (e.g., automatic execution for market makers, automatic
execution for ECNs that agree to participate in the automatic-execution
functionality of the system, order delivery for ECNs that choose to
take order delivery, and order delivery for UTP Exchanges). Nasdaq
believes that this should ensure efficient and expeditious routing of
orders and executions, while eliminating the potential for dual
liability that market markers currently face in Nasdaq. The proposed
changes described herein build upon those proposed in SR-NASD-99-11 and
would create the next generation Nasdaq trading platform.\12\ By
creating the OCF as the single point of order entry and the single
point of delivery of executions and orders, Nasdaq believes that the
proposal should fully integrate its two current trading systems,
SelectNet and SOES, from the end user's perspective.
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\11\ For purposes of this filing, the term ``Liability Order''
shall mean an order to which an ECN, market maker, or UTP Exchange
Specialist, owes a firm quote obligation under Exchange Act Rule
11Ac1-1 (``Liability Order''). See 17 CFR 240.11Ac1-1.
\12\ See note 5, above.
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E. Other Enhancements/Rule Changes
Other enhancements that Nasdaq is proposing to its current trading
environment include the addition of an odd-lot processing facility, and
the modification of current procedures that apply to a market maker's
failure to update its quote after being decremented to zero (commonly
referred to as ``SOESed-out-of-the-Box'' in the present system
architecture).
1. Background
As an equity market, Nasdaq collects, aggregates and displays pre-
trade information simultaneously to all market participants. This pre-
trade information currently takes the form of a quote, which represents
a single (or an aggregate of same-priced) agency or principal order(s).
Nasdaq also provides trading platforms through which market
participants may access the liquidity displayed in the Nasdaq
marketplace.
Nasdaq believes that the manner in which it currently collects,
aggregates and displays pre-trade information is not functionally
optimized presently, thus limiting the efficiency of Nasdaq's execution
services and increasing the relative cost of using those services. This
is due, in part, to the way market participants transmit pre-trade
information to Nasdaq. Presently, Nasdaq Quoting Market Participants
(i.e., ECNs and market makers who are NASD members) transmit quotation
information to Nasdaq, which may represent multiple agency or principal
orders that the participant has aggregated into a single quote, or may
represent only a single agency order or principal order. When Nasdaq
receives a quote, it cannot discern whether that quote represents a
single order or multiple orders at one price. Also, Nasdaq Quoting
Market Participants can only send Nasdaq a single, two-sided principal
quote (although in the future market makers may also be able to send a
single, one or two-sided Agency Quote to Nasdaq). Nasdaq believes that
the current inability of Nasdaq Quoting Market Participants to submit
to Nasdaq quotes or orders at multiple price levels has made compliance
with the OHR \13\ difficult, because participants cannot leave their
limit orders with Nasdaq for display when required by SEC rules.\14\
Nasdaq also believes that during fast market conditions this inability
to display a customer limit order without adjusting the Nasdaq Quoting
Market Participant's quote has resulted in limit orders being traded
through because the Nasdaq Quoting Market Participant cannot transmit
to Nasdaq quickly enough a revised quote representing such limit order.
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\13\ See Exchange Act Release No. 37619A (September 6, 1996), 61
FR 48290 (September 12, 1996).
\14\ See Exchange Act Rules 11Ac1-1, 17 CFR 240.11Ac1-1 (``Firm
Quote Rule'') and 11Ac1-4, 17 CFR 240.11Ac1-4 (``Limit Order Display
Rule'').
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Nasdaq believes that these developments, in turn, have led to the
proliferation of ECNs, which accept multiple price levels of orders and
display those orders when they become the best market in the ECN.
Nasdaq believes that while this has assisted market makers in meeting
their quotation and limit order display obligations under the OHR,\15\
it has led to increased fragmentation of pre-trade information.
Moreover, with the recent adoption of Rule 3b-16 under the Act \16\ and
the implementation of Regulation ATS,\17\ alternative trading systems
(``ATS'') that currently participate as ECNs in Nasdaq and are NASD
members/broker-dealers, may now register as exchanges and directly
compete for Nasdaq market share, as well as company listings. In short,
Nasdaq believes that the revolutionary changes in U.S. equity markets
spurred by dramatic shifts in the regulatory landscape and plummeting
technology costs have introduced novel challenges to Nasdaq. Nasdaq
believes that it is critical that Nasdaq be able to compete on the same
terms and offer the same services as it competitors. Nasdaq believes
that to do otherwise would render meaningless the concepts of fair
competition among markets and equal regulation, which would be contrary
to the clear mandates and proscriptions of the Exchange Act.
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\15\ See id.
\16\ 17 CFR 240.3b-16.
\17\ See Exchange Act Release No. 40760 (Dec. 8, 1998), 63 FR
70844 (Dec. 22, 1998) (``Regulation ATS'').
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To address the issue of fragmentation as well as the competitive
concerns, Nasdaq proposes to modify the display in the NWII and
Nasdaq's trading platforms. This proposed rule change builds upon, and
is contingent on the functional integration of SOES/SelectNet proposed
in SR-NASD-99-11 and should result in a substantially enhanced NNMS
trading platform. This proposed rule change also incorporates the
concept of a market maker agency quote proposed in SR-NASD-99-09.
2. Nasdaq Order Display Facility
Today, the NWII presentation is split into two primary display
components. The top portion of the NWII contains, among other things:
(1) the Market Minder Window, which allows market participants to
monitor price activity (inside bid/offer and last sale) of selected
stocks; and (2) the Dynamic Quote Window, which shows for a particular
stock the inside bid and offer, the last sale, change in price from
previous close, daily high and low, volume, and the short sale arrow
indicator. The bottom portion of the NWII contains the ``Nasdaq
Quotation Montage.'' The Nasdaq Quotation Montage shows for a
particular stock two columns (one for bid, one for offer), under which
is listed the MMIDs for each registered market maker, ECN, and UTP
Exchange in the stock and the corresponding quote (price and size) next
to the related MMID. Nasdaq ranks the bids and offers along with the
corresponding MMID in price/time priority. Accordingly, the market
participant at the best bid who is first in time appears first in the
montage, the
[[Page 68128]]
market participant at the best bid (or the next best bid) who is next
in time is ranked second, and so forth.
Market makers are required to submit a two-sided principal
quote,\18\ and ECNs that participate in Nasdaq may submit a one or two-
sided quote.\19\ UTP Exchanges that have an interface with Nasdaq are
required under the UTP Plan to submit to Nasdaq to two-sided quote,
which represents the exchange specialist's best quote in the stock at
issue. While a market maker's quoted price and size is attributed to
the market maker by the corresponding MMID, this may not represent the
market maker's best price if the market maker has placed a better
priced order into an ECN that complies with the Display Alternative in
Exchange Act Rule 11Ac1-4.\20\ Accordingly, market maker may be
displaying in the Nasdaq Quotation Montage a proprietary bid of $20
when the market is $20 1/8 to 20 1/4, but the market maker may be
displaying in a qualifying ECN a bid of $20 1/16. The $20 1/16 quote
may only be seen by subscribers of the ECN in which the market maker
has placed the order and is not visible to the Nasdaq system or Nasdaq
market participants unless and until $20 1/16 becomes the best bid in
the ECN or the best bid price moves in Nasdaq to $20 1/16.
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\18\ See NASD Rule 4613.
\19\ See NASD Rule 4623.
\20\ Exchange Act Rule 11Ac1-4 requires an OTC market maker to
make publicly available any superior prices that the market maker
privately quotes through an ECN. A market maker may comply with this
requirement by changing its quote to reflect the superior price or,
in the alternative, may deliver better priced orders to an ECN
provided that the ECN meets the ``Display Alternative'' in Exchange
Act Rule 11Ac1-4(c)(5). The Display Alternative states that a market
maker is not required to update its quote in Nasdaq if it is
displaying a better-priced order in an ECN if the ECN disseminates
these priced orders to the public quotation system and provides
broker-dealers equivalent access to these orders. Nasdaq market
makers currently utilize SelectNet to access ECN quotes.
Additionally, other investor protection rules, such as the Manning
Rule, will continue to apply to this facility.
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a. Enhanced Display of Trading Interest. Nasdaq proposes to add the
Nasdaq Order Display Facility, which would be displayed in the top
portion of the NWII. Nasdaq would retain the Nasdaq Quotation Montage
and the functionality it currently provides--the display of market
maker, ECN and UTP Exchange attributable quotes ranked in price/time
priority. The Nasdaq Order Display Facility would display the three
best price levels in Nasdaq on both the bid and offer side of the
market. Each price level will be updated and will display the aggregate
size of ``displayed'' trading interest (``attributable'' and ``non-
attributable,'' as explained below) at each price level.
Nasdaq Quoting Market Participants would be required to designate a
quote/order as ``attributable'' or ``non-attributable,'' \21\ and would
be able to indicate a reserve size for the quote/order.\22\ If an order
is ``attributable,'' the price and size of the order would be displayed
next to the Nasdaq Quoting Market Participant's MMID in the Nasdaq
Quotation Montage (assuming this is the Quoting Market Participant's
best-priced attributable order). Attributable orders or quotes would be
displayed in the Nasdaq Order Display Facility as part of the aggregate
trading interest when the price of the quote/order is within the best
three price levels (on either side of the market) in Nasdaq.
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\21\ A Nasdaq Quoting Market Participant must designate a quote/
order as either attributable or non-attributable. For purposes of
this filing, both attributable and non-attributable quotes/orders
are considered ``displayed orders'' since they are displayed in the
Nasdaq system and have the potential for being viewed in the NWII by
market participants.
\22\ The ``reserve size'' feature allows a Nasdaq market maker
on ECN, or a customer of either to display publicly part of the full
size of its order or interest with the remainder held in reserve on
an undisplayed basis to be displayed in whole or in part as the
displayed part is executed.
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Alternatively, if a Nasdaq Quoting Market Participant designates a
quote/order as ``non-attributable,'' it will be displayed in the Nasdaq
Order Display Facility as part of the aggregate trading interest when
the price of the quote/order is within the best three price levels.
That order or quote would not, however, be displayed in the Nasdaq
Quotation Montage next to the Quoting Market Participant's MMID. Thus,
Nasdaq believes that Nasdaq Quoting Market Participants would be able
to use a Nasdaq facility to display trading interest to the market
anonymously, without attribution to its MMID, and still be in
compliance with Exchange Act Rules 11Ac1-1 and 11Ac1-4.\23\
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\23\ 17 CFR 240.11Ac1-1 and 17 CFR 11Ac1-4.
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Market markers be required to publish in the Nasdaq Quotation
Montage a two-sided quote that is attributed to its MMID. \24\ Nasdaq
believes, however, that the Nasdaq Order Display Facility meets the
requirements of Exchange Act Rule 11Ac1-4. \25\ Thus, Nasdaq believes
it would be consistent with Exchange Act Rule 11Ac1-4 \26\ for a Nasdaq
market marker to give the system a non-attributable principal quote/
order that is priced better than its attributable quote/order displayed
in the Nasdaq Quotation Montage and display that non-attributable
quote/order only in the Nasdaq Order Display Facility without updating
its attributable quote/order in the Nasdaq Quotation Montage.\27\
Nasdaq also believes it would also be consistent with Exchange Act
Rules 11 Ac1-1 and 11Ac1-4 \28\ for a market maker that receives a
customer limit order that is priced better than the market marker's
attributable quote/order in the Nasdaq Quotation Montage, to designate
that limit order as non-attributable and display it only in the Nasdaq
Order Display Facility. Nasdaq notes that this arrangement and
treatment of the limit order must be consistent with the market maker's
best execution obligations and understanding with the customer.
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\24\ See proposed NASD Rule 4613(d). Additionally, Nasdaq will
display in the Nasdaq Quotation Montage only one MMID (two sided)
and one Agency MMID (one or two sided) for each market maker and one
MMID per ECN. See proposed NASD Rule 4707.
\25\ 17 CFR 240.11Ac1-4.
\26\ Id.
\27\ Nasdaq believes that the Nasdaq Order Display Facility
meets the requirements of the Display Alternative, Exchange Act Rule
11Ac1-4(c)(5). That is, if a market maker displays in the Nasdaq
Order Display Facility a non-attributable principal or agency
interest that is priced better than its attributable quote/order in
Nasdaq Quotation Montage, this would be consistent with Exchange Act
Rule 11Ac1-4(c)(5) because the better-priced non-attributable quote/
order will be displayed in Nasdaq once it is at the best bid/best
offer or two price levels away. Additionally, the prices in the
Nasdaq Order Display Facility will be accessible through Nasdaq's
traditional execution systems, thus providing equivalent access to
the quote. Nasdaq notes that if a market marker were to place an
order into a qualifying ECN, that order would not be displayed in
Nasdaq until it was at the top of the ECN's file. In the proposed
Nasdaq system, however, the market maker's order in the Nasdaq order
Display Facility will be displayed when it is within the best three
price levels on either side of the market.
The NASD believes that the Nasdaq Order Display Facility reduces
fragmentation and increases transparency in that quotes/orders that
might not be displayed to the market because they are in an ECN and
not at the top of the ECN's book, may now be displayed in Nasdaq.
\28\ 17CFR 240.11Ac1-1 and 17 CFR 240.11Ac1-4.
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b. Reserve Size. This proposal also would permit Nasdaq market
makers and ECNs to use reserve size. Reserve size, under the proposal,
would work in virtually the same manner as proposed in SR-NASD-99-
11.\29\ Specifically, reserve size could apply to a market maker's
principal or agency quote, and the market maker would be required to
display (either as attributable or non-attributable) 1,000 shares.
Reserve size would replenish displayed size (attributable or non-
attributable) by at least 1,000 shares (or a greater default amount)
once displayed size is decremented to zero. Reserve size along with
displayed (both attributable and non-attributable) size would be
accessible through Nasdaq's trading
[[Page 68129]]
platform. Reserve size, however, would not be displayed in either the
Nasdaq Order Display Facility or the Nasdaq Quotation Montage. As
described in the Order Execution Algorithm section of this filing,
Nasdaq would access reserve size after all displayed size at a given
price in the Nasdaq market is exhausted.
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\29\ See proposed NASD Rule 4710. Also see note 5, above.
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Next, a special MMID (to be named in the future, but for purposes
of this filing ``SIZE'') that represents the aggregate size of the
best-priced non-attributable bid quotes/orders and separately the best-
priced non-attributable offer quotes/orders in the system would be
displayed in the Nasdaq Quotation Montage, along with the other MMIDs
for the Quoting Market Participants displaying attributable size. There
would be one ``SIZE'' MMID for the bid and the offer side of the
market.\30\ Nasdaq believes that the ``SIZE'' MMID is necessary to
properly calculate and disseminate the Nasdaq best bid and best offer
(``BBO'') along with the accompanying market center over Nasdaq Level 1
Service and National Quotation Data Service (``NQDS'').\31\
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\30\ The aggregate size of the best bid/best offer displayed in
the Nasdaq Order Display Facility will equal the sum of the
individual sizes of the MMIDs at the best bid/best offer displayed
in the Nasdaq Quotation Montage and the size of the SIZE MMID when
that MMID is at the best bid/best offer.
\31\ Nasdaq Level 1 Service provides the inside bid/offer
quotations and identifies the market center at the best bid/best
offer based on an algorithm set out in the Nasdaq UTP Plan. See NASD
Rule 7010 and Nasdaq UTP Plan, Section VI, Paragraph C, Subparagraph
1. NQDS provides individual market maker quotes, Level 1 Service,
and last sale information. See id. The SIZE MMID will be used in
determining the best bid/best offer and corresponding market center
for purposes of Level 1 and UTP.
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Nasdaq would also provide a ``Summary Scan'' functionality as part
of the Nasdaq Order Display Facility. The Summary Scan feature would be
a query-only functionality that would provide a look at the total
displayed size (attributable and non-attributable) for all levels below
the three price levels in the Nasdaq Order Display Facility. The
Summary Scan would anonymously display interest (attributable and non-
attributable) at each price level on both sides of the market, but
would not be dynamically updated.
In essence, under the proposal the Nasdaq Quotation Montage would
represent all trading interest that a Quoting Market Participant wishes
to attribute to its MMID. This section may be viewed as a way for
Quoting Market Participants to advertise their trading interests, which
may be at the inside market or one or more ticks away. This section
should be useful for market participants who wish to trade a block or
large size at a price that is one or more ticks away from the market.
The Nasdaq Order Display Facility would allow Nasdaq Quoting Market
Participants to display size to the market anonymously, which should
minimize certain risks that a market participant encounters when large
size is attributable to its MMID. By allowing for the anonymous display
of size to the market and by providing a facility that Nasdaq believes
complies with the OHR, Nasdaq believes that the Nasdaq Order Display
Facility should encourage Nasdaq Quoting Market Participants to show
greater size and thereby increase transparency. Finally, Nasdaq
believes that reserve size should benefit the market by allowing Nasdaq
Quoting Market Participants to show the Nasdaq system back-book trading
interest, but not the market in general. This feature should minimize
potential market impact of displaying very large size, while enhancing
liquidity since reserve size will be electronically accessible.
Below is a schematic of the proposed modified display of the
NWII.\32\
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\32\ The description of the proposed modified display of the
NWII that follows was submitted by the NASD pursuant to a telephone
conversation between John F. Malitzis, Assistant General Counsel,
NASD Regulation and Marc McKayle, Attorney, Division, Commission on
November 19, 1999.
[[Page 68130]]
[GRAPHIC] [TIFF OMITTED] TN06DE99.000
In the above schematic, there are 9,000 shares at the inside bid of
$20. The Nasdaq Quotation Montage shows three Nasdaq Quoting Market
Participants--MMA, showing market maker A's proprietary quote, [email protected],
showing market maker B's agency quote, and ECN1--with attributable
orders/quotes having a total size of 3,300 shares. The Nasdaq Quotation
Montage also shows the SIZE MMID, which is displaying non-attributable
orders/quote with a total size of 5,700 shares. Thus, the total number
of attributable and non-attributable orders/quotes at the inside bid is
9,000 shares. The system rolls up into the Nasdaq Order Display
Facility (in the top portion of the NWII) the total number of
attributable and non-attributable orders, and shows in the top box an
aggregate of 9,000 shares at $20 (the inside bid).
At the $19.95 level on the bid side of the market, the Nasdaq
Quotation Montage shows four Nasdaq Quoting Market Participants--MMB,
ECN2, ECN3, and [email protected] attributable orders/quotes having a
total size of 3,100 shares. The Nasdaq Order Display Facility in the
top portion of the NWII shows that there are a total of 15,000 shares
at the $19.95 level, of which 3,100 are attributable orders/quotes
(which are identified in the Nasdaq Quotation Montage by MMID). The
remaining 11,900 shares represent non-attributable orders/quotes at the
$19.95 level which are not displayed in the Nasdaq Quotation Montage;
and/or attributable orders/quotes residing in the system for Nasdaq
Quoting Market Participants who are displaying a superior priced
attributable order/quote (e.g., MMA, who is at the inside bid of $20,
could also have an attributable order/quote at the $19.95 level, which
is aggregated into the second box in the Nasdaq Order Display Facility,
but is not displayed next to MMA's MMID unit MMA's $20 attributable
order/quote is filled). There is no SIZE MMID at $19.95 because such an
MMID would only display the best priced non-attributable orders/quotes,
which on the bid side of the market in the above schematic are
currently priced at $20 (i.e., there is only one SIZE MMID for each
side of the market, and it displays the best priced non-attributable
orders on each side). If $19.95 became the best bid, the SIZE MMID
would be displayed in the Nasdaq Quotation Montage and would show all
non-attributable orders/quotes at that price level.
3. Order Collector Facility
To further enhance the Nasdaq trading platform, Nasdaq proposes to
implement an OCF which would do the following: (1) transmit to Nasdaq
multiple quotes/orders and/or quotes/orders at multiple price levels by
Nasdaq Quoting Market Participants; (2) provide a unified point of
entry of orders into the Nasdaq system to access quotes/orders
displayed (as either attributable or non-attributable) in both the
Nasdaq Order Display Facility and the Nasdaq Quotation Montage; and (3)
provide a single point of delivery to Quoting Market Participants of
Liability Orders, which should eliminate all potential for dual
liability. Nasdaq believes that this proposed provision should
substantially enhance and modify its current architectures as well as
the NNMS trading platform proposed in SR-NASD-99-11, by overlaying the
OCF with the enhanced architecture to create a single point of order
entry and delivery for the end user.
a. Entry of Quotes/Orders. Nasdaq proposes to allow Nasdaq Quoting
Market Participants to transmit multiple quotes/orders and quotes/
orders at multiple price levels, which the system would manage and
display in Nasdaq (in the Nasdaq Order Display Facility
[[Page 68131]]
and/or in the Nasdaq Quotation Montage) consistent with an order's/
quote's parameters.
As noted previously, Nasdaq believes that Nasdaq Quoting Market
Participants encounter certain difficulties in managing their books,
because participants currently may only transmit a single quote (which
may represent a single order or an aggregate of principal/agency
interest at a single price). Nasdaq believes that, in addition to the
problems Nasdaq Quoting Market Participants ace, this limitation also
raises competitive concerns and limitations for Nasdaq and the services
it provides.
To remedy this situation, Nasdaq proposes to allow certain Nasdaq
Quoting Market Participant to give Nasdaq multiple principal and agency
orders or quotes at single as well as multiple price levels.\33\ Nasdaq
would time stamp each quote/order upon receipt, and the time stamp will
determine the quote's/order's ranking for automated execution purposes.
Additionally, as noted above, a Nasdaq Quoting Market Participant would
designate a quote/order as either attributable or non-attributable, and
could designate a reserve size. Nasdaq will aggregate in its system all
of a Nasdaq Quoting Market Participant's attributable and non-
attributable quotes/orders at a particular price level, which would
thereafter be disseminated into the Nasdaq Order Display Facility and/
or the Nasdaq Quotation Montage. For no-attributable quotes/orders,
Nasdaq would display the aggregate size of such quotes/orders in the
Nasdaq Order Display Facility when the quotes/orders fall within the
three top price levels (on either side of the market) in Nasdaq. For
attributable quotes/orders, Nasdaq would display the aggregate size of
such quotes/orders in the Nasdaq Quotation Montage, once the quote(s)/
order(s) at a particular price level becomes the market maker's best
attributable bid or offer in the bottom portion of the montage. (As
noted previously, market makers would still only display one MMID, and
possibly an agency MMID, in the Nasdaq Quotation Montage.)\34\ Nasdaq
Quoting Market Participants would have the option to forward their
``top of file'' as a single quote, instead of multiple quotes/orders at
multiple price levels, as they do today. That is, a market maker could
continue to send only its best bid/best offer to Nasdaq, and an ECN
could continue to send Nasdaq only its top of file and be accessed via
order delivery.
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\33\ This functionality will not be available to Quoting Market
Participants who are not NASD members (e.g., UTP Exchanges/Non-NASD
member ATSs).
\34\ If a market participant has an Agency Quote, attributable
quote/order or quotes/orders will be displayed once the quotes/
orders at a particular price level become the market participant's
best Agency Quote.
---------------------------------------------------------------------------
For example, assume if MMA sends Nasdaq five 1,000 share
attributable buy orders at $20 and two 1,000 share non-attributable buy
odes at $20, for total interest of 7,000 shares to buy at $20. Assume
further than $20 becomes the best bid and MMA is alone at the inside
bid. Nasdaq would aggregate all of the orders in the system and display
them as follows: 7,000 shares in the Nasdaq Order Display Facility;
5,000 shares (the attributable portion) in the Nasdaq Quotation Montage
next to MMA's MMID; and 2,000 (the non-attributable portion) in the
``SIZE'' MMID.
Nasdaq believes that the ability to transmit to Nasdaq multiple
orders at varying prices (instead of displaying interest under a single
quote) should provide many benefits to Nasdaq market makers and ECNs.
First, it should ensure compliance with the OHR, and in particular the
Limit Order Display and Firm Quote Rules.\35\ Additionally, Nasdaq
believes that it prevents any chance that a Nasdaq Quoting Market
Participant, because of system delays and/or fast moving markets will
miss a market because the participant is unable to quickly transmit to
Nasdaq a revised quote (which may represent a limit order).
Additionally, Nasdaq intends to include in the new system a ``request a
cancel'' functionality. Under this feature where a Nasdaq Quoting
market Participant will be required to request Nasdaq to cancel an
order before the order is removed from the Nasdaq system.\36\ The
request to cancel feature, along with the ability to leave orders with
Nasdaq, should benefit ECNs by allowing them to participate in
automatic execution while minimizing the potential for double liability
or taking on a proprietary position.\37\
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\35\ See Exchange Act Rules 11Ac1-1, 17 CFR 240.11Ac1-1, (``Firm
Quote Rule'') and 11Ac1-4, 17 CFR 240.11Ac1-4, (``Limit Order
Display Rule'').
\36\ If the order has already been executed or is in the process
of being executed, the request to cancel may be declined.
\37\ Nasdaq represents that ECNs do not currently participate
in SOES because of the potential for dual liability and assuming
proprietary positions. For example, if an ECN were to match orders
between two subscribers and contemporaneously receive an execution
from SOES against its quote, the ECN would be required to honor both
the internal execution and the SOES execution, effectively requiring
the ECN to take on a proprietary position. Dual liability does not
arise in SelectNet because that system delivers an order (message)
which can be declined if the ECN, after scanning its book,
determines that the quote in Nasdaq was taken out by an internal
execution. (An ECN cannot decline a SOES execution because the
system delivers an execution, as opposed to an order.) Under this
proposal, an ECN has the ability to give quotes/orders to Nasdaq. If
an internal subscriber wanted to access an order in an ECN that is
also being displayed in Nasdaq, the ECN could request a cancel
before effecting the internal match. If the request to cancel were
declined because the order was already executed in Nasdaq, the ECN
could decline his/her internal customer and avoid dual liability.
---------------------------------------------------------------------------
As another benefit, when an Nasdaq Quoting Market Participant is at
the best bid/best offer, Nasdaq would provide for internal matching of
a Nasdaq Quoting market Participant's agency (or principal) orders
against the participant's quotes/order before the order is sent into
the Nasdaq system. For example, if MMA sends all of its quotes/orders
to Nasdaq and is at the best bid of $20 showing (attributable and non-
attributable) 4,000 shares, and the MMA sends Nasdaq a 1,000 share
market sell order from one of its customers, Nasdaq would execute the
market sell order against the market maker's bid, instead of sending
the order to the Quoting Market Participant that otherwise would be
next in the queue to receive the market sell order.
b. Access to Displayed Quotes/Orders. 1. Order Entry Parameters.
Currently, to access quotes via automatic execution, a market
participant may enter an order into SOES if the order is for a public
customer and meets maximum order size requirements.\38\ If an order is
not SOES-eligible, a market participant may use SelectNet if the market
participant wishes to access a quote of an ECN or UTP Exchange, or if
the market participant wishes to use the negotiation features of
SelectNet. Presently, SOES and SelectNet are not integrated and operate
asynchronously. Notwithstanding, Nasdaq's proposal to integrate
SelectNet and SOES, those systems would continue to operate on separate
platforms.\39\ From an end-user's perspective, a market participant
would still have to operate and manage two separate systems. For
example, market participants would have to first determine the type of
order they wish to enter (liability versus non-liability) and/or to
whom they wish to send the order (market maker, ECN, or UTP Exchange),
and then decide which system (NNMS, the automated execution system, or
SelectNet) into which to enter the order. In addition, the proposal to
integrate the functionality of SOES and SelectNet (SR-NASD-99-11) does
not entirely eliminate the potential for dual
[[Page 68132]]
liability.\40\ Specifically, because UTP Exchanges needed a method of
delivering Liability Orders to Nasdaq market makers, Nasdaq proposed in
the SOES/SelectNet Integration to permit UTP Exchanges to send
SelectNet Liability Orders to market participants that participate in
the NNMS on an automatic execution basis. The OCF should eliminate all
potential for double liability because it would serve as the single
point of order entry and the single point of delivery of all Liability
Orders (as well as Non-Liability Orders) and executions.
---------------------------------------------------------------------------
\38\ See NASD Rule 4730(c).
\39\ See note 5, above.
\40\ To eliminate the potential for dual liability (e.g. receipt
of a SelectNet Liability Order followed immediately by the delivery
of a SOES execution against a market maker's quote), Nasdaq proposed
to limit SelectNet so that only non-Liability Orders could be
delivered to those market participants who participate in the NNMS
and are subject to automatic execution (i.e., market makers and ECNs
that agree to accept automatic executions). See SR-NASD-99-11. To
send a Liability Order to a market maker, a market participant would
use the NNMS system, which would route the order to the next market
maker in the queue. Market participants would still use SelectNet to
access quotes of ECNs that do not participate in NNMS and to direct
non-Liability Orders to a particular market maker. See NASD Rule
4730(c).
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To access quotes in Nasdaq, order entry firms, market makers, ECNs,
or UTP Exchanges, would enter either a directed or non-directed order
into the OCF. The order could be of any size, up to 999,999 shares
(there would be a separate odd-lot process), and would be required to
indicate whether it is a buy, sell, sell short, or sell short exempt
order.\40\ The order would be required to be priced or be a market
order.
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\41\ Although Nasdaq is proposing to eliminate the rule limiting
the size of orders that may be entered into the NNMS, the system in
the short term would only be able to deliver an execution up to
9,900 shares. However, if a market participant enters an order into
the system that is eligible for automatic execution and exceeds the
system size limit of 9,900, the OCF would break the order up into
multiples of 9,900 shares and execute the orders as such.
---------------------------------------------------------------------------
2. Non-Directed Orders
If a market participant wishes to immediately access the best
prices in Nasdaq, the market participant would be required to enter a
non-directed order into the OCF. A non-directed order, is one that the
market participant entering the order into the system does not send/
route to a particular Quoting Market Participant. A non-directed order
must be designated as a market order or a marketable limit order and
will be considered a ``Liability Order'' and treated as such by the
receiving market participant.\42\ Upon entry, the OCF would ascertain
who the next Quoting Market Participant in the queue to receive an
order is and, depending on how that receiving Quoting Market
Participant participates in Nasdaq (i.e., automatic execution versus
order delivery), the OCF would deliver either an execution or a
Liability Order.\43\ While market makers will continue to be required
to take automatic executions via the NNMS, the OCF will accommodate
ECNs that have the option, but are not required, to participate in the
system's automatic execution functionality.
---------------------------------------------------------------------------
\42\ If a non-directed limit order is marketable when entered
into the system but subsequently becomes non-marketable because of a
change in the inside market, the system will hold the order for 90
seconds rather than immediately returning the order to the
participant who entered it. If within that 90 seconds the order once
again becomes marketable, the system will send the order to the next
Quoting Market Participant in the queue. At any time within that 90
seconds, the participant who entered the order can obtain the status
of the order and request a cancel of such order.
If an order is a sell short that is not exempt from NASD Rule
3350 and the market moves from an up-bid to a down-bid after the
order is entered but before delivery or execution, the system will
return the order to the participant who entered it. Sell-short
exempt orders (i.e., those entered by primary market makers) may be
entered into the system for execution.
\43\ For example, if MMA and ECN1 (non-automatic execution
participant) are at the inside bid each displaying 1,000 shares at
$20, and OE Firm A enters a market order to sell 1,000 shares,
assuming that MMA is first in time priority, the OCF will deliver an
execution of 1,000 shares to MMA. If another market order to sell
1,000 shares is then entered into the system, the OCF will deliver a
Liability Order to ECN1. If ECN1 had opted to take automatic
executions, the OCF would have delivered an execution to ECN1.
---------------------------------------------------------------------------
a. Quote Decrementation of Non-Directed Orders. For a Nasdaq
Quoting Market Participant accepting automatic executions (i.e., a
market makers and ECN choosing to participate in the system's
automatic-execution functionality) the system would deliver an
execution up to the size displayed by the participant and, if the order
has not been filled by other displayed orders, to the participant's
reserve size. The system would automatically decrement the aggregate
quote in the Nasdaq Order Display Facility by the size of the delivered
execution, and the Nasdaq Quoting Market Participant's quote in the
Nasdaq Quotation Montage if the quote/order is attributable. Displayed
(attributable or non-attributable) size would be replenished from
reserve size for Nasdaq Quoting Market Participants accepting automatic
executions, if the participant's displayed size is decremented to zero
and the market participant has reserve size. If an ECN accepts
automatic executions and has its attributable quote/order exhausted to
zero without updating or transmitting of another attributable quote/
order to Nasdaq, Nasdaq would zero out the one side of the quote that
is exhausted. If both the bid and offer size of the ECN's market were
reduced to zero without the ECN updating or transmitting another
attributable quote/order, the ECN would be placed into an excused
withdrawal state and restored once the ECN transmitted to Nasdaq
revised attributable quotes/orders. Nasdaq believes that this is
necessary to ensure that Quoting Market Participants that do not
provide timely executions due to equipment or other failures do not
hold up the market and cause queuing of orders within the Nasdaq
system.\44\
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\44\ If an ECN's quote/order has been zeroed out and placed into
an excused withdrawal state and the ECN has non-attributable quotes/
orders in Nasdaq, the system will continue to provide access to
those orders from non-directed orders as described in this filing.
---------------------------------------------------------------------------
For Quoting Market Participants not participating in automatic
executions--ECNs that wish to accept order delivery and UTP Exchanges
that only participate in order delivery--Nasdaq would deliver an order
of a size up to the participant's displayed and reserve size (if
applicable). Nasdaq would automatically decrement the participant's
quote by the size of the delivered order, but Nasdaq would not deliver
another order to such Quoting Market Participant until the Quoting
Market Participant has processed the order by providing a complete or
partial fill of the order. If the Quoting Market Participant declines
or partially fills the order, Nasdaq would send the order (or remaining
portion thereof) back into the system for immediate delivery to the
next available Quoting Market Participant. In addition, if the Quoting
Market Participant declines or partially fills the order without
immediately transmitting a revised quote/order at an inferior price, or
if the participant fails to respond in any manner within five seconds
of order delivery, Nasdaq would immediately reroute the order to the
next Quoting Market Participant in the queue. For ECNs, the system
would zero out the ECN's quotes/orders at that price level on that side
of the market, and the ECN's quote/order would remain at zero unless
the ECN transmits to Nasdaq a revised attributable quote/order or the
ECN has other attributable quotes/orders in the system.\45\
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\45\ For UTP Exchanges, Nasdaq will place the side of the quote
that was being accessed, at the lowest bid or highest offer price
for 100 shares.
---------------------------------------------------------------------------
b. Quote Refresh and Revised SOESed-Out-of-the-Box Procedures. As
noted previously, market makers will be required to maintain a two-
sided, attributable principal quote (other than its Agency Quote) in
Nasdaq at all times. To assist with this requirement, market makers
would be able to use the Quote Refresh (``QR'') functionality
[[Page 68133]]
feature of the proposed NNMS.\46\ QR allows a market maker to designate
a refresh size (with a default refresh size of 1,000 shares) and price
(i.e., a tick amount away from the price of its decremented quote) to
which it wishes to refresh if its quoted size is decremented to zero.
If a market maker utilizing QR but has an attributable quote/order in
the system that is priced at or better than the quote/order that would
be created by the QR, Nasdaq would display the better-priced
attributable quote/order, not the QR-produced quote/order.\47\ If a
market maker is not utilizing QR and the market maker has given Nasdaq
multiple attributable quotes/orders, Nasdaq would display the market
maker's next best-priced attributable quote/order when its attributable
quote/order is decremented to zero.
---------------------------------------------------------------------------
\46\ The parameters for QR are the same as for the NNMS.
Accordingly, when a market maker's principal attributable quote
(both displayed and reserve) is exhausted to zero, the system will
refresh the market maker's price on the bid or offer side of the
market, whichever is decremented to zero, by an interval designated
by the market maker and the market maker's size to a level
designated by the market maker. When the market maker's quote is
refreshed, the QR will refresh the market maker's attributable
quote/order (not the non-attributable quote) to a default size of
1,000 shares or an amount designated by the market maker. See note
5, above.
\47\ For example, MMA's $20 bid is decremented to zero and MMA
has set an QR of \1/4\ (meaning the quote will be updated to $19\3/
4\--\1/4\ point away from the decremented $20 bid price). If MMA has
an attributable buy quote/order for 19\15/16\, the system will
display that order instead of the $19\3/4\. Alternatively, if MMA
has no other attributable quote/order in the system or it MMA's next
best attributable quote/order is priced inferior to the QR price of
$19\3/4\ (e.g., $19\1/2\), the system will display the QR-produced
quote of $19\3/4\.
---------------------------------------------------------------------------
If a market maker's quote/order is decremented to zero and does not
update its principal quote/order via QR, transmit a revised
attributable quote/order to Nasdaq, or have another principal (i.e.,
non-Agency Quote) attributable quote/order in the system, Nasdaq would
place the market maker's quote (both sides) in a closed state for three
minutes. At the end of that time, if the market maker has not
voluntarily updated or withdrawn its quote from the market, Nasdaq
would refresh the market maker's quote/order to 100 shares at the
lowest market maker bid and highest market maker offer currently being
displayed in that security and reopen the market maker's quote. Nasdaq
believes that in the proposed electronic environment, five minutes--the
current grace period--is too long a period to have a quote closed on
the Nasdaq screen. Nasdaq also believes that restoring the quote at the
lowest ranked bid or highest ranked offer price will ensure that market
makers maintain continued participation in the market and are available
to provide liquidity in a manner consistent with their market making
obligations.\48\
---------------------------------------------------------------------------
\48\ Under current NASD Rule 4730, a market maker whose quote is
decremented to zero and fails to restore its quote in the allotted
time will be deemed to have withdrawn as a market maker (``SOESed-
Out-of-the-Box''). Subject to certain specified exceptions, the
market maker is prohibited from re-entering quotations in that
security for twenty (20) business days. The NNMS Rules contain a
virtually identical procedure, called ``Timed Out of the Box'' See
note 5, above.
---------------------------------------------------------------------------
c. Order Execution Algorithm. In general, Nasdaq would execute non-
directed orders against Quoting Market Participant's quotes/orders
based on price/time priority. As noted above, each quote/order when
entered into Nasdaq would receive a time stamp. Nasdaq would execute
all orders at the best bid/best offer in general time priority based on
the time stamp of the quote/order, subject to the following specific
procedures.
First, the system would attempt to match orders entered by a Nasdaq
Quoting Market Participant against its own quote/order if the Nasdaq
Quoting Market Participant is at the best bid/bet offer. Thus, the
system would try to match a Nasdaq Quoting Market Participant's orders
and quotes/orders that are in the system if the participant is at the
BBO and receives a market or marketable limit order on the other side
of the market.
Second, after completing this process (when applicable), the
proposed NNMS would first execute against displayed quotes/orders
(attributable and non-attributable) of market makers and ECNs that
participate in the automatic-execution functionality of the system, in
time priority based on the entry time of the quotes/orders from these
market makers and ECNs.\49\ (There should be no interval delay between
the delivery of executions against the quotes/orders of a market maker
or ECN that participate in automatic execution (assuming the market
maker or ECN has size to access), because all Nasdaq Quoting Market
Participants may quote their actual size and may give Nasdaq multiple
quotes/orders and price levels.)
---------------------------------------------------------------------------
\49\ Time priority would be based on the Nasdaq system time
stamp for the individual quote/order.
---------------------------------------------------------------------------
Third, the NNMS would execute against the displayed quotes/orders
(attributable and non-attributable) of ECNs that participate in the
order-delivery functionality of the NNMS. This too would be based on
time priority of quotes/orders entered by ECNs that accept order
delivery. The system then will execute against reserve size of market
makers and ECNs that participate in the automatic-execution
functionality of the NNMS (in time priority), and then against the
reserve size of ECNs that participate in the order-delivery
functionality of the system.
Fourth, once displayed and reserve size in Nasdaq is exhausted, the
system would attempt to access the quotes of UTP Exchanges, again in
time priority based on the entry time of the UTP Exchanges' quotes
(assuming there is more than one UTP Exchange in the stock at that
price level). Similar to the Intermarket Trading System (``ITS''), the
system would first attempt to probe and sweep the Nasdaq market before
sending an order to another market center.\50\
---------------------------------------------------------------------------
\50\ See e.g., Section 8(a)(v) of the ITS Plan.
---------------------------------------------------------------------------
Last, the system would then move to the next price level. There
would be a five-second delay before the Nasdaq system would attempt to
execute any orders in its system at that time. Orders held during this
five-second period would then be executed in time priority, up to the
available size, at that next price level. The five-second interval
delay would not impact the processing of directed orders. Requests to
cancel orders would also be accepted during the five-second delay. This
delay will give market participants time to adjust their quotes and
trading interests before the market moves precipitously through
multiple price levels, which may occur when there is news, rumors, or
significant market events. Nasdaq believes that the delay is a modest
and reasonable attempt to limit volatility.
d. Directed Orders. The Nasdaq Quotation Montage would serve, in
part, as a method for Quoting Market Participants to advertise their
buying or selling interest. To access a specific quote/order in the
Nasdaq Quotation Montage, a market participant would enter into the OCF
a ``directed order'' to begin the negotiation process with a particular
Quoting Market Participant. A directed order is one that is routed by
the market participant entering the order to specific MMID. To limit
the possibility for dual liability, a directed order would have to be
designated as: (1) All-or-None (``AON'') and at least 100 shares
greater than the size of the displayed quote/order of the market
participant to which the order is directed; or (2) a Minimum Acceptable
Quantity order (``MAQ'') with a MAQ value of at least 100 shares
greater than the displayed amount of the quote/order of the participant
to which the order is directed. If a Quoting Market Participant is at
the inside or is displaying (attributable or non-attributable) interest
[[Page 68134]]
in the Nasdaq Quotation Montage and receives a directed, non-Liability
Order that it wants to fill, to avoid double execution, it may request
a cancel of its displayed quote/order in Nasdaq before it fills the
non-Liability Order. Nasdaq will not decrement a quote/order upon the
delivery of a directed, non-Liability Order.
e. Locked/Crossed Markets. Nasdaq believes with the implementation
of the OCF, locked and crossed markets should be virtually eliminated.
Specifically, if a Quoting Market Participant enters an order that
would lock or cross the market, the OCF would not display the order as
a quote/order, but instead the order would be treated as a marketable
limit order and entered into the OCF as a non-directed Liability Order
for execution in time priority. For locked market situations, the
orders would be routed to the Quoting Market Participant(s) next in the
queue who would be locked, and the order would be executed at the price
of the locking quote/order. For crossed market situations, the crossing
order would be entered into the system and routed to the next Quoting
Market Participant(s) in queue, and the order would be executed at the
price of the displayed quote/order that would have been crossed. Once
the lock/cross is cleared, if the Quoting Market Participant's order is
not completely filled, the OCF would reformat the order and display it
as a quote/order on behalf of the entering Quoting Market
Participant.\51\
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\51\ If the market moves and the order no longer is locking/
crossing, the OCF will return the order and format it as a quote/
order for display in Nasdaq.
---------------------------------------------------------------------------
Assuming, for example, that the inside market is $20 to $20\1/16\,
1,000 by 1,000, and MMA is at the inside bid, if MMC attempts to enter
into the system an offer quote/order of $20 for 4,000 shares, the
system would format MMC's quote/order as an order, route it to MMA
(assuming MMA is first in the queue and there are no other marketable
orders in the queue ahead of MMC's order), and execute MMC's order
against MMA's quote/order at $20 for 1,000 shares. Presuming the next
market participant on the bid side is quoting at $19\15/16\ and since
there are 3,000 shares remaining in MMC's order, the OCF would reformat
the remaining portion of the order and display it as a quote/order
(consistent with the order's parameters), thereby establishing a new
inside of $19\15/16\ bid and $20 offer.
As a second example, if MMC attempts to enter into the system an
offer quote/order of $19\15/16\ for 1,000 shares when MMA is at the
best bid of $20, the system would format MMC's quote/order as an order,
route it to MMA, and execute MMC's order against MMA's quote/order at
$20 for 1,000 shares, thus giving price improvement to MMC's order.
Finally, if the market is locked or crossed at 9:30 a.m., Nasdaq
would clear out the locked and/or crossed quotes by executing the
oldest bid (offer) against the oldest offer (bid) which it is
marketable against, at the price of the oldest quote/order. Nasdaq
would begin processing non-directed market and marketable limit orders
that are in the queue.\52\
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\52\ Prior to the opening, Nasdaq would continue to process
``trade or move'' messages, as proposed in SR-NASD-99-23. See
Exchange Act Release No. 41473 (June 2, 1999), 64 FR 31335 (June 10,
1999).
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F. UTP Exchange Participation
National securities exchanges trading pursuant to grants of UTP
would be able to enter orders into the OCF. Similar to today, UTP
Exchanges would continue to receive, and be obligated to execute,
Liability Orders. Specifically, when a UTP Exchange is next in queue to
receive a non-directed Liability Order, Nasdaq would deliver the order
to the UTP Exchange up to the size of the UTP Exchange's quote. The
system would decrement the UTP Exchange's quote by an amount equal to
the size of the delivered order. As described in the decrementation
procedures above, if a UTP Exchange declines or partially fills the
order, Nasdaq would send the order (or remaining portion thereof) back
into the system for immediate delivery to the next available Quoting
Market Participant. In addition, if the UTP Exchange declines or
partially fills the order without immediately transmitting a revised
quote/order at an inferior price, or if the UTP Exchange fails to
respond in any manner within 5 seconds of order delivery, Nasdaq would
presume equipment failure and immediately reroute the order to the next
Quoting Market Participant in the queue. The system would then place
the side of the UTP Exchange's quote that was being assessed, at the
lowest bid or highest offer price for 100 shares.
UTP Exchanges would be free to provide automatic executions against
their quotations. Additionally, if a UTP Exchange wishes to access the
best Nasdaq market, the UTP Exchange could enter a non-directed
Liability Order into the OCF. the OCF would be programmed to send the
next Quoting Market Participant an order for delivery, not automatic
execution, regardless of whether the receiving Quoting Market
Participant participates in automatic execution. UTP Exchanges would
also be able to direct non-Liability Orders for negotiation to
particular market makers. Finally, as is the case today, UTP Exchanges
would only be able to submit a single, two-sided attributable quote,
and would not be able to utilize reserve size or QR.
G. ECN Participation
As is the case today, ECNs who are NASD members would have the
choice of taking order delivery or participating in automatic
execution. Regardless, ECNs in Nasdaq would have full access to the OCF
for order entry and order delivery. Specifically, ECNs who are NASD
members would be able to designate quotes/orders as attributable/non-
attributable, and would be able to transmit multiple quotes/orders at
multiple prices. ECNs would be able to utilize the system's reserve
size feature for quotes/orders. ECN participation in Nasdaq would
continue to be governed by rule and private contract.
H. Odd-Lot Processing
Under this provision of the proposal, Nasdaq would accept and
execute orders less than one normal unit of trading, i.e., odd-lot
orders or orders less than one round lot (i.e. 100 shares for
equities). The system would provide a separate mechanism for processing
and executing these orders as distinct from normal units of trading.
Nasdaq would hold odd-lot orders in a separate file and automatically
execute such odd-lots against all registered market makers in round
robin rotation whenever the odd-lot order becomes marketable.\53\ For
example, if a member enters a market order for 50 shares into the
system, it would immediately and automatically execute the order at the
inside price against the market maker that is first in rotation for
execution of such orders, regardless of the market maker's quoted
price. The automatic execution would not decrement the market maker's
displayed size. Additionally, if a mixed lot is entered into the
system, to ensure continuity of price, once the round-lot portion is
executed, the odd-lot portion would be executed against the next market
maker in rotation at the round-lot portion price.
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\53\ An odd-lot order becomes marketable when the best price in
Nasdaq moves to the price of the odd-lot limit order. Odd-lot orders
that are marketable at entry or become marketable will execute
against the first market maker in rotation for odd-lot processing at
the best price or at the odd-lot order's price.
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I. Nasdaq SmallCap
Nasdaq proposes to use the expanded NNMS system and the Nasdaq
Order Display Facility for all Nasdaq
[[Page 68135]]
securities, including SmallCap securities. Nasdaq sees no reason to
continue to have separate systems for its listed securities.
Additionally, from a technological perspective, it is very costly and
difficult to run two separate platforms. As such, Nasdaq proposes to
delete the current SOES rules that apply to SmallCap.
2. Statutory Basis
Nasdaq believes that the proposed rule change is consistent, in
general, with the provisions of Section 15A of the Act, and in
particular, Sections 15A(b)(2),\54\ 15A(b)(6),\55\ and 15A(b)(11),\56\
and Section 11A of the Act,\57\ in that the proposed rule change is
designed to enhance the protection of investors and provide for the
fairest and most efficient mechanism for transactions in the market for
Nasdaq securities. Section 15A(b)(2) \58\ requires the Association to
be organized to enforce compliance by its members and associated
persons with the provisions of the Act, the rules thereunder, and the
rules of the Association. Section 15A(b)(6) \59\ requires that the
rules of a registered national securities association be designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, to foster cooperation and
coordination with persons engaged in regulating, clearing, settling,
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; and are not designed to
permit unfair discrimination between customers, issuers, brokers, or
dealers. The proposed rule change represents a significant effort to
provide for an integrated order delivery and execution system where all
market participants and investors may be brought together in a signal
system and where all orders are processed and distributed in a fair and
orderly fashion to achieve immediate or rapid executions at the best
available price.
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\54\ 15 U.S.C. 78o-3(b)(2).
\55\ 15 U.S.C. 78o-3(b)(6).
\56\ 15 U.S.C. 78o-3(b)(11).
\57\ 15 U.S.C. 78k-1.
\58\ 15 U.S.C. 78o-3(b)(6).
\59\ 15 U.S.C. 78o-3(b)(6).
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Nasdaq believes that the system will provide many benefits to
Nasdaq market makers, ECNs, and order entry firms. First, the system
through the OCF should eliminate, in total, the potential for double
execution and double liability that market makers currently face.
Second, market makers' regulatory burdens should be reduced because the
Nasdaq believes that Nasdaq Order Display Facility will comply with the
display alternative in Rule 11Ac1-4 under the Act.\60\ Thus, market
makers should be able to display their principal and agency interest
anonymously in the Nasdaq Order Display Facility without changing their
attributable quote in Nasdaq and still comply with Rules 11Ac1-1 and
11Ac1-4 under the Act.\61\ Moreover, the potential that a limit order
on a Nasdaq Quoting Market Participant's back book would be traded
through (or not be displayed as required by Rule 11Ac1-4 under the Act)
should be minimized because Nasdaq market makers and ECNs would be able
to give the system multiple orders. Thus, Nasdaq believes that the
proposed rule change is consistent with Section 11A(a)(1)(B) of the
Act, \62\ and Rule 11A thereunder,\63\ which sets forth findings of
Congress that new data processing and communications techniques create
the opportunity for more efficient and effective market operations.
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\60\ See 17 CFR 240.11Ac1-4.
\61\ See 17 CFR 240.11 Ac1-1 and 17 CFR 240.11 Ac1-4.
\62\ 15 U.S.C. 78k-1(a)(1)(B).
\63\ See 17 CFR 240.11A.
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In a similar vein, the Nasdaq believes that the Order Display
Facility should reduce fragmentation and increase transparency. The
Nasdaq believes that the Nasdaq Order Display Facility is consistent
with Section 15A(b)(11),\64\ which requires that the rules of a
registered national securities association be designed to produce fair
and informative quotations, prevent fictitious or misleading quotations
and to promote orderly procedures for collecting, distributing, and
publishing quotations. Specifically, Nasdaq market makers and ECNs
would no longer be limited to displaying to the market their best bid
and best offer quotes. If the proposal is approved, market makers and
ECNs would be able to display in Nasdaq multiple levels of trading
interest and varying prices. This interest would be electronically
accessible if/when the trading interest falls within the best three
prices on either side of the market. While a market maker or ECN
currently can only display one level of trading interest (on either
side of the market) to the market at any one point in time, the
proposal would enable market makers and ECNs to display (and
electronically access) three price levels of trading interest in the
Nasdaq Order Display Facility. Order entry firms would benefit from the
proposal because they would be able to view and electronically access
these additional levels of trading interest. Thus, Nasdaq believes that
the proposal should enhance liquidity and transparency, while reducing
fragmentation.
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\64\ 15 U.S.C. 78o-3(b)(11).
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Finally, the Nasdaq believes that the proposed rule change is
consistent with Section 11A(a)(1)(C) of the Act,\65\ which states that
it is in the public interest and appropriate for the protection of
investors and the maintenance of fair and order markets to assure: (1)
Economically efficient execution of securities transactions; (2) fair
competition among brokers and dealers; (3) the availability to brokers,
dealers and investors of information with respect to quotations and
transactions in securities; (4) the practicability of brokers executing
investors' orders in the best market; and (5) an opportunity for
investors orders to be executed without the participation of a dealer.
As noted above, the OCF should integrate Nasdaq's current trading
systems from an end user's prospective, substantially enhance these
systems, and provide a single point of entry and delivery of Liability
Orders. The OCF should also encourage ECNs to participate in automatic
execution because the potential for incurring a proprietary position
due to double executions should be minimized by the proposed new
functionality (i.e., the ability to give Nasdaq multiple quotes/
orders.) Nasdaq believes that this proposal advances all the goals of
Section 11A of the Act \66\ by providing an integrated order delivery
and execution system, enhanced display of agency and principal trading
interest via the Nasdaq Order Display Facility, and by increasing the
opportunity for market participants to participate in, and investors to
receive, automatic execution. Thus, the Nasdaq believes that the
proposal is designed to provide maximum transparency and efficient
executions at the best price for the benefit of all investors and
market participants.
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\65\ 15 U.S.C. 78k-1(a)(1)(C).
\66\ 15 U.S.C. 78k-1.
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(B) Self-Regulatory Organization's Statement on Burden on Competition
Nadaq 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.
[[Page 68136]]
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received from Members, Participants, or Others
Written comments were neither solicited nor received.
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 self-regulatory organization 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, including whether the proposed rule
change is consistent with the Act. 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-
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-99-53 and should
be submitted by December 27, 1999.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\67\
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\67\ 17 CFR 20.30-3(a)(12).
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Johathan G. Katz,
Secretary.
[FR Doc. 99-31527 Filed 12-6-99; 8:45 am]
BILLING CODE 8010-01-M
