[Federal Register Volume 60, Number 35 (Wednesday, February 22, 1995)]
[Notices]
[Pages 9878-9880]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-4358]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35391; File No. SR-NASD-94-62, Amendment No. 1]
Self-Regulatory Organizations; Notice of Filing of Amendment No.
1 to Proposed Rule Change by National Association of Securities
Dealers, Inc., Relating to Limit Order Protection for Member-to-Member
Limit Order Handling on Nasdaq
February 16, 1995.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on February
15, 1995, the National Association of Securities Dealers, Inc.
(``NASD'' or ``Association'') filed with the Securities and Exchange
Commission (``SEC'' or ``Commission'') an amendment to the proposed
rule change as described in Items I, II, and III below, which Items
have been prepared by the NASD. The Commission is publishing this
notice to solicit comments on the proposed rule change from interested
persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD proposes to amend SR-NASD-94-62 relating to limit order
protection for member-to-member limit order handling in the Nasdaq
Stock Market. Currently, the NASD's Interpretation to the Rules of Fair
Practice\1\ makes it a violation of just and equitable principles of
trade for a member firm to trade ahead of its own customer's limit
orders. In this amendment to its proposed expansion of the
Interpretation, the NASD is proposing to amend the Interpretation to
clarify that the ``terms and conditions'' exception to the
Interpretation applies only to limit orders from institutional
accounts, whether such limit orders come from a firm's own customers or
are member-to-member limit orders. The term ``institutional account''
is defined in Article III, Section 21(c)(4) of the Rules of Fair
Practice. Below is the text of the proposed rule change. Proposed new
language, including the language that was added in the original
proposal, is italicized; language to be deleted is bracketed.
\1\NASD Manual, Rules of Fair Practice, Art. III, Sec. 1 (CCH)
2151.07.
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Limit Order Protection Interpretation to Article III, Section 1 of the
NASD Rules of Fair Practice
To continue to ensure investor protection and enhance market
quality, the NASD Board of Governors is issuing an Interpretation to
the Rules of Fair Practice dealing with member firm treatment of
[their] customer limit orders in Nasdaq securities. This Interpretation
will require members acting as market makers to handle [their] customer
limit orders with all due care so that market makers do not ``trade
ahead'' of those limit orders. Thus, members acting as market makers
that handle customer limit orders, whether received from their own
customers or from another member, are prohibited from trading at prices
equal or superior to that of the limit order without executing the
limit order, provided that, prior to September 1, 1995, this
prohibition shall not apply to customer limit orders that a member firm
receives from another member firm and that are greater than 1,000
shares. Such orders shall be protected from executions at prices that
are superior but not equal to that of the limit order. In the interests
of investor protection, the NASD is eliminating the so-called
disclosure ``safe harbor'' previously established for members that
fully disclosed to their customers the practice of trading ahead of a
customer limit order by a market-making firm.
Interpretation
Article III, Section 1 of the Rules of Fair Practice states that:
A member, in the conduct of his business, shall observe high
standards of commercial honor and just and equitable principles of
trade.
The Best Execution Interpretation states that: In any transaction
for or with a customer, a member and persons associated with a member
shall use reasonable diligence to ascertain the best inter-dealer
market for the subject security and buy or sell in such a market so
that the resultant price to the customer is as favorable as possible to
the customer under prevailing market conditions. Failure to exercise
such diligence shall constitute conduct inconsistent with just and
equitable principles of trade in violation of Article III, Section 1 of
the Rules of Fair Practice.
In accordance with Article VII, Section 1(a)(2) of the NASD By-
Laws, the following interpretation under Article III, Section 1 of the
Rules of Fair [[Page 9879]] Practice has been approved by the Board.
A member firm that accepts and holds an unexecuted limit order
from a customer (whether its own customer or a customer of another
member) in a Nasdaq security and that continues to trade the subject
security for its own market-making account at prices that would
satisfy the customer's limit order, without executing that limit
order [under the specific terms and conditions by which the order
was accepted by the firm], shall be deemed to have acted in a manner
inconsistent with just and equitable principles of trade, in
violation of Article III, Section 1 of the Rules of Fair Practice,
provided that, until September 1, 1995, customer limit orders in
excess of 1,000 shares received from another member firm shall be
protected from the market maker's executions at prices that are
superior but not equal to the limit order, and provided further,
that a member firm may negotiate specific terms and conditions
applicable to the acceptance of limit orders only with respect to
limit orders for customer accounts that meet the definition of an
``institutional account'' as that term is defined in Article III,
Section 21(c)(4) of the Rules of Fair Practice. Nothing in this
section, however, requires members to accept limit orders from any
customer[s].
By rescinding the safe harbor position and adopting this
Interpretation of the Rules of Fair Practice, the NASD Board wishes to
emphasize that members may not trade ahead of customer limit orders in
their market-making capacity even if the member had in the past fully
disclosed the practice to its customers prior to accepting limit
orders. The NASD believes that, pursuant to Article III, Section 1 of
the Rules of Fair Practice, members accepting and holding unexecuted
customer limit orders owe certain duties to their customers and the
customers of other member firms that may not be overcome or cured with
disclosure of trading practices that include trading ahead of the
customer's order. The terms and conditions under which institutional
account customer limit orders are accepted must be made clear to
customers at the time the order is accepted by the firm so that trading
ahead in the firms' market making capacity does not occur. For purposes
of this Interpretation, a member that controls or is controlled by
another member shall be considered a single entity so that if a
customer's limit order is accepted by one affiliate and forwarded to
another affiliate for execution, the firms are considered a single
entity and the market making unit may not trade ahead of that
customer's limit order.
The Board also wishes to emphasize that all members accepting
customer limit orders owe those customers duties of ``best execution''
regardless of whether the orders are executed through the member's
market making capacity or sent to another member for execution. As set
out above, the best execution Interpretation requires members to use
reasonable diligence to ascertain the best inter-dealer market for the
security and buy or sell in such a market so that the price to the
customer is as favorable as possible under prevailing market
conditions. The NASD emphasizes that the order entry firms should
continue to routinely monitor the handling of their customers' limit
orders regarding the quality of the execution received.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The NASD has prepared summaries, set forth in Sections
(A), (B), and (C) below, of the most significant aspects of such
statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
The purpose of the amendment to the proposed rule change is to
clarify that the Interpretation's ``terms and conditions'' exception to
the protection of customer limit orders, whether the order is from a
member's own customer or is a customer limit order sent to it for
execution from another member (so-called ``member-to-member'' limit
orders), is intended to apply only to limit orders from institutional
accounts as that term is defined in Article III, Section 21(c)(4) of
the Rules of Fair Practice. The background and rationale for this
amendment to the proposed rule change are discussed below.
On December 23, 1994, the Commission published for comment the
NASD's proposed rule to expand the scope of limit order protection
beyond that presently afforded by member firms to their customers in
the Nasdaq Stock Market.\2\ The NASD'S current Interpretation to the
Rules of Fair Practice makes it a violation of just and equitable
principles of trade for a member firm to trade ahead of its own
customer's limit orders. The proposal before the Commission now would
extend this protection to limit orders from a customer of a firm that
sends that customer's limit order to another member for execution (so-
called ``member-to-member'' limit orders). In addition, the proposal
has a phase-in period until September 1, 1995, in which a firm
receiving a member-to-member limit order of greater than 1,000 shares
would be prohibited from trading for its own account at prices that are
superior but not equal to the limit order price. The NASD's proposal
also maintained language from the existing Interpretation regarding the
member's ability to negotiate with any customer specific terms and
conditions regarding its acceptance of limit orders, provided that the
member makes these conditions clear to the customer. It is that
language that this amendment is intended to affect.
\2\Securities Exchange Act Release No. 35122 (Dec. 20, 1994), 59
FR 66389 (Dec. 23, 1994).
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The NASD believes that it is necessary to clarify that the terms
and conditions exception to the handling of limit orders is intended to
apply only to customer orders from institutional accounts as that term
is defined in Article III, Section 21(c)(4) of the Rules of Fair
Practice. Using that definition, a firm could negotiate limit order
terms and conditions if the order came from:
Banks, savings and loan associations, insurance companies,
or registered investment companies;
Investment advisers registered under Section 203 of the
Investment Advisers Act of 1940; and
Any other entity (whether a natural person, corporation,
partnership, trust, or otherwise) with total assets of at least $50
million.
Accordingly, under the amended language, a member firm that accepts
a limit order from a person or entity that does not fall within the
definition of institutional account may not initiate the negotiation of
any terms and conditions on the acceptance of that limit order. On the
other hand, if the account placing the limit order meets the terms of
the definition of institutional account, the firm may negotiate special
terms and conditions with the customer of that account, or its
representative, that permit the firm to trade ahead of or at the same
price as the limit order. The amended Interpretation would apply to
limit orders placed by the firm's own customers and member-to-member
limit orders.
The NASD believes that this approach should minimize a retail
customer's potential for confusion regarding the acceptance of a limit
order that, under the existing Interpretation, could have
[[Page 9880]] qualified the protection of the limit order rule's scope.
At the same time, the amendment accurately reflects the ordinary
framework in which firms and institutions typically negotiate the
conditions under which an institution's limit order is to be handled.
For example, in its approval of the original NASD Interpretation
regarding the handling of customer limit orders,\3\ the Commission
specifically indicated its view that the terms and conditions language
of the original NASD Interpretation was included to permit special
treatment for institutional customer limit orders. In addition, in its
own proposal regarding customer limit order protection for Nasdaq
National Market securities, proposed Rule 15c5-1,\4\ the Commission
solicited comment on the ``terms and conditions'' provisions in its
rule, which would allow the parties to a trade to set special
conditions to allow a market maker to employ an appropriate strategy in
filling an institutional customer's order without violating the
proposed rule. Of course, the clarification of the Interpretation
continues to permit a member to establish with its customers or the
order entry firm commissioner or commission equivalents regarding the
handling of a limit order, provided that the member makes these charges
clear to the customer. In this connection, the NASD notes that Nasdaq
market makers are free to negotiate additional compensation from order
routing firms to the extent that such compensation is economically and
competitively justified. Similarly, the Interpretation continues in
place the understanding that nothing in the Interpretation would
obligate a market maker to accept limit orders from any or all
customers or member firms.
\3\See Securities Exchange Act Release No. 34279 (June 29,
1994), 59 FR 34883 (July 7, 1994).
\4\See Securities Exchange Act Release No. 34753 (Sept. 29,
1994), 59 FR 50866 (Oct. 6, 1994).
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The NASD believes that the proposed rule change is consistent with
section 15A(b)(6) of the Act in that these proposed changes are
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, to facilitate
transactions in these securities, to remove impediments to and to
perfect the mechanism of a free and open market and a national market
system, and in general to protect investors and the public interest.
(B) Self-Regulatory Organization's Statement on Burden on Competition
The NASD 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, as amended. Accordingly, while
the NASD will monitor carefully for any adverse competitive effects of
the Interpretation, it believes that any adverse effects are far
outweighed by the enhanced execution opportunities provided public
investors.
(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 NASD consents, the Commission will:
(A) By order approve such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to SR-NASD-94-62, Amendment No. 1
and should be submitted by March 7, 1995.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority, 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-4358 Filed 2-16-95; 5:00 pm]
BILLING CODE 8010-01-M
