[Federal Register Volume 62, Number 47 (Tuesday, March 11, 1997)]
[Notices]
[Pages 11245-11247]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-5983]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38354; File No. SR-NASD-97-13)
February 28, 1997.
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change by the National
Association of Securities Dealers, Inc. Relating to the Elimination of
the NASD's Excess Spread Rule Applicable to Market Maker Quotations in
Nasdaq SmallCap Securities
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder, \2\ notice is hereby given
that on February 24, 1997, the National Association of Securities
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities
and Exchange Commission (``Commission'') the proposed rule change as
described in Items I, II, and III below, which Items have been prepared
by the self-regulatory organization. The Commission is publishing this
notice to solicit comments on the proposed rule change from interested
persons and to grant accelerated approval to the proposed rule change.
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\1\ 15 U.S.C. Sec. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The NASD proposes to amend NASD Rule 4613(d) to exclude market
maker quotations in Nasdaq SmallCap securities from coverage under the
Rule. As a result, Rule 4613(d) will apply only to quoted spreads by
registered market makers in Nasdaq National Market securities. The text
of the proposed rule change is as follows [new text is italicized;
deleted text is bracketed]:
* * * * *
NASD Rule 4613 Character of Quotations
(d) Reasonably Competitive Quotations
A registered market maker in a Nasdaq National Market security
[listed on The Nasdaq Stock Market] will be withdrawn as a registered
market maker and precluded from re-registering as a market maker in
such issue for 20 business days if its average spread in the security
over the course of any full calendar month exceeds 150 percent of the
average of all dealer spreads in such issue for the month. This
subparagraph shall not apply to market makers in Nasdaq SmallCap
securities.
(1) If a registered market maker has not satisfied the average
spread requirement set forth in this subparagraph (d) for a particular
Nasdaq National Market security, its registration in such issue shall
be withdrawn commencing on the next business day following the business
day on which the market maker was sent notice of its failure to comply
with the requirement. A market maker may request reconsideration of the
withdrawal notification. Requests for reconsideration will be reviewed
by the Market Operations Review Committee, whose decisions are final
and binding on the members. A request for
[[Page 11246]]
reconsideration shall not operate as a stay of the withdrawal or toll
the twenty business day period noted in subparagraph (d) above.
(2)-(3) No change.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, 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 III 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
1. Purpose
On January 16, 1997, the Securities and Exchange Commission
(``SEC'' or ``Commission'') approved modifications to NASD Rule 4613(d)
on a temporary basis through July 1, 1997.\3\ Specifically, Rule
4613(d), which is commonly known as the NASD's ``excess spread rule,''
presently provides that registered market makers in securities listed
on The Nasdaq Stock Market (``Nasdaq'') shall be precluded from being a
registered market maker in that issue for 20 business days if its
average spread in the security over the course of any full calendar
month exceeds 150 percent of the average of all dealer spreads in such
issue for the month (``150% Excess Spread Rule'').\4\
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\3\ See Securities Exchange Act Release No. 38180 (Jan. 16,
1997), 62 FR 3725 (Jan. 24, 1997) (order approving File No. SR-NASD-
96-50).
\4\ Previously, Rule 4613(d) provided that registered market
makers in Nasdaq securities could not enter quotations that exceeded
125 percent of the average of the three narrowest market maker
spreads in that issue (``125 percent test''), provided, however,
that the maximum allowable spread shall never be less than \1/4\ of
a point (``125% Excess Spread Rule'').
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As noted in the NASD's filing seeking approval of the 150% Excess
Spread Rule on a temporary basis, the Rule is designed to help
ameliorate the adverse consequences the 125% Excess Spread Rule may
have had on the competitiveness and independence of quotations
displayed on the Nasdaq market.\5\ At the same time, the NASD and
Nasdaq believe the 150% Excess Spread Rule strikes a reasonable balance
between the need to eliminate any constraints that the 125% Excess
Spread Rule may have placed on firms to adjust their quotations and the
need to avoid fostering a market environment where registered market
makers can maintain inordinately wide spreads and still receive the
benefits of being a market maker, such as affirmative determination
exemptions and preferential margin treatment.
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\5\ The SEC found in its 21(a) Report on the NASD and Nasdaq
that ``the interdependence of quotes mandated by the rule may deter
market makers from narrowing their dealer spreads, because, once the
spread is tightened, the rule in some instances precludes a market
maker from widening the spread to earlier levels.'' See Appendix to
Report Pursuant to Section 21(a) of the Securities Exchange Act of
1934 Regarding the NASD and The Nasdaq Stock Market (``21(a)
Report'') SEC, Aug. 8, 1996, at p. 98. As a result, the SEC found
that the excess spread rule creates an economic incentive for market
makers to discourage one another from narrowing their quotes,
thereby interfering with the ``free flow of prices in the market and
imped[ing] attempts by the market to reach the optimal competitive
spread.'' Id. at p. 99 Accordingly, the SEC requested that the NASD
``modify the rule to eliminate its undesirable effects, or to repeal
it. Id.
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Nevertheless, while Nasdaq and the NASD believe the 150% Excess
Spread Rule will help to ensure that market makers maintain at least a
minimal level of commitment to their issues, Nasdaq and the NASD
believe it is prudent to not impose the Rule on a permanent basis until
there is a substantial basis to conclude that the 150% Excess Spread
Rule has not contributed to or fostered the same unintended
consequences created by the former 125% Excess Spread Rule, such as the
interdependence of market maker quote movements and the exacerbation of
locked and crossed market situations. Accordingly, the SEC approved the
NASD's proposal to implement the 150% Excess Spread Rule on a pilot
basis through July 1, 1997. During the pilot period, Nasdaq and the
NASD will analyze market maker quotation behavior to determine whether
the 150% Excess Spread Rule has met its dual objectives of removing
constraints on market maker quotation movements and ensuring some
minimal level of commitment by market makers to their issues.
Throughout the pilot period, Nasdaq and the NASD also will proactively
explore whether there are other alternative means to achieve these
objectives without reliance on a quotation-based evaluation
criteria.\6\
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\6\ The Commission has stated that ``[a]lthough the amended
excess spread rule may reduce some of the anticompetitive concerns
outlined in the 21(a) Report, the Commission believes that the
amendment . . . may not completely satisfy the NASD's obligations
under the Commission's Order with regard to the excess spread rule.
Release No. 34-38180, supra note 3. Specifically, it may not remove
completely the anticompetitive incentives for market makers to
refrain from narrowing quotes because the market makers' quotation
obligation continues to be dependent to some extent upon quotations
of other market makers in the stock.'' Id.
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The NASD and Nasdaq are proposing to exclude market maker
quotations in Nasdaq SmallCap securities from coverage under NASD Rule
4613(d). This is because, unlike with Nasdaq National Market
securities, Nasdaq does not presently calculate and display through the
Nasdaq system the average spread of all market makers in Nasdaq
SmallCap securities or a comparison of the size of an individual market
maker's quoted spread in a Nasdaq SmallCap security relative to the
average spread of all market makers in Nasdaq SmallCap securities.\7\
Thus, Nasdaq does not presently provide market makers in SmallCap
securities with any indication as to whether they are satisfying the
requirements of the 150% Excess Spread Rule.
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\7\ Market makers in Nasdaq National Market securities are able
to assess whether they are satisfying the 150% Excess Spread Rule on
a daily basis through use of the ``Primary Market Maker (PMM)
Window'' of Nasdaq Workstation II. Specifically, while the PMM
standards are used to determine the eligibility of market makers to
an exemption from the NASD's short-sale rule, Nasdaq's programs that
enable market makers to monitor their performance under the
``average spread'' component of the PMM standards also can be used
by market makers to evaluate whether they have satisfied the
requirements of the 150% Excess Spread Rule.
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Accordingly, given the pilot nature of the 150% Excess Spread Rule
and the length of time necessary to make system modifications to
provide market makers in Nasdaq SmallCap securities with the ability to
assess whether they are satisfying Rule 4613(d), the NASD and Nasdaq
propose to eliminate market maker quotations in Nasdaq SmallCap
securities from coverage under the 150% Excess Spread Rule. By
excluding market maker quotations in Nasdaq SmallCap securities from
the Rule, the NASD and Nasdaq will not be subjecting market makers in
these securities to a performance requirement that market makers are
incapable of monitoring. This is particularly important since failure
to satisfy the requirement of the Rule results in the loss of
registered market maker status for a period of 20 business days. In
addition, for those Nasdaq National Market securities that have trading
attributes similar to Nasdaq SmallCap securities, elimination of the
150% Excess Spread Rule for SmallCap securities will create a ``control
group'' that will afford Nasdaq a better opportunity to evaluate the
effects of the 150% Excess Spread Rule. The NASD and Nasdaq anticipate,
however, that market makers in Nasdaq SmallCap securities will be
subject to the same
[[Page 11247]]
excess spread requirements, if any, as market makers in the Nasdaq
National Market securities beyond July 1, 1997.
2. Statutory Basis
The NASD and Nasdaq believe that the proposed rule change is
consistent with Section 15A(b)(6) of the Act. Among other things,
Section 15A(b)(6) requires that the rules of a national securities
association be designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, to 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.
B. Self-Regulatory Organization's Statement on Burden on Competition
The NASD believes that the proposed rule change will not result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
No written comments were solicited or received with respect to the
proposed rule change.
III. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, 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. Sec. 552, will be available for inspection and copying at
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-97-13 and should
be submitted by [insert date 21 days from date of publication].
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
After careful review, the Commission finds, for the reasons set
forth below, that the NASD's proposal is consistent with the
requirements of Section 15A of the Act and the rules and regulations
thereunder applicable to the NASD and, in particular, Section
15A(b)(6).
The Commission believes that it is reasonable for the NASD to
remove application of the 150% Excess Spread Rule to market maker
quotations in Nasdaq SmallCap securities because it is difficult for
market makers to monitor their compliance with that Rule. This stems
from Nasdaq's inability to calculate and display through the system the
average spread of all market makers in Nasdaq SmallCap securities or a
comparison of the size of an individual market maker's quoted spread in
a Nasdaq SmallCap security relative to the average spread of all market
makers in Nasdaq SmallCap securities.
The NASD also points out that application of NASD Rule 4613(d) may
impose artificial constraints on market makers' quote movements.\8\
According to the NASD, market makers may be less apt to adjust their
quotes in response to market activity for fear that they will violate
the rule and be subject to mandatory withdrawal for 20 business days.
The Commission agrees that this is a possibility and prefers to
eliminate the potential restraint on market maker quote movements to
foster market maker competition, protect the price discovery process
and preserve the integrity of quotations in Nasdaq SmallCap securities
in furtherance of the objectives of Section 15A(b)(6). While the
Commission approves removal of the applicability of the NASD's excess
spread rule to market maker quotations in Nasdaq SmallCap securities,
however, it expects the NASD to develop other means of stimulating and
measuring sound market making performance for all Nasdaq stocks.
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\8\ See infra note 7 and accompanying text.
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The Commission finds good cause for approving the proposed rule
change prior to the thirtieth day after the date of publication in the
Federal Register. By accelerating the effectiveness of the proposed
rule change, market makers in Nasdaq SmallCap securities will not be
subject to mandatory market maker registration withdrawals for 20
business days for noncompliance with the 150% Excess Spread Rule.\9\
The Commission reiterates that the NASD should study alternative
methods that would enhance market making performance while completely
fulfilling the NASD's obligation regarding the excess spread rule
before the August 8, 1997 deadline contained in the Commission's
Order.\10\
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\9\ Because the 150% Excess Spread Rule evaluates a market
maker's spread over a full calendar month, February 1997 was the
first month in which market maker spreads were evaluated pursuant to
NASD Rule 4613(d). Accordingly, March 1997 will be the first month
in which market makers will be subject to the mandatory market maker
withdrawals for 20 business days for noncompliance with the Rule.
\10\ See Release 34-38180, supra note 3 and Order Instituting
Public Proceedings Pursuant to Section 19(h)(1) of the Securities
Exchange Act of 1934, Making Findings and Imposing Remedial
Sanctions, Securities Exchange Act Release No. 37538 (Aug. 8, 1996).
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\11\ that the proposed rule change (SR-NASD-97-13) is approved.
\11\ 15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\12\
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\12\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-5983 Filed 3-10-97; 8:45 am]
BILLING CODE 8010-01-M
