[Federal Register Volume 63, Number 48 (Thursday, March 12, 1998)]
[Notices]
[Pages 12124-12140]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-6340]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39718; File No. SR-NASD-98-17]
Self-Regulatory Organizations; Notice of Filing of Amendment No.
1 to a Proposed Rule Change by National Association of Securities
Dealers, Inc., Relating to an Integrated Order Delivery and Execution
System
March 4, 1998.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby
given that on February 19, 1998, the National Association of Securities
Dealers, Inc. (``NASD''), 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.\3\ On March 3, 1998, the NASD filed Amendment
No. 1 to the proposed rule change.\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. Sec. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ On December 22, 1997, the NASD filed a proposal (SR-NASD-97-
93) that was substantially similar to the proposal discussed in this
filing. The NASD withdrew that filing when it filed this proposal.
See letter from Robert E. Aber, Senior Vice President and General
Counsel, Nasdaq, to Katherine A. England, Assistant Director,
Division of Market Regulation, dated February 18, 1998. On February
20, 1998, the NASD filed a technical amendment adding certain
language regarding handling of non-directed orders. See fax from
Andrew S. Margolin, Senior Attorney, Office of General Counsel,
Nasdaq, to Jeffrey R. Schwartz, Special Counsel, Division of Market
Regulation, dated February 20, 1998. This technical amendment is
discussed in footnote 42 below
\4\ See letter from Robert E. Aber, Vice President and General
Counsel, Nasdaq, to Katherine A. England, Assistant Director,
Division of Market Regulation, dated March 3, 1998 (``Amendment No.
1''). Amendment No. 1 corrected several technical errors and added
language to Section D.3.b. noting that SR-NASD-98-05 changed the
manner in which Nasdaq handles SOES orders.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
Nasdaq is proposing new rules and amendments to existing rules of
the NASD to establish an integrated order delivery and execution
system, featuring a voluntary limit order book and market maker
sponsored direct access by non-members. The text of the proposed rule
change is contained in an Exhibit attached to this notice.
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 may be examined at the places 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
A. General
Nasdaq is proposing a new integrated order delivery and execution
system (``System''). The System responds to the demands of investors
and NASD members for a marketplace that provides for fast and efficient
access to the best prices in the market and effective integration of
price discovery, execution, and trade reporting. When combined with a
broadly accessible voluntary limit order file featuring order anonymity
and full display of limit order interest, Nasdaq's new System will
further enhance the satisfaction of a wide range of market participant
needs. The System represents a logical evolution of Nasdaq in light of
the changes and growth in trading behavior, particularly as a result of
the new SEC Order Handling Rules.\5\ The System is designed to leverage
the benefits of these rules while complementing Nasdaq's competing
dealer market structure.
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\5\ See Exchange Act Release No. 37619A (September 6, 1996) 61
FR 48290 (September 12, 1996) (``Adopting Release'').
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While Nasdaq seeks to incorporate more order-driven features in the
Nasdaq environment, Nasdaq will retain the benefits of a competitive
dealer network by maintaining incentives for market makers that also
contribute significantly to Nasdaq's liquidity. These incentives
include a reduction in market maker exposure to unintended multiple
executions through Nasdaq's systems, enhanced compliance with the Firm
Quote Rule, the ability for certain market makers to sponsor access by
institutional customers, and a means of reducing the cost of capital by
providing a low cost limit order book sponsored by Nasdaq. Importantly,
because the design of the System is based on the ability of market
makers to quote their actual size, Nasdaq also believes that a
disincentive for some market makers would be removed, thus attracting
more liquidity and pricing efficiency in the Nasdaq market.\6\
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\6\ Indeed, the Commission noted in its approval of the Actual
Size Rule pilot (discussed further in Section B.3. below) that ``the
1000 share minimum quote size represents a barrier to entry for
market making. Lowering this barrier to entry could attract more
market makers, thereby increasing liquidity and competition across
the market.'' See Exchange Act Release No. 38156 (January 10, 1997)
62 FR 2415, at 2425 (January 16, 1997) (order approving certain
changes related to implementation of the SEC Order Handling Rules).
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These incentives and benefits are important, in that Nasdaq
continues to
[[Page 12125]]
believe that market makers represent a key component of Nasdaq's
strength, providing necessary liquidity for the market in all Nasdaq
securities, but especially for lesser known and start-up issuers. The
new System will provide market makers with a tool that allows them
efficient and immediate access to the best prices in the market, levels
the competitive playing field between market makers and electronic
communications networks (``ECNs''), and provides market makers with
incentives to risk capital and supply liquidity. In designing this
proposed System, Nasdaq also has been mindful that the System also
should provide investors and other traders with immediate and automatic
executions. The NASD and Nasdaq have attempted to fulfill Nasdaq's
mission to provide accessible linkages to providers of liquidity as
displayed in a centralized system, thus facilitating a more efficient
marketplace. In summary, the System will bring together a broad range
of participants into a single, integrated electronic system that will
maximize the role of each participant to the ultimate benefit of all
participants in the Nasdaq Stock Market as a whole--individual and
institutional investors, order-entry broker-dealers, market makers, and
ECNs.
B. Integration of Order Delivery and Execution Systems
The new System will combine and enhance the functions of two
distinct trading mechanisms that currently form the core of the Nasdaq
trading environment: the Small Order Execution Service (``SOES'') and
SelectNet. As described later in the filing, the new System will
eliminate the two separate systems, but preserve in one integrated
system the features and functionality of an automatic order execution
system, SOES, and the order delivery and negotiation features of
SelectNet. The efficiency of this new integrated system should enhance
the ability of traders to trade, while minimizing regulatory concerns
associated with dual, non-integrated systems that are used to
simultaneously access the same quote.
1. Background
SOES was developed in 1984 to provide a simple and efficient means
to execute small agency orders at the inside quote, report trades for
public dissemination, and send trades to clearing for comparison and
settlement.\7\ Trading is done automatically and is negotiation-free.
In response to the October 1987 market break, SOES was enhanced in
several respects to provide individual investors with guaranteed
liquidity and assured access to market makers in times of market
disruption. In particular, SOES participation was made mandatory for
all market makers in Nasdaq National market securities, and minimum
quote size requirements were instituted.\8\ These minimum quote size
requirements, generally for 1,000 shares, continue to exist today
except for 150 designated securities for which market makers may quote
their ``actual size'' pursuant to a pilot program approved by the
SEC.\9\
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\7\ See Exchange Act Release No. 21743 (February 12, 1985) 50 FR
7432 (February 22, 1985) (order approving rule change describing
SOES).
\8\ See Exchange Act Release No. 25791 (June 9, 1988) 53 FR
22594 (June 16, 1988) (order approving amendments to rules governing
the operation of SOES).
\9\ See Section B.3. for discussion of actual size.
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SelectNet, originally referred to as the Order Confirmation
Transaction Service, was approved by the Commission in January 1988 to
provide an alternative to verbal contact among trading desks for
negotiating trades.\10\ SelectNet also was developed in response to the
difficulties experienced in the Nasdaq market during the market break
of October 1987.\11\
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\10\ See Exchange Act Release No. 25263 (January 11, 1988) 53 FR
1430 (January 19, 1988) (order approving SelectNet on a temporary,
accelerated basis). See also, Exchange Act Release No. 25523 (March
28, 1988) 53 FR 10965 (April 4, 1988) (order extending temporary
approval of SelectNet); Exchange Act Release No. 25690 (May 11,
1988) 53 FR 17523 (May 17, 1988) (order granting permanent approval
of SelectNet).
\11\ The service was enhanced and renamed SelectNet in 1990. See
Exchange Act Release No. 28636 (November 21, 1990) 55 FR 49732
(November 30, 1990). In 1992, the service was expanded to add pre-
opening and after-hours sessions, so that today SelectNet is
available for members to negotiate and execute orders from 9:00 a.m.
until 5:15 p.m. (ET). See Exchange Act Release No. 30581 (April 14,
1992) 57 FR 14596 (April 21, 1992).
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SelectNet is an electronic, screen-based order routing system
allowing market makers and order-entry firms (collectively referred to
as ``participants'') to negotiate securities transaction in Nasdaq
securities through computer communications rather than relying on the
telephone. Unlike SOES, SelectNet offers the opportunity to negotiate
for a price superior to the current inside quote. In addition,
SelectNet participants may provide that an order or counter-offer will
be in effect for anywhere from 3 to 99 minutes, specify a day order, or
indicate whether price or size are negotiable or whether a specific
minimum quantity is acceptable. Participants may accept, counter, or
decline a SelectNet order. Once agreement is reached, the execution is
``locked-in'' and reported to the tape for public dissemination and
sent to clearing to comparison and settlement.
SelectNet allows subscribers to direct, or ``preference'' orders to
specified market makers or to broadcast orders to all market makers.
Although SelectNet is an order delivery service, rather than an order
execution service, a preferenced SelectNet order presented to a market
maker at its displayed quote generally gives rise to a liability under
SEC Rule 11Ac1-1 (``Firm Quote Rule'') for the market maker to execute
the transaction at that price.\12\
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\12\ There are two exceptions to the Firm Quote Rule: (1) prior
to the receipt of the order, the market maker has communicated to
its exchange or association a revised quotation size or revised bid
or offer; or (2) prior to the receipt of the order, the market maker
is in the process of effecting a transaction in a security when an
order in the same security is presented, and immediately after the
completion of such transaction, the market maker communicates to its
exchange or association a revised quotation size or revised bid or
offer.
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More recently, Nasdaq established SelectNet as the link to ECNs in
conjunction with the SEC's Order Handling Rules. Specifically, an
amendment to SEC Rule 11Ac1-1 now 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 prices orders to an ECN provided that
the ECN disseminates these priced order to the public quotation system
and provides broker-dealers equivalent access to these orders (``ECN
Display Alternative''). The SelectNet linkage was implemented to
facilitate this dissemination and equivalent access.\13\
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\13\ See Exchange Act Release No. 38156 (January 10, 1997) 62 FR
2415 (January 16, 1997) (order approving certain changes related to
implementation of the SEC Order Handling Rules).
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2. Issues Related to the Current Operation of Nasdaq's Non-Integrated
Order Delivery and Execution Systems
While SOES and SelectNet each provide valuable services to market
participants for the benefit of investors, there are a number of
problems associated with maintaining these two separate systems side-
by-side, which are well understood by the SEC, NASD, and market
participants. Most troublesome are the problems members have in
managing multiple points of execution. This manifests itself most
noticeably when a market maker's quote is subject to multiple access
virtually simultaneously, through a combination of SOES and SelectNet,
from the same or different market participants. Because the Firm Quote
Rule obligates a member to execute orders presented to it at its
[[Page 12126]]
displayed quote, a firm may be subject to unintended double liability
while trying to effectively manage executions from SOES and liability
orders from SelectNet at the same time. This is compounded further when
market makers also are handling orders received by phone as well as
orders within their own internal execution systems.
The potential for this problem is exacerbated by an exponential
increase in the use of SelectNet during the last few years, and in
particular during the past several months. For example, for the period
of October, 1996 through September, 1997, both the number of
transactions and dollar volume executed through SelectNet has increased
nearly six-fold.\14\ In addition, SelectNet has represented an
increasing proportion of Nasdaq's total trades and dollar volume during
the same period--from approximately 5% to nearly 15%. This trend may be
attributed to several related factors, including: (1) The growing
importance of electronic access within the Nasdaq market and a
corresponding migration away from the ``phone trades'' to automated
systems; (2) increase in the use of SelectNet by market makers as a
vehicle for trading in size without negotiation, given that market
makers are prohibited from using SOES for proprietary transactions; (3)
implementation of the SEC's Order Handling Rules and the related role
SelectNet plays in providing a link between Nasdaq and ECNs,\15\ and
(4) a heightened awareness of trading obligations by market
participants.
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\14\ In comparison, average daily volume of Nasdaq during the
same period has increased a relatively modest 30 percent.
\15\ Growth in SelectNet usage closely tracks expansion in the
number of Nasdaq stocks covered by the SEC Order Handling Rules.
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As a result, there also has been a corresponding increase in
regulatory and compliance burdens for both market participants and
staff of NASD Regulation, Inc., (``NASDR''), who are responsible for
investigating complaints that may involve ``backing away'' from
published quotes, and enforcing the Firm Quote Rule.\16\ Indeed, in a
letter from staff of the SEC's Division of Market Regulation responding
to a request for interpretive guidance on the Firm Quote Rule in this
context, the SEC acknowledged the difficulty in articulating a ``bright
line'' test on what constitutes backing away, and noted that the double
execution problem arising from Nasdaq providing two automated order
delivery and execution systems could be eliminated by integrating these
two systems.\17\
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\16\ The NASD has rules similar to the SEC Firm Quote Rule. See
NASD Rules 3320 and 4613(b).
\17\ See letter from Richard R. Lindsey, Director, Market
Regulation, To Richard G. Ketchum, Executive Vice President and
Chief Operating Officer, NASD, and Mary L. Schapiro, President
NASDR, dated July 16, 1997.
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Given these practical and regulatory problems, the NASD and Nasdaq
believe that it would be prudent to combine the two systems as soon as
practicable. Integration would facilitate the orderly processing of
electronic orders through one communications facility while easing
associated regulatory and compliance burdens, in addition, to assist
market makers in complying with the Firm Quote Rule, Nasdaq is
proposing a System feature to provide market makers with a means to
indicate to staff of NASDR that the market maker has received an order
via the telephone to trade at the market maker's Nasd-displayed
quotation and that for a period of time while the System market maker
handles the telephone order, the System should not deliver additional
orders for execution.\18\ This ``Firm Quote Compliance Facility'' will
create an electronically time stamped record that will be critical in
NASDR's efforts to reconstruct activity that may involve backing
away.\19\
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\18\ See Section D.10. below and proposed NASD Rule 4960.
\19\ As part of the undertakings pursuant to the Commission's
administrative proceeding, the NASD is required to upgrade
substantially its capability to enforce the Firm Quote Rule by
implementing a process for backing away complaints to be addressed
as they are made during trading day do that valid complaints may be
satisfied with a contemporaneous trade execution, and taking other
appropriate actions. See Exchange Act Release No. 37538 (August
8,1996), Administrative Proceeding File No. 3-9056 (Order
Instituting Public Proceedings Pursuant to Section 19(h)(1) of the
Securities Exchange Act of 1934, Making Findings and Imposing
Remedial Sanctions).
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In developing an integrated System, Nasdaq seeks to provide the
most equitable and efficient means of access among market participants.
A key design requirement of such a system dictates that orders
communicated through Nasdaq be delivered in strict time priority,
regardless of whether the order is sent to a specific participant
(directed) or to any participant at the best available quote (non-
directed). This would be impossible in the current environment given
the nature of two separate and asynchronous order delivery and
execution systems. Most importantly, this also will assist market
makers in managing their displayed quotations, further enhancing the
efficiency of the market.
3. Relationship of Proposal To Actual Size Rule
It is important to note that the integration of Nasdaq's order
delivery and execution infrastructure and the ability of members to
enter orders of virtually unlimited size, as set forth in this filing,
is based on the ability of market makers to quote their actual size, as
opposed to artificial minimum quote size requirements currently in
effect for most stocks in SOES today. Under current rules, market
makers generally are required to quote a minimum of 1,000 shares on the
bid and the offer (for some less active issues, the minimum is 500 or
200 shares).
With the introduction of the SEC Order Handling Rules in January of
1997, market makers are now obligated to display customer limit orders
in their quotations. Given the full implementation of these rules,
which have altered Nasdaq's structure from a predominantly quote-driven
market toward a more order-driven market, Nasdaq believes that the
rationale for minimum quote size requirements no longer exists. We
believe these changes warranted consideration of eliminating the
requirement that market makers quote artificial minimum size of 1,000
shares. On January 20, 1997, therefore, we began a pilot covering 50
Nasdaq securities allowing market makers to quote their actual size,
thereby reducing minimum quotation size requirements to a least one
normal unit of trading and allowing market makers to quote in
accordance with their freely-determined trading interest (``Actual Size
Rule'').\20\ On November 10, 1997, the Actual Size Rule pilot was
expanded to include an additional 100 securities.\21\ These securities
represent a broad range of securities listed on the Nasdaq Stock
Market. We are monitoring this pilot and expect to report its effects
on the market to the SEC in early 1998.\22\
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\20\ See Exchange Act Release No. 38156 (January 10, 1997) 62 FR
2415 (January 16, 1997) (order approving, among other things, Actual
Size Rule pilot for first fifty stocks phased in under Order
Handling Rules).
\21\ See Exchange Act Release No. 39285 (October 29, 1997) 62 FR
59932 (order approving an expansion of the Actual Size pilot to 150
stocks and extending the pilot until March 27, 1998).
\22\ No other equity market requires minimum quote sizes greater
than 100 shares. Empirical analysis thus far has demonstrated that
the removal of minimum quote size requirements under the Actual Size
Rule pilot has not degraded market quality, and there is no basis to
conclude that such requirements are necessary. See NASD Economic
Research Department, Effects of the Removal of Minimum Sizes for
Proprietary Quotes in The Nasdaq Stock Market, Inc. (June 5, 1997).
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The changes to Nasdaq systems set forth in this proposal are
designed to complement market makers quoting in
[[Page 12127]]
actual size. To the extent that the Actual Size Rule is not approved
for all Nasdaq securities, an alternative proposal is being made to
minimize the exposure to market makers at artificial quote sizes. This
is particularly necessary given the potential under the new System to
access market marker quotes for much larger size than the current SOES
tier sizes would otherwise permit. Such alternative provisions are
noted in this filing where relevant, and are also identified in the
text of the proposed rule change accordingly.\23\
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\23\ See, e.g., proposed rules 4940(b)(3) and 4950(c).
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As part of the new System, Nasdaq is proposing to eliminate certain
rules that currently are in place for the operation of SOES. As
indicated, SOES was designed exclusively for individual retail
customers orders restricted to a maximum size. These order sizes
correspond to a market maker's minimum quote size requirements.
Specifically, NASD Rule 4730(c)(3) permits only agency orders from
public customers no larger than the maximum order size \24\ to be
entered into SOES (``Maximum Order Size Rule''). That rule also
prohibits large orders from being divided into smaller parts to be
entered into SOES. A related interpretation of this rule prohibits
behavior designed to circumvent the order size limits. Specifically, as
set forth in Notice to Members 88-61 (August 25, 1988), trades entered
within a five minute period are presumed to be part of a ``single
investment decision'' and are aggregated accordingly (``Five Minute
Rule''). Because Nasdaq is proposing to replace all the SOES rules, and
because the System is based on the ability of market makers to quote
actual size, the Maximum Order Rule and its related interpretation
(including the Five Minute Rule) become unnecessary, and therefore
those rules would be eliminated.
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\24\ Rule 4710(g) establishes the maximum order size for a
Nasdaq National Market security at 200, 500, or 1,000 shares,
depending on the trading characteristics of the security, such as
the average daily non-block volume, bid price, and number of market
makers. The maximum order size for Nasdaq SmallCap securities is 500
shares. The Maximum size for each security is published from time to
time by the NADAD.
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However, if the NASD's proposal to eliminate artificial quote size
requirements for all Nasdaq securities is not approved by the time that
the new integrated order delivery and execution system is approved, the
NASD believes that certain order entry features of the new System would
not be appropriate in an artificial quote size environment.
Specifically, the NASD proposes in the alternative that all of the
existing restrictions on order entry by non-market makers should
continue. Thus, in the absence of prior approval of the Actual Size
Rule, non-market makers should not be permitted to enter orders larger
than 1,000 shares for non-directed orders, and the prohibition on
splitting of orders and the Five Minute Rule be retained.\25\
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\25\ The only exception to the elimination of the old SOES Rules
concepts on limits on order entry is the continuation of the
prohibition that registered persons that have access to order entry
systems should not be permitted to enter orders for their own
accounts. Nasdaq believes that it is appropriate to continue this
prohibition because of the time and place advantage that such
persons may have over others not similarly situated. As a policy
matter, therefore, Nasdaq believes it would be inconsistent with the
obligations of member firms and their associated persons to
facilitate access that could potentially place the personal
interests of registered personnel ahead of their customers. The
prohibition, however, would no longer extend to accounts of
immediate family members of such registered persons.
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C. Limit Order Book
The System also will feature a voluntary limit order book (``Limit
Order File'' or ``File'') for the display and matching of limit orders.
Use of the Nasdaq Limit Order File will be completely voluntary on the
part of NASD members that have customer limit orders to display or
proprietary interest that such members may want to display anonymously.
It should be emphasized that the NASD and Nasdaq Boards, in authorizing
this rule filing, agreed that the NASD had not intention to create a
regulatory environment that would mandate NASD member use of the Limit
Order File. Furthermore, the proposal does not require members to
protect orders in the Limit Over File beyond the member's best
execution obligations. The new Limit Order File will simply be an
additional means for members and their customers to display priced
orders to the entire market. Thus, the proposed File merely provides
another option for displaying orders and is intended to supplement, not
supplant, the exiting options, i.e., a market maker's quotation or a
linked ECN.
The Limit Order File will facilitate the opportunity to obtain
price improvement by allowing member firms to display customer limit
orders or their own trading interest between the best dealer or ECN bid
and offer, and by facilitating interaction with other orders within the
File or with other participants who access the File, resulting in a
prompt, cost-effective execution at the best available price. The best
priced orders in the Limit Order File will be publicly displayed in
Nasdaq's quote montage and in a separate ``Top of File'' display. When
the Limit Order File contains the best priced orders in the market,
such prices will be used to calculate the Nasdaq ``inside'' quote,
providing increased transparency and pricing efficiency.
These orders, which can be accessed by other market participants,
will be entered and displayed anonymously. That is, the member that
enters the order will not have its identifier (its MMID symbol)
displayed with the order. Initially, the NASD is proposing that after
any resulting execution of a File order, the identity of the party
entering the order will be revealed to any counter-parties to the
execution in an execution report that is sent immediately after
execution to the parties to the trade. The NASD continues to analyze
the anonymity feature and, at a future date and subject to a new rule
proposal, may provide either anonymity of executions in the File until
the end of the trading day or complete anonymity of executions through
settlement. However, at this stage, the NASD believes that anonymity up
until execution provides sufficient protection to traders from negative
market impact costs caused by premature disclosure of trading interest.
As explained in more detail later, the NASD believes that it would be
useful if commenters specifically addressed the needs of traders and
investors with respect to these differing levels of anonymity.
Importantly, the Limit Order File can be used by market makers to
satisfy the customer limit order display rule, SEC Rule 11Ac1-4
(``Display Rule''), which would otherwise require a market maker to
update its own quote immediately to reflect a customer limit order.
Specifically, an exception to the Display Rule applies when limit order
are immediately displayed in an NASD-sponsored system that publishes
the best priced orders and permits access by other broker-dealers. As
indicated, the Top of File of the Nasdaq book is included in the Nasdaq
quote montage, and therefore a market maker may, upon receipt of a
customer limit order, deliver it to the File immediately to satisfy the
requirements of the Display Rule, pursuant to SEC Rule 11Ac1-4(c)(5).
In addition, a market maker may choose to use the File to display
orders priced better than its published quote without reflecting the
order in its quote as would be required pursuant to recent amendments
to SEC Rule 11Ac1-1. Specifically, this is permissible under paragraph
(c)(5) of that rule because the best priced orders contained in the
Limit Order File are publicly disseminated in Nasdaq and are
[[Page 12128]]
available for execution by other broker-dealers.
As indicated, the Limit Order File offers Nasdaq market makers a
voluntary mechanism to display customer limit orders when the market
maker chooses not to display such orders in its own quote or in an ECN.
Because the Limit Order File is completely voluntary, market makers
should be able to continue to attract limit orders from investors and
other broker-dealers by offering value-added features to customers that
a generic file such as that proposed by Nasdaq can not provide.
The Limit Order File also responds to the needs and desires of a
significant element of the investor community: the institutional ``buy-
side'' trader. The Institutional Committee of the Security Traders
Association (STA) recently completed a survey of such institutional
traders, wherein STA found that an overwhelming majority of
institutions were aware of Nasdaq's initiative to establish a limit
order book accessible to all market participants, and voiced strong
support for it.\26\ As explained in Sections D.5. and D.6. below, the
File will provide investors and others with the ability to anonymously
display orders. STA's survey indicated that some level of anonymity was
an important feature for institutional investors. By providing
anonymity as to the identity of the party entering the order, the File
can help to reduce market impact costs that may affect the ability of
institutions to obtain low-cost executions. In addition, because the
Limit Order File will be fully viewable to all subscribers of Nasdaq's
Workstation service and through vendor terminals, Nasdaq will be
providing added transparency to the market by displaying the entire
supply and demand schedule in the File.
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\26\ See STA Institutional Study (http://securitytraders.org/
newslett/news/release1/right.htm), October, 1997. According to STA,
the results were based on 154 responses received from buy-side
traders out of approximately 800 who were mailed the survey.
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Overall, the NASD believes that the development of a Nasdaq-
operated, voluntary limit order file will benefit investors and members
and, therefore, is in the best interest of the marketplace. The NASD
and Nasdaq note that virtually every other major equity market around
the world, including now the London Stock Exchange, provides a market-
run limit order facility for the display of limit orders; each of those
markets that recently added an electronic limit order book did so to
respond to investor needs. For investors, both retail and
institutional, the proposed voluntary File creates an additional and
efficient mechanism for investors to display priced orders and to
potentially trade at reduced spreads without the intermediation of a
dealer, a Congressional goal embedded in the Exchange Act. For retail
investors, the Limit Order File should promote greater confidence in
Nasdaq's market structure because it offers another vehicle for
transparency and more efficient execution of limit orders. In addition,
the File should work toward reducing the perception among some retail
investors that the playing field is tilted in favor of broker-dealers
and larger investors.
D. Description of New Rules
1. Overview and Scope
The new System will replace completely the existing SOES and
SelectNet systems. The functionality previously contained in these two
separate systems will be integrated into a single system, which should
alleviate many of the concerns market makers have had with exposure to
multiple points of simultaneous execution liabilities. The new System
will permit all registered participants to send orders to access either
the best market maker quote or ECN order, or orders visible in the
Nasdaq Limit Order File, and to obtain immediate or rapid executions of
such orders.
As occurs in today's environment, the new System will have three
types of registered executing participants: market makers, ECNs and UTP
exchange specialists. Quotations provided by these three entities will
be displayed on Nasdaq Workstation and disseminated through information
venders. Registered NASD members, and certain customers that are
sponsored by NASD members, will be able to deliver orders of varying
size through the new System to electronically access the displayed
quotations. Market maker and ECN display obligations will be the same
as today. As provided for in the proposed rules, market makers must
maintain two-sided quotations and be firm up to the displayed size of
such quotations. The System will provide for market makers an automated
quotation update facility similar to that which is provided today.\27\
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\27\ The automated quotation update facility will refresh a
market maker's quotation at an increment chosen by the market maker.
The facility will not permit a refresh at the same price as that
being quoted when the quotation size was reduced to zero. When the
facility refreshes the quotation, the size of the refresh quotation
will be 1,000 shares. If the market maker wishes to quote in a size
other than 1,000 shares, the market maker must manually enter that
size after the quote has been refreshed.
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The NASD and Nasdaq, however, are proposing a slight change to its
current operation. After a market maker's quote is exhausted, that is,
the System has decreased the displayed size to zero, if the market
maker is not using the system-provided automated quotation update
facility or the System's supplemental size feature,\28\ the market
maker's quote (both the bid and the offer sides, regardless of which
side was reduced to zero) will be placed in a closed quote state for
three minutes, instead of the current five minutes. At the end of that
time period, if the market maker has not on its own updated its
quotation or voluntarily withdrawn its quote from the market, the
System will refresh the side of the quotation that was reduced to zero
to 1,000 shares at the lowest bid or highest offer (depending on
whether the quote is a bid or offer, respectively) currently being
displayed in that security and reopen the market maker's quotation. The
NASD is proposing to make these two changes to the current approach
because its believes that in the proposed electronic environment, five
minutes is too long a period to have a quote closed on the Nasdaq
screen, and because it believes that restoring the quote at the lowest
ranked bid or highest ranked offer price and 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.\29\
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\28\ Supplemental size is discussed further in Sections D.3.a
and D.4.a. See, also, proposed rules 4950(d)(6), 4950(e)(3)(D), and
4950(f).
\29\ 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.
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2. Order Entry
The rules permit any size order up to 999,999 shares to be entered.
As indicated, however, it is important to note that this large size
permitted for order entry is based on the ability of market makers to
display actual size in their quotations.\30\ Thus, in the context of
non-directed orders, discussed further in Section D.3.b., the System
will permit order delivery for execution to each market maker, ECN or
the Nasdaq Limit Order File only up to the size of the quote or order
that is displayed.\31\
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\30\ See Section B.3. for discussion of actual size.
\31\ As explained below in Section D.3.a., any order entry firm
is permitted to direct an order to a specific market maker, ECN, or
UTP Exchange specialist. The size of such directed orders is not
constrained by the executing participant's displayed quote size.
However, the executing participant's liability to fill the order
under the Firm Quote Rule is limited to the amount of shares
publicly displayed in the quotation.
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[[Page 12129]]
The minimum life for such orders shall be 10 seconds. The NASD
believes that orders in the System should have a minimum life to
alleviate potential problems that could occur with fleeting or
ephemeral prices that are flashed to the market for brief periods of
time and are virtually inaccessible by other market participants.
a. Customer Orders. All members may enter orders on behalf of
customers. If the Actual Size Rule is approved for all Nasdaq stocks on
a permanent basis, Nasdaq would eliminate the current SOES rule
prohibiting the splitting of orders and requiring the aggregation of
orders within a five minute period, including orders from immediate
family members of associated persons, to evade the maximum order size
limits found in SOES.\32\ However, even in an actual size environment,
the NASD plans to maintain the current restriction on the ability of
registered representatives that have access to Nasdaq order entry
capabilities to enter orders for their own accounts into this system.
The NASD believes that maintaining this restriction is important to
minimize the time and place advantages that these professionals may
continue to have.
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\32\ See NASD Notice to Members 88-61 (August 25, 1988).
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If the Actual Size Rule is not approved, however, the NASD
proposes, in the alternative, to maintain the existing restrictions and
to limit the size of orders entered by non-market makers to 1,000
shares. The NASD believes that this alternative, contingent approach is
appropriate to ensure that market makers' risk is minimized and that
their capital is not accessed in an essentially unfettered manner in an
artificial quote size environment.
b. Proprietary Orders. Also contingent on the expansion and
approval of the Actual Size Rule for all Nasdaq stocks, the proposed
rules permit any NASD member to enter proprietary orders into the
System for immediate execution, order delivery, or display in the
Limited Order File. The NASD believes that any NASD member, whether it
is an order entry firm or a market maker in a particular stock, should
be permitted to enter proprietary orders. The rationale for permitting
a broad use of proprietary orders is that entry of such orders may
provide additional liquidity to the market and that any member is
currently able to enter such orders through an ECN. It would be
illogical to limit the use of Nasdaq's Limit Order File when the same
activity is already permissible through other vehicles. It should be
noted, however, that the NASD intends to monitor principal trading
activity by NASD members not registered as market makers to determine
if it may be necessary to adopt a rule similar to that found in the
exchange-listed market environment, where SEC rules require Third
Market Makers that effect more than 1% of the volume of a particular
stock to register and quote as a Third Market Maker.\33\ In any event,
without the approval of the Actual Size Rule for all Nasdaq securities,
the NASD is proposing an alternative to prohibit the entry of any
principal orders by non-market makers.
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\33\ In connection with the approval of the SEC Order Handling
Rules, the SEC adopted an amendment to Rule 11Ac1-1 to improve
transparency and provide the public with information about
significant market participants. The amendment requires OTC market
makers and exchange specialists to provide continuous two-sided
quotations for any exchange-listed security when they are
responsible for more than 1% of aggregated transaction volume in
that security. See Adopting Release, at 48317. Prior to this
amendment, mandatory quotations were only required from OTC market
makers and exchange specialists who transacted more than 1% of the
volume in a Rule 19c-3 security. In addition, the SEC has proposed a
similar rule for Nasdaq securities. See Exchange Act Release No.
37620 (August 29, 1996) 61 FR 48333 (September 12, 1996) (proposal
to amend SEC Rule 11Ac1-1).
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3. Types of Electronic Access Orders
The System will permit the entry of two types of orders that seek
to access displayed prices on the Nasdaq screen: directed and non-
directed orders.
a. Directed Orders. Directed orders are orders that an order-entry
firm chooses to send to a specific market maker, ECN or UTP exchange
for delivery and execution.\34\ The directed order concept is an
attempt to preserve certain features found in SelectNet where firms
seek to access a particular market maker's quotation and commence
electronic negotiation. During normal market hours,\35\ these orders
are processed in sequence with all other orders that may be sent to a
particular market maker, ECN or UTP exchange. Therefore, a directed
order would not enjoy any preferential delivery treatment over other,
non-directed orders (discussed below) delivered to the same market
maker, ECN or UTP. Directed orders do not interact with orders in the
Limit Order File \36\ or with other quotes displayed in the Nasdaq
quote montage. That is, all orders are time-sequenced without regard to
their classification as directed or non-directed, and thus a directed
order would not be delivered to, or executed against, a participant
until any order previously delivered to that participant was processed
first.
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\34\ The proposed rules continue to limit the ability of a
member to send orders to a UTP Exchange by the directed order
mechanism only. In other words, NASD members that uses Nasdaq's
system to access the quotation of a UTP Exchange must send that
order as a directed order to the Exchange. The NASD plans to discuss
with UTP Plan participants participation in the non-directed order
handling process.
\35\ Outside of normal market hours, e.g., from 9:00 a.m. until
9:30 a.m. and from 4:00 p.m. until 5:15 p.m., the only means to
reach a market maker quote or an ECN order through Nasdaq's
electronic system will be through the directed order feature. Such
orders must be sent to a specific quote with the appropriate MMID
identified. Such orders will not have any Firm Quote Rule liability
attached to them, unless during the post 4:00 p.m. period, a market
maker or ECN intentionally re-opens its quote that is automatically
placed in a closed quote state by Nasdaq at 4:00 p.m. A market maker
that opens its quote momentarily, however, solely for the purpose of
adjusting its quote to reflect the elimination of customer limit
orders, will not be subject to Firm Quote Liability. See letter from
Howard L. Kramer, Senior Associate Director, Market Regulation, to
Robert E. Aber, Vice President and General Counsel, Nasdaq, dated
August 25, 1997.
\36\ Nasdaq will provide a system capability to reach the Limit
Order File directly--the takeout facility. A takeout order will be a
System-provided feature that permits a member to directly interact
with orders displayed in the Limit Order File, but only those orders
that were entered by that member, either for itself or its customer.
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Upon order entry, a member that wishes to send an order to a
specific market maker, ECN or a UTP exchange would be required to
specifically enter the MMID for the quote that it wants to access. The
directed order will be entered into the System and placed in a time-
sequenced queue with all other orders, both directed and non-directed,
that have been entered for that security. Depending on the time
sequence of the directed order, the order will be delivered to the
particular MMID identified by the order entry firm when the order's
turn for delivery arrives. Once delivered to that MMID, the directed
order will be handled for execution purposes as described below in the
non-directed order context. That is, if the order is 1,000 shares or
less and the market maker or ECN quotation is equal to or greater than
the size of the order, the System will automatically execute the order
and decrease the displayed quote size by the amount executed. If the
order is larger than 1,000 shares but less than 5,000 shares, the order
will be delivered to the market maker or ECN for action for a period of
17 seconds. If the order is 5,000 shares or greater, it will be
delivered to the market maker or ECN for action for a period of 32
seconds. If the recipient of the order has done nothing at the end of
the applicable period, the System will execute the order up to the
displayed quote size of the recipient. During the
[[Page 12130]]
delivery period, the recipient is permitted to accept, partially
execute, or decline the order. Any partial execution or decline must be
done in compliance with the Firm Quote Rule; all such actions will be
forwarded to NASDR for its review.
Directed orders may be sent to a particular executing participant
at a price or size that is not being displayed by that participant. For
example, if a market maker is quoting 20 bid for 1,000 shares (with no
supplemental size), an order entry firm may choose to direct to that
market maker an order for 10,000 shares at 20. The market maker has
several options available when that order is received. First, pursuant
to the market maker's firm quote obligation, the market maker may
immediately choose to accept 1,000 shares and decline the balance. In
the alternative, the market maker could choose to accept any additional
amount up to 10,000 shares. Under another alternative, the market maker
may choose to do nothing, in which case at the end of 32 seconds
(because the order sent is 5,000 shares or greater) 1,000 shares will
be automatically executed against the market maker at 20 and its quote
will be decreased to zero.
Directed orders (as well as non-directed orders) will be able to
interact with a market maker's supplemental size. As explained below,
market makers will be permitted to enter a supplemental size that will
replenish their displayed quote sizes when the System executes an order
against the displayed quote.\37\ If a directed order larger than a
market maker's displayed size is sent to a market maker that is using
supplemental size, and the market maker does not respond to that order
within the 17 or 32 second period, depending on the size of the order
entered, the order will execute against the market maker's displayed
size and its supplemental size. For example, if MMA is displaying 20
bid for 1,000 shares with a supplemental size of 10,000 shares, and
order entry Firm B sends a directed order to sell 8,000 shares to MMA
at 20, and MMA does not respond with an accept, partial or decline
response within 32 seconds, the System will execute the entire order
against MMA for 8,000 shares.
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\37\ The amount of interest entered into supplemental size by a
System market maker may be any amount up to 99,000 shares, provided
that the facility will refresh quotations in a minimum increment of
1,000 shares. There will not be an ability to maintain unlimited
supplemental size (i.e., a ``No Dec'' feature will not be
available).
---------------------------------------------------------------------------
All directed orders that are delivered for a response (as opposed
to being automatically executed), will be designated by the System as
``liability'' or ``non-liability'' orders when delivered. A liability
order is an order that a broker-dealer is required to respond to
consistent with the obligations imposed by the SEC and NASD Firm Quote
Rules.\38\ For example, if Market Maker A is quoting 20 bid for 1,000
shares, a directed order that is sent to MMA to sell 1,000 shares at 20
is a liability order. In other words, MMA must respond consistent with
the Firm Quote Rule. If MMA is quoting 20 bid for 1,000 shares, and the
order entry firm directs an order to sell 20,000 shares at 20\1/16\th
to MMA, such an order would be a non-liability order for which MMA has
no responsibility to respond. MMA could, however, choose to accept the
order at the higher price. MMA also could do nothing with such order
and at the end of 32 seconds the order would time out and be returned
to the order entry firm. If the directed order sent to MMA were priced
to sell at 20 for 20,000 shares, MMA would have Firm Quote Rule
liability for 1,000 shares.
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\38\ Market makers that use supplemental size do not have
liability under the Firm Quote Rule for the amount of shares
contained in the supplemental size facility. However, the System
will reach into a market maker's supplemental size to execute
directed orders that are larger than displayed size, unless the
market maker declines the order prior to the expiration of the 17 or
32 second period normally allotted for directed orders. If the
market maker declines any portion of the order when using
supplemental size, the System will close the market maker's quote
and reduce the supplemental size to zero.
---------------------------------------------------------------------------
b. Non-Directed Orders. Non-directed orders are orders that are not
sent to a particular market maker or ECN. That is, when the member
entering the System does not specify the particular market maker, ECN
or UTP exchange it wants to access, the order will be sent to the next
available executing participant \39\ quoting at the best price
displayed in Nasdaq. Non-directed orders may be priced orders or market
orders. The first non-directed order in time sequence interacts with
the best quote or order in the Nasdaq quote montage (market maker
quotes, ECN orders, or Limit Order File orders) in price/time sequence,
that is, with the best priced quote or order. If two or more quotes or
orders are at the same price, then the non-directed order interacts
with the first such quote or order in time sequence.
---------------------------------------------------------------------------
\39\ At this time, non-directed orders cannot be sent to UTP
Exchanges because Nasdaq and the UTP Participants have not addressed
order handling in the context of the proposed System. As noted
above, Nasdaq plans to discuss the matter with the other UTP Plan
participants to seek a resolution of order delivery and execution in
the new System. Until such a resolution is reached, firms seeking to
access a UTP Exchange's quote through Nasdaq systems must send a
directed order to that exchange.
---------------------------------------------------------------------------
For example, MMA is quoting a bid of 20 for 1,000 shares; MMB is
also quoting a bid of 20 for 1,000 shares, but posted its quote 10
seconds after MMA; and MMC is quoting 19\7/8\ bid for 1,000 shares.
Another member seeks to sell 500 shares at the market in that security
and enters a non-directed order for that amount. Upon entry into the
System, the order is sent to MMA for execution. As explained below in
Section D.4.a. on Order Execution Parameters, this order will
automatically execute against MMA, and MMA's quote size will be
decreased by the System to 500 shares at 20 bid. If two non-directed
orders to sell 1,000 shares each had been entered, the first order
entered (as time-stamped by Nasdaq) would be automatically executed
against MMA, the second order would be automatically executed against
MMB and, assuming that neither market maker was using the supplemental
size feature provided by the System, both 20 bid quotes would be
decreased to 0 size and MMC at 19\7/8\ would become the best bid in
Nasdaq for this security. If an order entry firm entered a non-directed
2,000 share sell market order, the System will split that order, and
send 1,000 shares to MMA and 1,000 shares to MMB at the same time for
automatic execution.
The NASD believes that it is appropriate to place all providers of
liquidity in the Nasdaq market on the same footing with respect to
order executions through Nasdaq's systems. Thus, this proposal
contemplates that ECNs, as well as market makers, should be subject to
automatic executions of non-directed and directed orders. In the
current environment, quotes of linked ECNs that are displayed in Nasdaq
are accessible only through Nasdaq's SelectNet system, a system which
is not an automatic execution system like SOES.\40\ Market makers,
however, are accessible through both systems. As proposed, Nasdaq
believes that quotes of linked ECNs should also be
[[Page 12131]]
automatically executed against by other market participants on the same
terms as market makers. Without an equivalent execution mechanism, ECNs
would have an unfair advantage. Market makers are thus placed at a
competitive disadvantage with respect to the display and execution of
limit orders. Further, the disparity in executions may provide market
makers with an incentive to change their status from market makers to
ECNs, at a cost to market liquidity. Customers seeking to obtain
executions quickly may be placed at a disadvantage if one customer
receives an automatic execution against a market maker, while another
customer may have to wait for an ECN to respond.
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\40\ To facilitate the implementation of the SEC Order Handling
Rules at the beginning of 1997, the NASD established, on an interim
basis, a linkage to facilitate the operation of the ECN Display
Alternative. See Exchange Act Release No. 38156 (January 10, 1997)
62 FR 2415 (January 16, 1997). The ECN Display Alternative relieves
an exchange specialist or OTC market maker of the requirement to
publicly quote any superior prices that it privately displays
through an ECN if that ECN: (1) Ensures that the best priced orders
entered by market makers and specialists in the ECN are communicated
to an exchange or Nasdaq for public dissemination; and (2) provides
brokers and dealers access to orders entered by exchange specialists
and OTC market makers into the ECN, so that brokers and dealers who
do not subscribe to that ECN can trade with those orders. See SEC
Rule 11Ac1-1.
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The current dichotomy between ECNs and market makers in the
execution of orders has caused other anomalies with the processing of
orders through the SOES system. As indicated, SelectNet was chosen as
the linkage through which participants could deliver orders to access
orders displayed in the ECN because ECNs were unable to provide
automated executions through participation in SOES. As a consequence,
Nasdaq had to implement systems changes designed to suspend automated
execution in SOES whenever an ECN or UTP Exchange is alone at the
inside market.
This suspension of SOES when ECNs are at the inside quote has
resulted in an unintended consequence, however, that has caused
significant concern. Specifically, while the ECN quote effectively
halts executions in SOES for a security, it may also cause SOES orders
to be rejected back to the sending firm. Thus, there is the potential
for an ECN customer to enter an order to essentially control the inside
price, and then create an advantage in SOES for the ECN customer or
another order entry firm to then jump ahead of orders that would have
been executed in that issue if they had not been returned. This has
become problematic because the ECN then changes its quote almost
immediately, before it can be accessed through either SelectNet or its
own internal system. Once the ephemeral quote disappears and a new
dealer inside has been established, a new SOES order enters the system
which then executes as the first order against the first market maker
at the new inside price. Customer orders of order-entry firms may be
disadvantaged, in that orders entered earlier in time would be forced
to go to the back of the queue. The NASD notes that it recently
implemented a software modification intended to address this situation.
Specifically, when an ECN or UTP participant is alone at the inside,
orders sent through SOES are now held in queue for up to 90 seconds,
instead of being rejected immediately, unless they become executable
against a market maker that joins or becomes the inside quote. While
this modification preserves the sequence in which customer orders are
processed in SOES for a period of time, the NASD does not believe that
this is the optimal solution.\41\
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\41\ See Exchange Act Release No. 39637 (February 10, 1998) 63
FR 8242 (February 19, 1998) (notice of filing and immediate
effectiveness of SR-NASD-98-05 relating to modifications to SOES).
---------------------------------------------------------------------------
The NASD also is concerned about complaints from various SOES
system users that, although difficult to verify, nonetheless allege
that some traders may be using ECNs to affect the way the system
handles automatic executions in that system. The NASD does not want to
design a new system with the same potential problems. Consequently, the
NASD believes that the fairest approach to delivery and execution of
orders in the new System is to treat all participants equally and
require that all participants receiving orders through the System be
subject to the same obligations, including automatic executions of
smaller sizes. In developing the new System and proposing this level
playing field, Nasdaq recognizes that every effort must be made to work
with ECNs on changing the current approach. Nasdaq will discuss with
ECNs ways to avoid the possibility of double executions against an
ECN's displayed order and will work closely with each ECN to provide an
appropriate mechanism. Finally the NASD and Nasdaq note that there
should be sufficient programming lead time provided to ECNs to permit
them to properly program their own execution processes so as to
coordinate those processes with Nasdaq's new order delivery and
execution system.\42\
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\42\ When Nasdaq and the ECNs first established the linkage
under the Order Handling Rules in early 1997, given the very short
time frames for implementation of the new SEC rules, Nasdaq and the
ECNs did not have sufficient time to undertake major re-programming
efforts. Thus, in late fall 1996, Nasdaq and the ECNs, with SEC
approval, agreed to use the existing SelectNet system as the most
convenient application to establish a trading link between Nasdaq
and the ECNs. See Exchange Act Release No. 38156 (January 10, 1997)
62 FR 2415 (January 16, 1997) (order approving certain changes
related implementation of the SEC Order Handling Rules).
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4. Order Execution Parameters
a. Execution Parameters For Non-Directed Orders. Non-directed
orders that match against an order in the Limit Order File are executed
immediately. Non-directed orders delivered to a market maker or an ECN
will be handled in three different ways depending on the size of the
order, or portion of the order,\43\ delivered and the size of the quote
displayed by the market maker or ECN:
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\43\ As discussed below, non-directed orders may be split up and
delivered to multiple participants at the best price. Thus, an order
that is larger than a participant's displayed quotation may be split
such that only a portion of the original order is delivered to that
participant, with the balance being delivered to the remaining
participants up to their displayed size. The size of this delivered
portion is determinative of how the System applies the execution
parameters outlined herein. See letter from Andrew S. Margolin,
Senior Attorney, Office of General Counsel, Nasdaq, to Jeffrey R.
Schwartz, Special Counsel, Division of Market Regulation, dated
February 20, 1998.
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If the order, or portion of an order, is 1,000 shares or
less, an order delivered to a market maker or ECN will be executed
automatically, up to the displayed quote size. The market maker or ECN
will have up to 17 seconds thereafter to adjust its quote.\44\
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\44\ If a market maker or ECN updates its quotation price before
17 seconds has elapsed, it will be eligible immediately thereafter
for additional order delivery. Similarly, if the original execution
did not eliminate the entire size displayed at that price, the
executing participant is eligible within five seconds for additional
delivery up to the size of the quote remaining. For example, if MMA
displayed a quote of 20 for 1,000 shares, and the System
automatically executed 500 shares against that market maker, five
seconds after the first execution the System would be able to
deliver an execution for the remaining 500 shares.
---------------------------------------------------------------------------
If the order is greater than 1,000 shares and less than
5,000 shares, and the quote is equal to or greater than the order size,
the order will be presented for 17 seconds for action by the market
maker or ECN. The market maker or ECN may accept, decline, or do
nothing.\45\ if no response is received within that time, the System
will default to an execution against the quotation up to the displayed
quote size.
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\45\ A market maker may decline the order only to the extent
permissible under the Firm Quote Rule. Any declinations are
forwarded to NASDR.
---------------------------------------------------------------------------
If the order is 5,000 shares or larger and the quote
displayed is equal to or greater than the order size, the order will be
presented for review for 32 seconds.\46\ The market maker or ECN may
accept, decline, or do nothing. If there is no response after this
time, the system will default to an execution.
---------------------------------------------------------------------------
\46\ The intent here is to provide, in effect, two periods of 15
seconds each. Two additional seconds of communications time must be
added to reflect the time necessary for an execution report to be
received back from the System.
---------------------------------------------------------------------------
These default action features allow market makers and ECNs the
ability to act consistently with the Firm Quote Rule and decline large
sized orders that are delivered to them while in the process of
effecting an execution internally at their displayed quote, but before
they have had the chance to
[[Page 12132]]
update that quote.\47\ In any event, whether the order is executed
immediately or is delivered for review, executing participants will
have, depending on the order size, 17 or 32 seconds between orders to
be able to adjust their quotes before delivery of an additional order
or execution. These time periods provide appropriate windows of time to
permit market makers to manage their quote commensurate with the risk
and exposure of larger sized orders.
---------------------------------------------------------------------------
\47\ See SEC Rule 11Ac1-1.
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The System will split non-directed orders that are larger than
sizes displayed in quotes to quickly execute orders and minimize issues
related to queues of non-directed orders. For example, assume that an
order entry firm enters a 5,000 share order to buy when five market
makers or ECNs are each quoting 1,000 shares at the best offer. When
the order is entered, the System will split the order into five 1,000
share lots and automatically execute against each of the market makers
and/or ECNs at the inside offer. Each executing participant then has up
to 17 seconds to update its quote, although each may do so sooner, in
which case additional orders may be delivered more quickly.
A market maker's use of the supplemental size feature affects the
way non-directed orders may be executed. If a market maker using
supplemental size is alone at the inside price and a non-directed order
larger than the market maker's displayed quote size is entered, the
order will be delivered up to the size of the market maker's displayed
size and supplemental size for a period of 17 or 32 seconds, depending
on the size of the order delivered. At the end of the time period, the
order will be executed against the market maker, unless prior to the
end of the time period, the market maker took other action, such as
accepting all or part of the order, or declining the order. For
example, if a market maker is alone at the best offer of 20, and is
displaying 1,000 shares while its supplemental size is at 5,000 shares,
a non-directed order to buy 4,000 shares will be delivered in toto to
that market maker for 17 seconds. If the market maker does nothing, the
order will be executed at the end of 17 seconds for 4,000 shares, and
the market maker's quote will be refreshed at 1,000 shares, with 1,000
shares remaining in supplemental size.
Nasdaq plans to make the System flexible to allow participants to
adjust execution parameters. Thus, all parameters for order size for
delivery and execution that are minimum sizes can be adjusted by
executing participants as long as such adjustments exceed the minimum
standards established by Nasdaq in this filing. For example, an
executing participant can adjust the parameters for automatic
executions to allow automated executions for orders larger than 1,000
shares.
b. Limit Order File Executions. The matching process between orders
displayed in the File is simple. Non-directed orders that match against
an order in the Limit Order File are executed immediately. For example,
assume the best bid is an ECN showing an order to buy at 20 for 1,000
shares. Subsequently, a member enters a non-directed order to buy 100
shares at 20\1/16\. This limit order is displayed anonymously, as
described below, in the Nasdaq Limit Order File and sets a new inside
bid. Thereafter, another member enters a market order to sell 100
shares. The limit order and the market order will be matched and
automatically executed against each other at 20 \1/16\. If the market
order to sell were for 1,000 shares, 100 shares would execute
automatically against the limit order and the remaining 900 shares
would be executed automatically against the next best bid, the 20 bid
of the ECN. The ECN's displayed size would be reduced to 100
shares.\48\
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\48\ If a market maker or ECN order seeks to quote at a price
that would lock or cross the Limit Order File, the market maker or
ECN is required by rule to first enter a directed order that would
execute against the order in the file.
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5. Limit Order Display
Nasdaq will display limit orders entered into the Limit Order File
in three separate ways. First, Nasdaq will display the Top of File,
i.e., the best limit order to buy and the best limit order to sell, in
the Nasdaq quote montage, where it will be ranked in price/time
sequence with all other quotes and orders entered into Nasdaq, and
which will be used to calculate the inside quote. Nasdaq will also
display the Top of file in a separate window on the Nasdaq Workstation.
Both of these displays will be dynamically updated, i.e., the System
will automatically change the prices as orders enter and execute.
Finally, Nasdaq will maintain for all Nasdaq Workstation subscribers
and vendors a Full File display that will be available on a query/
response basis. in other words, the user must enter a key stroke to
obtain information regarding all of the orders displayed in the Full
File. To obtain new information about the status of orders in the Full
File, the subscriber must re-inquire of the System. At the first stage
of implementation, Nasdaq, for capacity reasons, will not dynamically
update the Full File. All orders displayed in the Limit Order File will
be displayed anonymously, i.e., the System will not attach the MMID of
the member entering the order to that order for display purposes.
6. Anonymity of Executions in the File
As proposed in this filing, Nasdaq will display all orders in the
File on an anonymous basis. Upon execution of any such order, either
when another limit order matches it, or when it interacts with a Nasdaq
displayed quote, the System will provide to all parties involved in the
execution an execution report that identifies the contra-party to the
trade. For example, when MMA enters a limit order into the File at 20
bid, it is displayed without an identifier indicating that MMA entered
the order. Subsequently, MMB enters a limit order to sell at 20.
Because the two limit orders match, they will execute against each
other. When the execution occurs, MMA will receive a report from the
system identifying MMB as the contra-party and MMB will receive a
report indicating that MMA was its contra-party.
Nasdaq is also evaluating whether additional anonymity for
executions should be provided in the future. There are two options
under consideration: anonymity until the end of the trading day and
anonymity throughout the settlement cycle. End of day anonymity would
work as follows. When an order that is displayed in the Limit Order
File is executed, either by matching against another order entered into
it or when a market maker or ECN executes the order, the System will
preserve the anonymity of the firm entering the order until the end of
the trading day provided that the party entering the order into the
File chose to keep its order anonymous following execution. The contra-
party would receive the indicator ``NSDQ'' as the MMID for the other
side to the trade. The true identity of the firm entering the order
would not be revealed to the contra-party until after trading for the
day has ceased. Nasdaq would provide to each party that received an
anonymous execution a report after 5:15 p.m. with the identity of the
party that entered the order into the File.
For example, assume that the inside market for a security is 19\15/
16\-20\1/8\, 10 x 10. MMA enters a non-directed proprietary limit order
to sell 1,000 shares at 20 into the File, and indicates upon order
entry that it wants the order to be executed anonymously. The order
[[Page 12133]]
will be placed on the File at 20 for 1,000 shares; because the limit
order is the best sell order in the market, the inside will change to
19\15/16\-20, 10 x 10. At this time, order entry firm X (``OEFX'')
enters a buy market order for 1,000 shares. OEFX's order is
automatically executed against the limit order at 20. OEXF receives a
report confirming that its market order was executed for 1,000 shares
at 20 against NSDQ.
As another example, assume the same facts as above, except that MMD
wants to move its bid of 19\15/16\ to 20. Under the locked/crossed
market rule, it must make an effort to avoid locking the market by
attempting to takeout the locking offer, in this case the limit order
to sell at 20.\49\ When MMD enters a non-directed order to buy 1,000
shares at 20, that order will match against the limit order to sell at
20 and MMD will receive a report indicating that it bought 1,000 shares
at 20 from NSDQ. After 5:15, MMD will receive a report that indicated
that this sell order was actually executed against MMA.
---------------------------------------------------------------------------
\49\ See NASD Rule 4613(e).
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Under a full anonymity proposal, the NASD could create a structure
to keep the contra-parties anonymous as to each other throughout the
settlement cycle. The NASD continues to evaluate the means by which
such anonymity could be provided. Before either end of day or full
anonymity would be offered, the NASD and Nasdaq would have to propose
any such approach as a new rule proposal or as an amendment to this
filing. The NASD believes at this time that it would be helpful if
commenters offered their views generally on the need for particular
levels of anonymity in the File.
7. Sponsored Access by Non-Members
A critical component of the new System will permit institutions and
other customers of NASD members to obtain direct electronic links to
the System through arrangements that are sponsored by an NASD member.
Under such an arrangement, a customer and an NASD member will be able
to sign an agreement that permits Nasdaq to provide the customer with
the electronic capability to enter orders into the System directly from
its trading desk. Such orders can be limit or market orders that access
prices displayed in Nasdaq (if they are market orders), or are
displayed in the Limit Order File (if they are limit orders). Only
market makers that are Primary Market Makers under NASD Rule 4612 are
eligible to enter into a sponsored arrangement for access by non-
members.\50\
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\50\ The NASD notes that under the current Primary Market Maker
qualification rule, all Nasdaq market makers qualify as Primary
Market Makers. Nasdaq plans to amend the qualification standards to
establish more stringent qualifying criteria.
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8. The Opening Process for Orders in the Limit Order File
Limit orders can be entered as good-till-canceled (``GTC'') or
good-till-date (``GTD''). Because of this capability, the File may
carry over limit orders from one trading day to the next. In addition,
the System will allow limit orders to be entered prior to the market
opening and also will permit the entry of market orders that will be
able to interact with limit orders in the Limit Order File at the
opening of the file for executions. Consequently, at the opening of the
market at 9:30, the Nasdaq Limit Order File could contain a number of
limit and market orders.
Nasdaq believes that the following approach to execution of all
such orders entered into the System prior to market open best
accommodates customer requirements that executions occur as rapidly as
possible and at prices as near as possible to the prevailing market at
the open. At 9:30, when quotations are first opened in the System,
Nasdaq will take a snapshot of the best quotes (the ``9:30 Inside'').
Thus, the 9:30 Inside includes market makers, ECNs and UTP exchanges,
but not the Top of File of Nasdaq's Limit Order File. The opening
process will use the 9:30 Inside to validate the executions of orders
in the File.
The System will process the orders in the File at 9:30 by first
matching the best priced limit order to buy against the best contra-
side limit order to sell, bound by the 9:30 Inside. The system will
continue to pair off matching buy and sell limit orders in the File,
until all possible limit order matches that can take place at or within
the 9:30 Inside have occurred. Limit orders that match other limit
orders will be matched at a midpoint, giving price improvement to both
where possible. If limits would match outside of the 9:30 Inside, then
no execution takes place, as the opening match is bounded by the 9:30
Inside. After all possible limit-to-limit matches have occurred, the
System will then match market orders to any remaining limit orders that
are priced at or within the 9:30 Inside and execute such matches at the
limit order price.
If the 9:30 Inside is locked at 9:30, the System will execute as
many orders as it can match at that price. The remaining unmatched
orders will be processed at 9:30 pursuant to normal business hours
processing. For example, assume that the best bids and offers at 9:30
are priced at 20, and four limit orders are in the File at 9:30, each
for 1,000 shares. There are limit orders to buy at 20 and 20\1/16\, and
limit orders to sell at 19\15/16\ and 20\1/16\. The system will execute
the buy limit at 20\1/16\ against the sell limit at 19\15/16\ at a
price of 20. The two remaining orders (buy at 20 and sell at 20\1/16\)
will not be executed. If the 9:30 Inside is crossed at 9:30 for a
particular security, the System will not perform the opening match
process for that security. Instead, in this situation, each order will
be matched or delivered for execution, as the case may be, according to
normal business hours processing. That is, limit orders that are
marketable against the 9:30 Inside, and may market orders that have
been entered prior to 9:30 will be delivered or executed against such
prices in time sequence, commencing at 9:30. Once the crossed market
has been eliminated, the File will be populated as during the normal
intra-day process and executions will continue according to normal
processing as discussed above. Thus, immediately after the match
process is concluded, any market or marketable limit orders that do not
match against limit orders in the opening process shall be delivered to
or automatically executed against (depending on the size of the order)
executing participants or the Limit Order File according to normal
business hours processing as set forth above for non-directed orders.
Execution reports for orders executed during the opening process will
be discussed starting at 9:30 a.m.
9. Odd-Lot Processing
The new System will accept and execute orders less than one normal
unit of trading, i.e., odd-lot orders less than 100 shares. The System
will provide a separate mechanism for processing and executing these
orders as distinct from normal units of trading. First, odd-lot priced
orders will not be displayed in the Limit Order File, nor will they
match against any displayed File orders. Instead, the System will hold
odd-lot orders in a separate file and automatically execute such odd-
lots against market makers whenever the odd-lot order becomes
marketable.\51\ For example, if a member enters a market order for 50
shares into the System, it will immediately and automatically
[[Page 12134]]
execute the order against the market maker that is first in rotation
for execution of such orders. The automatic execution will not decrease
the market maker's displayed size.
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\51\ 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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10. Firm Quote Compliance Facility
To assist market makers in complying with the Firm Quote Rule,
System market makers shall be provided with a means to indicate that
the market maker has received an order via the telephone to trade at
the market maker's Nasdaq-displayed quotation and that for a period of
time while the market maker handles the telephone order, the System
should not deliver additional orders for execution.
The market maker shall send via the System a message that records
the time indicating when the market maker entered the message regarding
the telephone order. When the System receives the message, the System
shall not present an order to that market maker until 17 seconds after
receipt of the original message. The System will provide the market
maker with a reference number that shall be attached to the execution
report that may occur as a result of the telephone order. A System
market maker may only send one such message through the System for each
telephone order necessitating the message. Sending such message without
a corresponding transaction may be a violation of just and equitable
principles of trade. Surveillance systems will be implemented to detect
a pattern or practice of entering messages without corresponding
transactions.
11. Amendments to Related Rules
In addition to the specific new rules proposed regarding the
operations of the System, several rules found in NASD Rule Series 4600
and throughout the NASD Manual will have to be conformed in technical,
non-substantive ways. In particular, Rule 4613 (Character of
Quotations), will be amended to eliminate the references to SOES Tier
Sizes for quotations of market makers. Rule Series 4700 (SOES Rules)
will be rescinded entirely, and other rules referencing SOES will be
rescinded or conformed accordingly, including Rule 4611(f)
(Registration as a Nasdaq Market Maker), Rule 4619 (Withdrawal of
Quotations and Passive Market Making), Rule 4620 (Voluntary Termination
of Registration), Rules 4632 and 4642 (Trade Reporting) \52\ and Rule
4618(c) (Clearance and Settlement).
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\52\ It should be noted that the rules governing the trade
reporting of Nasdaq National Market securities found in NASD Rule
4632 are part of an effective transaction reporting plan approved by
the Commission under SEC Rule 11Aa3-1. Accordingly, any proposed
amendments to these rules are proposed amendments to the transaction
reporting plan contemplated by that SEC rule.
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E. Statutory Basis
Nasdaq believes that the proposed rule change is consistent with
the provisions of Section 15A of the Exchange Act,\53\ in particular
subparagraphs (b)(2), (b)(6), (b)(9), and (b)(11), and Section 11A of
the Exchange Act, 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)(6) 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 single
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. This also is consistent with Section 11A(a)(1)(B) of
the Exchange Act, which sets forth findings of Congress that new data
processing and communications techniques create the opportunity for
more efficient and effective market operations.
---------------------------------------------------------------------------
\53\ 15 U.S.C. Sec. 78o-3.
---------------------------------------------------------------------------
The integrated nature of the System will address issues related to
unintended ``double liability'' that can be incurred by market makers,
thus reducing a disincentive for market maker participation, and, along
with the Firm Quote compliance Facility, should significantly ease the
associated regulatory and compliance burdens involving the Firm Quote
Rule and related NASD rules. Importantly, this also will enhance the
NASD's ability to assure compliance with the Firm Quote Rule. Thus, the
proposed rule change also comports with the requirements of
subparagraph (b)(2) of Section 15A, which requires the association to
be organized to enforce compliance by its members and associated
persons with the provisions of the Exchange Act, rules thereunder, and
the rules of the association.
In addition, the proposed rule change to establish a Nasdaq limit
order book is designed to facilitate the display of the best priced
limit orders in Nasdaq. Because the Top of File will be displayed in
the quote montage, this facility is consistent with Section 15A(b)(11),
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. In
this context, the proposed rule change also is consistent with the
SEC's Order Handling Rules, in particular Rules 11Ac1-1 and 11Ac1-4, in
that the book may be used by members to satisfy the requirements of the
Display Rule with respect to customer orders, and is consistent with
the ECN Display Alternative for market maker display of orders priced
better than the market maker's public quote.
Finally, the proposed rule change is consistent with Section
11A(a)(1)(C) of the Exchange Act, which states, among other things,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 for 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.
The NASD and Nasdaq believe that the System advances all of these goals
by providing an integrated order delivery and execution system and
Limit Order File designed to provide maximum transparency and efficient
executions at the best price for the benefit of all investors and
market participants.
(B) Self-Regulatory Organization's Statement on Burden on Competition
Nasdaq 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 Exchange Act, as amended.
[[Page 12135]]
(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
With 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 Exchange Act. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
DC 20549. Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. Sec. 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-98-17 and should be submitted by April 2, 1998.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\54\
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\54\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
Exhibit 1--Text of the Proposed Rule Change
The text of the proposed rule change as amended is as follows.
(Additions are italicized; deletions are bracketed.)
4611. Registration as a Nasdaq Market Maker
(a) through (e) No Change.
[(f) Unless otherwise specified by the Association, each Nasdaq
market maker that is registered as a market maker in a Nasdaq
National Market security shall also at all times be registered as a
market maker in the Small Order Execution System (SOES) with respect
to that security and be subject to the SOES Rules as set forth in
the Rule 4700 Series.]
(g) Re-designated as paragraph (f).
4613. Character of Quotations
(a) Two-Sided Quotations
[(1)] No Change.
[(2) Each member registered as a Nasdaq market maker in Nasdaq
National Market equity securities shall display size in its
quotations of 1,000, 500, or 200 shares and the following guidelines
shall apply to determine the applicable size requirement:
(A) a 1,000 share requirement shall apply to Nasdaq National
Market securities with an average daily non-block volume of 3,000
shares or more a day, a bid price of less than or equal to $100, and
three or more market makers;
(B) a 500 share requirement shall apply to Nasdaq National
Market securities with an average daily non-block volume of 1,000
shares or more a day, a bid price of less than or equal to $150, and
two or more market makers and
(C) a 200 share requirement shall apply to Nasdaq National
Market securities with an average daily non-block volume of less
than 1,000 a day, a bid price of less than or equal to $250, and
that have two or more market makers.
(3) Each member registered as a Nasdaq market maker in Nasdaq
SmallCap Market equity securities shall display size in its
quotations of 500 or 100 shares and the following guidelines shall
apply to determine the applicable size requirement:
(A) a 500 share requirement shall apply to Nasdaq SmallCap
Market securities with an average daily non-block volume of 1,000
shares or more a day or a bid price of less than $10.00 a share; and
(B) a 100 share requirement shall apply to Nasdaq SmallCap
Market securities with an average daily non-block volume of less
than 1,000 shares a day and a bid price equal to or greater than
$10.00 a share.
(4) Share size display requirements in individual securities may
be changed depending on unique circumstances as determined by the
Association, and a list of the size requirements for all Nasdaq
equity securities shall be published from time to time by the
Association.]
(b) No Change.
(c) No Change.
(d) No Change.
(e) No Change.
4618. Clearance and Settlement
(a)-(b) No Change.
[(c) All SOES transactions shall be cleared and settled through
a registered clearing agency using a continuous net settlement
system.]
4619. Withdrawal of Quotations and Passive Market Making
(a) No Change.
(b) No Change.
(c) Excused withdrawal status may be granted to a market maker
that fails to maintain a clearing arrangement with a registered
clearing agency or with a member of such an agency and is withdrawn
from participation in the Automated Confirmation Transaction
service, thereby terminating its registration as a market maker in
Nasdaq National Market issues. Provided however, that if the
Association finds that the market maker's failure to maintain a
clearing arrangement is voluntary, the withdrawal of quotations will
be considered voluntary and unexcused pursuant to Rule 4620 [and the
Rules for the Small Order Execution System, as forth in the Rule
4700 Series] and Rule 4940.
4620. Voluntary Termination of Registration
(a) A market maker may voluntarily terminate its registration in
a security by withdrawing its quotations from The Nasdaq Stock
Market. A market maker that voluntarily terminates its registration
in the System in a security may not re-register as a market maker in
that security for twenty (20) business days[.]; [Withdrawal from
SOES participation as a market maker in a Nasdaq National Market
security shall constitute termination of registration as a market
maker in that security for purposes of this Rule;] provided,
however, that a market maker that fails to maintain a clearing
arrangement with a registered clearing agency or with a member of
such an agency and is withdrawn from participation in the Automated
Confirmation Transaction System and thereby terminates its
registration as a market maker in [Nasdaq National Market issues]
the System may register as a market maker at any time after a
clearing arrangement has been reestablished and the market maker has
complied with ACT participant requirements contained in Rule 6100.
(b) No Change.
(c) No Change.
(d) No Change.
4632. Transaction Reporting
(a) through (d) No Change.
(e) Transactions Not Required To Be Reported.
The following types of transactions shall not be reported:
(1) transactions executed through the System or Computer
Assisted Execution System (CAES);
(f) No Change.
4642. Transaction Reporting
(a) through (d) No Change.
(e) Transaction Not Required To be Reported.
The following types of transactions shall not be reported:
(1) Transactions executed through the System or Computer
Assisted Execution System (CAES) [; the Small Order Execution System
(SOES) or the SelectNet service].
(f) No Change.
4700. Small Order Execution System
Rules 4710, 4720, 4730, 4740, 4750, 4760, and 4770 are being
rescinded in their entirety.
[[Page 12136]]
4900. Nasdaq Trading System
4910. Definitions
(a) The term ``Automated Confirmation Transaction service''
(``ACT''), for purposes of the System rules, shall mean the
automated system owned and operated by The Nasdaq Stock Market, Inc.
which accommodates trade reporting of transactions executed through
the System and submits locked-in trades to clearing.
(b) The term ``automated quotation update facility'' shall mean
the facility in the System that allows the System to automatically
refresh a System market maker's quotation in any security that the
System market maker designates when the System market maker's
displayed size (and supplemental size, if any has been reduced to
zero. The facility will update either the bid or the offer side of
the quote using a quotation interval designated by the market maker,
depending upon the side of the market on which the execution has
occurred and refresh the market maker's displayed size at an amount
pre-determined by the market maker.
(c) The term ``customer order'' shall mean an order from, or on
behalf of, a person that is not a registered broker-dealer, except
that for the purposes of these Rules, the term customer shall
include registered options market makers. An order will not be
considered an agency order if it is for any account of a person
associated with the member firm entering the order or any account
controlled by such an associated person.
(d) The term ``directed order'' shall mean an order (agency or
proprietary) entered into the System by a participant that is
directed to a particular Executing Participant.
(e) The term ``displayed size'' shall mean the actual size of
the quote displayed to the market as required by Rule 4613(a).
(f) The term ``ECN'' shall mean an electronic communications
network that is registered and displaying orders in Nasdaq pursuant
to Rule 4623 of the NASD Rules.
(g) The term ``Executing Participant'' shall include any of the
following participants: (1) System market makers; (2) electronic
communications networks (``ECNs''); and (3) UTP Exchange
Specialists.
(h) The term ``Firm Quote Rules '' shall mean SEC Rule 11Ac1-1
and NASD Rules 3320 and 4613(b).
(i) The term ``inside market'' shall mean the best bid and
associated size from Executing Participants and the best System
limit order(s) to buy, as ranked by price, and the best offer and
associated size from Executing Participants and the best System
limit order(s) to sell, as ranked by price, displayed by Nasdaq.
(j) The term ``liability order'' shall mean an order that when
delivered to an Executing Participant imposes obligations on the
Executing Participant to respond to such order in compliance with
the Firm Quote Rules.
(k) The term ``limit order'' shall mean an order entered into
the System that is a priced order.
(l) The term ``marketable limit order'' shall mean a limit order
that, at the time it is entered into the System, if it is a limit
order to buy, is priced at the current inside offer or higher, of if
it is a limit order to sell, is priced at the inside bid or lower.
(m) The term ``non-directed order'' shall mean an order entered
into the System and not directed to any particular Executing
Participant.
(n) The term ``open quote'' shall mean a System market maker's
quotation price and displayed size in an eligible security against
which orders may be executed through the System during normal
business hours, as specified by the NASD, or at such times that a
market maker has notified Nasdaq pursuant to Rule 4617 that it is
open for business. For the purposes of these Rules, a market maker
has a ``closed quote'' when (1) it is outside of normal business
hours; (2) its displayed quotation size has been decreased through
System executions to zero; or (3) it has been deemed ``closed''
pursuant to Rule 4940 below.
(o) The term ``Order Entry Participant'' shall mean shall mean a
member of the Association that is registered as a participant
authorized to enter orders on behalf of customers in the System
pursuant to Rule 4920 below. A System market maker is deemed to be
an Order Entry Participant in any security in which it is registered
as a System market maker.
(p) The term ``participant'' shall mean a person registered with
the NASD and authorized to undertake activity in the system.
(q) The term ``proprietary order'' shall mean an order for the
principal account of a broker or dealer.
(r) The term ``registered options market maker'' shall mean an
exchange member registered with a national securities exchange as a
market maker or specialist pursuant to the rules of such exchange
for the purpose of regularly engaging in market making activities as
a dealer or specialist in an option of a Nasdaq-listed security.
(s) The term ``sponsored participant'' shall mean a customer
that is an institution (as defined in NASD Rule 3110(c)(4)) or
registered options market maker that has entered into a sponsorship
arrangement accepted by Nasdaq pursuant to Rule 4920(e) below.
(t) The term ``supplemental size'' shall mean the size that a
System Market Maker chooses to maintain in the System-provided
supplemental size feature that refreshes the System Market Maker's
displayed size by the System Market Maker's pre-determined amount
after the displayed size has been reduced to zero following a
System-generated execution.
(u) The term ``System'' shall mean the order delivery and
execution system owned and operated by The Nasdaq Stock Market, Inc.
(a wholly owned subsidiary of the National Association of Securities
Dealers, Inc.).
(v) The term ``System eligible security'' shall mean any
security listed on the Nasdaq National Market or Nasdaq SmallCap
Market.
(w) The term ``System market maker'' shall mean a member of the
Association that is registered and quoting with an open quote as a
Nasdaq market maker pursuant to the requirements of Rule 4600 of the
NASD Rules and is registered pursuant to Rule 4920 below as a market
maker in one or more System-eligible securities.
(x) The term ``UTP exchange'' shall mean any registered national
securities exchange that has unlisted trading privileges in Nasdaq
securities pursuant to the Nasdaq/NMS/UTP Plan.
(y) The term ``UTP exchange specialist'' shall mean a broker-
dealer registered as a specialist in Nasdaq securities pursuant to
the rules of an exchange that: (1) is a signatory as either a
participant or limited participant in 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 Exchange
On An Unlisted Trading Privilege Basis (``Nasdaq/NMS/UTP Plan'');
(2) provides for electronic access that permits a UTP exchange
specialist to enter proprietary orders and permits System executions
against a UTP exchange specialist at its published quote pursuant to
these Rules; and (3) permits all transactions to be cleared and
settled through a registered clearing agency using a continuous net
settlement system.
4920. Registration Requirements
(a) Prior to entering or executing orders into the System,
participants seeking to participate in the System shall register and
be authorized by Nasdaq as Executing Participants, Order Entry
Participants or sponsored participants, provided that each such
participant meets the conditions set forth below:
(1) Executing Participants: Registration as an Executing
Participant shall be conditioned on the participant's initial and
continuing compliance with the following requirements:
(A) Membership in a clearing agency registered with the
Securities and Exchange Commission which maintains facilities
through which system-compared trades may be settled; or entry into a
correspondent clearing arrangement with an NASD member that clears
trades through such clearing agency;
(B) registration as: (i) a market maker or an ECN (as the case
may be) in Nasdaq pursuant to the Rule 4600 series of the NASD Rules
and compliance with all applicable rules and operating procedures of
the Association and the SEC; or (ii) as an exchange specialist in
good standing with an exchange that is a participant in the Nasdaq/
UTP Plan and compliance with all applicable rules and operating
procedures of the Association, its UTP Exchange and the SEC;
(C) maintenance of the security of any system that allows access
to Nasdaq systems so as to prevent improper use or access of Nasdaq
Systems, such as the unauthorized entry of orders or other data into
Nasdaq-operated systems; and
(D) acceptance and settlement of each trade that is executed
through the facilities of the System, or if settlement is to be made
through another clearing member, guarantee of the acceptance and
settlement of such identified System trades by the clearing
[[Page 12137]]
member on the regularly scheduled settlement date.
(2) Order Entry Participants: Registration as an Order Entry
Participant shall be conditioned upon the participant's initial and
continuing compliance with the following requirements:
(A) membership in a clearing agency registered with the
Securities and Exchange Commission which maintains facilities
through which System-compared trades may be settled; or entry into a
correspondent clearing arrangement with an NASD member that clears
trades through such clearing agency;
(B) compliance with all applicable rules and operating
procedures of the Association and the Securities and Exchange
Commission;
(C) maintenance of the security of any system that allows access
to Nasdaq systems so as to prevent Nasdaq systems from being
improperly used or accessed; such as the unauthorized entry of
orders or other data into the System or Nasdaq; and
(D) acceptance and settlement of each trade that is executed
through the facilities of the System, or if settlement is to be made
through another clearing member, guarantee of the acceptance and
settlement of such identified System trades by the clearing member
on the regularly scheduled settlement date.
(3) Sponsored Participants: Registration as a sponsored
participant shall be conditioned on the participant's and the
participant sponsor's initial and continuing compliance with the
following requirements:
(A) execution of, and continuing compliance with, at least one
valid sponsorship agreement, as set forth in paragraph (e);
(B) membership of the sponsoring NASD member in a clearing
agency registered with the Securities and Exchange Commission which
maintains facilities through which System-compared trades may be
settled; or such sponsoring NASD member's entry into a correspondent
clearing arrangement with an NASD member that clears trades through
such clearing agency;
(C) the sponsoring NASD member's acknowledgment that the
sponsored participant will maintain the security of any system that
allows access to Nasdaq-operated systems so as to prevent Nasdaq
systems from being improperly used or accessed, such as through the
unauthorized entry of orders or other data into Nasdaq-operated
systems;
(D) the sponsoring NASD member's acceptance and settlement of
each trade that is executed by the sponsored participant through the
facilities of the System, or if settlement is to be made through
another clearing member, guarantee of the acceptance and settlement
of such identified System trades by the clearing member on the
regularly scheduled settlement date.
(b) Upon effectiveness of a participant's registration to
participate in the System, participants may commence activity within
the System for entry and/or execution of orders, as applicable, and
their obligations as established in this rule will commence.
(c) Pursuant to Rule 4600 of the NASD Rules, participation as a
System Market Maker is required by any Nasdaq market maker
registered to make a market in a Nasdaq security. Pursuant to Rule
4623 of the NASD Rules, when an ECN is displaying an order in
Nasdaq, such displayed order must be accessible for execution
through the System.
(d) Each system participant shall be under a continuing
obligation to inform the Association of noncompliance with any of
the registration requirements set forth above.
(e) Sponsorship agreements:
(1) A System Market Maker that is a Primary Market Maker
pursuant to Rule 4612 in a particular security may establish for
such security a sponsorship arrangement with customers that permits
the customer to enter directly from the customer's facility orders
for display, delivery, or execution in Nasdaq's System and receive
execution reports by means of a Nasdaq-authorized protocol provided
by the System Market Maker, the customer or a third party vendor of
such services.
(2) Sponsorship arrangements must be pursuant to Nasdaq-
authorized sponsorship agreements. A Sponsored Participant may enter
into sponsorship agreements with more than one sponsoring NASD
member. A sponsorship agreement shall include, among other things,
terms establishing the customer's agreement to comply with all
applicable NASD Rules governing the entry, execution, reporting,
clearing and settling of orders in System-eligible securities;
(3) The sponsoring member must agree that it is responsible for
all orders entered into the System by the sponsored participant that
identify the sponsoring NASD member as the sponsor and that any
execution that occurs in the System as a result of such order is
binding in all respects on the sponsoring member so identified;
(f) Limitations on liability for System malfunctions: The
Association and its subsidiaries shall not be liable for any losses
or damages arising out of the use of the System. Any loss or damages
related to a failure of the System to deliver, display, execute,
compare, submit for clearance and settlement, or otherwise process
an order or message entered in the System shall be absorbed by the
member entering the message, or the member sponsoring the customer
that entered the message.
4930. Operating Hours of The System
Subject to any trading halt imposed by the SEC or NASD, or any
system malfunction or emergency condition that warrants interruption
of the operation of the System, the operating hours of the System
shall be as follows:
(a) For directed orders, the System shall be open and capable of
permitting the execution of such orders from 9:00 a.m. (ET) to 5:15
p.m. (ET).
(b) For non-directed orders, the System will commence normal
operations at 9:30 a.m. (ET) and close at 4:00 p.m. (ET), i.e.,
normal business hours as defined in Rule 4617, except as provided
for in the opening procedures set forth below. Non-directed orders
that are limit orders may be entered at any time from 8:00 a.m. (ET)
until 6:00 p.m. (ET) for processing in the System during normal
operations. Non-directed market orders may be entered at any time
from 8:00 a.m. (ET) until 4:00 p.m. (ET).
4940. Participant Obligations in the System
(a) Executing Participants
(1) A System Market Maker, ECN, or UTP Exchange Specialist shall
commence participation in the System by initially contacting Nasdaq
Market Operations to obtain authorization for order delivery and
execution purposes in particular Nasdaq securities and identifying
those devices through which such delivery and executions shall
occur. Thereafter, on-line registration on a security-by-security
basis is permissible, consistent with the requirements of Rule 4600
of the NASD Rules.
(2) Participation as a System Market Maker, ECN, or UTP Exchange
Specialist obligates the participant, upon presentation of a market
order or marketable limit order through the service, to execute such
order as provided in Rule 4950 below. The System will transmit to
the participant on the Nasdaq Workstation Service, or through a
computer interface, as applicable, an execution report generated
following each execution.
(3) A System Market Maker may elect to use the Nasdaq-provided
automated quotation update facility in one or more securities in
which it is registered. The facility will refresh the market maker's
quotation automatically by a quotation price and size interval
designated by the market maker, once its displayed size in the
security has been reduced to zero size by executions that occur
against the market maker in the System. The facility will refresh
the market maker's quotation on either the bid or the offer side of
the market, depending on the side that was reduced to zero size, by
the price interval and size designated by the market maker.
(4) A System Market Maker may terminate its obligation by
withdrawal from the System at any time. However, the market maker
has the specific obligation to monitor its status in the System to
assure that a withdrawal has in fact occurred. Except as otherwise
permitted by Rule 11890 regarding the Association's authority to
declare clearly erroneous transactions void, any transaction
occurring prior to the effectiveness of the withdrawal will remain
the responsibility of the market maker. A System Market Maker whose
displayed size is reduced to zero on one side of the market will
have a closed quote in Nasdaq and the System with respect to both
sides of its market and will be permitted a standard grace period of
three minutes within which to take action to restore its displayed
size, if the market maker has not authorized use of the automated
quotation update facility. A market maker that fails to renew its
displayed size in a security within the allotted time will have its
quotation on the side of the market that has been reduced to zero
restored by the System at the lowest bid price (for a bid) or the
highest offer price (for an offer) displayed in that security.
Except as provided in subparagraph (5) below, a market maker that
withdraws from a security may not re-register in the System as a
market maker in that security for twenty (20) business days.
[[Page 12138]]
(5) Notwithstanding the provisions of subparagraph (4) above:
(A) a market maker that obtains an excused withdrawal pursuant
to Rule 4619 of the NASD Rules prior to withdrawing from the System
may reenter the System according to the conditions of its
withdrawal;
(B) a market maker that fails to maintain a clearing arrangement
with a registered clearing agency or with a member of such an
agency, and its thereby withdrawn from participation in ACT and the
System, may reenter the System after a clearing arrangement has been
reestablished and the market marker has complied with ACT
participant requirements, provided however, that if the Association
finds that the ACT market marker's failure to maintain a clearing
arrangement is voluntary, the withdrawal of quotations will be
considered voluntary and unexcused pursuant to Rule 4620 and these
rules.
(6) In the event that a malfunction in the participant's System
devices occurs rendering electronic communications with the System
inoperable, the System participant is obligated to immediately
contact Nasdaq Market Operations by telephone to request a closed
quote status. If the closed quote status is granted, Market
Operations personnel will enter such status notification into the
System from a supervisory terminal. Such manual intervention,
however, will take a certain period of time for completion and,
unless otherwise permitted by the Association pursuant to its
authority under Rule 11890, the System participant will continue to
be obligated for any transaction executed prior to the effectiveness
of its closed quote.
(b) Order Entry Participants
(1) An NASD member that is not registered as a market maker or
as an ECN in a particular security must register as an Order Entry
Participant to be able to enter orders into the System. Order Entry
Participants can enter orders into the System only after an
application for registration is reviewed and accepted by Nasdaq.
(2) Entry of Customer Orders: Executing Participants and Order
Entry Participants are permitted to enter customer orders.
(3) Entry of Proprietary Orders: Provided that System market
makers are permitted to enter quotations for actual size pursuant to
Nasdaq market maker quotation rules, any Order Entry participant is
permitted to enter proprietary orders into the System for display,
delivery, and execution purposes. If, however, at the time that the
new system is available for use, System market makers are not
permitted to quote in actual size for all Nasdaq securities, only
System market makers, UTP Exchange specialists, and registered
option market makers may place proprietary orders for their market
making accounts into the System. Proprietary orders may be entered
only for securities for which the market maker or specialist is
registered as a market maker or specialist. Any such proprietary
order must be entered by an associated person of the market maker or
specialist who is actively engaged in a market making capacity for
that particular security.
(4) Proprietary Orders:
(A) Display and Execution--Proprietary orders are subject to the
same display and execution processes and requirements as agency
orders.
(B) Surveillance Requirements--A member that enters a
proprietary order must designate the order with the appropriate
designator to identify the order as proprietary.
(5) Time In Force Orders: The following types of orders may be
entered into the System:
(A) day orders;
(B) good-till-canceled (``GTC''); and
(C) good-till-date (``GTD'').
The System will not accept all or none (``AON'') orders; orders
with minimum size of executions; or other conditioned orders.
4950. Entry, Display, and Execution of Orders
(a) Types of Orders That May be Entered: The System will accept
limit orders, marketable limit orders, market orders, and odd-lot
orders. All such orders have a minimum life of 10 seconds during
which period such orders may not be canceled by the participant
entering the order.
(b) Order Price Increments: All priced orders submitted for
execution in the System are subject to the same policy for price
increments as market maker quotes. For securities priced at $10 or
more, the minimum order increment shall be \1/16\th. For stocks
priced less than $10, the minimum order increment shall be \1/32\th.
(c) Order Size: Any round or mixed lot order up to 999,999
shares may be entered into the System for normal display and
execution processing provided that System market makers may quote in
actual size. If market makers are not permitted to quote in actual
size, Order Entry Participants that are not System Market Makers or
registered options market makers may only enter orders up to 1000
shares for non-directed orders. Odd-lot orders are subject to a
separate display and execution process set forth below.
(d) Directed Orders:
(1) General Provisions--During normal business hours (i.e., 9:30
a.m. to 4:00 p.m.), orders entered into the System may be directed
to a particular Nasdaq Market Maker, ECN, or UTP Exchange Specialist
for execution.
(2) No Display of Directed Orders--Directed orders are not
displayed in the Nasdaq Limit Order File and do not interact with
any order displayed there, i.e., directed orders do not match
against limit orders in the Nasdaq Limit Order File.
(3) Price and Size of Directed Orders--Directed orders must be
priced orders in round or mixed lots and can be of any size
permitted in the System in accordance with paragraph (c) above.
(4) Processing of Directed Orders: Directed orders will be
processed in time sequence with non-directed orders entered into the
System; that is, a directed order will be queued with all other
orders (directed and non-directed) and will not be delivered to a
particular Executing Participant designated by the Order Entry
Participant until orders in sequence ahead of it are delivered for
execution.
(5) Liability for Directed Orders: Nasdaq Market Makers and ECNs
that receive directed orders at or better than their quoted price
(e.g., an order to sell at a price equal to or below their bid) are
obligated to execute such orders up to their size displayed at the
time that the order is delivered, in accordance with the same
parameters for processing executions for non-directed orders in Rule
4950(e)(3), unless an exception to the SEC and NASD Firm Quote Rules
applies. Directed orders that are sent at a price inferior to the
price displayed (e.g., an order to sell at a price higher than their
quoted bid) at the time of delivery or for a size greater than that
currently displayed size do not obligate the Executing Participant
to execute at that price or for any amount greater than the
displayed size, except as provided for when the System Market Maker
makes use of the supplemental size feature. All directed orders that
impose liability on the Executing Participant will be designated as
such on the order message delivered to such participant.
(6) Interaction of Directed Orders With Market Maker
Supplemental Size: If a System Market Maker has elected to use
supplemental size, and it receives a directed order greater than its
displayed size, and such order is equal to or less than its
supplemental size, the system shall either automatically execute
such order if it is 1000 shares or less, or wait for a response from
the market maker for either 17 seconds, if the order delivered is
more than 1,000 shares, but less than 5,000 shares, or 32 seconds,
if the order is 5,000 shares or greater, before executing the order
up to the amount of its displayed size and its supplemental size. If
the market maker accepts a partial amount or declines the order
within the allotted time period, the market maker's supplemental
size above the partial acceptance or the decline shall be eliminated
by the System.
(7) Time In Force and Execution Process for Directed Orders:
Order Entry Participants may cancel any directed order 10 seconds
after entry. Directed orders will be delivered to or executed
against an Executing Participant, except for a UTP Exchange
Specialist, in the same manner as non-directed orders, as described
in subparagraph (e)(3) below, except that non-liability orders
priced inferior to the displayed price or at size larger than
displayed size will be delivered for interaction by the Executing
Participant. All orders directed to a UTP Exchange Specialist shall
be delivered for the UTP Exchange Specialist's response. Delivery
and/or execution of a directed order shall reduce the displayed size
of the Executing Participant by the amount delivered or executed
against the displayed size. Time in force for all delivered directed
orders shall be the time parameters set forth in subparagraph (e)(3)
below.
(8) Directed Orders Outside of Normal Market Hours: From 9:00
a.m. to 9:30 a.m. (ET) (pre-open directed orders) and from 4:00 p.m.
to 5:15 p.m. (ET) (post-close directed orders) the System will
permit the entry of directed orders. As long as an Executing
Participant's quotation is in a closed quote state, the Executing
Participant has no liability for that directed order. If an
Executing Participant has chosen to open its quote after market
close and a directed order is delivered, the order is treated as a
liability
[[Page 12139]]
order subject to the same obligations described in subparagraph
(d)(5) above, except that a market maker that opens its quote
momentarily, solely for the purpose of adjusting its quote to
reflect the elimination of customer limit orders, will not be
subject to Firm Quote Liability. Directed orders outside of normal
market hours cannot be canceled within 10 seconds; the time in force
shall be one minute.
(e) Non-directed Orders:
(1) General Provisions: Unless an order is directed to a
particular Executing Participant pursuant to paragraph (d) above, an
order entered into the system shall be considered a non-directed
order that shall be displayed and/or executed according to the
provisions of this subparagraph. If a non-directed order is
executable at the time it is ready to be delivered for execution
(i.e., it is a market order or marketable limit order), it shall be
delivered for execution in time sequence based on the time the order
is received in the System. Delivery for execution shall occur
against the next available participant (either an Executing
Participant or the Nasdaq Limit Order File) based on a price and
time priority ranking. If a non-directed order is a limit order that
is not executable at the time it is received in Nasdaq's System, it
shall be delivered to the Nasdaq Limit Order File for immediate
display in the File.
(2) Entry of Non-Directed Orders: Round lot and mixed lot orders
of any size permitted pursuant to paragraph (c) of this rule may be
entered into the System on a non-directed basis. Orders will be
processed in the time sequence that they are received in Nasdaq's
System. Orders will be delivered to the best price quoted in
Nasdaq's System for execution purposes. Market orders and marketable
limit orders that are larger than the displayed size of a
participant will be split by the System and will be delivered to
multiple participants to obtain an execution at the best prices
available. Similarly, market orders and marketable limit orders
priced through the best prices will be executed against multiple
Executing Participants until the orders are fully executed.
Marketable limit orders that cannot be fully executed because all
displayed size at the marketable limit order's price is exhausted
shall become a limit order displayed in the Nasdaq Limit Order File
and subject to execution as described below.
(3) Processing of Non-Directed Orders: Non-directed orders shall
be delivered to the Executing Participant or the Nasdaq Limit Order
File at the best price on a time priority basis. Non-directed orders
delivered in this process are delivered in size up to the size
displayed by the Executing Participant or Limit Order File, except
as provided when a market maker chooses to use supplemental size as
described below in paragraph (f). Executing Participants are
responsible for executing orders delivered at their prices and up to
their displayed size, unless an exception to the Firm Quote Rules
applies. The System will take the following actions based on the
prices and size displayed and the execution parameters chosen by the
Executing Participants:
(A) Minimum Parameters For Automatic Execution: If the size of
an order, or part of an order, presented to an Executing Participant
is 1,000 shares or less, the System will deliver the order in a size
amount that is either (i) up to the displayed size of the Executing
Participant's quotation or (ii) the full size of the order if such
displayed quotation size is greater than the order size, and
immediately execute the order against the participant at the time of
delivery and decrease the displayed quote by the size of the order
executed. The system will permit up to a 17-second delay after
execution to permit the Executing Participant to update its
quotation before another non-directed order is delivered to that
participant.
(B) Default Execution: If the size of an order, or part of an
order, presented is greater than 1,000 shares but less than 5,000
shares, and an Executing Participant is displaying a quotation size
of 1,000 shares or greater but less than 5,000 shares, the System
will deliver an amount of the order up to the Executing
Participant's displayed size for execution and will decrease the
displayed size by the amount delivered immediately upon action by
the Executing Participant. The executing party has up to 17 seconds
from delivery to accept, decline, partial, price improve, or do
nothing with the delivered order. If the Executing Participant
declines the order, the Executing Participant's quotation shall be
immediately placed in a closed quote state. If the Executing
Participant does not respond to the order, the System will
automatically execute the order.
(C) Large Size Default Execution: If the size of an order, or
part of an order, presented is 5,000 shares or greater, and an
Executing Participant is displaying a quotation size of 5,000 shares
or greater, the System shall deliver the order to the Executing
Participant for execution and will decrease the displayed size by
the amount delivered immediately upon action by the Executing
Participant. The executing party has up to 32 seconds from delivery
to accept, decline, partial, price improve, or do nothing with the
delivered order. If the Executing Participant declines the order,
the Executing Participant's quotation shall be immediately placed in
a closed quote state. if the Executing Participant does not respond
to the order, the System will automatically execute the order.
(D) Non-Directed Order Interaction with Market Maker
Supplemental Size: If a market maker using supplemental size is
alone at the inside price, and a non-directed order larger than its
displayed size becomes available for delivery, the entire order, up
to the market maker's displayed size and its supplemental size,
shall either be automatically executed if it is up to 1000 shares,
or presented to the market maker for its action for up to 17
seconds, if the order is greater than 1,000 shares but less than
5,000 shares, or up to 32 seconds if the order is 5,000 shares or
greater. If the market maker accepts a partial amount less than its
remaining supplemental size or declines the order, the remainder of
the market maker's supplemental size shall be eliminated and the
market maker's quote shall be placed in a closed quote state until
the market maker updates its quote, or three minutes, whichever time
period is shorter. If the market maker does nothing within 17 or 32
seconds, depending on the size of the order presented, the amount of
the order presented to the market maker shall be executed against
the market maker.
(f) Supplemental Size: The System will permit System market
makers to establish supplemental size to their displayed size, i.e.,
a System market maker may establish additional, undisplayed size
that becomes displayed in market maker-established size increments
in the market maker's quotation after the System has executed an
order that decreases the market maker's displayed size to zero. The
amount of interest entered into the supplemental size feature may be
any amount established by the market maker, up to 99,000 shares,
provided that a market maker may not use the supplemental size
feature unless it is quoting in size of at least 1,000 shares and
the refreshed size of the quotation maintained by the supplemental
size facility is in a minimum increment of 1,000 shares.
(g) Limit Order File: The System will maintain a Limit Order
File that will hold and display limit orders entered on a voluntary
basis by participants. The System will display and execute limit
orders entered into the File in the following manner:
(1) Display of Limit Orders: Limit Orders entered into the Limit
Order File will be ranked according to price and time sequence. The
best-ranked limit order to buy and the best-ranked limit order to
sell in the file and the aggregate size of such orders associated
with such prices (i.e., the ``Top of File'') will be displayed
dynamically in a window on Nasdaq presentation devices and in the
Nasdaq quote montage where it will be ranked in price and time
sequence with market maker quotations and ECN-displayed orders. In
addition, Nasdaq will maintain for all Nasdaq subscribers a full
file display that will contain the prices and aggregate sizes of all
limit orders contained in the file. This full file display is not
updated dynamically and must be accessed on a query basis.
Marketable limit orders shall not be displayed in the Limit Order
File.
(2) Execution of Limit Orders Displayed In The Limit Order File:
When orders that are entered into the Nasdaq Limit Order File are
ranked first in priority in the System, the System will match non-
directed market and marketable orders against the best-priced limit
orders and immediately execute the orders and report such executions
to the consolidated trade reporting System for trade reporting and
the appropriate clearing agency as a locked-in trade.
(3) Short Sale Limit Orders: The System will permit the entry
and execution of limit orders that are short sales. The System will
not permit the execution of short sale orders that would violate the
NASD's Short Sale Rule, Rule 3350 of the NASD's Conduct Rules.
(4) Mixed Lot Orders: The System will display only the round lot
portion of a mixed lot order in the Top of File and Nasdaq Quote
Montage. The System will match the full size of a mixed lot order
only when such order can match exactly against another mixed lot
order. In cases where there is no exact match of mixed lot orders,
the System will match the round lot portions of such matching
orders, and maintain the remaining odd lot
[[Page 12140]]
portions of such orders for odd-lot processing.
(5) Opening Process: At 9:30 a.m. (ET) the System will commence
an opening match process as follows to attempt to execute as many
limit orders as possible held on the Limit Order File as of 9:30
together with any market orders also held at that time. At 9:30, the
System will first match limit orders to limit orders, based on
price/time priority, by providing executions bounded by the 9:30
inside quotation until all possible executions are exhausted. The
9:30 ``inside'' for this purpose includes quotations of ECNs and UTP
exchanges, but does not include the Top of File, Limits that cross
other limits, where both limits are outside the 9:30 inside, will be
executed at the mid-point of the 9:30 inside,. Limits that cross
other limits where one limit is at or within the 9:30 inside but the
other is outside will be executed at a price that would provide
price improvement for both orders if possible, provided the
execution is at or within the 9:30 inside. Any remaining limits that
cross other limits, both of which are within the 9:30 inside, will
be executed at the midpoint of the two limit orders, providing price
improvement to both. Next, the System executes as many market orders
as possible against any remaining limit orders, provided the limit
order is for a price at or within the 9:30 inside. If the inside
quotation is locked at 9:30, the System will execute as many orders
as can match at that price, with the remaining unmatched orders to
be processed at 9:30 pursuant to normal business hours processing.
If the inside quotation is crossed at 9:30 for a particular
security, the System will not execute the File orders in that
security. In this situation, each order will be matched or delivered
for execution, as the case may be, according to normal business
hours processing. Any market orders that do not match against limit
orders in the opening shall be delivered, starting 9:30, to
Executing Participants or the Limit Order File for execution
purposes according to normal business hours processing as set forth
above for non-directed orders. Execution reports for orders executed
during the opening will be disseminated starting at 9:30 a.m.
(6)(A) Display of limit orders: All orders entered and displayed
in Limit Order File shall be displayed anonymously.
(B) Execution of Limit Orders: When limit orders are executed,
the System shall provide an execution report to any participant that
participates in the execution and shall include the identifier of
each such participant.
(h) Odd-Lot Processing:
(1) Acceptance and Display: Odd lot orders, and the remainder of
mixed lot orders that could not be executed in the normal manner,
and are less than 100 shares, (market, limit, and marketable limit)
shall be accepted and processed by the System in a separate process.
Odd lot limit orders will not be displayed or matched in the Nasdaq
Limit Order File.
(2) Execution Process: An odd lot order shall be executed
automatically against the next available Nasdaq market maker in
rotation, when such odd lot order becomes executable. When the odd
lot order becomes executable, it will execute at the best price
available in the market against the market maker even if that market
maker is not quoting that price. Odd lot executions shall not
decrease the market maker's displayed size.
4960. Firm Quote Compliance Facility
(a) To assist System Market Makers in complying with the Firm
Quote Rules, System Market Makers shall be provided with a means to
indicate the NASD Regulation's Market Regulation that the System
Market Maker has received an order via the telephone to trade at the
System Market Maker's Nasdaq-displayed quotation and that for a
period of time while the System Market Maker handles the telephone
order, the System should not deliver additional orders for
execution.
(b) The System Market Maker shall send via the System a message
that creates a time record indicating when the Market Maker entered
the message regarding the telephone order. When the System receives
the message, the System shall not present an order to that Market
Maker until 17 seconds after receipts of the original message. The
System will provide the System Market Maker with a reference number
that shall be attached to the execution report that may occur as a
result of the telephone order. A System market maker may only send
one such message through the System for each telephone order
necessitating the message. Entering messages without corresponding
transactions shall be a violation of just and equitable principles
of trade.
4960. Clearance and Settlement
All transactions executed in the System shall be transmitted to
the National Securities Clearing Corporation to be cleared and
settled through a registered clearing agency using a continuous net
settlement system.
4970. Obligation to Honor System Trades
If a trade reported by a participant, or clearing member acting
on its behalf, is reported by the System to clearing at the close of
any trading day, or shown by the activity reports generated by the
System as constituting a side of a System trade, such System
participant, or clearing member acting on its behalf, shall honor
such trade on the scheduled settlement date.
4980. Compliance With Procedures And Rules
Failure of a participant or person associated with a participant
to comply with any of the rules or requirements of the System may be
considered conduct inconsistent with high standards of commercial
honor and just and equitable principles of trade, in violation of
the Conduct Rules. No member shall effect a System transaction for
the account of a customer, or for its own account, indirectly or
through the offices of a third party, for the purpose of avoiding
the application of these rules. Members are precluded from doing
indirectly what is directly prohibited by these rules. All entries
in the System shall be made in accordance with the procedures and
requirements set forth in the User Guide. failure by a non-member
participant to comply with any of the rules or requirements
applicable to the System shall subject the NASD member sponsoring
such non-member to censure, fine, suspension or revocation of its
registration as a participant or any other fitting penalty under the
Rules of the Association.
4990. Termination of System Service
The Association may, upon notice, terminate System service to a
participant in the event that a participant fails to abide by any of
the rules or operating procedures of the System or the Association,
or fails to pay promptly for services rendered.
[FR Doc. 98-6340 Filed 3-11-98; 8:45 am]
BILLING CODE 8010-01-M
