[Federal Register Volume 59, Number 53 (Friday, March 18, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-6323]
[[Page Unknown]]
[Federal Register: March 18, 1994]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33758; File No. SR-NASD-92-12, Amendment No. 6]
Self-Regulatory Organizations; Notice of Proposed Rule Change by
the National Association of Securities Dealers, Inc., Relating to
Amendments to the NASD's Proposed Short Sale Rule
March 11, 1994.
Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on March 8,
1994, the National Association of Securities Dealers, Inc. (``NASD'' or
``Association'') filed with the Securities and Exchange Commission
(``Commission'' or ``SEC'') Amendment No. 6 to the proposed rule change
as described in Items I, II, and III below, which Items have been
prepared by the NASD.\1\ The Commission is publishing this notice to
solicit comments on the proposed rule change, as amended, from
interested persons.
---------------------------------------------------------------------------
\1\On January 14, 1994, the NASD submitted Amendment No. 5 to
this filing. Amendment No. 6 supersedes and replaces Amendment No.
5, which was not published for comment.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The NASD is amending its proposed short sale rule or ``bid test''
applicable to stocks traded on the Nasdaq National Market by expanding
the options market makers' exemption from the rule to include certain
short sales effected by index options market makers. Specifically, for
an eighteen-month pilot period, the proposal provides that an NASD
member shall be permitted, consistent with its quotation obligations,
to execute a short sale for the account of an index options market
maker that would otherwise be in contravention of the NASD's short sale
rule so long as: (1) The short sales are hedges of existing or
contemporaneously established index options positions and (2) the
dollar value of all stock sold short to hedge the offsetting stock
index options position(s) does not exceed the aggregate current index
value of the offsetting index options position(s).
The NASD also is proposing four other amendments to the NASD's
short sale rule. First, the NASD proposes to amend the filing to
provide that all market maker exemptions from the rule will be uniform
in duration. Specifically, under the proposal, the exemptions afforded
qualified Nasdaq market makers, Nasdaq warrant market makers, and
qualified options market makers will all expire eighteen months after
the effective date of the NASD's short sale rule. Prior to the
termination of the eighteen-month period, the NASD will evaluate
whether these exemptions should be extended, modified, approved on a
permanent basis, or terminated. Second, with respect to the trading
activity of options market makers and warrant market makers, the
amendment clarifies that transactions unrelated to normal options/
warrant market making activity, such as index arbitrage or risk
arbitrage that in either case is independent of an options/warrant
market maker's market making functions, will not be considered a
hedging transaction for purposes of the options/warrant market maker
exemption from the NASD's short-sale rule. Third, consistent with Rule
10a-1 under the Act, the amendment expands the exemption from the
NASD's short-sale rule for certain transactions in special arbitrage
accounts and special international arbitrage accounts to include short-
sales effected by non-members. Prior to this amendment, only NASD
members would be able to avail themselves of these two exemptions from
the rule. Fourth, the NASD proposes to amend the options and warrant
market maker exemptions to provide that an NASD member would not be in
violation of the NASD's short sale rule if it executed an order for the
account of an options or warrant market maker in the good faith belief
that the order was in full compliance with the NASD's short sale rule
and it was subsequently determined that the order was either not
entitled to the exemption or it was incorrectly marked long. The NASD
also proposes to make some minor stylistic modifications and
grammatical corrections to the short sale rule and amend the section
numbers for the rule. The text of the proposed rule change is available
at the Office of the Secretary of the NASD and at the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The NASD has prepared summaries, set forth in sections
(A), (B), and (C) below of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the proposed Rule Change
On November 19, 1993, the NASD submitted Amendment No. 4 to its
proposed short sale rule or ``bid test'' applicable to stocks traded on
the Nasdaq National Market to provide for an eighteen-month pilot
program that would afford equity options market makers with a limited
exemption from the rule if the short sales were effected to hedge
options positions established as a result of bona fide market making
activity.\2\ This amendment reflected the NASD's efforts to strike a
reasonable balance between the needs of equity options market makers to
effectively hedge their long options positions through short
sales\3\and the NASD's need to implement a meaningful short sale rule
for the Nasdaq Stock Market (``Nasdaq'') that does not contain broad
and sweeping exemptions that eviscerate the rule's effectiveness.
---------------------------------------------------------------------------
\2\See Securities Exchange Act Release No. 33289 (December 3,
1993), 58 FR 64994 (December 12, 1993).
\3\The options exchanges and options market makers have
consistently argued, among other things, that the absence of an
exemption from the NASD's short sale rule for options market makers
will have an adverse impact on the liquidity and pricing of options
on Nasdaq securities and that it is inconsistent with the Act to
afford Nasdaq market makers an exemption from the rule and not
options market makers. See Securities Exchange Act Release No. 31729
(January 13, 1993), 58 FR 5791 (``Amendment No. 3 Notice''). See
also, e.g., letter to Jonathan G. Katz, Secretary, SEC, from the
American, New York, Pacific and Philadelphia Stock Exchanges, and
the Chicago Board Options Exchange dated February 18, 1993.
---------------------------------------------------------------------------
Recently, however, the options exchanges have maintained that it is
equally important for the efficiency of the marketplace that index
options market makers be able to avail themselves of an exemption from
the NASD's short sale rule for hedging purposes. Accordingly, the NASD
is proposing another amendment to its short sale rule to accommodate
the hedging needs of index options market makers. In particular, the
NASD proposes to modify the equity options market maker exemption to
include short sales effected by index options market makers.
Specifically, under the proposed index options market maker
exemption, an NASD member will be permitted, consistent with its
quotation obligations, to execute a short sale for the account of an
options market maker that would otherwise be in contravention of the
NASD's short sale rule so long as: (1) The short sale is an ``exempt
hedge transaction''; and (2) the options market maker is registered
with a ``qualified options exchange''\4\ as a ``qualified options
market maker'' on a ``qualified stock index.'' An ``exempt hedge
transaction'' is defined to be a short sale in a Nasdaq National Market
security that was effected to hedge, and in fact serves to hedge, an
existing offsetting stock index options position or an offsetting stock
index options position that was created in a transaction(s)
contemporaneous with the short sale, provided certain conditions are
satisfied. These conditions are as follows: (a) The security sold short
must be a component security of the index underlying such index option;
(b) the index underlying such offsetting index options position must be
a ``qualified stock index''; and (c) the dollar value of all exempt
short sales effected to hedge the offsetting stock index options
position(s) does not exceed the aggregate current index value of the
offsetting options position(s).
---------------------------------------------------------------------------
\4\As with the equity option market maker exemption, a
``qualified options exchange'' is defined to be a national
securities exchange that has received SEC approval of rules and
procedures governing: (1) The designation of options market makers
as qualified options market makers; (2) the surveillance of its
market makers utilization of the exemption; and (3) authorization of
the NASD to withdraw, suspend, or modify the designation of a
qualified options market maker in the event that the options
exchange determines that the qualified options market maker has
failed to comply with the terms of the exemption and the exchange
believes that such action is warranted in light of the substantial,
willful, or continuing nature of the violation.
---------------------------------------------------------------------------
A ``qualified stock index'' is defined to be a stock index that
includes one or more Nasdaq National Market securities, provided that
more than 10% of the weight of the index is accounted for by Nasdaq
National Market securities. The amendment also provides that a
qualified stock index shall be reviewed as of the end of each calendar
quarter, and the index shall cease to qualify if the value of the index
represented by one or more Nasdaq National Market securities is less
than 8% at the end of any subsequent calendar quarter. In this
connection, the NASD has proposed the 10% minimum requirement for
qualified stock indexes to help ensure that exempted short sales
effected by index options market makers are in fact the result of
legitimate hedging needs.
Thus, an index options market maker would become a ``qualified
options market maker'' for certain classes of stock index options only
if it has received an appointment as such from a qualified options
exchange. In this regard, the rule is designed to ensure that only
those index options market makers who regularly engage in making
markets in options classes overlying indexes containing Nasdaq-listed
securities are designated as qualified options market makers.
Specifically, before an options exchange can become a qualified options
exchange, it must have rules in place to identify and designate as
qualified options market makers those market makers who regularly
engage in market making activities in particular options classes.
As with the equity options market maker exemption, the NASD also
has proposed that the index options market maker exemption shall only
be in effect for an eighteen-month pilot period. Throughout this
eighteen-month period, the NASD will review and analyze with the
options exchanges whether the exemption is resulting in destabilizing
trading in Nasdaq stocks.
In addition, the NASD notes that the Intermarket Surveillance Group
Agreement, which provides for the sharing of surveillance information
between the exchanges and the NASD, may assist in evaluating possibly
manipulative activity and other possibly destabilizing short selling
activity by qualified options market makers and other options market
makers in Nasdaq securities.
The NASD also is proposing four other amendments to its short-sale
rule. First, the NASD proposes to amend its short sale rule to provide
that all market maker exemptions from the rule are uniform in duration.
Specifically, under the proposal, the exemptions afforded qualified
Nasdaq market makers, Nasdaq warrant market makers, and qualified
options market makers all will expire eighteen months after the
effective date of the NASD's short sale rule. Previously, only the
options market maker exemption was proposed on a pilot basis. With all
of the market maker exemptions expiring simultaneously, the NASD
believes it will be better able to evaluate and respond to the market
impacts, if any, resulting from these exemptions. Accordingly, prior to
the termination of the eighteen-month pilot period, the NASD will
evaluate whether these exemptions should be extended, modified,
approved on a permanent basis, or terminated.
Second, the NASD is clarifying that transactions by options market
makers and warrant market makers unrelated to their normal options/
warrant market making activity, such as index arbitrage or risk
arbitrage that in either case is independent of an options/warrant
market maker's market making functions, will not be considered a
hedging transaction for purposes of the options/warrant market maker
exemption from the NASD's short-sale rule. Amendment No. 4 to the short
sale rule provided that Nasdaq market makers will not be able to avail
themselves of an exemption from the short sale rule for ``transactions
unrelated to normal market making activity, such as index arbitrage and
risk arbitrage that is independent from a member's market making
functions * * *''. Thus, this amendment merely extends to options and
warrant market makers the same restriction that already applies to
Nasdaq market makers.\5\
---------------------------------------------------------------------------
\5\The NASD also would like to correct an error that was made in
the filing for Amendment No. 4 concerning the entitlement of a
Nasdaq market maker to an exemption from the NASD's short sale rule
when the risk arbitrage department of a firm takes over the firm's
market making functions after the announcement of a merger or
acquisition. Specifically, the filing stated that ``registered
Nasdaq market makers that qualify for the exemption according to the
standards of Sections 46 and 47 would relinquish their market making
exemption if the risk arbitrage department of the firm took over the
market making functions after the announcement of a merger or
acquisition.'' Instead, the filing should have stated that the firm
would not have to relinquish its market maker exemption if the risk
arbitrage department continued to engage in bona fide market making
and the firm continued to qualify for an exemption for that issue
under sections 46 and 47 of the NASD's Rules of Fair Practice. To
the extent that the risk arbitrage department effected risk
arbitrage transactions unrelated to bona fide market making
activity, however, the exemption would not be available for those
transactions. (As discussed below, the NASD proposes to renumber
Sections 46 and 47 upon approval of this filing.)
---------------------------------------------------------------------------
Third, the NASD proposes to amend its short sale rule to track
provisions of SEC Rule 10a-1(e) (7) and (8) concerning short sales
effected by special arbitrage accounts and special international
arbitrage accounts (``arbitrage accounts''). Currently, the NASD's
short sale rule only affords NASD members an exemption from the rule
for certain short sales effected in arbitrage accounts. The exemptions
from the SEC's short sale rule afforded by Rule 10a-1(e) (7) and (8),
however, are available to any person and are not limited to members of
an exchange or the NASD. Thus, the NASD is proposing to replace the
word ``member'' with the word ``person'' in the exemptions for
arbitrage accounts so that the NASD's short sale rule better tracks
comparable provisions of SEC Rule 10a-1.
Fourth, to clarify that the onus for determining entitlement to an
exemption falls squarely on options and warrant market makers, the NASD
proposes to add new Sections (h)(2)(f) and (i)(4) to the short sale
rule to provide that an NASD member will not be in violation of the
NASD's short-sale rule if the member executes a short sale for the
account of an options or warrant market maker that is in contravention
of the options or warrant market maker exemptions, provided that the
member did not know or have reason to know that the options or warrant
market maker's short sale was in contravention of these exemptions.
The NASD also is proposing several minor changes to its short sale
rule and the accompanying rule governing the designation of Primary
Nasdaq Market Makers. First, the NASD proposes to replace references to
Nasdaq/NMS securities in these rules with the term Nasdaq National
Market securities to ensure uniformity and avoid confusion. Second,
because another NASD rule has been designated as Section 46, the same
section number proposed for the short sale rule, the NASD proposes to
delete the section numbers for short sale rule and the accompanying
rule governing Primary Nasdaq Market Makers. Once this filing is
approved, these Sections will be numbered sequentially with the next
available section numbers. Third, the NASD proposes two minor
amendments to the first paragraph of Interpretation C to the short sale
rule to correct grammatical mistakes.
The NASD believes the proposed rule change is consistent with
sections 15A(b)(6) and 11A(c)(1)(F) of the Act. Section 15A(b)(6)
requires that the rules of a national securities association be
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, to foster cooperation
and coordination with persons engaged in regulating, clearing,
settling, processing information with respect to, and facilitating
transactions in securities, and to remove impediments to and perfect
the mechanism of a free and open market. Section 11A(c)(1)(F) assures
equal regulation of all markets for qualified securities and all
exchange members, brokers, and dealers effecting transactions in such
securities. Specifically, as noted in prior filings regarding the
NASD's short sale rule, approval of the proposed short sale rule would
result in equivalent short sale regulation in the exchange and Nasdaq
markets and would work to prevent fraud and manipulation with respect
to short sales in the Nasdaq market. Moreover, the NASD believes that
affording index options market makers with an exemption from the rule
for legitimate hedging transactions associated with their bona fide
options market making activity will serve to minimize the potential
adverse impacts, if any, on the options markets resulting from adoption
of the NASD's short sale rule. In addition, in light of the safeguards
proposed in conjunction with the index options market maker exemption
(e.g., the requirement that the short sales be hedges of existing or
contemporaneously established index options positions and the
limitation of the exemption to index options market makers on indexes
with a substantial Nasdaq component), the NASD does not believe that
the index options market maker exemption will subsume or eviscerate the
effectiveness of the NASD's short sale rule.
In addition, as with the exemption for equity options market
makers, the NASD believes it is reasonable and appropriate to approve
the index options market maker exemption on an eighteen-month pilot
basis. As noted in prior NASD filings concerning the NASD's short sale
rule, in the absence of a comparable short sale rule for the options
markets, it is not entirely clear to the NASD that abusive short
sellers will not be able to circumvent the NASD's short sale rule
through the use of the index options markets. Specifically, if index
options market makers are not required to adhere to the NASD's short
sale rule, the NASD believes it is possible that market participants
would aggressively buy puts or sell calls on indexes with a large
Nasdaq component confident in the knowledge that the options market
makers likely to bear the other side of the contract would almost
surely employ their short sale exemption to sell into the bid on
Nasdaq. Accordingly, the NASD believes it would be prudent and
consistent with the maintenance of fair and orderly markets to approve
the index options market maker exemption on an eighteen-month pilot
basis. During the term of the pilot, the NASD, in cooperation with the
options exchanges, will conduct a thorough analysis of the market
impacts, if any, resulting from short sales effected pursuant to the
exemption. Depending on the results of the study, the NASD will
consider whether to seek permanent approval of the exemption, modify
the exemption, or withdraw the exemption. In this connection, it is the
NASD's intention to not modify or withdraw the exemption unless it can
be shown that the exemption is causing demonstrable harm to Nasdaq.
Moreover, should it become clear during the term of the pilot that the
index options market marker exemption is having an adverse impact on
Nasdaq, the NASD will endeavor to make a good faith effort to work with
the options exchanges to correct or rectify the concerns associated
with the operation of the exemption before seeking to withdraw the
pilot.
The NASD also believes that approving the exemption for qualified
Nasdaq market makers on an eighteen-month pilot basis is consistent
with the maintenance of fair and orderly markets. While the NASD
continues to believe that Nasdaq market makers regularly performing an
effective market making function must be permitted the flexibility to
sell short when necessary to adjust quickly to market movements and
that there are more compelling reasons to provide Nasdaq market makers
with an exemption from the short sale rule than options market makers,
the NASD, nevertheless, believes it is appropriate to thoroughly
examine whether the Nasdaq market maker exemption is causing any
adverse market impacts before adopting the exemption on a permanent
basis. In addition, approving the Nasdaq market maker exemption on an
interim basis is consistent with the proposed pilot exemption for
options market makers. Finally, with respect to the other proposed
amendments discussed in this filing, the NASD believes they will serve
to reduce investor confusion concerning the application and operation
of the NASD's short sale rule, thereby promoting efficient and fair
markets.
B. Self-Regulatory Organization's Statement on Burden on Competition
The NASD believes that the proposed rule change will not result in
any burden on competition that is not necessary or appropriate in
furtherance of the purpose of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the NASD consents, the Commission will:
A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street NW., Washington, DC 20549. Copies
of the submission, all subsequent amendments, all written statements
with respect to the proposed rule change that are filed with the
Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to the file number in the caption
above and should be submitted by April 8, 1994.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\6\
---------------------------------------------------------------------------
\6\17 CFR 200.30-3(a)(12) (1993).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-6323 Filed 3-17-94; 8:45 am]
BILLING CODE 8010-01-M
