[Federal Register Volume 60, Number 62 (Friday, March 31, 1995)]
[Notices]
[Pages 16690-16693]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-7987]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35535; File No. SR-NASD-95-8]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Approving Proposed Rule Change To Extend Certain
SOES Rules Through October 2, 1995
March 27, 1995.
I. Introduction
On February 10, 1995, the National Association of Securities
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities
and Exchange Commission (``SEC'' or ``Commission'') a proposed rule
change pursuant to section 19(b)(1) of the Securities Exchange Act of
1934 (``Act'')\1\ and Rule 19b-4 thereunder.\2\ The NASD proposes to
extend through October 2, 1995 certain of the prior changes to its
Small Order Execution System (``SOES'') that were implemented in
January 1994 (``January 1994 Amended SOES Rules''),\3\ modified in
January 1995 [[Page 16691]] (``January 1995 Amended SOES Rules'')\4\
and are scheduled to expire today. Without further Commission action,
the SOES rules would revert to those in effect prior to the January
1994 Amended SOES Rules.
\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1994).
\3\Securities Exchange Act Release No. 33377 (Dec. 23, 1993), 58
FR 69419 (Dec. 30, 1993) (approving the Interim SOES Rules on a one-
year pilot basis effective January 7, 1994). See also Securities
Exchange Act Release No. 33424 (Jan. 5, 1994) (order denying stay
and granting interim stay through January 25, 1994) and Securities
Exchange Act Release No. 33635 (Feb. 17, 1994) (order denying
renewed application for stay).
\4\Securities Exchange Act Release No. 35275 (Jan. 25, 1995), 60
FR 6327 (Feb. 1, 1995).
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Although characterized by the NASD as a proposal to extend the
January 1995 Amended SOES Rules, under this proposal, SOES will operate
significantly different from its current operation. Most notably, the
NASD's current proposal does not include extension of the currently
effective 500 share maximum SOES order size limitation and,
accordingly, the maximum order size will return to 1,000 shares on
March 28, 1995. While the methodology for calculating the minimum
exposure limit will remain unchanged from the January 1994 Amended SOES
Rules, increasing the maximum order size from 500 shares to 1,000
shares will raise the minimum exposure limit applicable to
unpreferenced orders. For market makers electing not to use the
automated quotation update feature, the minimum exposure limit will
rise from 1,000 shares to 2,000 shares and, for those electing to use
this feature, the minimum exposure limit will rise from 500 to 1,000
shares. Moreover, the current proposal will not reinstate the short
sale prohibition. Thus, in comparison to the January 1994 Amended SOES
Rules, the effect of this proposal is to remove or alter every change
made to SOES so that retail investor access to the Nasdaq market is
improved.
Notice of the proposed rule change appeared in the Federal Register
on February 21, 1995.\5\ For the reasons discussed below, this order
approves the propose rule change until October 2, 1995.
\5\Securities Exchange Act Release No. 35364 (Feb. 13, 1995), 60
FR 9704 (Feb. 21, 1995).
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II. Description of the Current and Prior Proposals
The NASD proposes to extend two of the four January 1994 Amended
SOES Rules. Specifically, the NASD proposes to extend until October 2,
1995 changes that:
(1) Reduce the minimum exposure limit for ``unpreferenced'' SOES
orders from five times the maximum order size to two times the maximum
order size, and eliminate the exposure limits for ``preferenced'' SOES
orders; and
(2) Add an automated function for updating market maker quotations
when the market maker's exposure limit has been exhausted (market
makers using this update functions may establish an exposure limit
equal to the maximum order size for that security).
In contrast, the January 1994 Amended SOES Rules included the above
two changes as well as changes that:
(1) Reduced the maximum size order eligible for SOES execution from
1,000 shares to 500 shares; and
(2) Prohibited short sale transactions through SOES.
The January 1995 Amended SOES Rules continued all of the January
1994 Amended SOES Rules except for the short sale prohibition.\6\
\6\Thus, short sales in compliance with the NASD's short sales
rule applicable to the Nasdaq market as a whole are permitted in
SOES. NASD Manual, Rules of Fair Practices, Sec. 48, CCH 2200H.
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III. Comments
The Commission received comments from seven commenters, with four
supporting the proposal and three opposing it. The NASD responded to
these comments in a letter dated March 22, 1995.\7\ Subsequently, two
of the original seven commenters submitted letters reiterating their
respective positions; one of these supported the proposal and the other
opposed it.
\7\Letter from Richard Ketchum, Executive Vice President & Chief
Operating Officer, NASD, to Jonathan G. Katz, Secretary, SEC (Mar.
22, 1995).
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Generally, commenters supporting the proposal argue that approval
of the March 1995 Amended SOES Rules will limit the exposure of market
makers to multiple executions, which will benefit retail investors by
producing narrower spreads and more liquid markets.
Commenters opposed to the proposal argue that the statistical and
market quality data cited by the NASD in support of its proposal are
not sufficient to support the NASD's position. They contend that the
two studies on which the NASD relies fail to demonstrate any increase
in market quality as a result of the rules and that market makers have
ample opportunity to update their quotes in order to avoid multiple
SOES executions. One commenter also argued that the NASD has not
provided a sufficient basis for establishing the minimum exposure limit
at 2,000 shares and that determining the appropriateness of the
automated quotation update feature is not possible without information
about the extent of its use. Commenters opposed to the NASD's January
1994 Amended SOES Rules and January 1995 Amended SOES Rules argued that
decreasing the minimum exposure limit will increase the potential for
order queues to develop and, thus, result in inferior executions for
retail customers.
IV. Discussion
The Commission must approve a proposed NASD rule change if it finds
that the proposal is consistent with the requirements of the Act and
the rules and regulations thereunder that govern the NASD.\8\ In
evaluating a given proposal, the Commission examines the record before
it and relevant factors and information.\9\ After balancing the
advantages and disadvantages of extension, the Commission believes that
approval of the March 1995 Amended SOES Rules through October 2, 1995
meets the above standards. Specifically, the Commission believes that
returning the maximum order size to 1,000 shares, thus increasing the
minimum exposure limit from 1,000 shares to 2,000 shares, and
maintaining the automated quotation update feature is appropriate while
the NASD considers other methods for handling small orders from retail
customers.
\8\15 U.S.C. Sec. 78s(b). The Commission's statutory role is
limited to evaluating the rules as proposed against the statutory
standards. See S. Rep. No. 75, 94th Cong., 1st Sess., at 13 (1975).
\9\In the Securities Acts Amendments of 1975, Congress directed
the Commission to use its authority under the Act, including its
authority to approve SRO rule changes, to foster the establishment
of a national market system and promote the goals of economically
efficient securities transactions, fair competition, and best
execution. Congress granted the Commission ``broad, discretionary
powers'' and ``maximum flexibility'' to develop a national market
system and to carry out these objectives. Furthermore, Congress gave
the Commission ``the power to classify markets, firms, and
securities in any manner it deems necessary or appropriate in the
public interest or for the protection of investors and to facilitate
the development of subsystems within the national market system.''
S. Rep. No. 75, 94th Cong., 1st. Sess., at 7 (1975).
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In connection with the January 1995 Amended SOES Rules, the NASD
submitted an econometric study conducted by the NASD's Economic
Research Department\10\ and commissioned a consulting economist to
provide an assessment of the effect of the January 1994 Amended SOES
Rules.\11\ In summary, the NASD's [[Page 16692]] Economic Research
Department found that since implementation of the January 1994 Amended
SOES Rules: (a) spreads in Nasdaq securities have declined; and (b)
volatility of Nasdaq securities appears to be unchanged, except for a
brief, market-wide period of volatility in March and April 1994. The
commissioned study reported that while percentage quoted spreads
increased a statistically insignificant amount, percentage quoted
spreads adjusted for other determining factors declined by a
statistically significant, but economically insignificant, amount. From
this data, the author concluded that the January 1994 Amended SOES
Rules did not harm market quality. In support of its current proposal,
the NASD also relies on these studies for the proposition that the
January 1994 Amended SOES Rules and the January 1995 Amended SOES Rules
collectively and individually have improved the quality of the Nasdaq
market.
\10\Securities Exchange Act Release No. 35080 (Dec. 9, 1994), 59
FR 65109 (Dec. 16, 1994). The NASD's Economic Research Department
examined Nasdaq bid-ask spreads in specific stocks and price
volatility on two sample days each month from November 1993 (three
months prior to the effective date of the rules) through August
1994.
\11\Letter from John F. Olson, Counsel for the NASD, Gibson,
Dunn & Crutcher, to Jonathan Katz, Secretary, SEC (Dec. 30, 1994)
(submitting in connection with File No. SR-NASD-94-68 analysis
entitled The Association Between the Interim SOES Rules and Nasdaq
Market Quality prepared by Dean Furbush, Ph.D., Economists
Incorporated (Dec. 30, 1994)). This analysis compared sample days in
the three months prior to and three months after the effective date
of the January 1994 Amended SOES Rules.
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In its order approving the January 1995 Amended SOES Rules,
however, the Commission expressed its belief that the empirical data
submitted by the NASD demonstrated neither significant improvement to
nor serious deterioration in the quality of the Nasdaq market
subsequent to the adoption of the January 1994 Amended SOES Rules.\12\
Since Commission approval of the January 1995 Amended SOES Rules, no
data concerning the impact of the January 1994 Amended SOES Rules or
the January 1995 Amended SOES Rules has been submitted. The Commission,
therefore, continues to believe that empirical evidence submitted by
the NASD demonstrates neither a significant improvement to nor serious
deterioration in the quality of the Nasdaq market subsequent to the
adoption of the January 1994 Amended SOES Rules. Moreover, the
Commission believes this is true whether the amended SOES rules are
viewed collectively or individually.
\12\Securities Exchange Act Release No. 35275 (Jan. 25, 1995),
60 FR 6327 (Feb. 1, 1995).
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The absence of negative implications for market quality must be
considered in conjunction with other effects of the recent changes to
SOES on the investing public. The current proposal, in conjunction with
termination of the short sale prohibition in January 1995, restores
much of the access retail investors with small orders enjoyed prior to
the January 1994 Amended SOES Rules and, thus, the Commission believes
that a sufficient basis exists for approving the NASD's proposal.
Effective March 28, 1995, the 1,000 share maximum order size in effect
prior to the January 1994 Amended SOES Rules will be restored. This
will provide retail investors enhanced opportunity to obtain execution
of transactions between 500 and 1,000 shares and, accordingly, will
improve access to the Nasdaq market. The Commission believes that the
net effect of the instant proposal and the January 1995 Amended SOES
Rules is a substantial departure from the January 1994 Amended SOES
Rules, and would eliminate the economically significant restrictions
imposed on order entry firms by the prior rules.
The NASD's proposal will continue the methodology for calculating a
market maker's minimum exposure limit; that is, two times the maximum
order size rather than the pre-January 1994 Amended SOES Rules
calculation of five times the maximum order size. Restoring the pre-
January 1994 Amended SOES Rules maximum order size of increasing the
minimum exposure limit from 1,000 shares to 2,000 shares.
Moreover, the current methodology for calculating a market maker's
outstanding exposure limit will continue to exclude orders executed
pursuant to a preferencing arrangement. Under the SOES Rules prior to
the January 1994 Amended SOES Rules, both preferenced and unpreferenced
orders were considered when calculating a market maker's remaining
exposure limit. Thus, in relative terms, the 2,000 share exposure limit
potentially provides greater liquidity compared to the pre-January 1994
Amended SOES Rules' 5,000 share minimum exposure limit. This assures
enhanced access to Nasdaq market makers by both firms with and without
preferencing arrangements.
The Commission believes that while the proposal does not restore
the pre-January 1994 Amended SOES Rules minimum exposure limit, it
provides customers fair access to the Nasdaq market and reasonable
assurance of timely executions. In this regard, the maximum order size
will equal the size requirement prescribed under the Firm Quote Rule
and NASD rules governing the character of market maker quotations.\13\
Moreover, market maker's minimum exposure limit for unpreferenced
orders will be double its minimum size requirement prescribed under
these rules.\14\
\13\NASD Manual, Schedules to the By-Laws, Schedule D, Part V,
Sec. 2(a), (CCH) 1819.
\14\17 CFR 240.11Ac1-1(c). Nonetheless, the Commission is
concerned about the potential for delayed and/or inferior
executions. In this regard, the Commission expects the NASD to
monitor the extent to which exposure limits are exhausted, the
extent to which the automated quotation update feature is used, and
the effects these two aspects have on liquidity. Moreover, the
Commission expects the NASD to consider the possibility of
enhancements to eliminate the potential for delayed and/or inferior
executions.
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The Commission also believes that extending the automated update
function is consistent with the Firm Quote Rule. The update function
provides market makers the opportunity to update automatically their
quotations after executions through SOES;\15\ under the Commission's
firm Quote Rule, market makers are entitled to update their quotations
following an execution and prior to accepting a second order at their
published quotes.\16\
\15\In its response to commenters, the NASD indicated that 21
percent of market makers in Nasdaq National Market securities use
the automated quotation update feature resulting in 38 percent of
all market making positions in Nasdaq National Market securities.
Letter from Richard Ketchum, Executive Vice President & Chief
Operating Officer, NASD, to Jonathan G. Katz, Secretary, SEC (Mar.
22, 1995).
\16\The Firm Quote Rule requires market makers to execute orders
at prices at least as favorable as their quoted prices. The Rule
also allows market makers a reasonable period of time to update
their quotations following an execution, allows market makers to
reject an order if they have communicated a quotation update to
their exchange or association, and provides for a size limitation on
liability at a given quote. 17 CFR 240.11Ac1-1(c)(2). See also,
Securities Exchange Act Release No. 14415 (Jan. 16, 1978), 43 FR
4342 (Feb. 1, 1978).
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The Commission notes commenter views that the NASD's proposal does
not go far enough in restoring access available to investors prior to
the January 1994 Amended SOES Rules. As discussed above, however, the
current proposal does offer investors significantly wider latitude than
the January 1994 Amended SOES Rules and the January 1995 Amended SOES
Rules. Moreover, the limited duration of the proposal will give the
NASD and interested persons an opportunity to assess the broader
implications of immediate execution of orders between 500 and 1,000
shares through SOES.
V. Conclusion
As indicated above, the Commission has determined to approve the
March 1995 Amended SOES Rules through October 2, 1995. In light of the
balance of factors described above and the limited duration of the
current proposal, the Commission believes extension of the changed
methodology for calculating the minimum exposure and the addition of an
automatic quotation [[Page 16693]] update feature is consistent with
the Act.
The Commission, in the exercise of the authority delegated to it by
Congress, and in light of its experience regulating securities markets
and market participants, has determined that approval of the March 1995
Amended SOES Rules until October 2, 1995 is consistent with maintaining
investor protection and fair and orderly markets, and that these goals,
on balance, outweigh any possible anti-competitive effects on order
entry firms and their customers.
Accordingly, the Commission finds that the rule change is
consistent with the Act and the rules and regulations thereunder
applicable to the NASD and, in particular, Sections 15A(b)(6),
15A(b)(9), and 15A(b)(11). In addition, the Commission finds that the
rule change is consistent with the Congressional objectives for the
equity markets, set out in Section 11A, of achieving more efficient and
effective market operations, fair competition among brokers and
dealers, and the economically efficient execution of investor orders in
the best market.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the instant rule change SR-NASD-95-8 be, and hereby is, approved,
effective March 28, 1995 through October 2, 1995.
By the Commission.
Jonathan G. Katz,
Secretary.
[FR Doc. 95-7987 Filed 3-30-95; 8:45 am]
BILLING CODE 8010-01-M
