[Federal Register Volume 63, Number 75 (Monday, April 20, 1998)]
[Notices]
[Pages 19547-19549]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-10339]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39857; File No. SR-NASD-97-20]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval to
Amendment No. 1 to the Proposed Rule Change by the National Association
of Securities Dealers, Inc. Relating to the Elimination of the
Prohibitions Against NASD Members Accepting Stop Orders and Stop Limit
Orders in Exchange-Listed Securities
April 14, 1998.
I. Introduction
On March 10, 1997, the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association'') submitted to the Securities and
Exchange Commission (``SEC'' or ``Commission''), pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule
19b-4 thereunder,\2\ a proposal to amend paragraph (i) of NASD Rule
6440, ``Trading Practices,'' to (1) allow members to accept stop orders
\3\ in eligible securities; \4\ and (2) eliminate the requirement that
the stop price equal the limit price in order for a member to accept a
stop limit order \5\ in an eligible security.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ A buy stop order is an order to buy which becomes a market
order when a transaction takes place at or above the stop price.
Conversely, a sell stop order is an order to sell which becomes a
market order when a transaction takes place at or below the stop
price. See NASD Rule 6440(i)(1).
\4\ Under NASD Rule 6410(d), ``eligible securities'' means all
common stocks, preferred stocks, long-term warrants, and rights
entitling the holder to acquire an eligible security, listed or
admitted to unlisted trading privileges on the American Stock
Exchange (``Amex'') or the New York Stock Exchange (``NYSE''), and
securities listed on the regional stock exchanges which
substantially meet the original listing requirements of the Amex or
the NYSE.
\5\ A buy stop limit order is an order to buy that becomes a
limit order at the limit price when a transaction occurs at the stop
price. Conversely, a sell stop limit order is an order to sell that
becomes a limit order at the limit price when a transaction occurs
at the stop price.
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Notice of the proposed rule change was published for comment and
appeared in the Federal Register on March 28, 1997.\6\ No comment
letters were received on the proposal. On April 1, 1997, the NASD filed
Amendment No. 1 to the proposed rule change.\7\ In
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addition, the NASD submitted a letter describing the surveillance
procedures it will use to monitor the handling of stop orders and stop
limit orders.\8\ This order approves the NASD's proposal, as amended.
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\6\ See Securities Exchange Act Release No. 38429 (March 21,
1997) 62 FR 14953.
\7\ See Letter from Robert E. Aber, Vice President and General
Counsel, NASD, to Katherine England, Assistant Director, National
Market System and Over-the-Counter Regulation, Division of Market
Regulation (``Division''), Commission, dated April 1, 1997
(``Amendment No. 1''). In Amendment No. 1, the NASD corrected a
typographical error in NASD Rule 6440(i)(2). Specifically, NASD Rule
6440(i)(2) stated that when a transaction occurs at the stop price,
a stop limit order to buy or sell becomes a limit order at the stop
price. Amendment No. 1 revises NASD Rule 6440(i)(2) to state that
when a transaction occurs at the stop price, a stop limit order to
buy or sell becomes a limit order at the limit price.
\8\ See Letter from Thomas R. Gira, Vice President, NASD
Regulation, Inc., to Katherine England, Assistant Director, National
Market System and Over-the-Counter Regulation, Division, Commission,
dated February 27, 1998.
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II. Description of the Proposal
The NASD proposes to amend NASD Rule 6440 to eliminate current
restrictions on the ability of NASD members to accept stop orders and
certain stop limit orders in eligible securities. Currently, NASD Rule
6440(i)(1) prohibits NASD members from accepting stop orders in
eligible securities, and NASD Rule 6440(i)(2) allows members to accept
stop limit orders in eligible securities where the stop price and the
limit price are the same. The NASD proposes to amend NASD Rule 6440(i)
to: (1) allow members to accept stop orders in eligible securities; and
(2) eliminate the requirement that the stop price must equal the limit
price in order for a member to accept a stop limit order in an eligible
security. In addition, the proposal clarifies that NASD members are not
obligated to accept stop orders or stop limit orders.
The NASD believes there is no economic or regulatory reason to
preclude or restrict investors from placing stop orders or stop limit
orders in eligible securities. In this regard, the NASD notes that
there are no comparable restrictions on the placement of stop orders or
stop limit orders in securities listed on The Nasdaq Stock Market
(``Nasdaq''). The NASD believes that investors in the third market \9\
also should be able to receive the benefits and protections that result
from placing stop orders and stop limit orders. In particular, the NASD
believes that the placement of stop orders and stop limit orders will
help investors to implement their investment strategies and manage
their portfolios.
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\9\ The third market is the over-the-counter market for
exchange-listed securities.
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III. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to the NASD and, in particular, the requirements
of Section 15A(b)(6) in that it is designed to promote just and
equitable principles of trade, to remove impediments to and perfect the
mechanism of a free and open market, and, in general, to protect
investors and the public interest.\10\ Specifically, the Commission
believes that it is reasonable for the NASD to amend its rules to allow
members to: (1) accept stop orders in eligible securities; and (2)
accept stop limit orders in eligible securities where the limit price
differs from the stop price. The Commission also believes that it is
reasonable for the NASD to clarify its rules to indicate that members
are not obligated to accept stop orders or stop limit orders.
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\10\ In approving this rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
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The Commission believes that amending NASD Rule 6440(i)(1) to
permit members to accept stop orders in eligible securities will extend
the benefits and protections associated with stop orders to
transactions in the third market. In general, an investor enters a stop
sell order in a stock whose price has increased substantially in order
to protect his or her profit if the stock's price declines; similarly,
an investor with a short position may enter a stop buy order to limit
his or her losses if the stock's price increases.\11\ The Commission
believes that allowing NASD members to accept stop orders in eligible
securities will extend these benefits to investors trading eligible
securities in the third market and provide them with additional
flexibility in implementing their trading strategies. The Commission
notes that NASD members currently may accept stop orders in securities
that are not eligible securities (generally, securities listed on
Nasdaq), as well as stop limit orders in eligible securities.\12\ The
NASD represents that it has not experienced any problems in connection
with the use of stop orders for non-eligible securities or with the use
of stop limit orders for eligible securities.\13\
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\11\ See Securities Exchange Act Release No. 29063 (April 10,
1991) 56 FR 15652 (April 17, 1991) (order approving File No. SR-
Amex-90-31) (``Amex Approval Order'').
\12\ See NASD Rule 6440(i)(2).
\13\ Telephone conversation between Thomas R. Gira, Vice
President, NASD Regulation, and Yvonne Fraticelli, Attorney, Office
of Market Supervision, Division, Commission, on April 2, 1998.
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The Commission believes that the NASD has developed procedures that
will allow it to monitor the handling of stop orders and stop limit
orders in eligible securities.\14\ In addition to protections afforded
by market surveillance, the Commission believes that the NASD's
surveillance procedures will help to detect and deter efforts by market
makers to use stop orders to manipulate the price of stock. Several
characteristics of the trading in the third market minimize the
likelihood that NASD market makers would be able to manipulate the
price of an eligible security through their handling of stop orders. In
this regard, the Commission notes, first, that a limited amount of the
trading of eligible securities occurs in the third market.\15\ Second,
the exchanges, rather than the third market, are the primary price
discovery markets for eligible securities; third market makers usually
base their quotations on the primary market quote.\16\ Third, there are
multiple third market makers (as opposed to a single exchange
specialists) for each eligible security. The Commission believes that
these factors, taken together, would make it difficult for a third
market maker to manipulate the price of an eligible security through
the use of stop orders.
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\14\ The Commission has had a continuing interest in potential
manipulation and trading abuses in connection with elections of stop
orders by exchange specialists. See e.g., Division of Trading and
Exchanges, SEC, Stop Orders (1963) (detailing various problems
associated with the execution of stop orders); Securities Exchange
Act Release No. 24021 (January 21, 1987) 52 FR 3370 (February 3,
1987) (order approving File No. SR-Amex-84-32); and Amex Approval
Order, supra note 10. These abuses typically involved exchange
specialists electing stop orders through principal transactions at
price levels either well above the market price in the case of stop
buy orders or well below the market price in the case of sell stop
orders. See Amex Approval Order, supra note 10. As discussed more
fully infra, the Commission believes that the NASD has adequately
addressed the potential problems that may arise in connection with
the handling of stop orders.
\15\ In 1993, the third market garnered 7.4% of reported NYSE
volume and 9.3% of the reported trades. See Division, Commission,
Market 2000: An Examination of Current Equity Market Developments
(January 1994) (``Market 2000 Study'') at II-11.
\16\ See Market 2000 Study, supra note 16, at II-8.
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The Commission also believes that it is reasonable for the NASD to
amend NASD Rule 6440(i)(2) to allow members to accept stop limit orders
in eligible securities where the stop price differs from the limit
price in order to provide investors with additional flexibility in
using stop limit orders. A stop limit order, which must be executed at
the limit price or better, is designed to
[[Page 19549]]
guarantee that an order receives an execution at no worse than the
limit price. However, if the market drops below the limit price of a
sell stop order before the order can be executed, it is possible that
the order will be executed. For example, if an investor enters a sell
stop limit order where the stop price and the limit price are 34, then
the investor's order may be executed only at 34 or better and may not
be executed at all if the market moves below 34 before the order can be
executed. However, if the investor is able to enter a sell order with a
stop price of 34 and a limit price of 32, then the investor's order may
be executed at 32 or better. Accordingly, by permitting investors to
place orders where the limit price differs from the stop price, the
NASD's proposal will increase the opportunities for execution of
investors' orders and will allow investors to tailor their orders to
reflect their objectives and strategies.
The Commission also believes that it is reasonable for the NASD to
amend NASD Rule 6440(i) to clarify that members are not obligated to
accept stop orders or stop limit orders. Currently, NASD Rule
6440(i)(2) states that members may accept stop limit orders in eligible
securities. The NASD proposes to add language to NASD Rule 6440(i)(2)
indicating that members are not obligated to accept stop limit
orders.\17\ Because this is a clarification of the NASD's existing
policy, it does not raise new regulatory issues.
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\17\ Similarly, NASD Rule 6440(i)(1), as amended, will state
that a member may, but is not obligated to, accept a stop order in
an eligible security.
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The Commission finds good cause for approving Amendment No. 1 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice thereof in the Federal Register. Amendment No. 1
corrects a typographical error in NASD Rule 6440(I)(2). Specifically,
NASD Rule 6440(i)(2) stated that when a transaction occurs at the stop
price, a stop limit order to buy or sell becomes a limit order at the
stop price. Amendment No. 1 revises NASD Rule 6440(i)(2) to state that
when a transaction occurs at the stop price, a stop limit order to buy
or sell becomes a limit order at the limit price. Because Amendment No.
1 corrects the text of the NASD's rule, the Commission finds that it is
consistent with Sections 6(b) and 19(b)(2) of the Act to approve
Amendment No. 1 on an accelerated basis.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 1, including whether Amendment No. 1
is consistent with the Act. Persons making written submissions should
file six copies thereof with the Secretary, Securities and Exchange
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of
the submission, all subsequent amendments, all written statements with
respect to the proposed rule change that are filed with the Commission,
and all written communications relating to the proposed rule change
between the Commission and any person, other than those that may be
withheld from the public in accordance with the provisions of 5 U.S.C.
552, will be available for inspection and copying in the Commission's
Public Reference Room. Copies of such filing will also be available for
inspection and copying at the principal office of the NASD. All
submissions should refer to File No. SR-NASD-97-20 and should be
submitted by May 11, 1998.
V. Conclusion
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\18\ that the proposed rule change (SR-NASD-97-20) is approved, and
that Amendment No. 1 is approved on an accelerated basis.
\18\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\19\
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\19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-10339 Filed 4-17-98; 8:45 am]
BILLING CODE 8010-01-M
