[Federal Register Volume 59, Number 102 (Friday, May 27, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-13039]
[[Page Unknown]]
[Federal Register: May 27, 1994]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34092; File No. SR-NASD-92-12, Amendment No. 7]
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
May 20, 1994.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on May 16, 1994, the National
Association of Securities Dealers, Inc. (``NASD'' or ``Association'')
filed with the Securities and Exchange Commission (``Commission'' or
``SEC'') the proposed rule change as described in Items I, II, and III
below, which Items have been prepared by the NASD. The Commission is
publishing this notice to solicit comments on the proposed rule change
from interested persons.
---------------------------------------------------------------------------
\1\15 U.S.C. 78s(b)(1) (1988).
---------------------------------------------------------------------------
I. Self-Regulatory organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD is proposing two amendments to its proposed short sale
rule or ``bid test'' applicable to stocks traded on the Nasdaq National
MarketSM. First, the NASD proposes to amend the rule to provide
that a member may immediately become a qualified market maker in either
or both of the stocks involved in a merger or acquisition (``M&A
stock(s)''), even if the member was not previously a market maker in
either of the stocks. However, if a market maker withdraws on an
unexcused basis from any stock in which it was registered pursuant to
this subsection within 20 days of so registering, it shall not be
designated as a qualified market maker pursuant to this subsection for
any subsequent merger or acquisition announced within three months
subsequent to such unexcused withdrawal. Second, the NASD proposes to
amend Interpretation A under the rule to clarify that short sales
effected by a qualified market maker in one M&A stock will be deemed to
be bona fide market making activity if they hedge purchases in the
other M&A stock made by the market maker during the course of bona fide
market making activity. Therefore, the amendment clarifies that such
short sales will be exempted under the rule. The NASD also proposes to
make other minor amendments to the short sale 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
In response to concerns raised by several NASD members actively
engaged in risk arbitrage, the NASD is proposing two amendments to its
proposed short sale rule that are designed to enhance the liquidity of
stocks involved in a merger or acquisition.\2\ In essence, the risk
arbitrageurs contend that they should be afforded an exemption from the
short sale rule because they provide important market liquidity to the
marketplace during the period before a merger or acquisition is
consummated. Specifically, the risk arbitrageurs maintain that they
provide liquidity to security holders in a target company who are
unwilling to assume the risk of completion of the merger or
acquisition. The risk arbitrageurs also contend that they are more
likely to better analyze and understand a merger or acquisition
transaction than the market makers who were making markets in the
stocks prior to the announcement of the transaction. Thus, the risk
artibrageurs maintain that they are better able to price M&A stocks.
---------------------------------------------------------------------------
\2\Some of these members also submitted comment letters to the
Commission arguing that the NASD's short sale rule should exempt the
activities of risk arbitrageurs. See letters to Jonathan G. Katz,
Secretary, SEC, from, Michael B. Radest, Vice President, The First
Boston Corporation (Oct. 1, 1992); from Mark Lehman, General
Counsel, Bear Stearns & Co. (Oct. 2, 1992); from Anson M. Beard,
Jr., Morgan Stanley (Oct. 5, 1992); from Peter M. Schoenfeld, Vice
Chairman, Wertheim Schroder & Co. (Oct. 5, 1992); and from Bruce C.
Hackett and Rodney B. Berens, Managing Directors, Salomon Brothers
(Oct. 6, 1992).
---------------------------------------------------------------------------
The NASD has worked closely with the risk arbritrageurs to address
their concerns and formulate the current amendments to the rule. As a
result, the NASD believes the amendments strike a reasonable balance
between the needs of risk arbitrageurs to facilitate the liquidity
demands of investors in M&A stocks and the NASD's need to implement a
meaningful short sale rule for the The Nasdaq Stock MarketSM
(``Nasdaq'') that does not contain broad and sweeping exemptions that
eviscerate the rule's effectiveness. In addition, as described below,
even though the amendments were crafted with the concerns of risk
arbitrageurs in mind, they apply to all NASD members.
First, the NASD proposes to make it easier for market makers to
become qualified market makers in stocks involved in a merger or
acquisition. Specifically, under the amendment, once a merger or
acquisition is publicly announced, any market maker can immediately
become a qualified market maker in either M&A stock pursuant to Section
(1)(3)(iii) of the rule, regardless of whether the member previously
made a market in either or both of the stocks. Before this amendment,
if a market maker did not previously make a market in either of the M&A
stocks, it would have had to make a market in each of the stocks for 20
business days before it was eligible to be a qualified market maker in
the stocks. In addition, before this amendment, a market maker could
immediately become a qualified market maker in an M&A stock only if it
was already a qualified market maker in the other M&A stock. Even
though this amendment is designed to facilitate the market making
activities of risk arbitrageurs, there is no requirement that market
makers engage in risk arbitrage if they take advantage of the immediate
registration provisions contained in section (1)(3)(iii) of the rule.
The NASD believes that allowing members to immediately become
qualified market makers in M&A stocks will enable Nasdaq to better
satisfy investors' increased liquidity demands resulting from the
announcement of a merger or acquisition. In addition, the NASD believes
that allowing members to more readily become qualified makers in M&A
stocks will help to promote pricing efficiency in these stocks at a
time when they are more volatile. Moreover, the NASD believes
permitting market makers to immediately become qualified market makers
in M&A stocks is consistent with the treatment of market makers in the
context of initial public offerings (``IPOs'').\3\
---------------------------------------------------------------------------
\3\For IPOs, a market maker may immediately become a qualified
market maker, however, if the market maker withdraws on an unexcused
basis from the security within the first 20 days of the offering, it
shall not be designated as a qualified market maker on any
subsequent IPO for the next ten business days. In contrast to the
ten day restriction for unexcused withdrawals from an IPO, the NASD
believes a three month restriction is warranted for unexcused
withdrawals from an M&A stock because market makers in M&A stocks
will be afforded an immediate exemption from the short sale rule
even though they had an opportunity to ``earn'' their status as a
qualified market maker. In addition, a market maker that immediately
becomes a qualified market maker in an M&A stock is allowed to
compete on equal footing (i.e., avail themselves of an exemption
from the rule) with other market makers who have made a prior and
continuous commitment of capital to the market for the particular
stock. Thus, notions of fairness dictate that a three month
restriction is more appropriate for premature, unexcused withdrawals
in an M&A stock.
---------------------------------------------------------------------------
In order to deter market makers from entering and withdrawing as
qualified market makers in M&A stocks to suit their own pecuniary
interests, however, the proposal provides that if a market maker
withdraws on an unexcused basis from any M&A stock in which it
immediately registered as a qualified market maker within 20 days of so
registering, that it shall not be immediately designated as a qualified
market maker for any subsequent merger or acquisition announced within
three months subsequent to such unexcused withdrawal.
Second, the NASD proposes to amend Interpretation A under the rule
to provide more guidance to qualified market makers when they hedge
purchases in one M&A stock with sales in the other and vice versa.
Specifically, under the proposal, if a market maker purchases or
reasonably anticipates purchasing an M&A stock during the course of
bona fide market making, then short sales in the other M&A stock by the
market maker to hedge these purchases will be deemed to be bona fide
market making activity; and, therefore, exempt from the bid test.
Conversely, if a qualified market maker sells an M&A stock short during
the normal course of bona fide market making, the amendment provides
that these short sales will not lose their exemption if the market
maker later purchases the other M&A stock in a capacity other than
normal bona fide market making. In addition, the amended Interpretation
clarifies that the amount of stock sold short by a qualified market
maker to hedge purchases of the other M&A stock must be reasonably
consistent with the exchange ratio specified by the terms of the merger
or acquisition. Thus, if the exchange ratio is three shares of the
target for one share of the acquiring company, then the purchase of 300
shares of the target's stock would generally be hedged by no more than
100 shares of the acquiring company.
The NASD believes that the expanded Interpretation will provide
qualified market makers with more certainty when they hedge
transactions in one M&A stock with transactions in the other M&A stock.
Moreover, the NASD believes that requiring market makers to adhere to
the exchange ratios will help to ensure that market makers do not
``over short'' one M&A stock when hedging purchases in the other M&A
stock.
In addition, the NASD is proposing several minor changes to its
short sale rule. First, the NASD proposes to amend Section (c)(7) of
the short sale rule to clarify that the exemption from the rule
afforded transactions in special international arbitrage accounts is
available to non-NASD members as well as NASD members. Second, the NASD
proposes to amend Section (k) of its short sale rule and Sections (h)
and (i) of its proposed Primary Nasdaq Market Maker rule to reflect
recent amendments to the NASD's By-Laws concerning the ability of the
NASD's Board of Governors to adopt and amend NASD Rules of Fair
Practice without a membership vote.\4\ Lastly the NASD proposes to
clarify that the review period for review of market maker performance
in each of the Primary Nasdaq Market Maker qualification standards is
one month.
---------------------------------------------------------------------------
\4\See Securities Exchange Act Release No. 33737 (Mar. 8, 1994),
59 FR 12017 (Mar. 15, 1994).
---------------------------------------------------------------------------
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
allowing market makers to immediately register as qualified market
makers in M&A stocks will promote market liquidity and enhance pricing
efficiency at a time when they are most needed. In addition, the NASD
believes that the three month restriction for premature, unexcused
withdrawals in M&A stocks will help to ensure that market makers in M&A
stocks do not enter the market merely to use the exemption to the rule
to engage in aggressive short selling designed to drive down the price
of a security. Finally, the NASD believes the additions to
Interpretation A under the rule will provide market makers with more
certainty regarding when they are entitled to an exemption from the
rule, thereby promoting market efficiency and enhancing the orderliness
of the market.
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 purposes 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 SR-NASD-92-12 and
should be submitted by June 17, 1994.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\5\
---------------------------------------------------------------------------
\5\17 CFR 200.30-3(a)(12) (1993).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-13039 Filed 5-26-94; 8:45 am]
BILLING CODE 8010-01-M
