00-14251. Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change Relating to Regulation ATS

May 30, 2000.

I. Introduction

On September 21, 1999, the National Association of Securities Dealers, Inc. (“NASD” or “Association”), through its wholly owned subsidiary, the Nasdaq Stock Market, Inc. (“Nasdaq”), filed with 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 19(b)-4 thereunder,^[2] a proposed rule change to amend NASD Rules 4623 and 4613(e) to incorporate the requirements of Regulation ATS into the NASD's rules.

The proposed rule change was published for comment in the Federal Register on March 2, 2000.^[3] The Commission did not receive any comments on the proposed rule change. This order approves the proposed rule change.

II. Description of Proposed Rule Change

The proposal would amend the NASD Rules to incorporate the requirements of Regulation ATS. Specifically, the proposal would amend NASD Rule 4623, which currently governs electronic communications networks (“ECNs”) that display orders in Nasdaq (“ECN Rule”), and NASD Rule 4613(e), which governs locked and crossed markets (“Locked and Crossed Market Rule”). The amendments would: (1) Incorporate into the ECN Rule the new obligations that are imposed on ECNs under Regulation ATS, (2) extend the current ECN Rule so that it captures other types of alternative trading systems (“ATSs”), and (3) extend the current Locked and Crossed Market Rule to capture other types of ATSs.

ECN Rule

Regulation ATS requires ATSs (including ECNs) that account for a significant percentage of the volume in a security listed on Nasdaq to display in the public quotation stream the orders of all subscribers of the ATS, which includes orders from institutions and broker-dealers that are not market makers.^[4] Currently, the ECN Rule only requires ECNs to display orders entered by market makers. Accordingly, the proposal would amend the ECN Rule to require ECNs to display in Nasdaq any subscriber orders required under Regulation ATS.

Regulation ATS also governs alternative trading systems that are organized other than as ECNs. Consequently, these other types of ATSs may be required to display orders in Nasdaq. The proposal would expand the current ECN Rule to encompass these other types of ATSs. These systems will have to fulfill a series of obligations identical to those imposed on ECNs that display orders in Nasdaq.

Locked and Crossed Markets

The Locked and Crossed Markets Rule, NASD Rule 4613(e), is designed to limit locked and crossed markets by imposing on market makers an obligation to take reasonable measures before locking or crossing a market. Currently included within the definition of market maker for purposes of this rule is: (1) Any NASD member that enters orders into an ECN, or (2) any NASD member that operates as an ECN (when the priced order being displayed by the ECN has been entered by an entity that is not an NASD member). Reasonable measures include attempting to execute against the contra side of the market prior to entering an order into Nasdaq's systems that would lock or cross the market in a security. The proposal would amend the Locked and Crossed Markets Rule to capture NASD members that place orders in an ATS or operate as an ATS (when the priced order being displayed by the ATS has been entered by an entity that is not an NASD member).

III. Discussion

The Commission finds that the proposed rule change is consistent with the requirements of the Act ^[5] and the rules and regulations thereunder applicable to a national securities association. In particular, the Commission finds the proposal is consistent with the requirements of Sections 11A ^[6] and 15A(b)(6) ^[7] of the Act. Section 11A(a)(1)(C) ^[8] provides that it is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly 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 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. Section 15A(b)(6) ^[9] 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.

Recently, the Commission adopted a set of rules under the Act ^[10] that govern alternative trading systems, including ECNs.^[11] Regulation ATS governs alternative trading systems that choose to register as broker-dealers (ATSs). The most familiar type of ATS is an ECN; however, the definition of ATS encompasses other types of trading systems that register as broker dealers. For example, an electronic trading system that only accepts orders from institutions and non-market-maker broker-dealers would be an ATS. Such a system would not be an ECN, however, because, by definition, an ECN is a system that accepts orders from market makers.^[12] The NASD's current rules capture only those ATSs that meet the definition of ECN. Therefore, the Commission believes that it is necessary to amend these rules to capture those ATSs that do not meet the definition of ECN.

Accordingly, the Commission finds that the proposal is consistent with sections 11A(a)(1)(C) and section 15A(b)(6) ^[13] because it will permit Nasdaq to incorporate ATS orders into the Nasdaq quote montage and provide NASD members with the ability to access these orders. In addition, to limit market disruptions caused by locked or crossed markets, the proposal will require members that submit orders to ATSs and ATSs, in certain circumstances, to take reasonable measures before locking or crossing a market. Finally, the amendments will incorporate into the NASD's rules the new obligations imposed on ECNs by Regulation ATS.

IV. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,^[14] that the proposed rule change (SR-NASD-99-49) is approved.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[15]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  Securities Exchange Act Release No. 42461 (February 25, 2000), 64 FR 11359.

4.  Specifically, if during at least 4 of the preceding 6 calendar months an ATS accounts for five percent or more of the aggregate average share volume in a Nasdaq National Market (“NNM”) or SmallCap security, the ATS must display the best prices of orders entered by all subscribers (e.g., market makers, nonmarket makers, and institutions). For example, if as calculated on July 1, 1999 an ATS account for 7% of the trading volume in an NNM security during January, February, April, and May 1999, the ATS would be required to reflect in Nasdaq its best priced order even if the order is from an institution or other entity that is not a Nasdaq market maker. The Nasdaq securities subject to this requirement are being phased-in according to a schedule set by the Commission. See Securities Exchange Act Release No. 41297 (April 16, 1999), 64 FR 19450 (April 21, 1999).

5.  The Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

6.  15 U.S.C. 78k-1.

7.  15 U.S.C. 78 o-3(b)(6).

8.  15 U.S.C. 78k-1(a)(1)(C).

9.  15 U.S.C. 78o-3(b)(6).

10.  17 CFR 242.300 et seq. (“Regulation ATS”).

11.  See Securities Exchange Act Release No. 40760 (December 8, 1998), 63 FR 70844 (December 22, 1998).

12.  SEC Rule 11Ac1-1(a)(8), 17 CFR 240.11Ac1-1(a)(8).

13.  15 U.S.C. 78k-1 and 78o-3(b)(6).

14.  15 U.S.C. 78s(b)(2).

15.  17 CFR 200.30-3(a)(12).