[Federal Register Volume 62, Number 141 (Wednesday, July 23, 1997)]
[Notices]
[Pages 39565-39568]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-19445]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38851; File No. SR-NASD-97-49]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Notice of Filing and Order Granting Accelerated Approval
to Proposed Rule Change Relating to an Extension of the NASD's Rule
Permitting Market Makers To Display Their Actual Quotation Size
July 18, 1997.
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 July 11,
1997, 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 and is approving the
proposal on an accelerated basis.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD proposes to extend the effectiveness of NASD Rule
4613(a)(1)(C) until December 31, 1997. NASD Rule 4613(a)(1)(C) provides
that market makers in the first fifty Nasdaq stocks subject to the
Commission's Limit Order Display Rule are allowed to quote their actual
quote size (``Actual Size Rule'').1 The text of the proposed
rule change is as follows. (Additions are italicized; deletions are
bracketed.)
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\1\ The NASD has concurrently requested that the pilot for the
Actual Size Rule be expanded to apply to 100 additional Nasdaq
securities and extended until March 27, 1998. See Letter from Robert
E. Aber, Vice President and General Counsel, The Nasdaq Stock
Market, Inc., to Katherine England, Assistant Director, Office of
Market Supervision, Division of Market Regulation, Commission, dated
July 10, 1997.
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* * * * *
NASD Rule 4613 Character of Quotations
(a) Two-Sided Quotations.
(1) No change.
(A)-(B) No change.
(C) As part of a pilot program implemented by The Nasdaq Stock
Market, during the period January 20, 1997 through at least [July 18]
December 31, 1997,2 a registered market maker in a security
listed on The Nasdaq Stock Market that became subject to mandatory
compliance with SEC Rule 11Ac1-4 on January 20, 1997 must display a
quotation size for at least one normal unit of trading (or a larger
multiple thereof) when it is not displaying a limit order in compliance
with SEC Rule 11Ac1-4, provided, however, that a registered market
maker may augment its displayed quotation size to display limit orders
priced at the market maker's quotation.
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\2\ The NASD filed an amendment (``Amendment No. 1'') to extend
the pilot to December 31, 1997, rather than September 26, 1997. See
Letter from Robert E. Aber, Vice President and General Counsel, The
Nasdaq Stock Market, Inc., to Katherine England, Assistant Director,
Office of Market Supervision, Division of Market Regulation,
Commission, dated July 17, 1997.
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* * * * *
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 August 29, 1996, the Commission promulgated a new rule and
adopted amendments to other SEC rules that are designed to enhance the
quality of published quotations for securities and promote competition
and pricing efficiency in U.S. securities markets (these rules are
collectively referred to hereinafter as the ``Order Handling
[[Page 39566]]
Rules'').3 With respect to securities listed on Nasdaq, the
Order Handling Rules are being implemented according to a phased-in
implementation schedule. In particular, fifty Nasdaq securities became
subject to the rules on January 20, 1997 (``first fifty) 4
and an additional 650 Nasdaq securities have been phased in under the
Order Handling Rules since that time.5 The remaining Nasdaq
securities will become subject to the rules according to time tables
established by the Commission.6
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\3\ See Securities Exchange Act Release 37619A (September 6,
1996), 61 FR 48290 (September 12, 1996) (``Order Handling Rules
Adopting Release'').
\4\ See Securities Exchange Act Release No. 38139 (January 8,
1997), 62 FR 1385 (January 10, 1997).
\5\ See Securities Exchange Act Release No. 38490 (April 9,
1997), 62 FR 18514 (April 16, 1997); Securities Exchange Act Release
No. 38246 (February 5, 1997), 62 FR 6468, (February 12, 1997).
\6\ See Securities Exchange Act Release No. 38490 (April 9,
1997), 62 FR 18514 (April 16, 1997).
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In particular, the SEC adopted Rule 11Ac1-4, the ``Display Rule,''
which requires the display of customer limit orders: (1) That are
priced better than a market maker's quote; 7 or (2) that add
to the size associated with a market maker's quote when the market
maker is at the best price in the market.8 By virtue of the
Display Rule, investors will now have the ability to directly advertise
their trading interest to the marketplace, thereby allowing them to
compete with market maker quotations and affect the size of bid-ask
spreads.9 The other rule changes adopted by the SEC involve
amendments to the SEC's Firm Quote Rule, Rule 11Ac1-1. The most
significant of these amendments requires market makers to display in
their quote any better priced orders that the market maker places into
an electronic communications network (``ECN'') such as SelectNet or
Instinet (``ECN Rule''). Alternatively, instead of updating its quote
to reflect better priced orders entered into an ECN, a market maker may
comply with the display requirements of the ECN Rule through the ECN
itself, provided the ECN: (1) Ensures that the best priced orders
entered by market makers into the ECN are communicated to Nasdaq for
public dissemination; and (2) provides brokers and dealers access to
orders entered by market makers into the ECN, so that brokers and
dealers who do not subscribe to the ECN can trade with those orders.
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\7\ For example, if a market maker's quote in stock ABCD is 10-
10\1/4\ (1000 x 1000) and the market maker receives a customer limit
order to buy 200 shares at 10\1/8\, the market maker must update its
quote to 10\1/8\-10\1/4\ (200 x 1000).
\8\ For example, if a market maker receives a limit order to buy
200 shares of ABCD at 10 when its quote in ABCD is 10-10\1/4\ (1000
x 1000) and the NBBO for ABCD is 10-10\1/8\, the market maker must
update its quote to 10-10\1/4\ (1200 x 1000).
\9\ There are eight exceptions to the immediate display
requirement of the Limit Order Display Rule: (1) Customer limit
orders executed upon receipt; (2) limit orders placed by customers
who request that they not be displayed; (3) limit orders for odd-
lots; (4) limit orders of block size (10,000 shares or $200,000);
(5) limit orders routed to a Nasdaq or exchange system for display;
(6) limit orders routed to a qualified electronic communications
network for display; (7) limit orders routed to another member for
display; and (8) limit orders that are all-or-none orders. See Rule
11Ac1-4(c).
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In order to facilitate implementation of the SEC's Order Handling
Rules and reflect the order-driven nature of the Nasdaq market that
will be brought about by implementation of these rules, on January 10,
1997, the Commission approved a variety of amendments to NASD rules and
Nasdaq's Small Order Execution System (``SOES'') and SelectNet
Service.\10\ In particular, one of the NASD Rule changes approved by
the Commission as a temporary pilot provides that Nasdaq market makers
in the ``first fifty'' stocks subject to the Commission's Limit Order
Display Rule are required to display a minimum quotation size of one
normal unit of trading when quoting solely for their own proprietary
account.\11\ For Nasdaq stocks outside of the ``first fifty,'' the
minimum quotation size requirements remain the same.\12\
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\10\ See Securities Exchange Act Release No. 38156 (January 16,
1997), 62 FR 2415 (order partially approving SR-NASD-96-43)
(``Actual Size Quote Rule Approval Order'').
\11\ Thus, the Actual Size Rule does not affect a market maker's
obligation to display the full size of a customer limit order. If a
market maker is required to display a customer limit order for 200
shares or more, it must display a quote size of at least 200 shares
absent an exemption from the Display Rule.
\12\ In particular, NASD Rule 4613(a)(2) requires each market
maker in a Nasdaq issue other than those in the ``first fifty'' to
enter and maintain two-sided quotations with a minimum size equal to
or greater than the applicable SOES tier size for the security
(e.g., 1,000, 500, or 200 shares for Nasdaq National Market issues
and 500 or 100 shares for Nasdaq SmallCap Market issues)
(``Mandatory Quote Size Requirements'').
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The NASD submitted the proposal for the Actual Size Rule because it
believed, and continues to believe, that the new order-driven nature of
Nasdaq brought about by the Display Rule obviates the regulatory
justification for minimum quote size requirements because investors
will have the capability to display their own orders on Nasdaq. The
NASD believed it was appropriate to impose the Mandatory Quote Size
Requirements to ensure an acceptable level of market liquidity when
Nasdaq market makers were the only market participants who could quote.
Now that the Display Rule permits investors to set the quote, the NASD
believes it is appropriate to treat Nasdaq market makers in a manner
equivalent to exchange specialists and not subject them to minimum
quote size requirements when they are not representing customer orders.
In sum, with the successful implementation of the SEC's Order Handling
Rules, the NASD believes that mandatory quote size requirements impose
unnecessary regulatory burdens on market makers which are not
consistent with the Act.
At the same time, the NASD does not believe that implementation of
the Actual Size Rule in an environment where limit orders are displayed
has or will compromise the quality of the Nasdaq market. First, the
display of customer limit orders enhances the depth, liquidity, and
stability of the market and contributes to narrower quoted spreads,
thereby mitigating the effects of the loss of displayed trading
interest, if any, by market makers. Second, removing artificial quote
size requirements may lead to narrower market maker spreads, thereby
reducing investors' transaction costs. Third, permitting market makers
to quote in size commensurate with their own freely-determined trading
interest will enhance the pricing efficiency of the Nasdaq market and
the independence and competitiveness of dealer quotations. Fourth,
removing quotation size requirements will facilitate greater quote size
changes, thereby increasing the information content of market maker
quotes by facilitating different quote sizes from dealers who have a
substantial interest in the stock at a particular time and those who do
not.
Indeed, in its order approving the Actual Size Rule, the Commission
noted that it ``preliminarily believes that the proposal will not
adversely affect market quality and liquidity'' \13\ and that it
``believes there are substantial reasons * * * to expect that reducing
market makers' proprietary quotation size requirements in light of the
shift to a more order-driven market would be beneficial to investors.''
\14\ In addition, the Commission stated that, ``based on its experience
with the markets and discussions with market participants, [it]
believes that decreasing the required quote size will not result in a
reduction in liquidity that will hurt investors.'' \15\
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\13\ See Actual Size Rule Approval Order, supra note 5 at 2425.
\14\ Id. at 2423.
\15\ Id. at 2424.
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Nevertheless, in light of concerns raised by commenters opposed to
the Actual Size Rule regarding the potential adverse impacts of the
Rule on market liquidity and volatility, the Commission determined to
approve the Rule on a
[[Page 39567]]
three-month pilot basis to afford the Commission, the NASD and Nasdaq
an opportunity to gain practical experience with the rule and evaluate
the effects of the Rule. The factors identified by the Commission to be
considered in this evaluation include, among others, the impact of
reduced quotation sizes on liquidity, volatility and quotation spreads.
\16\
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\16\ The Commission stated that ``the NASD study should include
an analysis of: (1) The number of market makers in each of the 50
securities, and any change in the number over time; (2) the average
aggregate dealer and inside spread by stock over time; (3) the
average spread for each market maker by stock; (4) the average depth
by market maker (including limit orders), and any change in the
depth over time; (5) the fraction of volume executed by a market
maker who is at the inside quote by stock; and (6) a measure of
volume required to move the price of each security one increment (to
determine the overall liquidity and volatility in the market for
each stock). The Commission expects that these factors should be
contrasted over the time period immediately preceding the pilot and
after the beginning of the pilot.'' Id. at 2425. In addition, the
Commission stated that the NASD should conduct a similar study to
compare the ``first fifty'' stocks (to which the Rule applied) with
the ``second fifty'' stocks (stocks subject to the SEC's Order
Handling Rules but not the Actual Size Rule). Id.
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On April 11, 1997, the Commission approved an NASD rule filing that
extended the duration of the pilot program until July 18, 1997.\17\ In
this filing, the NASD and Nasdaq provided statistical information
prepared by the NASD's Economic Research Department concludes that: (1)
The SEC's Order Handling Rules have dramatically improved the quality
of the Nasdaq market, particularly with respect to the size of quoted
spreads; (2) among those securities subject to the SEC's Order Handling
Rules, there is no appreciable difference in market quality between
those stocks subject to the Actual Size Rule and those stocks subject
to Mandatory Quote Size Requirements; and (3) implementation of the
Actual Size Rule has not resulted in any significant diminution of the
ability of investors to receive automated executions through SOES,
SelectNet, or proprietary systems operated by broker-dealers.\18\
Subsequently, on June 3, 1997, the NASD submitted a formal study to the
Commission on the Actual Size Rule that, among other things, reiterated
these findings and provided more detailed information on the NASD's
analysis of the Rule.\19\
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\17\ See Securities Exchange Act Release No. 38512 (April 15,
1997), 62 FR 19373 (April 21, 1997).
\18\ See id. at 19375-77.
\19\ See Securities Exchange Act Release No. 38720 (June 5,
1997), 62 FR 31856 (June 11, 1997). A copy of the executive summary
of this report is available at Nasdaq's World Wide Web site at
``http://www.nasdaq.com''. Members of the public may also download a
file containing the entire report at this site.
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The NASD is proposing a further extension of the 50 stock pilot for
the Actual Size Rule until December 31, 1997. The NASD and Nasdaq
believe that experience with the Actual Size Rule has clearly
demonstrated that the Rule has not harmed investors or the quality of
the Nasdaq market and, thus, that the Rule should be permanently
approved and expanded to all Nasdaq securities. Nevertheless, the NASD
and Nasdaq believe it is prudent, in response to suggestions made by
Commission staff, to extend the 50 stock pilot program for the Rule
until December 31, 1997. Specifically, with the additional experience
with the Actual Size Rule that extension of the pilot period will
provide, the NASD and Nasdaq believe the Commission's analysis of the
NASD's proposal for expansion of the Rule will be more comprehensive.
For the reasons noted above, the NASD believes the proposed rule
change is consistent with Sections 11A(a)(1)(C), 15A(b)(6), 15A(b)(9),
and 15A(b)(11) of the Act. Section 11A(a)(1)(C) provides that it is in
the public interest to, among other things, assure the economically
efficient execution of securities transactions and the availability to
brokers, dealers, and investors of information with respect to
quotations for and transactions in securities. 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, 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. Section 15A(b)(9)
requires that rules of an Association not impose any burden on
competition not necessary or appropriate to furtherance of the purposes
of the Act. Section 15A(b)(11) requires the NASD to, among other
things, formulate rules designed to produce fair and informative
quotations.
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. 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, 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 number SR-NASD-97-49 and
should be submitted by August 13, 1997.
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
The Commission finds that the NASD's proposal is consistent with
the Act and the rules and regulations thereunder applicable to a
national securities association and has determined to approve the
extension of the pilot through at least December 31, 1997.\20\ The
Commission approved the Actual Size Rule on a pilot basis so that the
effects of the rule could be assessed. When approving the Actual Size
Rule on a pilot basis, the Commission stated that it believed that a
reduction in the quotation size requirement could reduce the risks that
market makers must take, produce accurate and informative quotations,
and encourage market makers to maintain competitive prices even in the
changing market conditions resulting from the Order Execution Rules.
The NASD has produced an extensive economic analysis of the pilot, and
several commentators have provided their own economic analysis in
rebuttal. An extension of the pilot
[[Page 39568]]
will provide the Commission with an additional period of time to
evaluate the economic studies and review the comments on the NASD's
study. In addition, the Commission believes that the proposed rule
change will benefit the markets by providing more experience with the
rule before a decision is made regarding permanent approval. The
Commission will consider the NASD's further proposals regarding the
Actual Size Rule in the coming months, as well as the future of the 50
stock pilot itself. Accordingly, the Commission believes that the pilot
is consistent with Sections 15A(b)(6) and 15A(b)(9) of the Act and
should be extended beyond the July 18, 1997, expiration date. The
Commission finds good cause for approving the proposed rule change
prior to the thirtieth day after the date of publication of notice of
filing thereof in the Federal Register in order to continue the pilot
on an uninterrupted basis while it evaluates the NASD's proposal for
expansion of the pilot.
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\20\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
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It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (SR-NASD-97-49) be, and hereby is,
approved.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\21\
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\21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-19445 Filed 7-22-97; 8:45 am]
BILLING CODE 8010-01-U
