[Federal Register Volume 60, Number 164 (Thursday, August 24, 1995)]
[Notices]
[Pages 44095-44098]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-21044]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36115; File No. SR-NASD-95-33]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Partial Accelerated Approval of Proposed Rule Change by
National Association of Securities Dealers, Inc., Relating to Actions
Taken During Extraordinary Market Conditions
August 17, 1995.
Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'')\1\ and Rule 19b-4 thereunder, \2\ notice is hereby given that
on July 21, 1995, the National Association of Securities Dealers, Inc.
(``NASD'' or ``Association'') filed with the Securities and Exchange
Commission (``SEC'' or ``Commission'') the proposed rule change as
described in Items I, II, and III below; Items I and II have been
prepared by the NASD. The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
As discussed below, the Commission has also granted accelerated
approval to a portion of the proposal.
\1\ 15 U.S.C. 78s(b)(1)(1988).
\2\ 17 CFR 240.19b-4 (1994).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD seeks the authority to modify temporarily the operation of
its SelectNet service and its Small Order Execution System (``SOES'')
during periods of unusually high Nasdaq broadcast volume. Specifically,
the NASD proposes that, during periods with a high number of quotation
updates, SelectNet broadcast orders and/or trade reports, it be
permitted to take the following action without having to file a
proposed rule change with the Commission:
(a) Suspend the entry of SelectNet broadcast orders from 9:30 to
10:30 a.m.;
(b) Execute immediately matched or crossed customer limit orders in
the SOES limit order file (i.e., rather than delay execution for five
minutes); and
(c) Increase from five minutes to ten minutes the standard grace
period in which market makers must refresh their SOES minimum exposure
limit.
The NASD requests the Commission to find good cause, pursuant to
Section 19(b)(2) of the Act, for approving the proposed rule change
prior to the thirtieth day after publication in the Federal Register.
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
1. Purpose
Pursuant to article VII, section 3 of the NASD By-Laws, a special
committee of the NASD Board of Governors was convened on July 20, 1995
to authorize action regarding the operation of certain Nasdaq automated
systems. Article VII, section 3 permits a committee consisting of the
Chairman, an Executive Committee member and the President of the NASD,
in lieu of full Board consideration, to take immediate action when
extraordinary market conditions exist.\3\ Extraordinary market
conditions are such conditions where the market is experiencing highly
volatile trading conditions that require prompt intervention to permit
continued efficient operation of the market. Until the new network \4\
is completely implemented later this year, and as long as Nasdaq
continues to experience trading activity exceeding the existing
network's stated capacity of 450 million shares per day, the NASD
believes Nasdaq must be considered to be experiencing extraordinary
market conditions that must be immediately addressed by appropriate
steps that will permit the continued efficient operation of the
market.\5\
\3\ In the event of an emergency or extraordinary market
conditions, Article VII, Section 3 permits the NASD to take any
action regarding the trading in or operation of the over-the-counter
securities market, the operation of any automated system owned or
operated by the NASD, and the participation in any such system of
any or all persons or the trading therein of any or all securities.
See NASD Securities Dealers Manual para.1182A.
\4\ That is, the migration from Nasdaq Workstation I to Nasdaq
Workstation II.
\5\ For example, on Wednesday, July 19, 1995, the NASD
experienced its highest trading volume ever, 597.5 million shares.
In addition, quotation updates were up to four times higher than the
previous peak update traffic.
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Therefore, until the new network is fully implemented, the special
committee of the NASD Board authorized the following actions to be
taken to permit its network to operate efficiently during such periods
as the Nasdaq market is experiencing, or reasonably anticipates, heavy
trading activity in excess of 450 million shares per day:
1. Between the hours of 9:30 to 10:30 a.m., SelectNet orders must
be directed to specific market makers;
2. The standard grace period for a market maker in a National
Market security to restore its minimum exposure limit in SOES will be
expanded from five minutes to ten minutes; and
3. Priced orders entered into the SOES limit order file on the
opposite side of the market from each other that match or cross in
price will be executed against each other immediately rather than after
five minutes.\6\
\6\ The NASD notes that the Committee also authorized and
approved the actions and regulatory changes described above for the
extraordinary market conditions experienced on July 19-21, 1995.
The NASD seeks to be able to implement these changes under the
described conditions without having to submit a proposed rule change
with the Commission each time it implements one of these changes. Under
the NASD's emergency authority, the NASD is required, among other
things, to file a proposed rule change under section 19(b)(3)(A)
promptly after exercising this authority.\7\ Under section
[[Page 44096]]
19(b)(3)(A), an NASD proposal becomes effective upon filing with the
Commission, but is subject to abrogation by the Commission within 60
days.\8\
\7\ Securities Exchange Act Release No. 26072 (Sept. 12, 1988),
53 FR 36143 (Sept. 16, 1988) (order approving proposed rule change
to provide the NASD Board of Governors and a proposed committee the
authority to take action during extraordinary market conditions).
The NASD is also required to use best efforts to consult with the
Commission in advance of exercising its emergency authority, provide
the Commission with a written report describing the action taken and
the reasons therefore, and prepare and maintain with its corporate
records a record of any actions taken under the proposed rule
change.
\8\ 15 U.S.C. 78s(b)(3)(C).
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The NASD believes these modifications to the operation of its
systems and rules associated with its systems are necessary and
appropriate for the protection of investors and to maintain the orderly
operation of the Nasdaq Stock Market as long as it continues to
experience the extremely high levels of trading activity (which
includes quotation updates, trade executions through automated
execution systems operated by Nasdaq, cancellations of orders, and
trade reporting) associated with 450 million share days, and the new
network is not yet fully implemented. As a prophylactic measure until
the new network is in place, therefore, the NASD will operate its
market with these changes (or a subset thereof, at the NASD's
discretion) in effect unless market conditions subside to an average
daily trading volume of less than 450 million and the associated
network traffic drops to acceptable levels.\9\
\9\ The NASD will provide its Board and the SEC with regular
updates on the status of these actions and the need for continuation
of these special measures.
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The NASD states that during periods when these procedures have been
implemented, the Nasdaq operations have continued to experience
accurate and timely quotations. The primary concern of the NASD during
these extraordinary market conditions has been to maintain the accuracy
and timeliness of its pricing mechanism. All executions of customer
orders, whether such orders are delivered to member firms by means of
the telephone, SOES, SelectNet, or member firm internal execution
systems, are ultimately driven by the Nasdaq quotation. Therefore, the
NASD believes it is essential to price discovery and market integrity
that Nasdaq maintain the validity of the quotations it displays.
The NASD believes the modification to SelectNet is the most prudent
possible change to Nasdaq services that provides the greatest benefit
to system capacity while having the smallest effect on investors.
SelectNet messages generally consume greater amounts of network
capacity than other messages sent through the network. By eliminating
the broadcast feature of SelectNet,\10\ the network obtains
approximately 20 percent more capacity than when broadcast messages
were permitted. Compared to any other option, the elimination of the
broadcast of a SelectNet message provides the most significant capacity
benefits to the network.
\10\ By ``broadcast,'' it is meant that a single order is
broadcast over the network to all available market makers. The
broadcasting of a message of such length to multiple sources
consumes significantly more capacity than a message directed to a
single point. Thus, limiting SelectNet to directed orders minimizes
network traffic while continuing to allow a firm to communicate an
order directly to an individual market maker.
The NASD believes the immediate execution of matched or crossed
limit orders in SOES provides two benefits. First, it permits customers
that place priced orders in the file an increased opportunity for rapid
execution of their orders, a measure that should be beneficial in heavy
trading days. Second, the step provides some minor benefit to the
network capacity constraints in that it eliminates a small number of
last sale reports that would have occurred had the orders been executed
separately.\11\
\11\ Letter to Mark Barracca, Branch Chief, SEC, for Richard G.
Ketchum, Chief Operating Officer and Executive Vice President (July
31, 1995).
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The NASD also notes that the change to the standard grace period is
also important to the overall well-being of the market during these
conditions. Because of the extraordinary levels of market activity that
are occurring, member firm trading desks are extremely busy handling
the multiple points of order flow; Because of the extent of such
activity at the trading desks, the NASD fears that the standard grace
period of five minutes to update the market maker's minimum exposure
limit in SOES is not sufficient to provide market makers a reasonable
opportunity to update their exposure limit. If the market maker fails
to update the exposure limit in a security within five minutes under
current SOES rules, the market maker may be deemed to have withdrawn as
a market maker in that security.\12\ In extraordinary market
conditions, the NASD believes that it would be unwise to lose the
liquidity provided by a market maker because such market maker was
unable to direct attention to its exposure limit within five minutes.
Accordingly, the NASD has determined to expand the standard grace
period to ten minutes.\13\
\12\ See SOES Rules of Procedure, (c) 2.(G). NASD Securities
Dealers Manual para. 2460.
\13\ The NASD has taken similar action in other extraordinary
market conditions. See e.g., Securities Exchange Act Release No.
27369 (Oct. 19, 1989), 54 FR 45832 (Oct. 31, 1989) and Securities
Exchange Act Release No. 29664 (Sept. 10, 1991), October 1989 Market
Break and the political upheaval in the former Soviet Union in
August 1991.
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2. Statutory Basis
The NASD believes that the proposed rule change is consistent with
the provisions of section 15A(b)(6) of the Act \14\ in that the
proposed changes are designed 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
fair and open market. The actions taken by the NASD and proposed herein
facilitate the continued operation of the systems during those periods
of extraordinary market conditions until the expanded network is ready
to be fully implemented.
\14\ 15 U.S.C. 78o-3.
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(B) Self-Regulatory Organization's Statement on Burden on Competition
The NASD does not believe that the proposed rule change will result
in any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act, as amended.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants, or Others
Written 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 self-regulatory organization 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.
The NASD has requested, however, that the Commission find good
cause pursuant to section 19(b)(2) for approving the proposed rule
change prior to the 30th day after publication in the Federal Register.
As discussed below, the Commission finds that the portion of the
proposed rule change that modifies the operation of SOES to execute
immediately matched or crossed customer limit
[[Page 44097]]
orders in the SOES limit order file is consistent with the requirements
of the Act. Further, the Commission finds good cause for approving,
prior to the 30th day after the date of publication of notice of filing
in the Federal Register, the proposal to execute immediately matched or
crossed limit orders in SOES. The Commission believes that accelerated
approval of this portion of the proposal will benefit investors by
creating a greater assurance that the Nasdaq market will continue to
operate efficiently during periods of market stress and high volume.
IV. Commission's Findings and Order Granting Partial Accelerated
Approval of Proposed Rule Change
The Commission finds that the proposal to permit the NASD to modify
the operation of SOES to allow matched or crossed customer limit orders
in the SOES limit order file to execute immediately against each other
(i.e., rather than be delayed for five minutes) is consistent with the
Act and the rules and regulations promulgated thereunder. Specifically,
the Commission finds that the proposed rule change is consistent with
the requirements of Section 15A(b)(6) which requires that the NASD
rules be designed, among other things, to facilitate securities
transactions and protect investors and the public interest. Removing
the five-minute delay in the execution of matched or crossed limit
orders in the SOES limit order file will facilitate the NASD's load
shedding efforts by increasing the speed of execution and removing
orders from the Nasdaq system more quickly. Moreover, the greater
likelihood that an investor will receive an execution of a limit order
placed in SOES may encourage greater use of the SOES limit order file.
This will further decrease the burden on market makers and increase the
message handling capabilities of Nasdaq during high volume periods.
Finally, the Commission notes that the proposal will further the
Congressional objective to increase the opportunity for investors'
orders to be executed without the participation of a dealer.\15\
\15\ Id. section 78k-1(a)(1)(C)(v).
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Nonetheless, the Commission is concerned about the effects of
service changes on the Nasdaq market. Accordingly, the Commission
directs the NASD to notify, prior to implementing this change to SOES
or as soon as practicable thereafter, its members via the Nasdaq
Workstation and the staff of the Division of Market Regulation by
telephone. In addition, on a weekly basis, the NASD should submit a
written report to the Division of Market Regulation providing
information on any service changes since the last report.\16\ The
information provided should include: (a) a brief description of the
change; (b) the event(s) triggering the change; and (c) the NASD's
assessment of the effect of the change on the Nasdaq system.
\16\ The NASD's notification via the telephone and its written
report to the Commission should be directed to the Branch Chief,
Office of Automation & International Markets, Division of Market
Regulation or his designee.
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As a more general matter, the Commission is concerned about
capacity limitations in the Nasdaq system. Since 1989, the Commission
has urged self-regulatory organizations, among other things, to develop
current and future capacity estimates, conduct capacity stress tests,
and contract with independent reviewers to assess annually whether
their systems can perform adequately under varying degrees of market
activity.\17\ While the Commission recognizes that the NASD expects
that its planned system changes will address these issues, we are
concerned about the ongoing stress in the Nasdaq system, as well as the
inability to resolve that stress without service reductions.
Accordingly, the Commission has requested the NASD to obtain an
independent review of its current capacity.
\17\ Securities Exchange Act Release No. 29185 (May 19, 1991),
56 FR 22490 (May 15, 1991) and Securities Exchange Act Release No.
27445 (Nov. 16, 1989), 54 FR 48703 (Nov. 24, 1989).
V. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. The Commission specifically
requests that commenters address the appropriateness of the NASD's
approaches to address system capacity during periods of market stress.
The Commission shares the NASD's concerns about timely and accurate
quotes and trade reports in high volume market conditions. While the
Commission understands that suspending SelectNet's broadcast feature
during high volume markets will free up broadcast capacity, the
Commission requests that the NASD elaborate on the effects of this
modification on quotes and trade reports. In this regard, it would be
helpful if the NASD and market participants described their experience
over the past month with the timeliness and accuracy of quotes and
trade reports during SelectNet broadcast suspensions.
In addition, the NASD has stated that suppression of the SelectNet
broadcast feature offers the greatest benefits in terms of system
capacity with the least effect on investors. The Commission invites
comment on the implications of this modification for investors and
firms in terms of market access, execution quality, transparency, and
price discovery. The Commission also invites comment on whether there
may be alternatives available for improving system capacity that would
have a smaller impact on market participants.
The Commission also seeks comments on the NASD's proposal to double
the length of the standard grace period in which market makers must
refresh their SOES minimum exposure limit. SOES--with mandatory market
maker participation and an automatic twenty-day suspension for failure
to refresh exposure limits within the grace period--was enhanced in
1988 to provide small investors with access to market during periods of
extraordinary activity. In the pending proposal, the NASD wishes to
reduce the availability of SOES under precisely those conditions. The
Commission invites comment on whether this proposal undermines the
purpose of SOES and any relevant experience from either of the last two
times that the NASD extended the grace period.
The Commission also notes that the practical effect of the NASD's
proposal is to limit the availability of automatic execution in order
to protect the liquidity of the overall market. That is, market makers
will be permitted to remain active in a security despite more lengthy
periods of inactivity on SOES. The Commission solicits comments on
whether there are alternatives available that would continue the
availability of automatic executions for small orders that would not
have a negative impact on the liquidity of the overall Nasdaq market.
For example, given the availability of auto-refresh in the Nasdaq
market, comments are invited on whether such a system is adequate to
address this concern, and whether private systems exist that can notify
market makers when they have been executed against the SOES and are
about to be taken off the screen because of the expiration of the grace
period.
Finally, given that the NASD will implement these changes based on
its continuing assessment of market conditions and the need to
implement any one or any combination of the changes, comment is invited
on the potential for confusion, both to investors and to other market
participants as to which changes are in place on any given day and the
implications of these changes for trading in the over-the-counter
market.
[[Page 44098]]
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 No. SR-NASD-95-33 and should be
submitted by September 8, 1995.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the portion of the proposed rule change (SR-NASD-95-33) providing
the NASD the authority to modify the operation of SOES by allowing
matched or crossed limit orders to execute automatically is approved
until January 5, 1996 or the completion of the roll-out of Workstation
II, whichever occurs first.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-21044 Filed 8-23-95; 8:45 am]
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