[Federal Register Volume 62, Number 189 (Tuesday, September 30, 1997)]
[Notices]
[Pages 51170-51172]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-25794]
[[Page 51170]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39120; File No. SR-NSAD-97-70]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change by the National
Association of Securities Dealers, Inc. Relating to an Extension of the
Effectiveness of the NASD's Excess Spread Rule Until October 13, 1997
September 23, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act''), 15 U.S.C.. 78s(b)(1), notice is hereby given that
on September 15, 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 Nasdaq Stock Market, Inc. (``Nasdaq''). The
Commission is publishing this notice to solicit comments from
interested persons and to grant accelerated approval of the proposed
rule change.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD proposes to amend NASD Rule 4613(d) to extend the
effectiveness of its current excess spread rule through October 13,
1997. The excess spread rule is applicable to Nasdaq National Market
(``NNM'') securities and provides that a registered market maker in a
security listed on Nasdaq shall be precluded from being a registered
market maker in that issue for twenty (20) business days if its average
spread in the security over the course of any full calendar month
exceeds 150 percent of the average of all dealer spreads in such issue
for the month. The text of the proposed rule change is as follows.
Additions are italicized and deletions bracketed.
NSAD Rule 4613
(d) Reasonably Competitive Quotations.
A registered market maker in a Nasdaq National Market security will
be withdrawn as a registered market maker and precluded from re-
registering as a market maker in such issue for 20 business days if its
average spread in the security over the course of any full calendar
month exceeds 150 percent of the average of all dealer spreads in such
issue for the month. This subparagraph shall not apply to market makers
in Nasdaq SmallCap securities.
(1) If a registered market maker has not satisfied the average
spread requirement set forth in this subparagraph (d) for a particular
Nasdaq National Market security, its registration in such issue shall
be withdrawn commencing on the next business day following the business
day on which the market maker was sent notice of its failure to comply
with the requirement. A market maker may request reconsideration of the
withdrawal notification. Requests for reconsideration will be reviewed
by the Market Operations Review Committee, whose decisions are final
and binding on the members. A request for reconsideration shall not
operate as a stay of the withdrawal or toll the twenty business day
period noted in subparagraph (d) above.
(2) Grounds for requests for reconsideration shall be limited to
claims that Nasdaq's calculation of the market maker's average spread
for the month was in error.
(3) This subparagraph (d) shall be in effect until October 13, 1997
(September 30, 1997).
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 III below. Nasdaq 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.
Prior to January 20, 1997, the NASD's excess spread rule (the
``Rule'' or the ``Excess Spread Rule'') provided that registered market
makers in Nasdaq securities could not enter quotations that exceeded
125 percent of the average of the three narrowest market maker spreads
in that issue, provided, however, that the maximum allowable spread
could never be less than \1/4\ of a point (``125% Rule''). The Rule was
originally designed to bring a measure of quality to the Nasdaq market
by preventing firms from holding themselves out as market makers
without having a meaningful quote in the system. Despite the regulatory
objectives underlying the rule, however, many market participants
believed the rule produced a variety of unintended consequences that
undermined the integrity of Nasdaq. Most notably, the SEC found in its
21(a) Report on the NASD and Nasdaq that ``the interdependence of
quotes mandated by the rule may deter market makers from narrowing
their dealer spreads, because, once the spread is tightened, the rule
in some instances precludes a market maker from widening the spread to
earlier levels.'' \1\ As a result, the SEC found that the Excess Spread
Rule created an economic incentive for market makers to discourage one
another from narrowing their quotes, thereby interfering with the
``free flow of prices in the market and imped[ing] attempts by the
market to reach the optimal competitive spread.'' \2\ Accordingly, the
SEC requested that the NASD ``modify the rule to eliminate its
undesirable effects, or to repeal it.'' \3\
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\1\ See ``Appendix to Report Pursuant to Section 21(a) of the
Securities Exchange Act of 1934 Regarding the NASD and The Nasdaq
Stock Market,'' at p. 98 (``21(a) Report'') (S.E.C., Aug. 8, 1996).
\2\ Id. at p. 99.
\3\ Id.
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In response to the SEC's 21(a) Report, the NASD submitted a
proposal, which was approved by the SEC and which amended the Excess
Spread Rule on a pilot basis through July 1, 1997.\4\ Under the revised
Excess Spread Rule, a registered market marker in a Nasdaq security is
precluded from being a registered market maker in that issue for twenty
business days if its average spread in the security over the course of
any full calendar month exceeded 150 percent of the average of all
dealer spreads in such issue for the month (``150% Rule).\5\
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\4\ See Securities Exchange Act Rel. No. 38180 (January 16,
1997), 62 FR 3725 (``Pilot Program Approval Order''). The pilot
originally was set to expire on July 1, 1997, but was extended
through September 30, 1997. See Securities Exchange Act Rel. No.
38804 (July 1, 1997), 62 FR 36588.
\5\ On February 28, 1997, the SEC approved the NASD's proposal
to exclude Nasdaq Small-Cap Securities from the Excess Spread Rule.
This rule change was necessary because, unlike the manner in which
Nasdaq National Market securities are handled for purposes of the
rule, Nasdaq does not presently calculate and display through the
Nasdaq system the average spread of all market makers in a
particular SmallCap issue or a comparison of the size of an
individual market maker's quoted spread relative to the average
spread of all market makers. Thus, Nasdaq does not presently afford
market makers in SmallCap securities with any indication as to
whether they are satisfying the requirements of the 150% Rule.
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In formulating the 150% Rule, Nasdaq Committees and Nasdaq staff
felt that it was important to strike a reasonable balance between the
need to eliminate any constraints that the Excess Spread
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Rule places on firms to adjust their quotations and the need to avoid
fostering a market environment where registered market makers can
maintain inordinately wide spreads and still receive the benefits of
being a market maker (e.g., affirmative determination exemption and
preferential margin treatment). Nasdaq also believed it was critical to
transform the Excess Spread Rule into a performance standard used to
determine market maker eligibility, instead of a strict regulatory
requirement applicable to every quote update in a Nasdaq security,
violations of which were punishable by disciplinary action. Based on
its experience with the Rule, the Nasdaq Board of Directors in June
1997 approved a resolution to seek permanent approval of the 150% Rule
``as is,'' without modifications. In addition, the NASD ratified the
Nasdaq Board resolution in July of 1997 and Nasdaq planned to seek
permanent approval shortly thereafter.
However, the Commission has expressed, and continues to express,
serious concerns about the effects of the Rule on market maker
activity. More specifically, in its approval order of the 150% Rule,
the SEC stated that ``[a]lthough the amended excess spread rule may
reduce some of the anticompetitive concerns outlined in the 21(a)
Report, the Commission believes that the amendment * * * may not
completely satisfy the NASD'S obligations under the Commission's Order
with regard to the excess spread rule. Specifically, it may not remove
completely the anticompetitive incentives for market makers to refrain
from narrowing quotes because the market makers' quotation obligation
continues to be dependent to some extent upon quotations of other
market makers in the stock.'' \6\
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\6\ Pilot Program Approval Order, supra note 4.
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Additionally, in recent discussions, SEC staff has indicated that
it believes that the 150% Rule may not have completely eliminated the
concerns outlined in the 21(a) Report and may not completely satisfy
the NASD's obligations under the Commission's Order. SEC staff further
has stated that it believes that the Rule should be completely
eliminated, or at the very least, be eliminated for stocks with a small
number of market makers.
In light of the foregoing, the NASD is proposing to extend the
Excess Spread Rule only until October 13, 1997. Additionally, Nasdaq
staff will ask the Nasdaq Board of Directors (``Board'') at its
September 23, 1997 board meeting to reconsider its previous decision to
seek permanent approval of the Rule, in light of the Commission's
concerns that the Rule does not remove completely incentives for market
makers to refrain from narrowing quotes. Nasdaq will inform the
Commission by letter of the final disposition of the Board's
reconsideration of this matter as soon as possible.
The NASD and Nasdaq believe that the proposed rule change is
consistent with Sections 15A(b)(6), 15A(b)(9), 15A(b)(11) and
11A(a)(1)(C) of the Exchange Act. Among other things, 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)
provides that the rules of the Association may not impose any burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act. Section 15A(b)(11) empowers the NASD to adopt
rules governing the form and content of quotations relating to
securities in the Nasdaq market. Such rules much be designed to produce
fair and informative quotations, prevent fictitious and misleading
quotations, and promote orderly procedures for collecting and
distributing quotations. 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.
Specifically, the NASD and Nasdaq believe that the 150% Rule has
promoted the integrity of quotations on the Nasdaq market and has
enhanced competition among market makers, thereby contributing to
greater market liquidity, improved price discovery, and the best
execution of customer orders. The Rule has helped to ensure that all
registered market makers are providing some threshold level of market
making support in their issues, and has helped to avoid a market
environment where registered market makers can maintain inordinately
wide spreads and still receive the benefits of being a market maker.
Thus, a continuation of the Rule until October 13, 1997, will address
the Commission's aforementioned concerns while preserving the Rule's
benefits (such as ensuring meaningful market maker quotes) until the
Nasdaq Board reconsiders its previous position on the Rule.
Additionally, the proposed to extend the pilot program for a limited
period is consistent with the Exchange Act and will ensure continuity
of regulation until the Nasdaq Board reconsiders its previous position
on the Rule.
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 Exchange 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 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-97-70 and
should be submitted by October 21, 1997.
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
The Commission has determined to approve the extension of the 150%
Rule pilot until October 13, 1997. As noted previously, the Commission
has identified anticompetitive concerns associated with the 125% Rule
in place prior to January 20, 1997. Further, in the Pilot Program
Approval Order, the Commission recognized that while the
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150% Rule could reduce, to some degree, the Commission's concerns
regarding the 125% Rule, the Commission was not convinced that
permanent approval of the 150% rule would sufficiently address those
concerns. The Commission believes that the pilot should continue to
operate on a temporary basis through October 13, 1997, while the Nasdaq
Board reconsiders its position on permanent approval. Consequently an
extension will ensure that the Rule remains in effect on an
uninterrupted basis until the Nasdaq Board has had an opportunity to
fully evaluate the most appropriate permanent solution regarding the
excess spread rule.
In addition, the Commission believes that the temporary rule can
remain limited to National Market securities. Due to Nasdaq's current
systems limitations, market makers in Nasdaq SmallCap securities are
unable to monitor compliance with the Rule. However, the NASD has
stated that it anticipates that market makers in Nasdaq SmallCap
securities will be subject to the same excess spread requirements, if
any, as market makers in Nasdaq National Market securities when a
permanent resolution is reached.
Accordingly, the Commission finds that the NASD's proposal is
consistent with Sections 11A and 15A of the Exchange Act and the rules
and regulations thereunder applicable to the NASD and, in particular,
Sections 11A(a)(1)(C), 15A(b)(6), 15A(b)(9), and 15A(b)(11). Further,
the Commission finds good cause for approving the proposed rule change
prior to the thirtieth day after the date of publication in the Federal
Register. In addition to the reasons discussed above, the Commission
believes that accelerated approval of the NASD's proposal is
appropriate given the fact that the proposal is a temporary extension
of the 150% Rule that has been in effect since January 1997. An
uninterrupted application of the 150% Rule for a short period of time
should be less disruptive to market makers while the Nasdaq Board
reconsiders its permanent approach to the concerns raised by the
Commission regarding the excess spread rule.\7\
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\7\ The Commission notes that a failure to extend the 150% Rule
past the October 13, 1997 date would result in no excess spread
standard for Nasdaq market makers.
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act, that the proposed rule change (SR-NASD-97-70) is approved
through October 13, 1997.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\8\
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\8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-25794 Filed 9-29-97; 8:45 am]
BILLING CODE 8010-01-M
