[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]
BILLING CODE 8010-01-M