[Federal Register Volume 60, Number 195 (Tuesday, October 10, 1995)]
[Proposed Rules]
[Pages 52792-52815]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-24911]




[[Page 52791]]

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Part III





Securities and Exchange Commission





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17 CFR Part 240



Order Execution Obligations; Proposed Rules

  Federal Register / Vol. 60, No. 195 / Tuesday, October 10, 1995 / 
Proposed Rules   

[[Page 52792]]


SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-36310; File No. S7-30-95]
RIN 3235-AG66


Order Execution Obligations

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rules.

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SUMMARY: The Securities and Exchange Commission (``Commission'') today 
is proposing two rules and amendments to a rule to improve the handling 
and execution of customer orders. In light of the availability of 
improvements in order handling technology and the proliferation of 
ancillary order handling arrangements, including payment for order 
flow, directed order handling and internalization, the Commission is 
proposing rules that are intended to improve the opportunity of 
investors to obtain the best execution possible for their orders. At 
the same time, the proposals are designed to preserve the benefits of a 
competitive market structure that has greatly enhanced market 
liquidity, transparency and efficiency.

DATES: Comments should be submitted on or before January 16, 1996.

ADDRESSES: Interested persons should submit three copies of their 
written data, views and opinions to Jonathan G. Katz, Secretary, 
Securities and Exchange Commission, 450 Fifth Street NW., Washington, 
DC 20549, and should refer to File No. S7-30-95. All submissions will 
be made available for public inspection and copying at the Commission's 
Public Reference Room, Room 1024, 450 Fifth Street NW., Washington, DC 
20549.

FOR FURTHER INFORMATION CONTACT: David Oestreicher regarding Rules 
11Ac1-4 and 11Ac1-5, Ethan Corey regarding best execution obligations, 
and Gautam S. Gujral, Elizabeth Prout Lefler or Gail A. Marshall 
regarding amendments to Rule 11Ac1-1 at (202) 942-0158, Division of 
Market Regulation, Securities and Exchange Commission, 450 Fifth Street 
NW., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission proposes to amend Rule 11Ac1-
1 (``Quote Rule'') \1\ under the Securities Exchange Act of 1934 
(``Exchange Act'') \2\ to require exchanges and over-the-counter 
(``OTC'') market makers in listed securities to publish quotations for 
listed securities where the exchange or OTC market maker trades more 
than 1% of the aggregate trading volume for that security. The 
Commission also proposes to amend the Quote Rule to require exchange 
specialists and OTC market makers to quote to the public any better 
prices that they privately quote through certain electronic 
communications networks. Further, the Commission proposes to require 
specialists and OTC market makers to display customer limit orders 
priced better than the specialist's or OTC market maker's quote. 
Finally, the Commission proposes to require that specialists and OTC 
market makers provide customer market orders some opportunity for price 
improvement before executing the order. The rule provides for order 
exposure procedures that, if followed, would be deemed to satisfy the 
requirement that a specialist or OTC market maker provide an 
opportunity for price improvement. These procedures are not, however, 
intended to be the only method by which OTC market makers and 
specialists may offer the opportunity for price improvement.

    \1\ 17 CFR 240.11Ac1-1.
    \2\ 15 U.S.C. 78a to 78ll (1988).
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I. Introduction

A. Background

    The vision of a ``national market system'' (``NMS''), which 
Congress adopted in the Securities Acts Amendments of 1975 (``1975 
Amendments''),\3\ has served our markets well, fostering a market 
system that by any measure is the fairest and most efficient in the 
world. The idea of an integrated system in which competition among 
linked markets would make the best prices universally available, 
transparent disclosure of quotes and trades would promote best 
execution, and broker-dealers would place the interests of customers 
first, represented a significant step forward for our markets. The 
costs and dislocations associated with implementing the systems 
required were substantial and concerns that liquidity would be impaired 
were pervasive. The undertaking primarily was placed on the shoulders 
of the securities industry: the Commission took seriously the 
Congressional mandate that it ``facilitate'' these goals while allowing 
maximum flexibility in the design.

    \3\ Pub. L. No. 94-29, 89 Stat. 97 (1975).
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    The last 20 years have seen continued progress toward an NMS. Major 
infrastructure developments such as the Consolidated Quotation System 
(``CQS''), the consolidated transaction tape, last-sale reporting for 
OTC securities, and the Intermarket Trading System (``ITS'') have made 
information about trading interest, volume, and prices widely available 
to market participants. The technological innovations of the last two 
decades have made it possible to display, route, and execute orders in 
volumes unheard of even a few years ago. Communication among markets 
and market participants, once slow and costly, is now instantaneous and 
economical. Now more than ever, investors can expect that their orders 
will be executed at the best prices available across a spectrum of 
markets. In a very real sense, investors have benefited directly from 
the NMS initiatives, as increased transparency has contributed to 
greater liquidity and better enabled investors to monitor the quality 
of their executions, and technology has allowed better, quicker, and 
cheaper access to the markets.
    Notwithstanding these positive developments, improved technology 
also has made possible market practices and structures that raise the 
issue of whether customers are consistently afforded the enhanced 
opportunities for better prices made possible by innovations in price 
dissemination and order handling. Questions have been raised about 
whether increasingly commonplace practices such as the routing of 
customer order flow to market makers and specialists in return for 
payment and the internalization of customer orders by integrated firms 
may reduce competition based on published quotes. In addition, 
customers' limit orders are not always displayed in all markets. At a 
minimum, those customers whose orders are not displayed lose the 
opportunity to have their orders interact with the market.
    There are also concerns about whether quotations fully convey the 
quality of information intended by the 1975 Amendments. The development 
of electronic trading systems that allow market makers to display 
different prices to different customers has created the potential for 
two-tiered markets in which market makers quote one price to public 
investors while quoting better prices in private systems. As a result, 
investors without access to these ``hidden'' quotes may not obtain the 
benefit of the best available prices. Similarly, investors may not 
receive the best available prices when other customers' limit orders 
are not represented in the quotes. When specialists and OTC market 
makers fail to display limit orders that improve the inside quotes, the 
quotes do not convey the real quotation spread and may 

[[Page 52793]]
present an inaccurate picture of trading interest.
    In many respects, these structures and practices have neither kept 
pace with investors' needs nor advanced Congress' mandate for an NMS. 
Some investors have sufficient market power, sophistication and access 
to information and markets necessary to ensure best execution of their 
orders. Retail customers, however, typically depend on their brokers 
for information and access to the market. Regardless of whether the 
execution occurs in an exchange market or OTC, investors expect prompt 
executions at the best prices reasonably obtainable. Investors should 
be able to rely on published quotations for an accurate picture of the 
market. Investors should receive fair treatment for their orders and 
should not have to compete with their own brokers for quality 
executions.
    Ultimately, if market structures and practices work to their 
disadvantage, investors will lose confidence in the fairness of the 
market. The tremendous success of our markets over the last 20 years 
has been due in large part to investor confidence in their fairness, 
integrity, and efficiency. To the extent that practices and structures 
such as hidden limit orders, payment for order flow, internalization, 
and two-tiered markets may not satisfy investor needs and diminish 
transparency, these practices threaten to undermine investor confidence 
and market efficiency.
    Congress saw competition as the primary source of change and 
innovation in achieving an NMS and directed the Commission to use its 
rulemaking authority to remove impediments to competition and 
facilitate the development of an NMS. To the extent that order flow 
increasingly is routed on a basis other than quote competition, the 
transparency and competitiveness of our markets may suffer. Similarly, 
the continued fragmentation of quotations erodes the value of the 
quote. Accordingly, the Commission believes that it is time to propose 
action to ensure the future confidence of investors and the 
competitiveness of American markets.
    The Commission today is proposing a series of initiatives that 
would enhance transparency in our markets and improve the handling and 
interaction of customer orders. The proposed rules stress that markets 
and dealers should disclose as much information about supply and demand 
as is practicable. Transparency of customer orders ensures that prices 
fully reflect overall supply and demand and prevents market 
fragmentation. The proposed rules assure the continued availability of 
quality information with respect to quotations. In addition, the 
proposed rules seek to improve opportunities in auction and dealer 
markets for market orders to interact directly with other market orders 
and public limit orders, consistent with the goals of a national market 
system.
    The proposed rules reinforce the importance of fair competition 
among markets and market participants. The Commission believes that the 
introduction of new technologies during the past 20 years has been 
largely a product of competition in our markets. In recognition of the 
importance of fostering continued innovation through competitive market 
forces, as well as Congress's mandate to facilitate-but-not-design, the 
proposals do not require any particular system or market structure. 
Rather, they attempt to achieve their intended effect by establishing 
minimum standards for the handling of customer orders. The intent is to 
further the goals of an NMS while preserving an atmosphere in which 
innovation is welcome and rewarded.

B. The Duty To Seek Best Execution of Customer Orders

    Even absent the rule proposals being issued for comment today, the 
duty of best execution requires a broker-dealer to seek the most 
favorable terms reasonably available under the circumstances for a 
customer's transaction.4 Although the duty of best execution is 
longstanding, the specific obligations of broker-dealers in fulfilling 
that duty have evolved over time. As developments in market structure 
and technology create new opportunities to achieve better execution of 
customer orders, it is incumbent on the Commission and the markets to 
take full advantage of those developments.

    \4\ See Securities Exchange Act Release No. 30920 (July 14, 
1992), 57 FR 32587 (July 22, 1992); Division of Market Regulation, 
Market 2000: An Examination of Current Equity Market Developments 
(Jan. 1994) (``Market 2000''), Study V.
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    Historically, with the development of sophisticated price 
dissemination and order routing systems, broker-dealers gained better, 
more economical means to determine the best price for a security 
trading in multiple markets. For example, before the advent of the 
Nasdaq automated quotation system, broker-dealers manually routed their 
customer orders to OTC market makers, and were viewed as having made 
reasonable efforts if they contacted three market makers to find the 
best available price. The development of Nasdaq enabled broker-dealers 
to check the quotations of all Nasdaq market makers at once, thus 
expanding the range of OTC quotes to be taken into account in seeking 
best execution.5 In the listed markets, the CQS provided broker-
dealers for the first time with the currently reported bids, offers, 
and quotation sizes of brokers and dealers trading listed securities 
both on exchanges and in the OTC market.6 In approving the CQS, 
the Commission stressed that it would expect broker-dealers to take 
into account the pricing information made available through the system 
in fulfilling their best execution obligations.7

    \5\ Market 2000, supra note 4, at II-11.
    \6\ Securities Exchange Act Release No. 15009 (July 28, 1978), 
43 FR 34851 (Aug. 7, 1978)(first declaring temporarily effective CQS 
Plan); Securities Exchange Act Release No. 16518 (Jan. 22, 1980), 45 
FR 6521 (June 28, 1980) (permanently approving CQS Plan).
    \7\ Id.
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    Over time, exchanges and broker-dealers also have developed 
automated order routing systems to process small trades. The Commission 
concluded in response that an automated order routing environment was 
not necessarily inconsistent with the achievement of best 
execution.8 Indeed, the Commission recognized that it could be 
impractical, both in terms of time and expense, for a broker that 
handled a large volume of orders to determine individually where to 
route each order it received. The Commission therefore stated that 
broker-dealers routing orders for automated execution could satisfy 
their best execution obligations by assessing periodically the quality 
of competing markets to assure that aggregated order flow was directed 
to markets providing the most advantageous terms for their customers' 
orders.9

    \8\ Securities Exchange Act Release No. 15671 (Mar. 22, 1979), 
44 FR 20360 (Apr. 4, 1979); Securities Exchange Act Release No. 
15926 (June 15, 1979), 44 FR 36912, 36923 n. 118 (June 22, 1979); 
Securities Exchange Act Release No. 17583 (Feb. 27, 1981), 46 FR 
15713, 15715 n. 16 (Mar. 9, 1981); Securities Exchange Act Release 
No. 26870 (May 26, 1989), 54 FR 23963, 23973 n. 127 (June 5, 1989); 
Market 2000, supra note 4, Study V at V-1 n. 8; Securities Exchange 
Act Release No. 34902 (Oct. 27, 1994), 59 FR 55006, 55009 n. 30 
(Nov. 2, 1994) (``Payment for Order Flow Release'').
    \9\ See sources cited supra note 8.
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    In this regard, the Commission recently cited a staff position 
warning broker-dealers against presuming that routing order flow to a 
market providing quote-based executions always would satisfy the duty 
of best execution for small orders in listed securities; at the same 
time, the Commission noted the role of price improvement as a factor in 
best execution, speaking in the context of aggregate order routing 
decisions for 

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listed and OTC stocks.10 For example, trades in listed securities 
that are routed to an exchange typically are exposed to other public 
orders or interest in the trading crowd that exists on the trading 
floor.11 Such order exposure brings with it the possibility for 
price improvement, i.e., an execution at a price that is better than 
the existing quotes. In addition, with the development of sophisticated 
order handling systems, some OTC market makers are now providing an 
opportunity for price improvement for their customer orders.

    \10\ See Payment for Order Flow Release, supra note 8, at text 
accompanying nn. 31-33.
    \11\ See Payment for Order Flow Release, supra note 8. In 
addition, most regional exchanges have incorporated order exposure 
features into their small order routing and execution systems so 
that price improvement may be offered. Most regional exchanges 
program their automated execution systems to ensure that customer 
orders receive a price at the national best bid or best offer 
(``NBBO'') or better, and the specialist is provided an opportunity 
to improve the price. Payment for Order Flow Release, supra note 8, 
at n. 32 and sources cited therein. This feature by itself, however, 
rarely provides an execution between the spread.
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    As technology has advanced, certain order handling routines that 
may not have been economical or even possible several years ago have 
become available. Using internal automated systems, some broker-dealers 
now are able to route orders automatically to the dealer market or 
automated system offering the best price, or alternatively, match the 
best price themselves and execute the order as principal. It now is 
possible for some broker-dealers to seek better prices for their 
customers' orders not only on the CQS and Nasdaq, but also on other 
market systems, such as SelectNet. More importantly, the availability 
of sophisticated order handling systems has made it possible for some 
broker-dealers and market centers to provide an opportunity for price 
improvement for their customer orders. The use of these efficient 
routing and execution facilities by firms and exchanges suggests that 
price improvement procedures and other best execution safeguards in an 
automated environment are increasingly practicable and are setting new 
standards for the industry.
    In the past, quote based executions in OTC securities were 
generally recognized as satisfying best execution obligations.12 
The development of efficient new facilities, however, alters what 
broker-dealers must consider in seeking best execution of customer 
orders. In determining the parameters of what is reasonable in 
particular circumstances, the Commission believes that in light of 
recent developments broker-dealers must now consider not only their 
customers' expectations, but also ways of obtaining improved executions 
for customers using the range of available new technologies as they 
evolve. While not all markets and trading systems are equally 
accessible to large and small broker-dealers, and not all order 
handling technologies are equally affordable to all broker-dealers, 
when efficient and cost effective systems are readily accessible, 
broker-dealers must evaluate carefully whether they can be used in 
fulfilling their duty of best execution.

    \12\ Market 2000, supra note 4, Study V at V-4.
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C. Overview of the Proposed Rules

    The rules proposed today will increase the opportunities for 
investors to receive best execution for their orders and promote market 
efficiency. Moreover, by stressing the importance of transparency and 
price improvement, the proposed rules should reinforce competition 
among markets and market participants. The rules proposed today, 
however, are not intended to alter or displace the well-established 
duty under the antifraud principles for market participants to provide 
customers with best execution. Broker-dealers remain obligated to seek 
the most favorable terms possible under the circumstances for their 
customers.
    The first of these rule proposals involves amendments to the Quote 
Rule that would improve information about the significant market makers 
in a security and the prices they are quoting. The proposals would 
require exchanges and OTC market makers that account for more than 1% 
of the volume in a listed security to publish their quotations for that 
security. In addition, the amendments would require exchange 
specialists and OTC market makers who submit priced orders to certain 
electronic communications networks to include those orders in their 
published quotes.
    Second, the Commission is proposing a minimum standard for all 
markets that would require the display of customer limit orders under 
certain circumstances. The proposed rule would promote best execution 
of customer limit orders, and would increase market transparency and 
efficiency by ensuring that prices fully reflect overall supply and 
demand.
    Finally, the Commission has previously stated in other contexts 
that broker-dealers have a duty to consider opportunities for price 
improvement when deciding where to route customer orders for 
execution.13 In support of this duty, the rules would require OTC 
market makers and specialists to provide their customer orders with an 
opportunity for price improvement. Recognizing that OTC market makers 
and specialists currently employ a variety of systems and procedures to 
provide price improvement opportunities, the proposed rule does not 
impose any one formula or mechanism for achieving price improvement. 
Nonetheless, to provide guidance to dealers as to one set of conditions 
under which they would satisfy their obligation under the rule, the 
Commission is proposing a non-exclusive safe harbor. The safe harbor 
sets out a procedure that would satisfy the price improvement 
obligation while allowing for the duty to be satisfied by alternative 
means. The Commission also seeks comment on alternative safe harbors.

    \13\ See Payment for Order Flow Release, supra note 8.
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    While the legislative history of the 1975 Amendments recognized 
that order exposure and interaction may not be appropriate for some 
securities, Congress intended that for as many securities as feasible, 
the NMS should ensure that public investors receive the benefits and 
protections associated with transparency and order interaction. 
Accordingly, the rules proposed today are designed to comport with the 
principle that a broker-dealer will seek the same quality of execution 
regardless of whether the broker-dealer is acting as principal or 
agent, and regardless of whether the transaction is effected in an 
exchange or OTC market.

II. Proposals

A. Amendments to the Quote Rule

1. Background
    The proposed amendments to the Quote Rule are designed to: (1) 
expand the coverage of existing broker-dealer quotation requirements to 
include substantial market makers in non-Rule 19c-3 securities,14 
and (2) ensure that OTC market makers and exchange specialists reflect 
in their public quotes the best prices they have published in certain 
electronic communications networks.

    \14\ See 17 CFR 240.19c-3. Exchange Act Rule 19c-3 prohibits the 
application of off-board trading restrictions to securities that: 
(1) were not traded on an exchange before April 26, 1979; or (2) 
were traded on an exchange on April 26, 1979, but ceased to be 
traded on an exchange for any period of time thereafter. 
Accordingly, exchange-traded securities not subject to off-board 
trading restrictions are referred to as Rule 19c-3 securities, and 
exchange-traded securities subject to off-board trading restrictions 
are referred to as non-Rule 19c-3 securities.
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    The Commission believes these amendments are important to enhance 
competition in publicly disseminated 

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quotes. Furthermore, these amendments are intended to improve published 
quotation information by ensuring that OTC market makers and exchanges 
publicly disseminate quotations in the exchange-listed securities they 
actively trade, and by ensuring that the best bid and offer prices are 
made available to public investors.
    The legislative history of the 1975 Amendments makes it clear that 
a prompt, accurate and reliable composite quotation reporting system is 
an essential element of the NMS.15 Congress believed it essential 
that the composite quotation reporting system include quotations from 
all market centers.16 Those Amendments also granted the Commission 
``pervasive rulemaking power to regulate securities communications 
systems.'' 17

    \15\ S. Rep. No. 75, 94th Cong., 1st Sess. 9-10 (1975) (``Senate 
Report''). Cf. H.R. Rep. No. 229, 94th Cong. 1st Sess. 29 (1975) 
(``House Report) (noting that conference committee adopted the 
Senate's provisions on the NMS with minor revisions).
    \16\ Senate Report, supra note 15 at 101.
    \17\ Id. at 93.
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a. Dissemination of Quotes Under the Rule
    Public quote reporting for equity securities is governed by Section 
11A of the Exchange Act,18 the Quote Rule 19 and Rule 11Aa3-2 
(the ``Plan Rule''),20 as well as exchange and NASD rules. These 
rules require registered exchanges and securities associations 21 
to file quotation reporting plans with the Commission that provide for 
the collection and transmission of quotation information on a real-time 
basis.22 Specialists and OTC market makers communicate their 
quotes to the exchange and to the NASD pursuant to these plans and the 
SROs in turn make this information available to vendors for 
dissemination to the public.23 The Quote Rule requires public 
dissemination of the best bid, best offer, and size for each market 
trading the security as well as the consolidated best bid and 
offer.24 Quotations provided to vendors must be firm, and a 
specialist or OTC market maker generally is obligated to execute any 
order at a price at least as good as its published bid or offer.25 
Brokers and dealers covered by the Rule, including dealers trading 
listed securities in the OTC market (i.e., third market makers), must 
supply quotations to their exchange or association for dissemination to 
quotation vendors.

    \18\ 15 U.S.C. 78k-1.
    \19\ 17 CFR 240.11Ac1-1 (1993). See Securities Exchange Act 
Release No. 14415 (Jan. 26, 1978), 43 FR 4342 (Feb. 1, 1978).
    \20\ 17 CFR 240.11Aa3-2 (1993).
    \21\ The NASD is the only registered national securities 
association.
    \22\ See Rule 11Ac1-1(b)(1), 17 CFR 240.11Ac1-1(b)(1) 
(dissemination requirements for exchanges and associations).
    \23\ Rule 11Ac1-2, 17 CFR 240.11Ac1-2 (``Vendor Display Rule'') 
requires vendors of market information to display quotation 
information in a non-discriminatory manner.
    \24\ See Rule 11Ac1-1(b)(1), 17 CFR 240.11Ac1-1(b)(1).
    \25\ See Rule 11Ac1-1(c)(1), 17 CFR 240.11Ac1-1(c)(1).
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b. Mandatory and Voluntary Quotes Under the Rule
    When the Commission first proposed the Quote Rule, it noted that a 
lack of reliable quotation information from the various markets was 
hampering private and self-regulatory efforts to establish a viable 
composite quotation system which consequently was impeding the 
development of an NMS.26 Accordingly, the Quote Rule, as 
originally adopted, mandated that specialists and OTC market makers 
subject to the Rule's provisions communicate their quotations promptly 
to their relevant exchange or association and that such quotations be 
``firm.''

    \26\ See Securities Exchange Act Release No. 12670 (July 29, 
1976), 41 FR 32856 (Aug. 5, 1976) (``Quote Rule Proposing 
Release'').
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    Shortly after the rule was adopted, the Commission granted 
exemptive relief to exchanges and OTC market makers 27 responsible 
for less than 1% of the aggregate trading volume in a reported 
security, primarily because the costs of compliance with the mandatory 
Quote Rule for such exchanges and OTC market makers with de minimis 
market share were substantially disproportionate to any reasonably 
anticipated competitive benefits.28

    \27\ See e.g. Securities Exchange Act Release No. 15747 (Apr. 
19, 1979), 17 S.E.C. Doc. 304, granting Amswiss International 
Corporation exemptive relief from paragraph (c)(1) of the Quote 
Rule, pursuant to paragraph (d) of the rule, (``Amswiss 
exemption''). The Commission also granted exemptive relief to 
certain exchanges which accounted for a de minimis share of the 
consolidated volume in any reported security. See Securities 
Exchange Act Release No. 15012 (July 28, 1978), 43 FR 33978 (Aug. 2, 
1978) (Intermountain Stock Exchange); Securities Exchange Act 
Release No. 15011 (July 28, 1978), 43 FR 33983 (Aug. 2, 1978) 
(Spokane Stock Exchange); Securities Exchange Act Release No. 15010 
(July 28, 1978), 43 FR 33976 (Aug. 2, 1978) (Cincinnati Stock 
Exchange); Securities Exchange Act Release No. 15013 (July 28, 
1978), 43 FR 33981 (Aug. 2, 1978) (Philadelphia Stock Exchange).
    \28\ See Securities Exchange Act Release No. 15771 (Apr. 26, 
1979), 44 FR 26067 (May 4, 1979). See also Securities Exchange Act 
Release No. 18482 (Feb. 11, 1982), 47 FR 7399, 7405 ( Feb. 19, 1982) 
(stating that the Commission has followed an established policy of 
granting exemptive relief to OTC market makers with a de minimis 
share of the order flow in a particular security).
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    In 1982, the Commission amended the rule to make quote 
dissemination voluntary rather than mandatory for those OTC market 
makers and exchanges with less than 1% of the volume in Rule 19c-3 
securities. For non-Rule 19c-3 securities, the amendment required OTC 
market makers and exchanges to communicate quotes only when they 
qualified as the principal market for the security. Market makers could 
voluntarily quote if they elected to do so in accordance with the Rule. 
Thus, under the Quote Rule presently, unless an OTC market maker or 
exchange is responsible for such a significant share of the trading 
volume that it can be considered the principal market for an exchange-
traded security, its decision to register to communicate its quotes in 
non-Rule 19c-3 securities is purely voluntary.29

    \29\ An OTC market maker in reported securities may effectively 
elect to disseminate quotations under proposed paragraph 
(a)(25)(ii)(B) by registering as a NASD market maker and 
``communicating'' its best bids and offers to the association by 
entering two-sided quotations in the Nasdaq System. See NASD By-
Laws, Schedule D, Part V, Sec. 1 (CCH) para. 1816D.
    Similarly, an exchange that is not the principal market for a 
reported security may voluntarily elect to disseminate quotes for 
the security pursuant to proposed paragraph (a)(25)(i)(B).
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    The Commission noted that many of the quotations provided by 
dealers to comply with the mandatory rule had been inaccurate and stale 
or produced by systems designed to track the primary market 
automatically.30 Processing and dissemination of the resulting 
quotation information, some of which was deemed unreliable, had been a 
strain on vendor systems. The Commission also believed that the 
operation of the ITS,31 through which third market makers who 
disseminate quotes may effect transactions with other markets in Rule 
19c-3 securities, would create an economic incentive to quote 
competitively in the affected securities in the absence of a mandate.

    \30\ See Securities Exchange Act Release No. 17583 (Feb. 27, 
1981), 46 FR 15713 (Mar. 9, 1981).
    \31\ The ITS commenced operation on a pilot basis on April 17, 
1978. The ITS is an intermarket order routing facility which permits 
orders for the purchase and sale of multiply-traded securities to be 
sent directly from one market center to another. OTC market makers 
do not have access to ITS for non-Rule 19c-3 securities.
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    However, after the adoption of the voluntary quote rule, regional 
exchanges continued to quote the securities they traded using automated 
quotation devices that tracked the national best bid and offer.32 
Today, although many 

[[Page 52796]]
third market makers quote competitively, some do so selectively, 
choosing not to display quotes for securities that are subject only to 
voluntary quote provisions. In fact, several active third market makers 
maintain continuous, two-sided quotations but do not disseminate them 
to the investing public because they are not obligated to do so. This 
has left a significant gap in the quotation information which is 
available to all investors, contrary to an essential goal of the NMS.

    \32\ In this regard, the ITS Plan provides:
    each Participant that furnishes to other Participants bid-asked 
quotations that are generated by an automated quotation tracking 
system (such as the Autoquote or the Centramart system currently 
employed by certain Participants) agrees that no such quotation 
shall be for more than 100 shares.
    ITS Plan, 8(d)(ii). Thus, it is not unusual for exchanges to 
disseminate quotations, presumably generated by computers, that are 
bid at \1/8\ below the best national bid and offered at \1/8\ above 
the best national offer, for 100 shares on each side.
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    While the Commission believes that the 1% threshold for mandatory 
quotes continues to be appropriate, the Commission believes the 
disparate treatment of Rule 19c-3 and non-Rule 19c-3 securities now 
should be revisited.33 Since the Quote Rule initially was 
promulgated, and thereafter amended, trading under the regulatory 
scheme has evolved and market participants and the Commission have 
gained substantial experience under Rule 19c-3 and the Quote Rule. For 
example, as more securities have become subject to Rule 19c-3, trading 
volume in the third market has grown.34 Thus, off-board trading in 
Rule 19c-3 securities now accounts for a greater number of stocks and a 
more substantial percentage of U.S. trading volume than it did when the 
Commission initially established the disparate treatment for quotations 
in Rule 19c-3 and non-Rule 19c-3 securities under the Quote Rule.

    \33\ Firms that trade non-Rule 19c-3 securities off an exchange 
are not subject to the same requirements as third market makers that 
meet the 1% threshold for Rule 19c-3 securities. For example, a 
third market maker required to quote in a Rule 19c-3 security must 
register as a CQS market maker with the NASD. NASD Manual, Schedule 
D to the By-Laws, Part VI, Sec. 1, (CCH) para. 1828. CQS market 
makers are subject to the NASD's CQS market maker rules, which 
include firm and continuous two-sided quote obligations and 
mandatory participation in Nasdaq's Computer Assisted Execution 
System (``CAES''), and in the ITS. NASD Manual, Schedule D to the 
By-Laws, Part IV, Sec. 1, 2, (CCH) para. 1828, 9.
    \34\ See Fragmentation vs. Consolidation of Securities Trading: 
Evidence from the Operation of Rule 19c-3, Office of Economic 
Analysis, SEC, pp. 4-5 (Mar. 29, 1995).
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    In view of the growth of third market trading volume, much of which 
is executed by automated systems at prices derived from the principal 
markets, the Commission questions whether this trading should continue 
to be conducted on the basis of voluntary quotations, or whether it 
should be subject to standards similar to those for trading Rule 19c-3 
securities. Under the Quote Rule presently, executing market makers are 
subject to disparate quotation requirements for non-Rule 19c-3 and Rule 
19c-3 securities. The Commission questions whether there are sufficient 
distinctions between trading in Rule 19c-3 securities and other listed 
securities to justify different quotation standards. Requiring OTC 
market makers and exchanges that account for more than 1% of the volume 
in a listed security to disseminate quotations for that security would 
provide greater information about significant market makers in the 
security, and the prices at which they are willing to trade.
    The proposed uniform application of the Quote Rule to all exchange-
listed securities, if adopted, raises the issue of the disparate 
treatment of Rule 19c-3 and non-Rule 19c-3 securities under the ITS 
Plan. Currently, the ITS Plan provides access to any participant in any 
Rule 19c-3 security in which the participant disseminates continuous 
two-sided quotations, but excludes OTC market makers from ITS access 
for non-Rule 19c-3 securities. The proposed amendments to the Quote 
Rule would subject OTC market makers and exchanges to the same 
quotation requirements for all exchange-listed securities. Accordingly, 
the Commission believes it is appropriate to reconsider the issue of 
ITS access by third market makers. The Commission requests comment on 
whether the amendments should be accompanied by an expansion of the 
linkage between ITS and the NASD's CAES to provide ITS access to and 
from any market maker for any exchange-listed security in which that 
market maker disseminates continuous two-sided quotations.
    Requiring active third market makers to quote also raises the issue 
of whether revisions to a current NASD rule that restricts certain 
computer generated quotations are necessary.35 Regional exchange 
specialists currently may use automated mechanisms to track the NBBO in 
a security if they maintain a quotation size of no more than 100 
shares. OTC market makers, however, are prohibited, by NASD 
requirements, from using similar automated quotation tracking systems. 
The NASD requirements are designed to prevent the multiplication of 
non-competitive quotes, with their attendant burden on system capacity. 
In the absence of an amendment to the NASD rule, market makers in 
effect often would be required to maintain firm, continuous two-sided 
markets without using computers to generate those quotes. The 
Commission requests comment on whether computer generated quotations 
should be permitted if active third market makers are required to quote 
in non-Rule 19c-3 securities, and if so, under what conditions.

    \35\ NASD Manual, Schedules to the By-Laws, Schedule D, Part IV, 
Sec. 2, (CCH) para. 1829. The NASD, however, provides an automated 
quotation update capability (auto-refresh) which market makers may 
elect to use. Specifically, the quote of a market maker using auto-
refresh will be automatically updated when the market maker exhausts 
its exposure limit in the NASD's Small Order Execution System.
---------------------------------------------------------------------------

    The Commission also notes that the proposed amendments to the Quote 
Rule would extend the coverage of the rule to all Nasdaq securities 
(including SmallCap securities) where previously the rule applied only 
to Nasdaq/National Market securities. The Commission preliminarily 
believes that this element of the proposal should not impose new costs 
on market participants because the NASD rules concerning quotations 
already treat Nasdaq/National Market and SmallCap securities similarly. 
The Commission believes that this aspect of the proposed Quote Rule 
amendment, therefore, simply extends Exchange Act rule coverage to the 
same range of securities as existing NASD rules.
c. Dissemination of Quotes Through Electronic Communications Networks
    Since the Quote Rule's adoption in 1978, electronic communications 
networks have been developed that allow participants to enter priced 
orders which are widely disseminated to third parties and which permit 
such orders to be executed in whole or in part. Participants may 
include investors (retail and institutional), broker-dealers, and 
market makers. The sponsors of these systems may be regulated as 
broker-dealers even though the manner of operation of the systems may 
differ from the activities of traditional broker-dealers.36

    \36\ See Market 2000, supra note 4, at III-12. See also 17 CFR 
240.17a-23 regarding regulation of Broker Dealer Trading Systems.
---------------------------------------------------------------------------

    The Commission traditionally has been concerned with the creation 
of so-called ``hidden markets'' whereby an OTC market maker or 
specialist publishes quotations in some market centers at prices 
superior to the quotation information disseminated broadly by such OTC 
market maker or specialist.37 Due to an increasing number of 
electronic communications networks being developed by market 
participants and market centers, quotation information is becoming 
splintered, with OTC market makers and specialists publishing different 


[[Page 52797]]
proposed trading prices in different quotation systems, some with 
limited access. As a result, smaller retail customers do not always 
obtain the benefit of the best available price.

    \37\ See Securities Exchange Act Release No. 17583, supra note 
30.
---------------------------------------------------------------------------

    While these systems may have increased intermarket competition, the 
Commission believes that consolidated quotations and their 
dissemination to the public continue to be important elements of the 
NMS. Moreover, while competition is an important goal of the NMS, 
competition based on fragmented quotations may reduce efficient pricing 
of publicly disseminated bids and offers, thereby impeding the NMS goal 
of consolidated quotations. More importantly, the availability of 
accurate quotation information enables investors to police the efforts 
of their brokerage firms to obtain the best price possible for their 
orders.
    Over 20 years ago, the Commission noted that an essential purpose 
for the establishment of an NMS ``is to make information on prices, 
volume, and quotes for securities in all markets available to all 
investors, so that buyers and sellers of securities, wherever located, 
can make informed investment decisions and not pay more than the lowest 
price at which someone is willing to sell, or not sell for less than 
the highest price a buyer is prepared to offer.'' 38 In adopting 
the 1975 Amendments, Congress embraced the Commission's position by 
specifying in Section 11A(a)(1)(C)(iii) of the Exchange Act that it is 
in the public interest and appropriate for the protection of investors 
and the maintenance of fair and orderly markets to assure ``the 
availability to brokers, dealers and investors, of information with 
respect to quotations for and transactions in securities.'' 39

    \38\ Securities and Exchange Commission, Statement of the 
Securities and Exchange Commission on the Future Structure of the 
Securities Markets (Feb. 2, 1972) (``Future Structure Statement'') 
at 9-10, 37 FR 5286, 5287 (Feb. 4, 1972) (emphasis added). See also 
SEC, Policy Statement of the Securities and Exchange Commission on 
the Structure of a Central Market System (1973) at 25-28.
    \39\ 15 U.S.C. Sec. 78k-1(a)(i)(c)(iii).
---------------------------------------------------------------------------

    The proposed amendments to the Quote Rule are intended to improve 
the quality and expand the scope of published quotation information 
from OTC market makers and specialists by requiring them to reflect in 
their public quotes the bid and offer prices (e.g., priced orders) they 
disseminate through electronic communications networks that provide the 
ability to execute against these priced orders. The amendments are 
designed specifically to address what the Commission believes to be the 
potential for market makers to quote one price to public investors but 
to publish firm quotes in private systems at better prices.
2. Proposed Amendments
a. Definition of Subject Security
    Coverage of the Quote Rule would be expanded pursuant to proposed 
subparagraph (a)(6), which defines a ``covered security.'' As proposed, 
a covered security would mean any reported security and any other 
security for which a transaction report, last sale data or quotation 
information is disseminated through an automated quotation system as 
described in Section 3(a)(51)(A)(ii) of the Exchange Act.40 This 
expansion of coverage would bring Nasdaq SmallCap securities within the 
scope of the Quote Rule.41 Thus, market makers in those securities 
would be obligated under the Rule, as well as NASD rules, to provide 
quotes and to honor those quotes in trading with the public.42

    \40\ 15 U.S.C. Sec. 78c(a)(51)(A)(ii).
    \41\ Section 11A(c)(1) grants the Commission the authority to 
prescribe, among other matters, rules and regulations to assure 
accurate and reliable quotations ``with respect to any security 
other than an exempted security.'' The Commission believes that 
extending the requirements of the Quote Rule to Nasdaq SmallCap 
securities will further these interests.
    \42\ In addition to the changes discussed in greater detail 
herein, the Commission is proposing to make technical, non-
substantive changes to the Quote Rule. The terms ``association,'' 
``revised bid or offer,'' and ``revised quotation size'' will be 
separately defined in the rule. The definition of ``exchange-traded 
security'' has been revised to exclude OTC securities traded on an 
exchange pursuant to unlisted trading privileges. The definition of 
``plan processor'' has been amended to reflect the appropriate 
cross-reference. The definition of ``principal market'' has been 
removed from the Quote Rule because it is no longer applicable. In 
addition, the definitions have been rearranged in alphabetical 
order.
    Paragraph (b)(1)(i) of the rule has been reorganized to 
separately set forth the exclusions in subparagraphs (A) and (B). 
Paragraph (b)(1)(iii) has been eliminated and the substance of the 
provision has been incorporated into paragraphs (b)(1)(i) and 
(b)(1)(ii).
    The Commission is also proposing to amend the definition of the 
term ``reported security'' as it appears in Rule 11Aa3-1(a)(4). The 
amendment alters the form but not the meaning of the term or its 
application. The amendment will make the term consistent with the 
definition of ``reported security'' in the Quote Rule.
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b. Market Makers That Trade More Than 1% of a Security in a Quarter
    The proposed amendments to the Quote Rule would expand the 
definition of a subject security to include non-Rule 19c-3 securities 
as well as Rule 19c-3 securities. As a result, firms that hold 
themselves out as willing to buy and sell non-Rule 19c-3 securities on 
a regular or continuous basis, even if they have not elected to 
register as market makers with the NASD, would be subject to the rule, 
contingent upon meeting the 1% threshold. Exchanges that trade more 
than 1% of either a Rule 19c-3 or a non-Rule 19c-3 security would also 
be required to make continuous two-sided quotes available to the 
public.
    The practical implication of this amendment is that the most active 
market makers in non-Rule 19c-3 securities, who currently have no 
obligations to report quotations, would be required to register as CQS 
market makers and disseminate continuous two-sided quotations publicly.
    The Commission also is proposing an amendment to the definition of 
``OTC market maker'' to include a market maker that holds itself out as 
willing to buy from and sell to its customers, if it does so on a 
regular or continuous basis. This would apply even if the market maker 
does not hold itself out as willing to buy and sell to the market in 
general. Dealers that internalize customer order flow in particular 
stocks, and dealers that hold themselves out to particular firms as 
willing to execute their customer order flow, and who execute these 
orders on a regular or continuous basis, would be considered market 
makers under the proposed amendment. As in the past, broker-dealers 
would not be considered to be holding themselves out as regularly or 
continuously willing to buy or sell a security if they occasionally 
execute a trade as principal to accommodate a customer's request. 
Moreover, the proposed definition does not encompass block positioning.
c. Use of Electronic Communications Networks
    The Commission is proposing to include prospectively within the 
definition of ``bid'' or ``offer'' under the Quote Rule priced orders 
that market makers enter into widely disseminated electronic 
communications networks, thereby requiring market makers to include 
such orders in the bids and offers they communicate to their exchange 
or association for reflection in their published quotations.43 New 
paragraph (c)(5)(i)(A) would deem, prospectively, dissemination of a 
priced order by an exchange market maker, defined to include 
specialists, and an 

[[Page 52798]]
OTC market maker in an electronic communications network to be a 
publication of a bid or offer.44 The rule would not require the 
OTC market maker or specialist to publish in its publicly disseminated 
quote the full size of the priced order included in the electronic 
communications network. Rather, the OTC market maker or specialist 
would be required to disseminate publicly the price of the order and 
the minimum size set by the exchange or association.

    \43\ Paragraph (a)(3) of the amended Quote Rule defines the 
terms ``best bid'' and ``best offer'' to mean the highest priced bid 
and lowest priced offer.
    Conforming amendments to the definition of ``bid'' and ``offer'' 
and paragraph (c)(1) are proposed to, in effect, require brokers and 
dealers to report their ``best bids'' and ``best offers'' rather 
than their ``most recently'' communicated bids and offers. This 
represents a change from the existing rule's reliance on a temporal 
standard to a price standard.
    \44\ Pursuant to proposed subparagraph (c)(4)(i), no exchange or 
OTC market maker would be able to make available, disseminate or 
otherwise communicate to any quotation vendor, directly or 
indirectly, for display on a terminal or other display device any 
bid, offer, quotation size, or aggregate quotation size for any 
covered security which is not a subject security with respect to 
such exchange or OTC market maker.
---------------------------------------------------------------------------

    The term ``electronic communications network'' would include 
continuous auction systems, but is not intended to include crossing 
systems or broker-dealer internal order routing systems. The term 
``priced order'' within the rule refers to orders at a specified price, 
not indications of interest. Thus, the Commission intends the scope of 
this proposal to include disseminated commitments to buy or sell a 
security at a particular price for a particular number of shares (which 
may be effected in whole or in part). The Commission does not intend 
the scope of the amendments to include disseminated interest to buy or 
sell a security where price or the number of shares is not included as 
part of the dissemination. Furthermore, the rule does not apply to odd-
lot orders. Unlike the other proposals, these proposed amendments do 
not include exceptions for block orders or orders for which an OTC 
market maker's or specialist's customer has expressly requested that 
the order not be displayed. However, the Commission requests comment on 
whether the rule should exclude orders where an OTC market maker or 
specialist is acting as agent if its customer requests that the order 
not be displayed.
    The Commission recognizes that the exchanges and the NASD impose 
minimum price variations for securities traded or quoted by their 
members. For example, currently most exchange-listed securities are 
quoted and traded with a minimum price variation of \1/8\ point or, in 
some instances, \1/16\ point. Nasdaq securities may be traded and 
reported in variations as low as \1/256\, and may be quoted in minimum 
variations of \1/16\. Some existing electronic communications networks 
allow for trading variations as low as \1/256\, and some systems also 
provide for decimal variations as low as a penny. The fact that systems 
allow for different minimum variations in the quote may cause conflicts 
for OTC market makers and specialists attempting to comply with the 
proposed amendments to the Quote Rule. For example, a market maker may 
submit an order in an electronic communications network at a price of 
20\5/16\, but only have the facility to post a quote in the primary 
market in minimum variations of \1/8\. The Commission does not intend 
to create incentives for OTC market makers or specialists to increase 
the size of the fractions they would quote in electronic communications 
networks or in any other market. As such, the proposed amendment to the 
quote rule, if adopted, may necessitate simultaneous changes to the 
minimum price variations across markets.
    The proposed amendments would ensure that OTC market makers and 
specialists in a stock reflect in their quotes superior priced 
quotation information including buy and sell orders in that stock that 
they have entered into electronic communications networks, as 
described. As a result, an OTC market maker or specialist that was 
making a continuous market in a stock, but was not previously 
publishing quotes in that stock, would obligate itself by making quotes 
available to electronic communications networks to publish two-sided 
quotes in that stock. While this obligation to publish quotations 
resulting from entry of a priced order in an electronic communications 
network would end once the order is removed from the network, as a 
practical matter, immediate withdrawal of public quotations could 
result in the OTC market maker or specialist being unable to re-enter 
quotations for that security for a subsequent period.
3. Request for Comments
    The Commission requests comment on issues raised by the proposed 
amendments to the Quote Rule. Concerning the proposed addition of 
quotations in non-Rule 19c-3 securities in the existing mandatory and 
voluntary Quote Rule requirements, commenters are encouraged 
specifically to address the following questions:
    (1) The primary effect of this amendment is that the most active 
market makers in non-Rule 19c-3 securities (generally, those trading 
more that 1% of the consolidated volume in the securities), who 
currently are not required to disseminate quotes in the securities, 
would be required to register as ``CQS market makers,'' pursuant to 
NASD rules. The Quote Rule and NASD rules currently require CQS market 
makers, among other matters, to maintain firm, continuous two-sided 
markets in the securities they trade. The Commission seeks comment on 
whether the proposed amendment would result in more accurate and useful 
quotations. The Commission also seeks comment on whether market makers 
required to register as CQS market makers, and thereby maintain two-
sided quotes, should be granted greater ITS access.
    (2) In view of the various ITS and NASD restrictions on computer 
generated quotations, the Commission seeks comment on the costs and 
benefits to market participants and the markets in general that would 
be associated with the proposed amendments. The Commission also invites 
comment on whether amendments to SRO rules are necessary to achieve the 
Commission's objectives.
    Concerning the proposed amendment for inclusion of best bids and 
offers that are disseminated through electronic communications 
networks, the Commission specifically seeks comment on the following 
issues:
    (1) The proposed amendments are designed to deter fragmented 
markets and to promote improved quotations. The Commission seeks 
comment on whether the proposed amendments achieve this goal, and 
invites suggestions for alternatives to the rule that would better 
achieve this goal. The Commission also requests comment generally as to 
whether there are business justifications or economic rationale for 
permitting market makers to publish bid and offer prices for execution 
in electronic communications networks which differ from their 
quotations in public markets. The Commission requests comment on 
whether market participants utilize electronic communications networks 
to quote in finer increments because such finer increments are not 
possible on an exchange or Nasdaq.
    (2) The Commission notes that the proposed rule will have the 
effect of prohibiting market makers that do not currently publish 
quotes in a covered security from placing an order, bid or offer into 
an electronic communications network, unless they elect to publish 
quotations for such orders in that security. The Commission seeks 
comment on whether this result is appropriate.
    (3) The Commission seeks comment on the types of electronic 
communications networks that would be subject to the rule. The 
Commission solicits comment on whether the definition of the term 
``electronic 

[[Page 52799]]
communications network'' unintentionally captures crossing systems or 
broker-dealer internal order routing systems or any other systems 
inconsistent with the Commission's objectives. The Commission also 
seeks comment on whether the proposal should apply to crossing systems 
or broker-dealer internal systems in some manner. Finally, the 
Commission seeks comment on the competitive effects of the proposal on 
existing electronic communications networks, their subscribers and 
users, and whether there are alternatives to the proposal that would 
minimize any negative competitive effects while achieving the 
Commission's goals. For example, should the Commission require these 
systems to furnish these prices to the applicable exchange or 
association for further dissemination, and provide some access, such as 
a linkage, to the prices in their electronic network?
    (4) As indicated in the discussion, differences in the minimum 
trading variation across markets and electronic communication networks 
raise concerns about how the proposed amendment to the Quote Rule would 
apply across all systems. The Commission seeks comment on the steps 
necessary to ensure that differential minimum variation requirements do 
not frustrate the purposes of the rule. What modifications to SRO 
member firm facilities are required?
    Would an acceptable alternative be to require an OTC market maker 
or specialist that enters a priced order at a smaller price variation 
than is used by the exchange or association's quotation system, to 
display a quotation at a price that is rounded to the next quotation 
increment used in that market? While this approach would not provide 
full public disclosure of the better price available in the electronic 
communications network, it also would not require changes to existing 
quotation systems.
    (5) As discussed above, the proposed amendments would not apply to 
any firm that occasionally executes customer orders as principal, but 
does not generally hold itself out as willing to buy and sell the 
security. The Commission seeks comment on whether the proposed 
amendments should be modified to include these firms in the definition 
of OTC market maker. In addition, the Commission requests suggestions 
for alternative language to achieve the Commission's stated goals.
    (6) The Commission requests comments on whether there should be 
exceptions under the rule, and if so, under what circumstances. 
Specifically, the Commission seeks views on whether the rule should 
exclude orders where a market maker is acting as agent if its customer 
expressly requests that the order not be displayed. In particular, 
should an exception be provided for customer limit orders entered into 
an electronic communications network if the customer has requested, 
pursuant to the exception from the limit order display rule, that its 
limit order not be displayed?
    (7) The proposed rule would only require OTC market makers and 
specialists to display the minimum quotation size established by an 
exchange or association for an order displayed in an electronic 
communications network. Should the OTC market maker or specialist be 
required to display publicly the full size of the order? Alternatively, 
should the rule require the public display of the full size unless the 
customer requests otherwise?
4. Consideration of the Proposed Rule's Costs and Benefits
    The proposed amendments would require some market participants to 
modify their current quotation dissemination systems. Although the 
Commission believes that these amendments would not impose significant 
implementation costs, it seeks comment on the order of magnitude of the 
costs. The Commission believes that the proposed amendments would 
provide several benefits to the markets and to investors in those 
markets, including improved price discovery, liquidity and competition 
between market makers. In addition, the proposed amendments would 
improve execution prices of customer market orders that are priced off 
the consolidated best bids and offers. These benefits are distributed 
across a wide constituency, so the Commission seeks guidance on how 
best to evaluate the benefits associated with the proposed amendments.
    The Commission seeks detailed comment on the following specific 
questions regarding the costs and benefits of amendments to the Quote 
Rule:
    (1) What system changes and costs under the proposed amendments to 
the Quote Rule would be necessary?
    (2) If the amendments were adopted, what would be the likely impact 
on OTC market makers, specialists, and electronic communications 
networks?
    (3) Currently, some market makers receive the benefits associated 
with OTC market maker or specialist designation (e.g., favorable margin 
treatment, short-sale trading exemptions, and enhanced market access) 
without being required to disseminate continuous two-sided quotes. How 
should the Commission quantify the benefits derived from OTC market 
maker or specialist status? How should the Commission quantify the 
costs associated with disseminating continuous two-sided quotes? In 
particular, how should the Commission quantify the costs associated 
with disseminating such quotes manually, rather than through computer 
generated mechanisms?
    (4) How should the Commission assess the potential benefits 
associated with public access to the best prices in the market and how 
should those benefits be quantified?
    (5) How would the proposed amendments contribute to transparency in 
the market and how should the improvements in transparency be 
quantified?
    (6) To the extent that OTC market makers and specialists maintain 
superior bids (offers) in electronic communications networks, those 
bids (offers) would be reflected in the consolidated quotes that are 
available to the public. How should the Commission quantify the savings 
to customers associated with the concomitant narrowing of publicly 
disseminated spreads?

B. Display of Customer Limit Orders

1. Background
    The failure to display limit orders that are priced better than 
current quotes raises at least three regulatory concerns. First, the 
failure to display limit orders can produce an artificial widening of 
spreads, raising the concern that investors may not have access to 
optimum prices. Second, there are concerns about fair competition. If 
the quotes from a market or market maker do not fully represent the 
buying and selling interest in a given security, quote competition is 
less keen, and the price discovery process may be impaired. Third, 
because many markets and market makers offer automatic executions of 
small orders at the best displayed quotes, a failure to display limit 
orders that improve the best displayed quotes can result in inferior 
executions for these orders.
    In connection with Market 2000,45 the Commission received 
comments 

[[Page 52800]]
concerning whether the optimal degree of pre-trade disclosure of limit 
orders was being achieved within a given market. Some commentators 
alleged that specialists and third market dealers sometimes fail to 
display limit orders priced better than the displayed quotation.46 
Questions were also raised about the lack of limit order exposure on 
Nasdaq. Although the OTC market recently has made improvements in the 
manner in which customer limit orders are handled, there is no 
requirement that limit orders be displayed.47

    \45\ Market 2000 recommended that the securities exchanges 
consider whether to encourage the display of all limit orders (i.e., 
orders to buy or sell at a specified price) in listed stocks priced 
better than the best intermarket quotes, unless the ultimate 
customer requests that the order not be displayed. Market 2000 also 
recommended that the NASD consider whether to encourage the display 
of limit orders in Nasdaq stocks when the orders are at prices 
better than the best Nasdaq quotes, unless the customer requests 
that the order not be displayed. See Market 2000, supra note 4 at 
IV-6.
    \46\ See Thomas H. McInish & Robert A. Wood, ``Hidden Limit 
Orders on the NYSE'', 21 J. Portfolio Mgmt 19 (No. 3, Spring 1995). 
The authors assert that New York Stock Exchange (``NYSE'') 
specialists only display about 50% of limit orders that better 
existing quotes. In their opinion, this practice represents a 
serious policy issue because it places both public investors and 
regional exchanges at a disadvantage. They assert that hiding limit 
orders impedes strategic decisions on order placement; results in 
publicly submitted market orders receiving inferior prices; hampers 
the monitoring of order executions; reduces the probability of a 
limit order being executed; results in a delay in reporting limit 
order executions; interferes with the ability of the regional 
exchanges to execute public orders; and artificially improves NYSE 
performance relative to the regional exchanges using a common 
benchmark. The authors also claim that NYSE Rule 60 is ambiguous in 
that the specialists may have some leeway in choosing what to 
disclose in their quotes. The NYSE, in Information Memo 93-12, infra 
note 51-52 and accompanying text, reminded members of the duty to 
represent limit orders at their limit prices when requested to do 
so. Some traders, however, have continued to accuse NYSE specialists 
of hiding limit orders. See Traders Accuse Specialists of Holding 
Back Limit Orders, Investment Dealers' Digest, 8, (Feb. 14, 1994).
    In its comment letter to Market 2000, however, the NYSE asserted 
that its publicly disseminated best bid or offer includes all firm 
trading interest announced on the floor as required by the 
exchange's rules. See Letter from William H. Donaldson, Chairman and 
Chief Executive Officer, NYSE, to Jonathan G. Katz, Secretary, SEC 
at 25-26 (Nov. 24, 1992) (``NYSE Letter''). In addition, as 
discussed later, a recently issued NYSE policy statement indicates 
that specialists have an obligation to reflect in their quotes 
certain limit orders received manually or via the Designated Order 
Turnaround System (``SuperDot''). See infra note 54-55 and 
accompanying text.
    \47\ See infra note 56-60 and accompanying text.
---------------------------------------------------------------------------

    Section 11A(a)(1)(C)(v) of the Exchange Act expresses Congress' 
goal that, consistent with the other objectives of the NMS, investor 
orders, including limit orders, should be permitted to interact without 
the participation of a dealer.48 Congress envisioned that the NMS 
would make all specialists and market makers aware of public customer 
limit orders held anywhere in the system, and provide enhanced 
protection and priority for those orders.49

    \48\ 15 U.S.C. Sec. 78k-1(a)(1)(C)(v) (1988).
    \49\ Senate Report, supra note 15 at 18 (``The Committee is 
satisfied that [the legislation] grants the Commission complete and 
effective authority to implement a system for the satisfaction of 
public limit orders.'').
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    The Commission does not believe that the differences between dealer 
and auction markets compel different results in the degree of investor 
protection afforded in competing markets. Accordingly, the Commission 
believes it is appropriate at this time, and consistent with investor 
expectations, to propose the uniform disclosure of customer limit 
orders across all markets. The increased transparency of customer limit 
orders in all markets could produce, among other benefits, spreads that 
more fully represent buying and selling interest in the market and 
enhance an investor's ability to monitor execution quality. This, in 
turn, should increase competition among dealers based on their 
respective quotations.
    The Commission also believes that the proposed rule will benefit 
orders routed to automated execution systems. Execution on these 
systems is often tied to the best displayed quotation for a particular 
security. The display requirement should result in executions at prices 
that more accurately reflect buying and selling interest in the market, 
thus resulting in better executions for orders priced through automated 
execution systems.
2. Discussion
    Limit orders currently are handled differently in the various 
auction and dealer markets. Generally, exchange rules require that a 
limit order be displayed in the quotation for a security when it 
improves the best bid or offer. NYSE specialists, for example, must 
reflect a customer limit order in their quotations at the limit price 
when requested to do so.50 In addition, the NYSE's order handling 
procedures assume that all limit orders routed to a specialist through 
SuperDot implicitly contain a display request.51 Therefore, except 
in the unusual and infrequent circumstance where a specialist believes 
market conditions suggest the likelihood of imminent price improvement, 
a limit order received by a specialist through SuperDot should be 
reflected in the specialist's quote as soon as practicable following 
receipt of the order.52 According to the NYSE, 93% of all limit 
orders that improve the best bid or offer displayed are reflected in 
the specialist's quote within two minutes of receipt, while 98% of such 
limit orders are reflected within five minutes of receipt.53

    \50\ See NYSE Rule 79A.10 (when a limit order is presented to 
the specialist by a floor broker, the floor broker must 
affirmatively request that the specialist display the limit order; 
failure to so request leaves the decision whether to display the 
limit order to the discretion of the specialist); see also NYSE Rule 
60 (requiring specialists to promptly report, inter alia, the best 
bid and offer in the trading crowd in each reported security in 
which the specialist is registered).
    Of course, adoption of the Commission's proposal would supersede 
any exchange or association rule regarding the display of customer 
limit orders to the extent such exchange or association rule is 
inconsistent with the Commission's proposal.
    \51\ NYSE Information Memo 93-12 (Mar. 30, 1993).
    \52\ Id.
    \53\ Telephone Conference between Edward A. Kwalwasser, 
Executive Vice President, NYSE, and Holly Smith, Associate Director, 
Division of Market Regulation, SEC, January 9, 1995.
    Other exchanges also have rules regarding dissemination of bids 
and offers. Generally, these rules either cite, in whole or in part, 
language from the Quote Rule, or are drafted in such a manner as to 
allow for broad interpretation with respect to the display of limit 
orders. See, e.g., Boston Stock Exchange Guide, Rules of the Board 
of Governors, Chapter II, Sec. 7, (CCH) para. 2020; Pacific Stock 
Exchange Guide, Rules of the Board of Governors, Rule 5.6(f), (CCH) 
para. 3979; American Stock Exchange Guide, General and Floor Rules, 
Rule 115, (CCH) para. 9265; Chicago Stock Exchange Guide, Article 
XX, Rule 7, (CCH) para. 1688; Philadelphia Stock Exchange Guide, 
Rules 105 and 229 (CCH) para. 2105 and 2229.
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    The Commission recently approved a proposed rule change by the NYSE 
that clarifies the exchange's policy with respect to the display of 
limit orders received by a specialist.54 This policy requires 
specialists to display the full size of all orders received through 
SuperDot as well as orders received by specialists manually which are 
subsequently entered into the electronic book. This requirement 
includes increasing the size of a quotation for orders at the same 
price as the current bid or offer; when a member requests that less 
than the full size of the order be shown, the specialist is obligated 
to show the size requested. Specialists must display as soon as 
practicable any order which, in relation to current market conditions 
in a particular security, represents a material change in the supply or 
demand for that security. If the quotation already reflects significant 
supply or demand, and the specialist receives an order that is de 
minimis in relation to such supply or demand, the specialist may take a 
reasonable time (generally not more than two minutes) before updating 
the size of the quotation.55

    \54\ See Securities Exchange Act Release No. 35687 (May 8, 
1995), 60 FR 25751 (May 12, 1995) (notice of the proposal), and 
Securities Exchange Act Release No. 36231 (Sept. 14, 1995), 60 FR 
48736 (Sept. 20, 1995) (approval order).
    \55\ The NYSE provides the following example of when a 
specialist may take a reasonable time to update the size of the 
quotation: If the market in XYZ security is 20 (5000)-20\1/4\ 
(50,000), and the specialist receives an order to sell 200 shares at 
20\1/4\, such order would be considered de minimis and the 
specialist would be permitted to wait a reasonable period of time 
(but not more than two minutes) before changing the size of the 
offer to 50,200. The Commission requests comment on whether, in the 
context of its rule proposal, a discretionary de minimis threshold 
is appropriate; whether an alternative standard (e. g., 5% of the 
outstanding size) is appropriate; or whether there should be no 
exception for de minimis size orders. See Part 4, Request for 
Comments (No. 3). 

[[Page 52801]]

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    The OTC market operates as a dealer market, in which the quote for 
any security represents a dealer's own bid and offer. The rules of the 
NASD currently do not require market makers to display customer limit 
orders that better the best bid or offer for the security.56 
Generally, customer limit orders in OTC securities either will be 
routed to a broker-dealer's market making desk or to a non-affiliated 
market maker for execution if the firm does not make a market in the 
security.57 In the past, market makers typically did not execute 
limit orders until the best bid or offer displayed on Nasdaq equaled 
the limit price. This practice has changed, however, over the course of 
the past year. In June 1994, the Commission approved a proposed rule 
change filed by the NASD that prohibits broker-dealers from trading 
ahead of their customers' limit orders.58 The Commission further 
expanded this prohibition in May 1995, when it approved another NASD 
proposed rule change that prohibits broker-dealers from trading ahead 
of customer limit orders they accept from other brokers.59 The 
Commission also has published for comment a proposed rule change filed 
by the NASD that would require, in certain circumstances, the display 
of customer limit orders for exchange-listed securities traded 
OTC.60

    \56\ See NASD Manual, Schedule D to the By-Laws, Part V, Section 
2 (CCH) para. 1819.
    \57\ Market 2000, supra note 4 at V-5.
    \58\ See Securities Exchange Act Release No. 34279 (June 29, 
1994), 59 FR 34883 (July 7, 1994).
    \59\ See Securities Exchange Act Release No. 35751 (May 22, 
1995), 60 FR 27997 (May 26, 1995).
    \60\ See Securities Exchange Act Release No. 35471 (Mar. 10, 
1995), 60 FR 14310 (Mar. 16, 1995). The proposed rule, applicable to 
exchange listed securities traded OTC, generally would require a 
market maker either to execute immediately a limit order of 500 
shares or less priced better than the market maker's quotation, or 
display the order in its quotation with a minimum quotation size of 
500 shares. Limit orders greater than 500 shares would be required 
to be displayed in the market maker's quotation but the quotation 
size need not equal the size of the limit order. Any portion of the 
order not displayed, however, would have to be executed at a price 
at least as favorable as the displayed price.
---------------------------------------------------------------------------

    The exchanges and the NASD use automated trading systems to route 
and, in some instances, execute orders of predetermined size. Some of 
these systems accept limit orders. Each system, however, may differ in 
its handling of limit orders that are not executed immediately upon 
receipt. For example, the NYSE's SuperDot system routes limit orders to 
the specialists' posts where they are handled in accordance with NYSE 
rules governing specialist representation of such orders. The American 
Stock Exchange's (``Amex'') PER system routes limit orders in the same 
manner as SuperDot and the orders are handled in accordance with Amex 
rules. The NASD's Small Order Execution System (``SOES'') treats limit 
orders priced at the current inside market as market orders that are 
immediately executed.61 All other limit orders reside in a limit 
order file that can be reviewed by market makers.62 The NASD has 
filed for Commission approval a proposed system, ``NAqcess,'' that 
would replace SOES and include a limit order file designed to improve 
the handling of customer limit orders.63

    \61\ Preferenced orders (i.e., orders routed to a specific 
market maker pursuant to a pre-existing agreement) are executed 
immediately at the inside quote. Unpreferenced orders are executed 
against market makers in a security in rotation. SOES, however, does 
not execute an unpreferenced order against a single market maker 
more than once every 15 seconds.
    \62\ The current SOES rules have been extended, with certain 
changes that do not affect the handling of limit orders, through 
October 2, 1995. See Securities Exchange Act Release No. 35535 (Mar. 
27, 1995), 60 FR 16690 (Mar. 31, 1995). The NASD has requested that 
the Commission grant a further extension through January 31, 1996. 
Securities Exchange Act Release No. 36154 (Aug. 25, 1995), 60 FR 
45502 (Aug. 31, 1995).
    \63\ See File No. SR-NASD-95-42, submitted on September 22, 
1995.
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    The Commission is proposing new Rule 11Ac1-4 to require the uniform 
display of customer limit orders that improve a specialist's or OTC 
market maker's best bid or offer for a particular security as well as 
the size of such orders. In addition, the rule would require the 
display of the size of certain limit orders priced at the NBBO. The 
Commission has considered and is building upon the special role played 
by market makers and specialists in discovering prices and providing 
liquidity to the securities markets. While the proposed rule generally 
mandates display of limit orders, market makers and specialists still 
would retain some flexibility in handling limit orders accepted for 
execution.
    Specifically, the rule would allow an OTC market maker or 
specialist, immediately upon receipt of the limit order, to: (1) Change 
its quote and the size associated with its quote to reflect the limit 
order; (2) execute the limit order; (3) place the limit order in a 
limit order book in its own market or another market that complies with 
the requirements of the rule; or (4) send the limit order to another 
market maker or specialist who complies with the requirements of the 
rule. The proposed rule prescribes the duty of a specialist or OTC 
market maker to display a customer limit order when the order is 
``held'' by the specialist or OTC market maker. If the specialist or 
OTC market maker immediately sends the order to a limit order book or 
another specialist or OTC market maker that would display the order in 
compliance with the rule, the specialist or OTC market maker that 
routes the order would have no duty to display. The Commission believes 
that these alternatives will provide all market makers, specialists, 
and market centers an opportunity to continue to provide their valuable 
services while offering customers the best available execution 
opportunities.
3. Proposed Rule
    Proposed Rule 11Ac1-4 applies to ``customer limit orders'' in 
``covered securities.'' A covered security is defined as any reported 
security and any other security for which a transaction report, last 
sale data or quotation information is disseminated through an automated 
quotation system that is sponsored by a registered securities 
association. This definition is designed to encompass all exchange-
listed securities, Nasdaq National Market securities and Nasdaq 
SmallCap securities.64

    \64\ Regionally listed securities that do not substantially meet 
NYSE or Amex original listing criteria do not satisfy the definition 
of ``covered security.'' Such securities are not ``reported 
securities'' as that term is defined, nor do they meet the other 
elements of the definition of covered security. OTC Bulletin Board 
(``OTCBB'') securities also do not satisfy the definition of covered 
security. The Commission has determined not to extend the display 
requirement to such securities at the present time. The Commission 
requests comment, however, on the appropriate scope of the rule. See 
Part 4, Request for Comments (No.5).
---------------------------------------------------------------------------

    A customer limit order includes any order to buy or sell a covered 
security at a specified price not for the account of a broker or 
dealer. Limit orders transmitted for execution by a broker or dealer on 
behalf of a customer are included in the definition.65 The size of 
any limit order that improves the NBBO would be displayed in full. The 
size of a limit order priced at the NBBO would be displayed when it 
represents more than a de minimis change in relation to the size 
displayed by the specialist or OTC market maker.

    \65\ SRO rules typically provide some time and price priority 
for orders submitted by non-broker-dealer customers, in recognition 
of the time and price advantages associated with professional 
orders. But see Securities Exchange Act Release No. 35751, supra 
note 59, in which the Commission discussed the appropriateness of 
excluding options market makers from the customer class protected by 
the NASD prohibition against ``trading ahead.'' 

[[Page 52802]]

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    The proposed rule would apply to: (i) Every member of an exchange 
that is registered by that exchange as a specialist or has been 
authorized by an exchange to perform functions substantially similar to 
that of a specialist (collectively ``specialist''); 66 (ii) third 
market makers; 67 (iii) members of an association that are OTC 
market makers; 68 and (iv) exchange members that trade an OTC 
security pursuant to UTP.69 These persons would be required to 
reflect immediately in their bid or offer the price and size of each 
customer limit order they hold at a price that would improve their bid 
or offer in the security.70 For example, in the case where a 
person covered by the rule is quoting 10-10\1/2\ when it receives a 
customer limit order in a covered security to buy at 10\1/4\, it must 
change its bid to 10\1/4\ immediately to reflect the limit order. The 
size of the order also must be included in the quote. Where the order 
betters the NBBO, the person would be required to change the price and 
size of its quote regardless of the size of the limit order, except in 
the case of an odd-lot or block size order. Nasdaq market makers, 
however, are subject to minimum quotation size requirements which 
depend on the characteristics of the security. The proposed rule would 
require that the size of the customer limit order be displayed. The 
Commission recognizes, therefore, that the NASD may need to amend its 
quote size rules to allow display of small customer limit 
orders.71

    \66\ Proposed Sec. 240.11Ac1-4(b)(1)(i).
    \67\ Proposed Sec. 240.11Ac1-4(b)(1)(ii).
    \68\ Proposed Sec. 240.11Ac1-4(b)(2)(i). If an OTC market maker 
is not quoting publicly, it still must publish a quotation that 
identifies the limit order, or avail itself of one of the 
exceptions.
    \69\ Proposed Sec. 240.11Ac1-4(b)(2)(ii).
    \70\ See Proposed Sec. 240.11Ac1-4(b)(1)(i)(A), (b)(1)(ii)(A), 
(b)(2)(i)(A) and (b)(2)(ii)(A). The Commission notes that the rule 
does not provide for any discretion in the timing of the display of 
the limit order.
    \71\ See also Section II.C.2. (regarding proposed price 
improvement rule).
---------------------------------------------------------------------------

    All persons covered by the rule also would be obligated to reflect 
in their quotes the size of a customer limit order that: (1) Is priced 
equal to their bid or offer; (2) is priced equal to the national best 
bid or offer for the security; and (3) represents more than a de 
minimis change in relation to the size associated with their bid or 
offer.72 For example, assume a regional specialist's quote is 10 
(1000)-10\1/2\ (1000), when the specialist receives a customer limit 
order to buy 2000 shares at 10. Assume further that the NBBO is 10-
10\1/4\. Under the rule, the specialist would be obligated to change 
immediately its bid to 10 (3000).

    \72\ See Proposed Sec. 240.11Ac1-4(b)(1)(i)(B), (b)(1)(ii)(B), 
(b)(2)(i)(B) and (b)(2)(ii)(B).
---------------------------------------------------------------------------

    As noted above, the rule would require the ``immediate'' display of 
certain customer limit orders. To satisfy this requirement, a 
specialist or OTC market maker must display the limit order immediately 
upon receipt unless there exists an applicable exception to the display 
requirement.
    There are six exceptions to the general requirements of the 
proposed rule. The first exception applies to any customer limit order 
that is executed upon receipt of the order.73 If the order is 
executed upon receipt, then no duty arises under the proposed rule.

    \73\ Proposed Sec. 240.11Ac1-4(c)(1).
---------------------------------------------------------------------------

    The second exception applies to any limit order that is placed by a 
customer who expressly requests that the order not be displayed.74 
This exception is included because there may be instances where a 
customer may prefer to exclude its order from public display. This 
exception will permit customers to negotiate individually execution 
parameters for the handling of their orders with their broker-dealers 
either on an order-by-order basis or prospectively. Standardized 
disclaimers or contractual language by a firm would not be deemed to be 
a request by a customer that its order not be displayed. For example, a 
customer with a large limit order may wish to let its broker work the 
order rather than display the entire order. This exception gives the 
customer the right to decide if the order should be displayed in total, 
in part, or not at all. The rule would require a customer to expressly 
request that an order not be displayed. A customer request that an 
order be placed in a particular non-public trading system would not, by 
itself, be deemed to come within the exception. The Commission expects 
that most retail customers will want their limit orders displayed 
pursuant to the rule. Thus, the Commission has crafted the rule to 
require specialists and OTC market makers to assume that retail 
customers wish to have their orders displayed.

    \74\ Proposed Sec. 240.11Ac1-4(c)(2).
---------------------------------------------------------------------------

    The third exception applies to odd-lot orders.75 The rule does 
not require the display of an order for less than a unit of trading 
pursuant to the rules of the exchange or association. In the event that 
a round-lot limit order represented in the quote is partially filled 
and, as a result, would then be deemed an odd-lot order, the exchange 
or association may treat the remainder of the order as an odd-lot for 
purposes of this rule.

    \75\ Proposed Sec. 240.11Ac1-4(c)(3).
---------------------------------------------------------------------------

    The fourth exception applies to block size orders.76 Orders of 
at least 10,000 shares or for a quantity of stock having a market value 
of at least $200,000 need not be displayed in accordance with the 
rule.77 Customers placing block orders, however, may request that 
the order be displayed in accordance with the requirements of the rule. 
The specialist or OTC market maker would be obligated to honor such a 
request.

    \76\ Proposed Sec. 240.11Ac1-4(c)(4).
    \77\ This block definition is consistent with the current 
definition used in NYSE Rule 127.10.
---------------------------------------------------------------------------

    The fifth exception applies to a limit order that is delivered 
immediately to an exchange or association sponsored system that 
displays limit orders and complies with the requirements of the rule 
with respect to that order.78 This exception, however, does not 
relieve a specialist or OTC market maker from its display obligation 
for orders it receives through exchange or association facilities, 
unless the system itself displays the order.

    \78\ Proposed Sec. 240.11Ac1-4(c)(5).
---------------------------------------------------------------------------

    The sixth exception applies to a limit order that is delivered to 
another exchange member or OTC market maker that complies with the 
display requirements of the rule with respect to that order.79 For 
example, a market maker that receives a limit order subject to the 
display requirement under the rule may immediately send the order to 
another market maker in the security if it reasonably believes that the 
other market maker will display the order in accordance with this rule.

    \79\ Proposed Sec. 240.11Ac1-4(c)(6).
---------------------------------------------------------------------------

4. Request for Comments
    The Commission requests comment on issues raised by this proposal, 
including the following matters:
    (1) The proposed rule is designed to increase transparency of 
customer limit orders. The Commission seeks comment on whether the rule 
promotes transparency consistent with customers' agency expectations.
    (2) As discussed earlier, some commenters believe that specialists 
sometimes fail to display limit orders entered at prices better than 
the displayed quotation. The present rule proposal is designed, in 
part, to address this concern. Accordingly, the Commission seeks 
comment on the extent to which specialists currently fail to reflect 
immediately in their quotes limit orders that improve the best bid or 
offer; whether the rule addresses legitimate concerns that limit orders 
are not presently displayed in a consistent manner in all auction 
markets; and whether there may be situations where, 

[[Page 52803]]
in the interest of best execution, a specialist should have the 
discretion not to announce some or all of a customer's order on the 
floor.80

    \80\ See NYSE Letter, supra note 46 at 26 (specialist allowed to 
use professional judgment as an agent on how best to serve the 
customer). But see NYSE Information Memo 93-12, supra note 51 
(except in unusual and infrequent circumstances, a limit order 
received through SuperDot will be reflected in the specialist's 
quote).
---------------------------------------------------------------------------

    (3) In certain circumstances, the rule would require that the size 
of a customer limit order be reflected where the limit order is priced 
equal to the NBBO and represents more than a de minimis change in 
relation to the size displayed by the specialist or OTC market maker. 
The Commission seeks comment on whether it is appropriate to base the 
display requirement on a de minimis threshold; whether this threshold 
should be quantified (e.g., 5% of current quote size); or whether the 
size of all orders priced equal to the NBBO should be displayed.
    (4) The Commission seeks comment on whether the scope of the 
definition of ``block size'' is appropriate, particularly whether the 
definition should be changed to apply to orders of greater size or 
market value (e.g., 25,000 shares as in NYSE Rule 72(b)). 
Alternatively, the Commission requests comment on whether orders of 
block size should be subject to the display requirement.
    (5) The proposed rule would apply to exchange listed securities, 
Nasdaq National Market securities and Nasdaq SmallCap securities. The 
Commission seeks comment on the scope of the rule.
    (6) The Commission seeks comment on the rule's interaction with 
other initiatives, such as the NASD's proposal to create a new small 
order execution system; 81 the NASD's proposal to impose display 
requirements on market makers holding limit orders for exchange-listed 
securities traded over-the-counter; 82 and the NASD's trading 
ahead prohibitions.83

    \81\ See File No. SR-NASD-95-42, supra note 63.
    \82\ See Securities Exchange Act Release No. 35471, supra note 
60.
    \83\ See, supra note 58-59.
---------------------------------------------------------------------------

    (7) The Commission requests comment on whether the exception to the 
display requirement for limit orders delivered immediately upon receipt 
to an exchange- or association-sponsored system that displays those 
limit orders in accordance with the rule should be extended to 
electronic communications networks or other proprietary trading 
systems. If so, the Commission seeks comment on whether the extension 
of such exception should be predicated on the level of accessibility 
and transparency afforded by these systems.
    (8) The Commission seeks comment on whether it would be appropriate 
to include within the definition of limit orders those orders, however 
defined by a particular exchange or association, as to which a 
specialist, market maker or system sponsor has some discretion over the 
price at which the order is executed. For example, the Commission is 
interested in the potential costs and benefits of including CAP orders 
within the scope of the rule.84

    \84\ Such orders are percentage orders entered with a ``convert 
and participate'' instruction, and are executed based on the 
execution of other orders. For a discussion of percentage orders, 
see NYSE Rule 123A.
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    (9) The Commission seeks comment on the effect of the rule on 
passive market making activities pursuant to Rule 10b-6A of the 
Exchange Act (17 CFR 240.10b-6A).
    (10) The Commission seeks comment on whether a market maker should 
be required to obtain some form of assurance that a customer limit 
order it sends to another market maker will be displayed in accordance 
with this rule, before the market maker would be allowed to send the 
limit order pursuant to paragraph (c)(6) of the rule.
5. Consideration of the Proposed Rule's Costs and Benefits
    To evaluate fully the impact of the proposed rule, the Commission 
requests commenters to provide their views on the costs and benefits 
associated with the proposed rule, and any data that may support those 
views.
    The proposed limit order display rule would require market makers 
and specialists to display customer limit orders that either narrow 
their own spread or increase the size associated with the NBBO. This 
rule is intended to encourage quote competition between markets and 
market participants; to enhance customer-to-customer interaction 
without the intervention of a specialist or OTC market maker; to 
increase opportunities for the execution of limit orders; and to 
improve transparency in all markets.
    The Commission acknowledges that the display obligations would 
require some market participants to modify their current order handling 
and display practices. The Commission notes that market makers may 
continue to receive or demand compensation for executing customer limit 
orders, such as by charging a commission for handling the order. The 
Commission believes that the implementation cost of the proposed rule 
is minor, but seeks comment on the order of magnitude of such costs.
    The Commission envisions that this rule would have significant 
benefits for the financial markets and investors in those markets. 
Investors are expected to benefit from enhanced transparency, improved 
price competition and the interaction of customer orders without the 
intervention of a market maker or specialist, all of which should lower 
the cost for investors to trade in the market. The financial markets as 
a whole should benefit from the proposed rule because the price 
discovery process will be enhanced, market transparency will be 
improved and price competition will be promoted. By their very nature, 
these benefits are broad-based and pervasive. Because incremental 
amounts on a trade-by-trade basis produce significant cumulative 
amounts for the market as a whole, the Commission seeks guidance on how 
to represent accurately the savings associated with the implementation 
of this rule.
    The Commission seeks further comment on the following specific 
questions:
    (1) What would be the necessary system changes and costs associated 
with implementation of the limit order display rule?
    (2) If the rule were adopted, what would be the likely impact on 
OTC market makers and specialists? Would these effects on the 
commitment of capital be influenced by the trading characteristics of 
particular securities, e.g., high volume vs. limited volume?
    (3) The Commission recognizes that subsequent to adoption of the 
rule, market makers may need to charge commissions for the handling and 
display of public limit orders. What would be the anticipated level of 
commissions for a limit order and what would be the overall cost to the 
customer?
    (4) How should the Commission assess the potential benefits 
associated with the narrowing of spreads?
    (5) What would be the likely impact of the proposed rule on the 
depth of the market and how should that impact be quantified?
    (6) What would be the likely impact of the rule on the liquidity of 
the market and how should that impact be quantified?
    (7) How would the proposed rule contribute to transparency in the 
market and how should the improvements in transparency be quantified?
    (8) What degree of customer-to-customer interaction could be 
expected if the rule is adopted and what are the savings to those 
customers? 

[[Page 52804]]


C. Price Improvement for Customer Market Orders

1. Background
    The Commission today seeks comment on a market-wide price 
improvement rule for customer market orders. The rule would apply 
across exchange and OTC markets to promote best execution for all 
securities covered by the rule. The Commission also is proposing a non-
exclusive safe harbor as one means by which a specialist or OTC market 
maker can be assured that an order has received a sufficient 
opportunity for price improvement for purposes of the rule.
    The Commission believes this rule will encourage market 
participants to take advantage of current technologies and provide 
customer market orders with improved access to price improvement 
opportunities, regardless of where such orders are routed for 
execution. Although the proposed rule speaks to OTC market makers and 
specialists, if adopted it would have clear implications for the best 
execution obligations of broker-dealers generally. The Commission does 
not intend for the proposed rule to displace the existing best 
execution obligation; 85 rather, the Commission believes that the 
rule would complement the long-standing duties of broker-dealers to 
seek to obtain best execution of their customer orders. Moreover, the 
rule is intended to foster competition among markets and market makers 
on the basis of price improvement opportunities.

    \85\ See Payment for Order Flow Release, supra note 8.
---------------------------------------------------------------------------

    Although the rule proposed today would require OTC market makers 
and specialists to provide price improvement opportunities for customer 
orders, the Commission is not prescribing any particular method of 
achieving price improvement in recognition of the fact that competition 
can produce innovative price improvement mechanisms. However, to 
provide certainty regarding one alternative by which a specialist or 
OTC market maker will be deemed to have provided price improvement 
opportunities to customer market orders, the Commission is proposing a 
non-exclusive safe harbor. A specialist or OTC market maker that 
executes a customer market order in accordance with the conditions of 
the safe harbor would be deemed to have satisfied its price improvement 
obligation.
    The Commission wishes to stress, however, that the order exposure 
procedures set out in the proposed safe harbor are not mandatory, nor 
are they the exclusive means by which to satisfy the obligation to 
provide an opportunity for price improvement. The Commission believes 
that methods other than the exposure of customer orders can satisfy the 
obligation. The Commission is interested in receiving comment regarding 
alternative methods by which price improvement opportunities may be 
provided. For example, some specialists and OTC market makers utilize 
systems based on algorithms that automatically provide an opportunity 
for price improvement. Orders that are processed manually also can be 
provided enhanced opportunities to achieve better executions. The 
Commission requests comment on an alternative safe harbor procedure, 
described infra.86

    \86\ See Part 3, Request for Comments (No. 15).
---------------------------------------------------------------------------

    Under the safe harbor proposed today, a specialist or market maker 
would expose in its quote a customer order at an improved price and 
provide the customer with a guaranteed execution at the ``stop'' price. 
This procedure is designed to promote the interaction of exposed orders 
at prices better than the displayed NBBO with orders or trading 
interest in other markets. The safe harbor also could lead to increased 
competition by encouraging OTC market makers and specialists to compete 
more actively for order flow on the basis of their published 
quotations.
    The 1975 Amendments were designed to facilitate the creation of a 
``market characterized by economically efficient executions, fair 
competition, broad dissemination of basic market information and the 
maximum interplay of auction market principles.'' 87 One of the 
``paramount objectives'' Congress established for the NMS was ``the 
centralization of all buying and selling interest so that each investor 
will have the opportunity for the best possible execution of his 
order.'' 88 Congress made it clear that the Commission has broad 
discretion how best to facilitate the development of an NMS.89

    \87\ Senate Report, supra note 15 at 101.
    \88\ Id. at 100.
    \89\ Id. at 18, 19; accord H.R. Rep. No. 229, 94th Cong., 1st 
Sess. 29 (1975).
---------------------------------------------------------------------------

    The proposed safe harbor is based, in part, on the order exposure 
proposals considered by the Commission in 1982.90 In August 1983, 
the Commission postponed further action on these initiatives, due, in 
part, to then existing market structure and practices.91 The 
largest market maker trading Rule 19c-3 securities had ceased 
operations earlier that year and the Commission believed that, due to 
the low level of OTC trading in Rule 19c-3 securities and certain 
technological impediments, the costs associated with the rule would 
outweigh the benefits that could be achieved at that time.

    \90\ See Securities Exchange Act Release No. 18738 (May 13, 
1982), 47 FR 22376 (May 24, 1982); Securities Exchange Act Release 
No. 19372 (Dec. 23, 1982), 47 FR 58287 (Dec. 30, 1982).
    \91\ See Securities Exchange Act Release No. 20074 (Aug. 12, 
1983), 48 FR 38250 (Aug. 23, 1983).
---------------------------------------------------------------------------

    The utility of an order exposure requirement was debated again in 
response to Market 2000,92 with comment divided on the need for 
such a rule.93 The NYSE suggested that the Commission reconsider 
an order exposure rule to provide for greater interaction and enhance 
best execution of customer orders. The regional exchanges believed that 
an order exposure rule could restore the incentive of market makers and 
exchanges to compete on the basis of their displayed quotations.94 
The U.S. General Accounting Office suggested that order exposure rules 
be considered in connection with any new proposals to further repeal 
off-board trading restrictions.95 Other commenters to Market 2000 
were ambivalent; for example, the Securities Industry Association noted 
that ``currently there is no compromise or consensus between those who 
would advocate a uniform public order exposure rule for listed 
securities and those who believe transparency requirements should be 
determined by customer demand and not mandated.'' 96 The National 
Specialists Association, commenting on prior Commission NMS 
initiatives, stated that the Association was ``aware of nothing that 
should persuade the Commission to revisit any of these proposals, 
except, perhaps, the order exposure rule.'' 97 The NASD stated 
that a new order exposure rule was unnecessary, but that if one were to 
be 

[[Page 52805]]
developed it should apply to all markets equally.98

    \92\ See Market 2000, supra note 4 at IV-10. Because some SROs 
supported an order exposure rule, Market 2000 suggested that all 
interested SROs coordinate the development of an order exposure rule 
for Commission consideration. See, e.g., NYSE Letter, supra note 46; 
Letter from William G. Morton, Jr., Boston Stock Exchange, John L. 
Fletcher, Midwest Stock Exchange, Leopold Korins, Pacific Stock 
Exchange, and Nicholas A. Giordano, Philadelphia Stock Exchange, to 
Jonathan G. Katz, Secretary, SEC (Dec. 11, 1992) (``Regional 
Letter''). Since the publication of Market 2000, however, no efforts 
have been initiated toward this end.
    \93\ See NYSE Letter, supra note 46.
    \94\ See Regional Letter, supra note 92.
    \95\ See GAO, Securities Markets: SEC Actions Needed to Address 
Market Fragmentation Issues (June 1993).
    \96\ See Letter from Thomas M. O'Donnell, Chairman, and Marc E. 
Lackritz, President, Securities Industry Association, to Jonathan G. 
Katz, Secretary, SEC (July 1, 1993).
    \97\ See Letter from David Humphreville, National Specialists 
Association, to Jonathan Katz, Secretary, SEC (Dec. 11, 1992).
    \98\ See Letter from Joseph R. Hardiman, President, NASD, to 
Jonathan G. Katz, Secretary, SEC (Nov. 20, 1992).
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2. Proposed Rule
    Proposed Rule 11Ac1-5 would require each specialist or OTC market 
maker 99 in a covered security that accepts a customer market 
order to provide that order with an opportunity for price 
improvement.100 The term ``price improvement'' is defined as the 
execution of an order at a price that is better than the existing 
NBBO.101 A covered security is defined as any reported security 
and any other security for which a transaction report, last sale data, 
or quotation information is disseminated through an automated quotation 
system that is sponsored by a registered securities association. 
Therefore, the definition of covered security includes exchange-listed 
securities, and those Nasdaq securities that satisfy a threshold 
requirement based on average daily volume.102 The threshold for 
inclusion of Nasdaq securities has been proposed to include the 250 
Nasdaq stocks with the highest average daily trading volume over the 
previous quarter. The Commission preliminarily believes that customer 
market orders for certain Nasdaq securities are not presently received 
with sufficient regularity to provide a substantial likelihood of price 
improvement. Therefore, at the present time, the Commission questions 
whether the potential costs associated with providing the opportunity 
for price improvement are justified for these securities. Accordingly, 
the Commission has set a threshold in an attempt to identify the 
securities for which price improvement opportunities are appropriate. 
The Commission would consider, at a later date, whether to extend the 
rule with respect to Nasdaq securities falling below the threshold.

    \99\ See Proposed Sec. 240.11Ac1-5(a)(9). The term OTC market 
maker has the same meaning provided in Sec. 240.11Ac1-1. This 
definition is not coextensive with the definition found at 15 U.S.C. 
78c(a)(38). See supra section II.A.2.b. regarding the amendments to 
the Quote Rule.
    \100\ Proposed Sec. 240.11Ac1-5(b).
    \101\ Proposed Sec. 240.11Ac1-5(a)(10).
    \102\ Proposed Sec. 11Ac1-5(a)(3). In addition, regionally 
listed securities that do not substantially meet NYSE or Amex 
original listing criteria do not satisfy the definition of ``covered 
security.'' Such securities are not ``reported securities'' as that 
term is defined in the proposed rule, nor do they meet the other 
elements of the definition of covered security. OTC Bulletin Board 
securities also do not satisfy the definition. The Commission has 
determined not to extend the requirements of the rule to such 
securities at the present time. The Commission has, however, 
requested comment on the appropriate scope of the rule. See Part 3, 
Request for Comments (Nos. 11 and 17).
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    The proposed rule applies to all customer market orders, defined to 
include any order to buy or sell a covered security at the best 
available price that is not for the account of either a broker or a 
dealer. Further, the proposed rule applies in those instances where the 
spread between the NBBO is greater than the minimum variation. The 
``minimum variation'' is defined as the minimum increment by which a 
covered security may be quoted on the primary market for the 
security.103

    \103\ Proposed Sec. 240.11Ac1-5(a)(6).
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    The proposed rule does not specify the extent to which an 
opportunity for price improvement must be provided, or what method must 
be used to provide this opportunity. To clarify one acceptable means of 
satisfying the rule's requirement, however, the rule includes a safe 
harbor that describes order exposure procedures that would be deemed to 
provide sufficient price improvement opportunities under the 
rule.104 Under these procedures, prior to executing a customer 
market order in a covered security, the specialist or market maker 
would be required to stop the customer order at the NBBO,105 and 
publish, and maintain for 30 seconds, a bid or offer on behalf of the 
customer. The specialist or market maker's quote must be for at least 
the size of the customer order, at a price one minimum variation away 
from the stop price on the opposite side of the market.106 If the 
exposed order is not executed at the new quote, the specialist or 
market maker would fill the customer order at the stop price for the 
lesser of: (1) the full number of shares of the order; or (2) the size 
associated with the NBBO at the time the order was stopped. The 
exposure procedures would not apply in circumstances where the order is 
for a security with a spread between the NBBO greater than four times 
the minimum variation to avoid excessive quotation volatility resulting 
from the exposure requirement in markets with a wide spread.107

    \104\ Proposed Sec. 240.11Ac1-5(c).
    \105\ Proposed Sec. 240.11Ac1-5(d)(1)(i).
    \106\ Proposed Sec. 11Ac1-5(d)(1)(ii). When a specialist or 
market maker ``stops'' an order, such specialist or market maker 
guarantees the execution or partial execution of the order at a 
specified price. Proposed Sec. 240.11Ac1-5(a)(12). The specified 
price is defined as the ``stop price.'' Proposed Sec. 240.11Ac1-
5(a)(13).
    \107\ Proposed Sec. 240.11Ac1-5(d)(5)(i). For example, a 
customer market order for an NYSE listed security with a current bid 
of 20 and an offer of 20\3/4\ would not be subject to the exposure 
requirements of the safe harbor.
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    The following example illustrates the operation of the safe harbor. 
Assume that an exchange specialist is quoting 20 (500)--20\3/8\ 
(1,000), the NBBO for XYZ security. Assume further that a customer 
market order to sell 1000 shares of XYZ security is received by that 
exchange specialist. Pursuant to the safe harbor, the exchange 
specialist would stop the order at 20 for 500 shares, and expose the 
entire 1,000 share order on the offer at an increment \1/8\ higher than 
the stop price for 30 seconds. The new inside quote, therefore, would 
be 20 (500)--20\1/8\ (1000) for 30 seconds. The size associated with 
the exposed order may be reduced to the extent of any partial execution 
during the exposure period.108

    \108\ Proposed Sec. 240.11Ac1-5(d)(4).
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    Although the exposure procedures require a market maker or 
specialist to expose a customer market order at a price that is one 
minimum variation better than the stop price, the Commission considered 
alternative approaches. For example, the Commission considered whether 
to require exposure of the order at one minimum variation better than 
the bid (for a buy order) or the offer (for a sell order). To 
illustrate, assume that the NBBO is 20--20\3/8\, and a customer market 
order to sell is received. The proposed exposure procedures would 
require that the order be stopped at 20 (up to the size associated with 
the NBBO) and exposed as an offer at 20\1/8\. The Commission considered 
whether the exposure procedures should, instead, require the specialist 
to stop the order at 20 and expose it as an offer at 20\1/4\ (\1/8\ 
better than the best offer). Although the alternative potentially would 
result in a better execution price for an exposed order where the 
spread between the NBBO was greater than \1/4\, it appears that there 
would be less likelihood that the order would receive price improvement 
because it would be displayed at a price less likely to draw contra-
side orders.109 Nevertheless, the Commission seeks comment on 
whether this alternative would be preferable.

    \109\ For example, if the NBBO is 20--20\3/8\ when a customer 
sell order is received, the new NBBO under the proposal would be 
20--20\1/8\ and 20 --20\1/4\ under the alternative. If a buy market 
order was received, the current proposal could result in execution 
at 20\1/8\ and the alternative could result in an execution at 20\1/
4\. However, the buy market order would be more likely to be 
executed on the offer of 20\1/8\ because it is more advantageous for 
buy orders and so would be more likely to be executed at the 
exposure price.
---------------------------------------------------------------------------

    It should be noted that because exposure of orders under the 
proposed safe harbor would result in the dissemination of a new NBBO 
during the exposure period, the price improvement opportunity for other 
customer market orders received during 

[[Page 52806]]
the exposure period will be determined on the basis of the new NBBO. 
For example, if the NBBO is 20--20\1/2\ and thereafter is reduced to 
20--20\1/8\ because of the exposure of a customer sell order, customer 
market orders sent to other markets during the exposure period would 
not be entitled to price improvement under the rule because the new 
NBBO (during the exposure period) has been narrowed to the minimum 
variation, although the Commission is seeking comment on whether the 
safe harbor should be extended to minimum increment markets. But, under 
best execution principles, other customer orders presumably would be 
required to be executed at prices at least as favorable as the new NBBO 
during the period it existed.
    The order exposure procedures contain provisions designed to 
facilitate efficient order execution during periods in which orders are 
received in rapid succession. For example, the order exposure 
procedures provide that if the specialist or market maker receives a 
subsequent customer market order on the same side of the market during 
the exposure period, the specialist or market maker may immediately 
execute the exposed order at the stop price and must stop and expose 
the subsequent customer market order.110 This means that in the 
example stated above, the specialist could execute immediately the 
exposed order at the stop price of 20 (up to the amount of the order 
that has been stopped), stop the subsequent sell-side customer market 
order at 20, and expose the subsequent order at 20\1/8\ for 30 seconds 
(assuming the NBBO remains the same).

    \110\ Proposed Sec. 240.11Ac1-5(d)(2).
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    The order exposure procedures also provide an exception for order 
execution where another specialist or market maker executes a 
transaction at a price equal or inferior to the stop price on the same 
side of the market.111 In the example given above, if the XYZ 
specialist in another market executes an order at 20, the specialist 
who currently is exposing an order at 20\1/8\ could immediately execute 
the exposed order at 20 rather than continue to expose the order for 
the full 30 seconds.

    \111\ Proposed Sec. 240.11Ac1-5(b)(3)(i).
---------------------------------------------------------------------------

    In addition, the order exposure procedures provide for the 
execution of an exposed order prior to the expiration of the exposure 
period where the market for a particular security moves away from the 
stop price.112 This exception is meant to reduce the risk 
associated with stopping an order during a substantial market move. If 
another specialist or market maker changes its bid (in the case of a 
stopped buy order) or offer (in the case of a stopped sell order) to 
the stop price, then the specialist or market maker exposing the order 
may execute that exposed order at the stop price prior to the 
expiration of the exposure period. For example, if a specialist on 
another exchange changes its offer to the stop price in response to 
market conditions, the specialist that has been exposing the customer 
market order at 20\1/8\ also may change its offer and immediately 
execute the customer order at the stop price of 20 rather than expose 
the order for the full 30 second period at 20\1/8\.

    \112\ Proposed Sec. 240.11Ac1-5(b)(3)(ii).
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    The order exposure procedures would not apply in certain 
circumstances. The procedures contain an exception for any order of 
block size.113 The safe harbor also contains an exception for 
orders of non-block size that are effected in conjunction with a block 
trade effected outside of the NBBO.114 For example, if a customer 
order to sell is stopped at 20 and exposed on the offer at 20\1/8\, and 
a block transaction is effected at 20\1/4\, the exposed order may be 
executed in accordance with exchange practices.

    \113\ Proposed Sec. 240.11Ac1-5(d)(5)(ii).
    \114\ Proposed Sec. 240.11Ac1-5(d)(5)(v).
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    The final two exceptions to the safe harbor apply to odd-lot orders 
and orders received within 5 minutes of the opening and closing of the 
trading day. The latter exception is intended to allow for the 
efficient opening and closing of all markets.
    The rule, as a whole, contains an exception for ``fast market'' 
conditions.115 Specifically, the requirement to provide an 
opportunity for price improvement would not apply to transactions where 
firm quotations on an exchange or by the association are not required 
based on unusual market conditions. In addition, the proposed rule 
contains an exception that permits a specialist or market maker to send 
a customer market order to another market or market maker if those 
markets or market makers are in compliance with the rule.116

    \115\ Proposed Sec. 11Ac1-5(e) (1), (2) and (3).
    \116\ Proposed Sec. 11Ac1-5(e)(4).
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3. Request for Comments
    The Commission requests comment on issues raised by this proposal, 
including the following matters:
    (1) The proposed rule would require that market makers or 
specialists provide an opportunity for price improvement before 
executing customer orders, and sets forth non-exclusive procedures that 
would satisfy that requirement. The Commission requests comment on 
whether the rule should set forth the specific degree or manner by 
which the price improvement opportunity must be provided.
    (2) The Commission recognizes that some automated execution systems 
operated by markets do not currently provide an opportunity for price 
improvement for market orders, but include the possibility of 
interaction with limit orders entered into the system. The Commission 
seeks comment on whether these systems should be adapted to allow 
market makers to provide opportunities for price improvement, or 
whether they should be deemed to satisfy the rule's requirement as 
currently operated.
    (3) The payment for order flow rules require broker-dealers that 
receive payment for order flow in a security to disclose their order 
routing practices to their customers, including the availability of 
price improvement opportunities. The Commission seeks comment on 
whether an extension of these disclosure rules to all covered 
securities, irrespective of whether payment for order flow is received, 
would provide sufficient additional incentive for market makers and 
specialists to provide price improvement opportunities, without the 
adoption of a specific price improvement rule.
    (4) Under the order exposure procedures, the quote exposing the 
order would become the NBBO for the length of time that the order is 
exposed (e.g., up to 30 seconds). After execution of the order or 
expiration of the exposure period, the spread for the NBBO would widen. 
The Commission seeks comment on what effect, if any, rapid quote 
changes may have on system capacity, autoquote systems, automated 
execution systems that execute customer orders at the NBBO, and the 
expectations of investors with respect to the execution prices of 
market orders.
    (5) Under the safe harbor, the Commission has proposed an exposure 
period of 30 seconds. The Commission seeks comment on the effect of a 
30-second exposure period on the functions of specialists or market 
makers, and whether a longer (e.g., 45 or 60 seconds) or shorter (e.g., 
15 seconds) period is appropriate.
    (6) As noted above, the proposed rule is designed to ensure that 
price improvement opportunities will be more widely available for 
customer orders. Such a rule should promote the interaction of exposed 
orders with orders or trading interest in other markets. The Commission 
seeks comment on whether exposure of orders 

[[Page 52807]]
in non-Rule 19c-3 listed securities would be fully effective without 
extension of the ITS interface, which links Nasdaq with the registered 
securities exchanges for trading in Rule 19c-3 securities, to all 
listed securities.117

    \117\ See supra section II.A.1.b. regarding the amendments to 
the Quote Rule.
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    (7) The Commission has proposed several exceptions to the order 
exposure procedures for situations where a specialist or market maker 
receives orders in rapid succession. While alleviating the problems 
associated with queuing, the exceptions may affect the overall utility 
of the rule. The Commission seeks comment on alternative methods for 
addressing potential order queues and rapidly moving markets.
    (8) As proposed, the requirement to provide an opportunity for 
price improvement would apply to situations where the spread between 
the NBBO is greater than the minimum variation. The Commission seeks 
comment on whether application of the rule should be extended to 
situations where the spread between the NBBO is equal to the minimum 
variation. If extended, under the exposure procedures a specialist or 
market maker would be required to stop a customer buy order at the 
national best offer and expose it at the national best bid; a sell 
order would be stopped at the national best bid and exposed at the 
national best offer.
    (9) If the exposure procedures were extended to minimum variation 
markets, the Commission seeks comment on whether the rule should 
contain an exception to the exposure procedures in situations where a 
specialist or market maker receives an order that would be executed 
against a limit order represented in the quote. The effect of the 
exception is illustrated in the following example: assume that the NBBO 
is 20-20\1/8\ and that the offer price represents a customer limit 
order. If a market order to buy is received, the exception would allow 
the trade to be executed immediately at 20\1/8\. Alternatively, if 
there were no exception for agency orders represented in the quote, the 
market order would be stopped at 20\1/8\ and exposed at 20 for 30 
seconds. Comment is requested on both approaches. Further, the 
Commission seeks comment on whether the rule should contain an 
exception to the exposure procedures in situations where a specialist 
or market maker receives an order that would be executed against a 
limit order represented in the quote, where the spread between the NBBO 
is greater than the minimum variation.
    (10) The Commission seeks comment on whether the order exposure 
procedures should apply to agency cross transactions, e.g., the 
execution of a buy and sell order for the same security by an entity 
acting as agent for both orders.
    (11) The proposed rule would apply to exchange listed securities, 
and those OTC securities that satisfy the threshold requirement. The 
Commission seeks comment on whether the scope of the rule is 
appropriate.
    (12) The Commission seeks comment on how the rule would interact 
with other initiatives, such as the Commission's proposed amendments to 
the Quote Rule and the Commission's proposed Limit Order Display Rule.
    (13) In light of the activity that takes place at the beginning and 
the end of the trading day, the proposed safe harbor includes an 
exception from the exposure requirement during the first five minutes 
of trading, as well as the last five minutes of the trading day. The 
Commission seeks comment on whether this exception is appropriate.
    (14) Some SROs maintain rules regarding excess spread 
parameters.118 The Commission seeks comment on the impact of the 
proposed rule on such excess spread parameters.

    \118\ See, e.g., NASD Manual, Schedule D to the By-Laws, Part V, 
Section 2(d), (CCH) para. 1819.
---------------------------------------------------------------------------

    (15) The Commission seeks comment on alternative methods by which 
price improvement opportunities for customer market orders may be 
achieved, and on alternative safe harbor procedures, including reliance 
on internal order crossing and intermarket print protection systems. 
For example, an alternative may be to permit a specialist or market 
maker to stop a customer market order at its proposed execution price 
for a short period of time (e.g., 1 minute). If during this time period 
the specialist or market maker received a customer market order on the 
opposite side of the market from the stopped order, the specialist or 
market maker would cross the orders at a price better than the proposed 
execution price. In addition, if during this time period a trade in the 
stock is reported in another market at a price better than the proposed 
execution price, the specialist or market maker would also be required 
to execute the customer order at a price better than the proposed 
execution price.
    The Commission requests comment on whether this alternative would 
provide sufficient opportunity for price improvement to be included as 
a safe harbor under the rule. Unlike the order exposure safe harbor, it 
would not require publication of a quotation reflecting the order, and 
may, therefore, provide a simpler process with less impact on quote 
variations, while still providing customer orders an opportunity for 
better prices based on other internal orders and superior reported 
trade prices. At the same time, because the customer order would not be 
publicly displayed, this procedure would not result in narrower quotes 
or provide an opportunity for greater intermarket order interaction.
    The Commission also requests comment on the mechanics of how the 
alternate safe harbor should function. First, in the event of an 
intervening trade away from the specialist, market maker, or dealer, 
should protection be offered at the print price or at a price that is 
better than the minimum price variation? Second, how should subsequent 
orders received during the period the stop is in effect be handled; 
should they be immediately executed at the stop price or should a new 
time period be created? Finally, should price protection be offered 
only up to the size of the intervening trade (if it is less than the 
size of the order) or for the full size of the order?
    (16) The Commission seeks comment on alternative procedures under 
the proposed safe harbor:
    (a) The first alternative would require a specialist or OTC market 
maker that receives a customer market order to stop the order at the 
price at which it was quoting when the order was received, or if it was 
not publicly quoting, at its proposed execution price. Under this 
scenario, if the NBBO was 20-20\1/4\, and the market maker was quoting 
20-20\1/2\ when it received a customer market order to buy, the market 
maker would be allowed to stop the order at 20\1/2\. If, however, the 
best offer remained 20\1/4\ at the time of execution, execution at an 
inferior stop price would be constrained by best execution principles.
    (b) The second alternative would require a specialist or market 
maker that receives a customer market order to stop the order if the 
bid (for a sell order) or offer (for a buy order) is the specialist's 
or market maker's principal quotation. If, however, the bid or offer 
represents an agency order, the specialist or market maker would not be 
required to stop the incoming market order.
    (17) The Commission seeks comment on the liquidity threshold, 
specifically:
    (a) Whether a selection based on average daily trading volume is 
appropriate and, if not, alternative selection criterion that would be 
appropriate given the Commission's stated goals;

[[Page 52808]]

    (b) Whether the 250 issue cutoff is appropriate 119 and, if 
not, a more appropriate cutoff and the basis for that selection; and

    \119\ For the quarter beginning April 1995 and ending June 1995, 
the 250 stocks with the highest average daily volume on Nasdaq had 
an average daily trading volume of 731,000 shares per stock per day.
---------------------------------------------------------------------------

    (c) Whether an average daily trading volume threshold should be 
applied only to Nasdaq securities or all securities.
    (18) In addition, for all markets, the Commission recognizes that 
the proposed safe harbor may not be appropriate for stocks which trade 
with significant spreads. For example, when a market order to sell is 
received for a stock that trades with a bid of 330 and an offer of 334, 
it may not be appropriate to narrow the spread to 330-330\1/8\. For 
this reason, the Commission is proposing an exemption to the safe 
harbor for stocks whose spread is greater than four times the minimum 
variation in the stock.120 The Commission seeks comment with 
respect to this spread threshold, specifically:

    \120\ This exemption would exclude approximately 6% of NYSE 
listed stocks and 5% of AMEX listed stocks but no stocks in the 250 
Nasdaq stocks that meet the liquidity threshold. If applied to all 
Nasdaq securities, this exemption would exclude approximately 7% of 
Nasdaq stocks.
---------------------------------------------------------------------------

    (a) Whether a spread threshold should be applied, or whether all 
market makers and specialists, regardless of the spread, should offer 
price improvement under the proposed safe harbor for all stocks; and
    (b) Whether the proposed spread threshold of greater than four 
times the minimum variation should be higher or lower.
    (19) The proposed rules are designed to enhance opportunities for 
price improvement of customer orders in light of the existing \1/8\ 
point minimum trading variation that exists for most stocks in the 
market. The Commission understands that, to some extent, the minimum 
variation itself may serve as an impediment to quote based competition 
and price improvement opportunities. Under the existing scheme, market 
participants must pay up the entire \1/8\ point to obtain price 
priority. A reduction in the minimum trading variation would lower this 
cost and provide additional opportunities for customer limit orders and 
market maker quotes to narrow spreads not only in those stocks where 
the minimum variation is \1/8\ of a point, but in all stocks.
    The Commission recognizes that there are many issues related to a 
change in the minimum variation--including, among others, the effect 
that a reduction in the \1/8\ point increment might have on the 
priority of orders and the liquidity of the markets more generally. In 
this regard, the Commission's Division of Market Regulation previously 
requested that SROs study these potential costs, as well as the 
benefits that might be associated with a system of decimal pricing. The 
ultimate goal of such a study would be to determine whether such a 
shift would strengthen the competitive posture of the U.S. equity 
markets as they position themselves in a global marketplace.121

    \121\ See Market 2000, supra note 4 at 18.
---------------------------------------------------------------------------

    Notwithstanding the lack of a comprehensive study by the SROs, the 
Commission continues to believe that decimal pricing is the next 
logical step for the markets to pursue to improve transparency and 
provide opportunities for narrower spreads.122 Although the 
Commission is not prepared to mandate such a change in the minimum 
increment at this time, comment is requested on the costs and benefits 
of a change in the minimum variation either relative, or as a 
supplement to, the rules being proposed today. Comment is also 
requested on whether any reduction in the minimum increment should be 
in a finer increment of fractions (e.g., \1/16\ or \1/32\) or decimals 
(e.g., $0.10, or $0.05).

    \122\ Payment for Order Flow Release, supra note 8.
---------------------------------------------------------------------------

4. Consideration of Proposed Rule's Costs and Benefits
    To evaluate fully the impact of the proposed rule, the Commission 
requests commenters to provide their views on the costs and benefits 
associated with the rule, and any data that may support those views.
    The proposed rule would require each OTC market maker or specialist 
that accepts a customer market order to provide that order with an 
opportunity to receive price improvement when the difference between 
the NBBO for the security is greater than the minimum variation by 
which the security may be quoted on the principal market for such 
security. This rule is intended to enhance best execution opportunities 
for customer market orders in all markets. The rule is intended to 
encourage quote competition between markets and market participants; to 
enhance customer-to-customer order interaction without the intervention 
of a specialist or market maker; to improve transparency in all 
markets; and provide more opportunities for broker-dealers to satisfy 
their best execution obligations.
    The Commission acknowledges that the price improvement obligations 
would require some market participants to modify their current order 
handling and display practices. The Commission seeks comment on the 
magnitude of such costs. Further, the Commission recognizes that the 
price improvement requirement and direct interaction between customers 
may reduce the profitability associated with market making activities. 
To the extent that this can be quantified, the Commission seeks comment 
as to how much profit market makers would forego if the proposed rule 
is adopted.
    The Commission envisions that this rule would have significant 
benefits for the financial markets and investors in those markets. 
Investors are expected to benefit from the enhanced transparency, 
improved price competition, the interaction of customer orders without 
the intervention of an OTC market maker or specialist, and improved 
opportunities to receive better executions, all of which should lower 
the cost for investors to trade in the market. Additionally, the 
financial markets as a whole should benefit from the proposed rule 
since the price discovery process will be enhanced, transparency will 
be improved and price competition will be promoted. By their very 
nature, these benefits are broad-based and pervasive. Because 
incremental amounts on a trade-by-trade basis produce significant 
cumulative amounts for the market as a whole, the Commission seeks 
guidance on how to represent accurately the savings associated with the 
implementation of this rule.
    The Commission seeks detailed comment on the following specific 
questions:
    (1) What would be the necessary system changes and costs associated 
with implementation of the proposed rule?
    (2) If the proposed rule were to be adopted, what effect would the 
interaction of customer orders have on market makers and specialists?
    (3) The Commission recognizes that subsequent to the adoption of 
the proposed rule, market makers may need to charge commissions for the 
handling of market orders. What would be the anticipated level of 
commissions for a market order and what would be the overall cost to 
the customer?
    (4) How should the Commission assess the potential benefits 
associated with the narrowing of spreads?
    (5) What would be the likely impact of the proposed rule on the 
depth of the market and how should it be quantified?
    (6) What would be the likely impact on the liquidity of the market 
and how should that impact be quantified? 

[[Page 52809]]

    (7) What degree of customer-to-customer interaction could be 
expected if the proposed rule is adopted and what are the savings to 
those customers?

III. Statutory Basis

    The amendments to Rule 11Ac1-1 and adoption of Rules 11Ac1-4 and 
11Ac1-5 are being proposed pursuant to 15 U.S.C. 78 et seq., 
particularly sections 11A, 6, 10(b), 11(a)(2), 11(b), 15A, 15(c) and 
23(a)(1); 15 U.S.C. 78k-1, 78f, 78j(b), 78k(a)(2), 78k(b), 78o-3, 
78o(c) and 78w(a)(1) (1988).

IV. Summary of the Initial Regulatory Flexibility Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis (``IRFA'') in accordance with 5 U.S.C. Section 603 regarding 
proposed Rule 11Ac1-4, Rule 11Ac1-5, and amended Rule 11Ac1-1. The 
following summarizes the conclusions of the IRFA.
    The IRFA uses certain definitions of ``small entities'' adopted by 
the Commission for purposes of the Regulatory Flexibility Act. In the 
IRFA, the Commission states that regulatory action is proposed to 
ensure the display of customer limit orders that are priced better than 
the current inside quotes, and to ensure the exposure of customer 
market orders when the spread between the NBBO is greater than the 
minimum increment by which a security may be quoted. Specifically, by 
requiring display, Rule 11Ac1-4 would narrow spreads, increase 
competition, and improve the price discovery process. Likewise, by 
providing for order exposure, Rule 11Ac1-5 would enhance best execution 
opportunities, increase competition, and improve the price discovery 
process.
    In the IRFA, the Commission states that the amendment to the Quote 
Rule is proposed to ensure that market makers in reported securities 
and other securities adhere to firm quote reporting obligations. 
Specifically, requiring both 19c-3 and non-19c-3 market makers to 
communicate quotes if they trade more than 1% of the aggregate trading 
volume, and requiring OTC market makers and specialists to display in 
their quote orders placed into an electronic communications network 
will contribute to price discovery, promote liquidity, enhance 
competition among market makers and facilitate the best execution of 
customer orders.
    The Commission is unable to quantify reasonably the impact that the 
proposed rules and amendments would have on small brokers or dealers. 
The Commission does not believe it would be practicable to exempt small 
entities from the proposed rules and amendments because to do so would 
be inconsistent with the Commission's statutory mandate.
    A copy of the IRFA analysis may be obtained by contacting Mignon 
McLemore, Division of Market Regulation, SEC, 450 Fifth Street NW., 
Washington, DC 20549, (202) 942-0158.

V. Paperwork Reduction Act

    Certain provisions of proposed Rule 11Ac1-4 and the proposed 
amendments to Rule 11Ac1-1 may contain ``collection of information'' 
requirements within the meaning of the Paperwork Reduction Act of 1995 
(44 U.S.C. 3501 et seq.), and the Commission has submitted them to the 
Office of Management and Budget for review in accordance with 44 U.S.C. 
3507(d). The title for the collection of information is: ``Proposed 
Amendments to Rule 11Ac1-1; Proposed Rule 11Ac1-4.''
    The proposed amendments to Rule 11Ac1-1, and in particular the 
definition of ``subject security'' under paragraph (a)(25), would 
increase the number of OTC market makers who are required under 
paragraph (c)(1) of the Quote Rule to communicate their bids, offers, 
and quotation sizes to their association which, in turn, disseminate 
the information in the form of public quotations pursuant to paragraph 
(b); it would also require an exchange that meets the threshold to 
disseminate the information in the form of public quotations pursuant 
to paragraph (b). This collection of information will be used to ensure 
public dissemination of quotations in accordance with the Quote Rule. 
The collection of information is necessary to expand the coverage of 
existing broker-dealer quotation requirements to include substantial 
market makers in non-Rule 19c-3 securities and to improve public 
information about the prices they are quoting. The likely respondents 
to the proposed collection of information will be the 10 or less third 
market makers not already subject to the Quote Rule. They will respond 
to the collection of information each time they initially enter and 
then update their quotations, estimated to be 120-200 times per trading 
day per respondent. The Commission anticipates the collection of 
information will result in a negligible additional burden to the NASD 
(the association to which the 10 or so market makers would be required 
to communicate their bids, offers, and quotation sizes). The collection 
of information would require the 10 or so respondents to access Nasdaq 
Work Station Level III (the media through which market makers update 
their quotations). Because the respondents should already subscribe to 
Nasdaq Work Station Level II, and because there is no additional fee 
for Level III, the 10 or so respondents would not incur any additional 
expense to comply with the collection of information. To the extent 
that updating quotations for reporting purposes requires manual entry 
on Level III, the Commission estimates an additional clerical burden of 
approximately 25.2-42 hours per year for each respondent (based on an 
estimated average of 3 seconds for each update). The estimated total 
annual reporting burden for a total of 10 respondents combined is 252-
420 hours per year.
    In addition, the Commission notes that specialists and OTC market 
makers who currently publish quotations for non-Rule 19c-3 securities 
pursuant to the voluntary election provisions of the Rule would be 
required to do so under the proposed amendments. Because these 
specialists and market makers are already publishing quotations, no 
additional burden should result from the collection of information. 
Similarly, because OTC market makers in Nasdaq SmallCap securities are 
already required to publish quotations in accordance with NASD rules, 
no additional burden should result to such market makers from the 
proposed collection of information.
    The Commission is also proposing new Rule 11Ac1-4 which, with 
certain exceptions and in certain circumstances, would require 
specialists and OTC market makers to change their published quotation 
to reflect the price and/or size of a customer limit order which would 
improve their published bid or offer. This collection of information 
will be used to require generally that market makers reflect 
immediately in their bid or offer the price and size of each customer 
limit order they hold at a price that would improve their bid or offer 
in the security. The collection of information is necessary to provide 
a minimum standard for all markets that would require the display of 
customer limit orders under certain circumstances.
    The likely respondents to the collection of information will be 
approximately 500-600 OTC market makers. They will respond to the 
collection of information each time they update their quotations in 
response to the customer limit orders described above, estimated to 
average 30-60 times per trading day per respondent. The Commission 
estimates on average for each OTC market maker that the additional 
clerical burden for updating 

[[Page 52810]]
quotations based on customer limit orders would be 7-13 hours per year 
per respondent (based on an estimated average of 3 seconds for each 
update). The Commission does not anticipate any significant additional 
burden on exchange specialists in light of current exchange order 
handling practices. The estimated total annual reporting burden for all 
respondents combined is 5,530 hours per year.
    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comments to--
    (i) Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the agency, 
including whether the information shall have practical utility;
    (ii) Evaluate the accuracy of the agency's estimate of the burden 
of the proposed collection of information;
    (iii) Enhance the quality, utility, and clarity of the information 
to be collected;
    (iv) Minimize the burden of collection of information on those who 
are to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons desiring to submit comments on the collection of 
information requirements should direct them to the Office of Management 
and Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Washington, 
DC 20503, and should also send a copy of their comments directly to the 
Commission. OMB is required to make a decision concerning the 
collections of information between 30 and 60 days after publication, so 
a comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days of publication.

VI. Effects on Competition

    Section 23(a)(2) of the Exchange Act 123 requires the 
Commission, in adopting rules under the Exchange Act, to consider any 
anti-competitive effects of such rules and to balance these effects 
against the regulatory benefits gained in furthering the purposes of 
the Exchange Act.

    \123\ 15 U.S.C. 78w(a)(2) (1988).
---------------------------------------------------------------------------

    The Commission preliminarily views the proposed amendments to Rule 
11Ac1-1 and proposed Rules 11Ac1-4 and 11Ac1-5 as causing no burden on 
competition unnecessary or inappropriate in furtherance of the purposes 
of the Exchange Act. The Commission believes that the proposed rules 
are consistent with the principles for the development of the national 
market system that Congress specified in the Exchange Act. The 
Commission also believes that any burden on competition that the 
proposed rules and amendments may impose on the exchanges, Nasdaq and 
their members, and applicable proprietary trading systems is necessary 
and appropriate.
    As noted above, the Commission has asked for comments on the costs 
and benefits of each of the proposed rules and amendments. In 
addressing those issues, the Commission also requests comment on any 
competitive burdens that might result from adoption of the proposed 
rules described in this release. In particular (but without 
limitation), the Commission requests comment on the effect adoption of 
the proposed rules would have on competition among primary exchanges, 
regional exchanges and third market makers; among integrated broker-
dealers, wholesale market makers, and specialists; between integrated 
broker-dealers and order entry firms; among Nasdaq, exchanges and 
proprietary trading systems; and between U.S. broker-dealers, exchanges 
and associations and overseas broker-dealers and exchanges.

Text of the Proposed Rules

List of Subjects in 17 CFR Part 240

    Confidential business information, Registration of securities 
information processors, Securities.

    For the reasons set out in the preamble, the Commission proposes to 
amend Part 240 of Chapter II of Title 17 of the Code of Federal 
Regulations as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The general authority citation for part 240 is revised to read 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg, 
77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78k, 78k-1, 78l, 78m, 
78n, 78o, 78p, 78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-
23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
    2. Section 240.11Aa3-1 is amended by revising paragraph (a)(4) to 
read as follows:


Sec. 240.11Aa3-1  Dissemination of transaction reports and last sale 
data with respect to transactions in reported securities.

    (a) Definitions. * * *
    (4) The term reported security shall mean any security or class of 
securities for which transaction reports are collected, processed and 
made available pursuant to an effective transaction reporting plan.
* * * * *
    3. Section 240.11Ac1-1 is revised to read as follows:


Sec. 240.11Ac1-1  Dissemination of quotations.

    (a) Definitions. For the purposes of this section:
    (1) The term aggregate quotation size shall mean the sum of the 
quotation sizes of all responsible brokers or dealers who have 
communicated on any exchange bids or offers for a covered security at 
the same price.
    (2) The term association shall mean any association of brokers and 
dealers registered pursuant to section 15A of the Act (15 U.S.C. 78o-
3).
    (3) The terms best bid and best offer shall mean the highest priced 
bid and the lowest priced offer.
    (4) The terms bid and offer shall mean the bid price and the offer 
price communicated by an exchange member or OTC market maker to any 
broker or dealer, or to any customer, at which it is willing to buy or 
sell one or more round lots of a covered security, as either principal 
or agent, but shall not include indications of interest.
    (5) The term consolidated system shall mean the consolidated 
transaction reporting system.
    (6) The term covered security shall mean any reported security and 
any other security for which a transaction report, last sale data or 
quotation information is disseminated through an automated quotation 
system as described in section 3(a)(51)(A)(ii) of the Act (15 U.S.C. 
78c(a)(51)(A)(ii)).
    (7) The term effective transaction reporting plan shall have the 
meaning provided in Sec. 240.11Aa3-1.
    (8) The term exchange market maker shall mean any member of a 
national securities exchange (``exchange'') who is registered as a 
specialist or market maker pursuant to the rules of such exchange.
    (9) The term exchange-traded security shall mean any covered 
security or class of covered securities listed and registered, or 
admitted to unlisted trading privileges, on an exchange, provided, 
however, that securities not listed on any exchange that are traded 
pursuant to unlisted trading privileges are excluded.
    (10) The term make available, when used with respect to bids, 
offers, quotation sizes and aggregate quotation sizes supplied to 
quotation vendors by an exchange or association, shall mean to provide 
circuit connections at the premises of the exchange or association 
supplying such data, or at a common 

[[Page 52811]]
location determined by mutual agreement of the exchanges and 
associations, for the delivery of such data to quotation vendors.
    (11) The term odd-lot shall mean an order for the purchase or sale 
of a covered security in an amount less than a round lot.
    (12) The term OTC market maker shall mean any dealer who holds 
itself out as being willing to buy from and sell to a customer, or 
otherwise, a covered security for its own account on a regular or 
continuous basis otherwise than on an exchange in amounts of less than 
block size.
    (13) The term plan processor shall have the meaning provided in 
Sec. 240.11Aa3-2.
    (14) The term published aggregate quotation size shall mean the 
aggregate quotation size calculated by an exchange and displayed by a 
quotation vendor on a terminal or other display device at the time an 
order is presented for execution to a responsible broker or dealer.
    (15) The terms published bid and published offer shall mean the bid 
or offer of a responsible broker or dealer for a covered security 
communicated by it to its exchange or association pursuant to this 
section and displayed by a quotation vendor on a terminal or other 
display device at the time an order is presented for execution to such 
responsible broker or dealer.
    (16) The term published quotation size shall mean the quotation 
size of a responsible broker or dealer communicated by it to its 
exchange or association pursuant to this section and displayed by a 
quotation vendor on a terminal or other display device at the time an 
order is presented for execution to such responsible broker or dealer.
    (17) The term quotation size, when used with respect to a 
responsible broker's or dealer's bid or offer for a covered security, 
shall mean:
    (i) The number of shares (or units of trading) of that covered 
security which such responsible broker or dealer has specified, for 
purposes of dissemination to quotation vendors, that it is willing to 
buy at the bid price or sell at the offer price comprising its bid or 
offer, as either principal or agent; or
    (ii) In the event such responsible broker or dealer has not so 
specified, a normal unit of trading for that covered security.
    (18) The term quotation vendor shall mean any securities 
information processor engaged in the business of disseminating to 
brokers, dealers or investors on a real-time basis, bids and offers 
made available pursuant to this section, whether distributed through an 
electronic communications network or displayed on a terminal or other 
display device.
    (19) The term reported security shall mean any security or class of 
securities for which transaction reports are collected, processed and 
made available pursuant to an effective transaction reporting plan.
    (20) The term responsible broker or dealer shall mean:
    (i) When used with respect to bids or offers communicated on an 
exchange, any member of such exchange who communicates to another 
member on such exchange, at the location (or locations) designated by 
such exchange for trading in a covered security, a bid or offer for 
such covered security, as either principal or agent; provided, however, 
that, in the event two or more members of an exchange have communicated 
on such exchange bids or offers for a covered security at the same 
price, each such member shall be considered a ``responsible broker or 
dealer'' for that bid or offer, subject to the rules of priority and 
precedence then in effect on that exchange; and further provided, that 
for a bid or offer which is transmitted from one member of an exchange 
to another member who undertakes to represent such bid or offer on such 
exchange as agent, only the last member who undertakes to represent 
such bid or offer as agent shall be considered the ``responsible broker 
or dealer'' for that bid or offer; and
    (ii) When used with respect to bids and offers communicated by a 
member of an association to another broker or dealer or to a customer 
otherwise than on an exchange, the member communicating the bid or 
offer (regardless of whether such bid or offer is for its own account 
or on behalf of another person).
    (21) The term revised bid or offer shall mean a market maker's bid 
or offer which supersedes its published bid or published offer.
    (22) The term revised quotation size shall mean a market maker's 
quotation size which supersedes its published quotation size.
    (23) The term specified persons, when used in connection with any 
notification required to be provided pursuant to paragraph (b)(3) of 
this section and any election (or withdrawal thereof) permitted under 
paragraph (b)(5) of this section, shall mean:
    (i) Each quotation vendor;
    (ii) Each plan processor; and
    (iii) The processor for the Options Price Reporting Authority (in 
the case of a notification for a subject security which is a class of 
securities underlying options admitted to trading on any exchange).
    (24) The term subject security shall mean:
    (i) With respect to an exchange:
    (A) Any exchange-traded security other than a security for which 
the executed volume of such exchange, during the most recent calendar 
quarter, comprised one percent or less of the aggregate trading volume 
for such security as reported in the consolidated system; and
    (B) Any other covered security for which such exchange has in 
effect an election, pursuant to paragraph (b)(5)(i) of this section, to 
collect, process, and make available to quotation vendors, bids, 
offers, quotation sizes, and aggregate quotation sizes communicated on 
such exchange; and
    (ii) With respect to a member of an association:
    (A) Any exchange-traded security for which such member acts in the 
capacity of an OTC market maker unless the executed volume of such 
member, during the most recent calendar quarter, comprised one percent 
or less of the aggregate trading volume for such security as reported 
in the consolidated system; and
    (B) Any other covered security for which such member acts in the 
capacity of an OTC market maker and has in effect an election, pursuant 
to paragraph (b)(5)(ii) of this section, to communicate to its 
association bids, offers and quotation sizes for the purpose of making 
such bids, offers and quotation sizes available to quotation vendors.
    (b) Dissemination requirements for exchanges and associations. (1) 
Every exchange and association shall establish and maintain procedures 
and mechanisms for collecting bids, offers, quotation sizes and 
aggregate quotation sizes from responsible brokers or dealers who are 
members of such exchange or association, processing such bids, offers 
and sizes, and making such bids, offers and sizes available to 
quotation vendors, as follows:
    (i) Each exchange shall at all times such exchange is open for 
trading, collect, process and make available to quotation vendors the 
best bid, the best offer, and aggregate quotation sizes for each 
subject security listed or admitted to unlisted trading privileges 
which is communicated on any exchange by any responsible broker or 
dealer, but shall not include:
    (A) Any bid or offer executed immediately after communication and 
any bid or offer communicated by a responsible broker or dealer other 
than an exchange market maker which is 

[[Page 52812]]
cancelled or withdrawn if not executed immediately after communication; 
and
    (B) Any bid or offer communicated during a period when trading in 
that security has been suspended or halted, or prior to the 
commencement of trading in that security on any trading day, on that 
exchange;
    (ii) Each association shall, at all times that last sale 
information with respect to reported securities is reported pursuant to 
an effective transaction reporting plan, collect, process and make 
available to quotation vendors the best bid, best offer, and quotation 
sizes communicated otherwise than on an exchange by each member of such 
association acting in the capacity of an OTC market maker for each 
subject security and the identity of that member (excluding any bid or 
offer executed immediately after communication), except during any 
period when over-the-counter trading in that security has been 
suspended; and
    (2) Each exchange shall, with respect to each published bid and 
published offer representing a bid or offer of a member for a subject 
security, establish and maintain procedures for ascertaining and 
disclosing to other members of that exchange, upon presentation of 
orders sought to be executed by them in reliance upon paragraph (c)(2) 
of this section, the identity of the responsible broker or dealer who 
made such bid or offer and the quotation size associated with it.
    (3) (i) If, at any time an exchange is open for trading, such 
exchange determines, pursuant to rules approved by the Securities and 
Exchange Commission pursuant to section 19(b)(2) of the Act (15 U.S.C. 
78s(b)(2)), that the level of trading activities or the existence of 
unusual market conditions is such that the exchange is incapable of 
collecting, processing, and making available to quotation vendors the 
data for a subject security required to be made available pursuant to 
paragraph (b)(1) of this section in a manner that accurately reflects 
the current state of the market on such exchange, such exchange shall 
immediately notify all specified persons of that determination. Upon 
such notification, responsible brokers or dealers that are members of 
that exchange shall be relieved of their obligation under paragraph 
(c)(2) of this section and such exchange shall be relieved of its 
obligations under paragraphs (b)(1) and (2) of this section for that 
security: Provided, however, That such exchange will continue, to the 
maximum extent practicable under the circumstances, to collect, 
process, and make available to quotation vendors data for that security 
in accordance with paragraph (b)(1) of this section.
    (ii) During any period an exchange, or any responsible broker or 
dealer that is a member of that exchange, is relieved of any obligation 
imposed by this section for any subject security by virtue of a 
notification made pursuant to paragraph (b)(3)(i) of this section, such 
exchange shall monitor the activity or conditions which formed the 
basis for such notification and shall immediately renotify all 
specified persons when that exchange is once again capable of 
collecting, processing, and making available to quotation vendors the 
data for that security required to be made available pursuant to 
paragraph (b)(1) of this section in a manner that accurately reflects 
the current state of the market on such exchange. Upon such 
renotification, any exchange or responsible broker or dealer which had 
been relieved of any obligation imposed by this section as a 
consequence of the prior notification shall again be subject to such 
obligation.
    (4) Nothing in this section shall preclude any exchange or 
association from making available to quotation vendors indications of 
interest or bids and offers for a subject security at any time such 
exchange or association is not required to do so pursuant to paragraph 
(b)(1) of this section.
    (5) (i) Any exchange may make an election for purposes of paragraph 
(a)(24)(i)(B) of this section for any covered security, by collecting, 
processing, and making available bids, offers, quotation sizes, and 
aggregate quotation sizes in that security; except that for any covered 
security previously listed or admitted to unlisted trading privileges 
on only one exchange and not traded by any OTC market maker, such 
election shall be made by notifying all specified persons, and shall be 
effective at the opening of trading on the business day following 
notification.
    (ii) Any member of an association acting in the capacity of an OTC 
market maker may make an election for purposes of paragraph 
(a)(24)(ii)(B) of this section for any covered security, by 
communicating to its association bids, offers, and quotation sizes in 
that security; except that for any other covered security listed or 
admitted to unlisted trading privileges on only one exchange and not 
traded by any other OTC market maker, such election shall be made by 
notifying its association and all specified persons, and shall be 
effective at the opening of trading on the business day following 
notification.
    (iii) The election of an exchange or member of an association for 
any covered security pursuant to this paragraph shall cease to be in 
effect if such exchange or member ceases to make available or 
communicate bids, offers, and quotation sizes in such security.
    (c) Obligations of responsible brokers and dealers. (1) Each 
responsible broker or dealer shall promptly communicate to its exchange 
or association, pursuant to the procedures established by that exchange 
or association, its best bids, best offers, and quotation sizes for any 
subject security.
    (2) Subject to the provisions of paragraph (c)(3) of this section, 
each responsible broker or dealer shall be obligated to execute any 
order to buy or sell a subject security, other than an odd-lot order, 
presented to it by another broker or dealer, or any other person 
belonging to a category of persons with whom such responsible broker or 
dealer customarily deals, at a price at least as favorable to such 
buyer or seller as the responsible broker's or dealer's published bid 
or published offer (exclusive of any commission, commission equivalent 
or differential customarily charged by such responsible broker or 
dealer in connection with execution of any such order) in any amount up 
to its published quotation size.
    (3)(i) No responsible broker or dealer shall be obligated to 
execute a transaction for any subject security as provided in paragraph 
(c)(2) of this section to purchase or sell that subject security in an 
amount greater than such revised quotation if:
    (A) Prior to the presentation of an order for the purchase or sale 
of a subject security, a responsible broker or dealer has communicated 
to its exchange or association, pursuant to paragraph (c)(1) of this 
section, a revised quotation size; or
    (B) At the time an order for the purchase or sale of a subject 
security is presented, a responsible broker or dealer is in the process 
of effecting a transaction in such subject security, and immediately 
after the completion of such transaction, it communicates to its 
exchange or association a revised quotation size, such responsible 
broker or dealer shall not be obligated by paragraph (c)(2) of this 
section to purchase or sell that subject security in an amount greater 
than such revised quotation size.
    (ii) No responsible broker or dealer shall be obligated to execute 
a transaction for any subject security as provided in paragraph (c)(2) 
of this section if:
    (A) Before the order sought to be executed is presented, such 
responsible broker or dealer has communicated to 

[[Page 52813]]
its exchange or association pursuant to paragraph (c)(1) of this 
section, a revised bid or offer; or
    (B) At the time the order sought to be executed is presented, such 
responsible broker or dealer is in the process of effecting a 
transaction in such subject security, and, immediately after the 
completion of such transaction, such responsible broker or dealer 
communicates to its exchange or association pursuant to paragraph 
(c)(1) of this section, a revised bid or offer: Provided, however, That 
such responsible broker or dealer shall nonetheless be obligated to 
execute any such order in such subject security as provided in 
paragraph (c)(2) of this section at its revised bid or offer in any 
amount up to its published quotation size or revised quotation size.
    (4) Subject to the provisions of paragraph (b)(4) of this section:
    (i) No exchange or OTC market maker may make available, disseminate 
or otherwise communicate to any quotation vendor, directly or 
indirectly, for display on a terminal or other display device any bid, 
offer, quotation size, or aggregate quotation size for any covered 
security which is not a subject security with respect to such exchange 
or OTC market maker; and
    (ii) No quotation vendor may disseminate or display on a terminal 
or other display device any bid, offer, quotation size, or aggregate 
quotation size from any exchange or OTC market maker for any covered 
security which is not a subject security with respect to such exchange 
or OTC market maker.
    (5)(i) Entry of any priced order for a covered security by an 
exchange market maker or OTC market maker in that security into an 
electronic communications network that widely disseminates such orders 
to third parties and permits such orders to be executed against in 
whole or in part shall be deemed to be:
    (A) A bid or offer under this section, to be communicated to the 
market maker's exchange or association pursuant to paragraph (c) of 
this section for at least the minimum quotation size that is required 
by the rules of the market maker's exchange or association; and
    (B) A communication of a bid or offer to a quotation vendor for 
display on a display device for purposes of paragraph (c)(4)(i) of this 
section.
    (ii) Paragraph (c)(5)(i) of this section shall not apply to any 
odd-lot order.
    (d) Exemptions. The Commission may exempt from the provisions of 
this section, either unconditionally or on specified terms and 
conditions, any responsible broker or dealer, exchange, or association 
if the Commission determines that such exemption is consistent with the 
public interest, the protection of investors and the removal of 
impediments to and perfection of the mechanism of a national market 
system.
    4. Sections 240.11Ac1-4 and 240.11Ac1-5 are added to read as 
follows:


Sec. 240.11Ac1-4  Display of customer limit orders.

    (a) Definitions. For purposes of this section:
    (1) The term association shall mean any association of brokers and 
dealers registered pursuant to Section 15A of the Act (15 U.S.C. 
Sec. 78o-3).
    (2) The terms best bid and best offer shall mean the highest priced 
bid and lowest priced offer.
    (3) The terms bid and offer shall mean the bid price and the offer 
price communicated by a broker-dealer to any broker or dealer, or to 
any customer, at which it is willing to buy or sell one or more round 
lots of a covered security, as either principal or agent.
    (4) The term block size shall mean any order:
    (i) Of at least 10,000 shares; or
    (ii) For a quantity of stock having a market value of at least 
$200,000.
    (5) The term covered security shall mean any ``reported security'' 
and any other security for which a transaction report, last sale data 
or quotation information is disseminated through an automated quotation 
system as described in 15 U.S.C. 78c(a)(51)(A)(ii).
    (6) The term customer limit order shall mean an order to buy or 
sell a covered security at a specified price that is not for the 
account of either a broker or dealer; Provided, however, that the term 
customer limit order shall include an order transmitted by a broker or 
dealer on behalf of a customer.
    (7) The term exchange-traded security shall have the meaning 
provided in Sec. 240.11Ac1-1.
    (8) The term OTC market maker shall mean any dealer who holds 
itself out as being willing to buy from and sell to its customers, or 
otherwise, a covered security for its own account on a regular or 
continuous basis otherwise than on a national securities exchange in 
amounts of less than block size.
    (9) The term reported security shall have the meaning provided in 
Sec. 240.11Aa3-1.
    (b) Specialists and OTC market makers. (1) For covered securities 
that are exchange-traded securities:
    (i) Each member of an exchange that is registered by that exchange 
as a specialist, or is authorized by that exchange to perform functions 
substantially similar to that of a specialist, shall publish 
immediately a bid or offer that reflects:
    (A) The price and size of each customer limit order held by such 
member that is at a price that would improve the best bid or offer of 
such member in such security; and
    (B) The size of each customer limit order that:
    (1) Is priced equal to the bid or offer of such specialist for such 
security;
    (2) Is priced equal to the national best bid or offer; and
    (3) Represents more than a de minimis change in relation to the 
size associated with the specialist's bid or offer.
    (ii) Each registered broker or dealer that acts as a OTC market 
maker shall publish immediately a bid or offer that reflects:
    (A) The price and size of each customer limit order held by the 
broker or dealer for execution otherwise than on the floor of an 
exchange that is at a price that would improve the bid or offer of such 
broker or dealer in such security; and
    (B) The size of each customer limit order held by the broker or 
dealer for execution otherwise than on the floor of an exchange that:
    (1) Is priced equal to the bid or offer of such broker or dealer 
for such security;
    (2) Is priced equal to the national best bid or offer; and
    (3) Represents more than a de minimis change in relation to the 
size associated with the broker or dealer's bid or offer.
    (2) For covered securities that are not exchange-traded securities:
    (i) Each member of an association that is an OTC market maker shall 
publish immediately a bid or offer that reflects:
    (A) The price and size of each customer limit order held by the OTC 
market maker when the customer limit order is at a price that would 
improve the bid or offer of such OTC market maker in such security; and
    (B) The size of each customer limit order held by the OTC market 
maker that:
    (1) Is priced equal to the bid or offer of such OTC market maker 
for such security;
    (2) Is priced equal to the national best bid or offer; and
    (3) Represents more than a de minimis change in relation to the 
size associated with the OTC market maker's bid or offer.
    (ii) Each exchange member shall publish immediately a bid or offer 
that reflects:
    (A) The price and size of each customer limit order held by the 
exchange member when the customer 

[[Page 52814]]
limit order is at a price that would improve the bid or offer of such 
exchange member in such security; and
    (B) The size of each customer limit order held by the exchange 
member that:
    (1) Is priced equal to the bid or offer of such exchange member for 
such security;
    (2) Is priced equal to the national best bid or offer; and
    (3) Represents more than a de minimis change in relation to the 
size associated with the member's bid or offer.
    (c) Exceptions. The requirements in paragraph (b) of this section 
shall not apply to any customer limit order:
    (1) That is executed upon receipt of the order.
    (2) That is placed by a customer who expressly requests, either at 
the time that the order is placed or prior thereto pursuant to an 
individually negotiated agreement with respect to such customer's 
orders, that the order not be displayed.
    (3) That is an odd-lot order.
    (4) That is a block size order, unless a customer placing such 
order requests that the order be displayed in compliance with this 
section.
    (5) That is delivered immediately upon receipt to an exchange or 
association-sponsored system that displays those limit orders, and 
complies with the requirements of this section with respect to that 
order.
    (6) That is delivered immediately upon receipt to another exchange 
member or OTC market maker that complies with the requirements of this 
section with respect to that order.


Sec. 240.11Ac1-5  Price improvement for customer market orders.

    (a) Definitions. For purposes of this section:
    (1) The term association shall mean any association of brokers and 
dealers registered pursuant to section 15A of the Act (15 U.S.C. 78o-
3).
    (2) The term block size shall mean any order:
    (i) Of at least 10,000 shares; or
    (ii) For a quantity of stock having a market value of at least 
$200,000.
    (3) The term covered security shall mean any ``reported security'' 
and any other security for which a transaction report, last sale data 
or quotation information is disseminated through an automated quotation 
system as described in 15 U.S.C. 78c(a)(51)(A)(ii); Provided, however, 
that with respect to over-the-counter securities, the term covered 
security shall include only the 250 over-the-counter securities with 
the highest average daily trading volume over the previous quarter.
    (4) The term customer market order shall mean an order to buy or 
sell a covered security at the best available price that is not for the 
account of either a broker or a dealer; Provided, however, that the 
term customer market order shall include an order transmitted by a 
broker or dealer on behalf of a customer.
    (5) The term exchange-traded security shall have the meaning 
provided in Sec. 240.11Ac1-1.
    (6) The term minimum variation shall mean the minimum increment by 
which a covered security may be quoted on the primary market for the 
security.
    (7) The term national best bid shall mean, with respect to a 
``covered security,'' the highest bid published for that security in 
the United States equity markets.
    (8) The term national best offer shall mean, with respect to a 
``covered security,'' the lowest offer published for that security in 
the United States equity markets.
    (9) The term OTC market maker shall mean any dealer who holds 
itself out as being willing to buy from and sell to its customers, or 
otherwise, a covered security for its own account on a regular or 
continuous basis otherwise than on a national securities exchange in 
amounts of less than block size.
    (10) The term price improvement shall mean the execution of an 
order at a price that is better than the existing national best bid or 
offer.
    (11) The term reported security shall have the meaning provided in 
Sec. 240.11Aa3-1.
    (12) The term stop shall mean to guarantee the execution or partial 
execution of an order at a specified price.
    (13) The term stop price shall mean the specified price at which an 
order is stopped.
    (b) Execution duty. Each specialist or OTC market maker that 
accepts a customer market order in a covered security shall provide 
that order an opportunity to receive price improvement when the 
difference between the national best bid and offer for the security is 
greater than the minimum variation by which the security may be quoted 
on the principal market for such security.
    (c) Compliance with the duty. Each specialist or OTC market maker 
shall be deemed to have provided an opportunity for price improvement 
pursuant to paragraph (b) of this section, if the specialist or OTC 
market maker follows the procedures set forth in paragraph (d) of this 
section.
    (d) Order exposure procedures. (1) To provide an opportunity for 
price improvement pursuant to this paragraph, when the spread between 
the national best bid and offer is greater than the minimum variation, 
an exchange specialist or OTC market maker shall, before executing a 
customer market order in a covered security:
    (i) Stop the customer order at the national best bid (for a sell 
order) or offer (for a buy order) for the lesser of:
    (A) The full size of the order; or
    (B) The size associated with the national best bid (for a sell 
order) or offer (for a buy order); and
    (ii) Publish and maintain for at least 30 seconds an offer (for a 
sell order) or a bid (for a buy order) on behalf of the customer, for 
the full number of shares of the order, at a price that is one minimum 
variation higher (for a sell order) or lower (for a buy order) than the 
stop price.
    (2) If, during the time a specialist or OTC market maker is 
exposing a customer market order pursuant to paragraph (d)(1)(ii) of 
this section, the specialist or OTC market maker receives a subsequent 
customer market order on the same side of the market as the exposed 
order, such specialist or OTC market maker may execute immediately the 
exposed order at the stop price and shall stop and expose the 
subsequent customer market order pursuant to paragraph (d)(1) of this 
section.
    (3) When a specialist or OTC market maker is exposing a customer 
market order pursuant to paragraph (d)(1)(ii) of this section, such 
specialist or OTC market maker may execute immediately such order at 
the stop price if, after exposure has commenced:
    (i) Another specialist or OTC market maker executes a transaction 
at a price equal or inferior to the stop price; or
    (ii) Another specialist or OTC market maker changes its bid or 
offer to a price equal or inferior to the stop price.
    (4) The size associated with any bid or offer required to be 
maintained on behalf of a customer pursuant to paragraph (d)(1)(ii) of 
this section may be reduced to the extent of any partial execution 
during the exposure period.
    (5) The requirements of paragraph (d) of this section shall not 
apply to:
    (i) Any order for a covered security with a spread between the 
national best bid and offer of greater than four times the minimum 
variation;
    (ii) Any order of block size;
    (iii) Transactions for odd-lot orders;
    (iv) Customer market orders in covered securities received within 
five minutes of the opening or closing of the trading day for the 
primary market in which the security trades; or
    (v) Customer orders effected in conjunction with a block size trade 


[[Page 52815]]
effected outside the national best bid or offer.
    (e) Exceptions. The requirements of paragraphs (b) and (d) of this 
section shall not apply to:
    (1) Any transaction for an exchange-traded covered security 
effected on an exchange during any period when such exchange is 
relieved of its obligation to collect, process and make available to 
quotation vendors bids and offers pursuant to paragraph (b)(3)(i) of 
Sec. 240.11Ac1-1;
    (2) Any transaction for an exchange-traded covered security 
effected otherwise than on the floor of an exchange during any period 
when the principal exchange market for the security is relieved of its 
obligation to collect, process and make available to quotation vendors 
bids and offers in such security pursuant to paragraph (b)(3)(i) of 
Sec. 240.11Ac1-1;
    (3) Any transaction for a non-exchange-traded covered security 
effected during any period when an association determines, pursuant to 
rules and regulations approved by the Commission pursuant to Section 
19(b)(2) of the Act (15 U.S.C. 78s(b)(2)), that the level of trading 
activities or the existence of unusual market conditions is such that 
the association is incapable of collecting, processing, and making 
available to quotation vendors the data normally reported with respect 
to the security; or
    (4) A customer market order that is delivered immediately upon 
receipt to another specialist or OTC market maker that complies with 
the requirements of this section with respect to that order.


    Dated: September 29, 1995.

    By the Commission.
Jonathan G. Katz,
Secretary.
[FR Doc. 95-24911 Filed 10-6-95; 8:45 am]
BILLING CODE 8010-01-P