[Federal Register Volume 60, Number 204 (Monday, October 23, 1995)]
[Notices]
[Pages 54398-54401]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-26184]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36374; File No. SR-NASD-95-41]


Self-Regulatory Organizations; Notice of Proposed Rule Change by 
National Association of Securities Dealers, Inc. Relating to an 
Expansion of the NASD's Short-Sale Rule to Include Nasdaq SmallCap 
Market Securities

October 16, 1995.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on September 22, 1995, the 
National Association of Securities Dealers, Inc. (``NASD'' or 
``Association'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the NASD. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.

    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD is proposing to expand the scope of its short-sale rule to 
include Nasdaq SmallCap Market (``SCM'') securities. 
Consistent with the current short-sale rule applicable to Nasdaq 
National Market (``NNM'') securities, the NASD proposes to 
implement the short-sale rule for SCM securities on a pilot basis until 
June 3, 1996.
    The text of the proposed rule change is available at the Office of 
the Secretary of the NASD and at the Commission.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The NASD has prepared summaries, set forth in Sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    On June 29, 1994, the SEC approved a new short sale rule for NNM 
securities traded on The Nasdaq Stock MarketSM (``Nasdaq'').\2\ 
The NASD's short sale rule, which became effective on September 6, 1994 
for an eighteen-month pilot period,\3\ prohibits member firms from 
effecting short sales \4\ at or below the current inside bid as 
disseminated by the Nasdaq system whenever that bid is lower than the 
previous inside bid.

    \2\ See Securities Exchange Act Release No. 34277 (June 29, 
1994), 59 FR 34885 (July 7, 1994).
    \3\ The Commission subsequently approved a NASD proposal 
extending the pilot period until June 3, 1996. Securities Exchange 
Act Release No. 36171 (Aug. 30, 1995), 60 FR 46651 (Sept. 7, 1995).
    \4\ A short sale is a sale of a security which the seller does 
not own or any sale which is consummated by the delivery of a 
security borrowed by, or for the account of, the seller. To 
determine whether a sale is a short sale members must adhere to the 
definition of a ``short sale'' contained in SEC Rule 3b-3, which 
rule is incorporated into Nasdaq's short sale rule by Article III, 
Section 48(l)(1) of the NASD Rules of Fair Practice.
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    Nasdaq calculates the best bid from all market makers in the 
security (including bids on behalf of exchanges trading Nasdaq 
securities on an unlisted trading privileges basis), and disseminates 
symbols to denote whether the current inside bid is an ``up bid'' or a 
``down bid.'' Specifically, and ``up bid'' is denoted by a green ``up'' 
arrow symbol and a ``down bid'' is denoted by a red ``down'' arrow. 
Accordingly, absent and exemption from the rule, a member can not 
effect a short sale of or below the inside bid in a security in its 
proprietary account or an account of a customer if there is a red arrow 
next to 

[[Page 54399]]
the security's symbol on the screen. In order to effect a ``legal'' 
short sale on a down bid, the short sale must be executed at a price at 
least a \1/16\th of a point above the current inside bid. Conversely, 
if the security's symbol has a green up arrow next to it, members can 
effect short sales in the security without any restrictions. The rule 
is in effect during normal domestic market hours (9:30 a.m. to 4:00 
p.m., Eastern Standard Time).
    In order to ensure that market maker activities that provide 
liquidity and continuity to the market are not adversely constrained 
when the short sale rule is invoked, the rule provides an exemption to 
``qualified'' Nasdaq market makers. Even if a market maker is able to 
avail itself of the qualified market maker exemption, it can only 
utilize the exemption from the short sale rule for transactions that 
are made in connection with bona fide market making activity. If a 
market maker does not satisfy the requirements for a qualified market 
maker, it can remain a market maker in the Nasdaq system, however, it 
can not take advantage of the exemption from the rule.
     Until December 1, 1995, a ``qualified'' Nasdaq market maker is 
defined to be a registered market maker that has entered quotations in 
the relevant security into the Nasdaq system on an uninterrupted basis 
for the preceding 20 business days (the ``20-day'' test). The ``20-
day'' test is applied to initial public offerings, secondary offerings, 
and merger and acquisition situations in the following manner:
     for initial public offerings, a market maker may 
immediately become a qualified market maker in an IPO by immediately 
registering (by 9:30 of the business day after completion of the 
offering) and entering quotations in the issue. However, if the market 
maker withdraws from the security on an unexcused basis within the 
first 20 days after the offering, it will not be eligible for 
designation as a qualified market maker in any subsequent IPO for the 
next 10 business days following the unexcused withdrawal.
     For secondary offerings, unless a market maker was 
registered in a security prior to the time a secondary offering in that 
stock has been publicly announced or a registration statement has been 
filed, it cannot become a qualified market maker in the stock unless 
the secondary offering has become effective and the market maker has 
been registered in the security and maintained quotations without 
interruption for 40 calendar days.
     In merger and acquisition situations, after a merger or 
acquisition involving an exchange of stock has been publicly announced 
and not yet consummated or terminated, a market maker may register and 
begin entering quotations in either or both of the two affected 
securities and immediately become a qualified market maker in either or 
both of the issues. However, if the market maker withdraws on an 
unexcused basis from any stock in which it has so registered within 20 
days of so registering, the market maker will not be eligible for 
immediate designation as a qualified market maker for any merger or 
acquisition announced within three months subsequent to such unexcused 
withdrawal.
    From December 1, 1995 to June 3, 1996, a ``qualified'' market maker 
must satisfy the criteria for a ``Primary Nasdaq Market Maker'' 
(``PMM'') found in new Section 49 of the NASD Rules of Fair 
Practice.\5\ After December 1, 1995, a ``P'' indicator will be 
displayed next to ever qualified market maker that is exempt from the 
rule according to the PMM standards. To qualify as a PMM, market makers 
must satisfy at least two of the following four criteria:

    \5\ The PMM standards were originally scheduled to go into 
effect on September 6, 1995; however, the implementation date for 
the standards was postponed to December 1, 1995. Securities Exchange 
Act Release No. 36171 (Aug. 30, 1995), 60 FR 46651 (Sept. 7, 1995).
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    (1) The market maker must be at the best bid or best offer as shown 
on the Nasdaq system no less than 35 percent of the time;
    (2) The market maker must maintain a spread no greater than 102 
percent of the average dealer spread;
    (3) No more than 50 percent of the market maker's quotation updates 
may occur without being accompanied by a trade execution of at least 
one unit of trading; or
    (4) The market maker executes 1\1/2\ times its ``proportionate'' 
volume in the stock.\6\

    \6\ For example, if there are 10 market makers in a stock, each 
dealer's proportionate share volume would be 10 percent; therefore, 
1\1/2\ times proportionate share volume would mean 15 percent of 
overall volume.
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    The review period for satisfaction of the Primary Market Maker 
performance standards is one calendar month. If a Primary market maker 
has not satisfied the threshold standards after a particular review 
period, the Primary Market Maker designation will be removed commencing 
on the next business day following notice of failure to comply with the 
standards. Market makers may requalify for designation as a Primary 
Market Maker by satisfying the threshold standards for the next review 
period.
    If a market maker is a PMM in 80 percent or more of the securities 
in which it has registered, it may immediately become a PMM (i.e., a 
qualified market maker) in a NNM security by registering and entering 
quotations in that issue. If the market maker is not a PMM in at least 
80 percent of its stocks, it may qualify as a PMM in that stock if the 
market maker registers in the stock but does not enter quotes for five 
days or the market maker registers in the stock as a regular Nasdaq 
market maker and satisfies the qualification criteria for the next 
review period. In addition, the PMM standards are applied to initial 
public offerings, secondary offerings, and merger and acquisition 
situations in the following manner:
     For initial public offerings, a market maker may 
immediately become a PMM in an IPO issue by immediately registering and 
entering quotations in the issue, provided it has obtained status in 80 
percent or more of the stocks in which it has registered. However, if 
at the end of the first review period a market maker has failed to 
satisfy the qualification criteria or has withdrawn on an unexcused 
basis from the security, it is prohibited from becoming a PMM in any 
other IPO for the next 10 business days.
     For secondary offerings, unless market maker was 
registered in a security prior to the time a secondary offering in that 
stock has been publicly announced or a registration statement has been 
filed, it cannot become a PMM in the stock unless the secondary 
offering has become effective and the market maker has satisfied the 
PMM standards between the time the market maker registered in the 
security and the time the offering became effective or the market maker 
has satisfied the PMM standards for 40 calendar days.
     In merger and acquisition situations, after a merger or 
acquisition is announced, a market maker that is a PMM in one stock may 
immediately become a PMM in the other stock by registering and entering 
quotations in that issue. In addition, if a market maker is a PMM is 80 
percent of the stocks it makes a market in, it may register and 
immediately become a PMM in both issues.
    In order to reduce compliance burdens for members, the NASD's short 
sale rule also incorporates the exemptions in SEC Rule 10a-1 that are 
relevant to trading on Nasdaq. Specifically the rule exempts:
     Sales by a broker-dealer for an account in which it has no 
interest and that are marked long;

[[Page 54400]]

     Any sale by a market maker to offset odd-lot orders of 
customers;
     Any sale by any person, for an account in which he has an 
interest, if such person owns the security sold and intends to deliver 
such securities as soon as possible without undo inconvenience or 
expense;
     Sales by a member to liquidate a long position which is 
less than a round lot, provided the sale does not change the member's 
position by more than one unit of trading (100 shares);
     Short sales effected by a person in a special arbitrage 
account if the person effecting the short sale then owns another 
security by virtue of which the person is, or presently will be, 
entitled to acquire an equivalent number of securities of the same 
class of securities sold; provided such sale, or the purchase which 
such sale offsets, is effected for the bona fide purpose of profiting 
from a current difference between the price of the security sold and 
the security owned and that such right of acquisition was originally 
attached to or represented by another security or was issued to all the 
holders of any such class of securities of the issuer;
     Short sales effected by a person in a special 
international arbitrage account for the bona fide purpose of profiting 
from a current difference between the price of such security on a 
securities market not within or subject to the jurisdiction of the 
United States and on such a securities market subject to the 
jurisdiction of the United States; provided the person at the time of 
such sale knows or, by virtue of information currently received, has 
reasonable grounds to believe that an offering enabling a person to 
cover such sale is then available to the person in such foreign 
securities markets and intends to accept such offer immediately; and
     Short sales by an underwriter or any member of the 
distribution syndicate in connection with the over-allotment of 
securities, or any lay-off sale by such a person in connection with a 
distribution of securities rights pursuant to SEC Rule 10b-18 or a 
standby underwriting commitment.
    The rule also provides that a member not currently registered as a 
Nasdaq market maker in a security that has acquired the security while 
acting in the capacity of a block positioner shall be deemed to own 
such security for the purposes of the rule notwithstanding that such 
member may not have a net long position in such security if and to the 
extent that such member's short position in such security is subject to 
one or more offsetting positions created in the course of bona fide 
arbitrage, risk arbitrage, or bona fide hedge activities.\7\ The rule 
also contains certain limited exemptions for options market makers and 
warrant market makers.

    \7\ The NASD also has interpreted its short-sale rule to provide 
exemptions consistent with SEC staff interpretations of SEC Rule 
10a-1 dealing with the liquidation of index arbitrage positions and 
trading in foreign securities (the so-called ``international 
equalizing exemption''). See Securities Exchange Act Release No. 
30772 (June 3, 1992), 57 FR 26891 (June 16, 1992).
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    As with the short-sale rule for NNM securities, which the 
Commission has approved on a pilot basis, the NASD believes imposing a 
short-sale rule on SCM securities will promote the maintenance of fair 
and orderly markets and the protection of investors. Specifically, by 
helping to prevent speculative short selling in SCM securities from 
rapidly accelerating a decline in the price of a security and a form of 
manipulation known as ``bear raiding'' or ``piling on,'' \8\ the NASD 
believes its proposal will enhance the market for SCM securities. The 
NASD also is concerned that in instances of extreme intra-day 
volatility in SCM securities that the ability of existing shareholders 
to sell their stock may be inhibited because professional short sellers 
are in the market before them, exacerbating downward pressure on stocks 
and reducing overall liquidity in the marketplace. The NASA believes 
that expanding the scope of its short-sale rule to include SCM 
securities will help to curb abusive short selling, reducing the 
exposure of the Nasdaq market to manipulation and excessive intra-day 
volatility. Without a short-sale rule for SCM securities, the NASD also 
believes issuers of SCM securities may be disadvantaged in offerings on 
Nasdaq because the increased potential for short selling may 
artificially affect the prices at which such offerings are conducted. 
In this regard, members report that their investment banking 
departments may recommend exchange listings for SCM securities because 
of the lack of adequate short sale regulation in the Nasdaq market. 
Accordingly, the NASD believes that the proposed modification to the 
NASD's short-sale rule will assure both issuers and investors in SCM 
securities that they are subject to at least equivalent protection from 
predatory short selling in the Nasdaq market as they are on an 
exchange.

    \8\ ``Piling on'' occurs all when short sellers exert 
substantial selling pressure on a stock with the intent to dominate 
and demoralize the market for that sotck, forcing the price to drop 
precipitiously, frequently with a single trading day.
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    In addition, because the short-sale rule applicable to SCM 
securities will be identical to the short-sale rule applicable to NNM 
securities, the NASD believes its proposal is structured in a manner to 
best prevent abusive short sales while also preserving the depth and 
liquidity of the markets for SCM securities. In this connection, the 
NASD notes that the Nasdaq Stock Market provides an efficient and 
liquid trading environment through quote competition among competing 
market makers. Crucial to the maintenance of this competitive market 
structure is the requirement for market makers to display firm two-
sided quotations. Moreover, the very nature of the competitive market 
maker system requires dealers to take substantial inventory positions. 
Accordingly, the NASD believes application of a short-sale rule to SCM 
securities without an exemption for qualified market makers would 
result in degradation of the accuracy and reliability of quotations.
    The NASD also believes qualified market makers in SCM securities 
must be permitted the flexibility to sell short when necessary so that 
they will be able to adjust quickly to market movements and control the 
risks associated with market making, while continuing to provide the 
maximum possible liquidity. The ability to manage risk with short 
positions is fundamental to market maker performance. Market makers 
need the constant ability to effect short sales to ``reliquefy'' their 
positions throughout the trading day. If a short-sale rule were to 
impact adversely their ability to manage risk, dealers may be forced to 
reduce their market making support for the SCM securities in which they 
currently make markets.\9\

    \9\ Based on data for the month of August 1995, 73 percent of 
the market making positions in Nasdaq SmallCap securities would have 
satisfied the PMM standards.
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    Finally, the NASD believes that adoption of a short-sale rule for 
SCM securities will enhance the Nasdaq Stock Market's ability to 
compete with exchange primary markets for listings of SCM securities. 
From a competitive standpoint, the primary exchanges regularly use the 
lack of a short-sale rule for SCM securities as an argument to try to 
persuade companies to list on their exchange. Adoption of a short-sale 
rule for SCM securities will further emphasize to shareholders that 
Nasdaq provides equivalent short-sale protection to the investing 
public through rules that are fair, equitable, and consistent with the 
operation of a quality marketplace.
    The NASD believes the proposed rule change is consistent with 
Sections 15A(b) (6) and (9), Section 11A(a)(1)(C)(i), and Section 
11A(c)(1)(F) 

[[Page 54401]]
of the Act. Section 15A(b)(6) requires that the rules of a national 
securities association be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
of a free and open market and a national market system and in general 
to protect investors and the public interest. The NASD believes that 
the proposed short-sale rule for SCM securities is consistent with each 
of these requirements. First, the NASD's proposal is premised on the 
same anti-manipulation concerns that were relied upon by the SEC to 
promulgate a short-sale rule for exchange-listed securities, SEC Rule 
10a-1. Second, the short-sale rule for SCM securities will promote just 
and equitable principles of trade by permitting long sellers access to 
market prices at any time, while requiring short sellers in a declining 
market to execute their short sales above the bid or wait for an up 
bid, similar to the constraints placed upon short sellers of exchange-
listed securities. Third, the proposal removes impediments to a free 
and open market for long sellers and ensures liquidity at bid prices 
that might otherwise be usurped by short sellers. Finally, since the 
immediate beneficiaries of a short-sale rule for SCM securities are the 
shareholders who own stock, the NASD believes its proposal is 
consistent with the protection of investors and the public interest.
    Section 15A(b)(9) of the Act requires that the NASD's rules not 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act. The NASD acknowledges that a 
short-sale rule applicable to SCM securities does impose burdens and 
restrictions on members and their customers where there were none 
before, but believes that these burdens and restrictions are 
appropriate and necessary to ensure the standing of long sellers in the 
marketplace and the integrity of the Nasdaq market. This concern with 
market integrity for existing shareholders has always been paramount in 
exchange markets and the NASD believes it is now appropriate to extend 
the same protections to shareholders in SCM securities as well.
    Section 11A(a)(1)(C)(i) sets out the economically efficient 
execution of securities transactions as an objective of a national 
market system for securities. The NASD's proposed short-sale rule for 
SCM securities would operate to level the playing field between 
investors and short sellers by enabling those investors with long 
positions in a security to liquidate their positions at any time, at 
any price, while permitting short sellers access to bid prices when 
that access will not exacerbate downward pressure in the stock, thus 
promoting the efficiency of the Nasdaq market. Moreover, the NASD 
believes that the primary market maker qualifications are critical to 
ensuring that the proposed rule operates effectively and should have 
the additional benefit of providing incentives for improved market 
maker performance in SCM securities.
    Section 11A(c)(1)(F) assures ``equal regulation of all markets for 
qualified securities and all exchange members, brokers, and dealers 
effecting transactions in such securities.'' \10\ The NASD believes 
that approval of the proposed short-sale rule for SCM securities will 
result in equivalent short sale regulation for exchange-listed 
securities and SCM securities.

    \10\ 15 U.S.C. Sec. 78k-1(c)(1)(F).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD believes that the proposed rule change will not result in 
any burden on competition that is not necessary or appropriate in 
furtherance of purposes of the Act. The NASD believes the PMM standards 
that would be applicable to market makers in Nasdaq SmallCap securities 
are designed in a manner to permit market makers of all sizes to meet 
the standards. Moreover, it is important to note that market makers in 
Nasdaq SmallCap securities that do not meet the standards will still be 
permitted to remain registered market makers in these securities. 
Finally, the NASD is hopeful that the proposed criteria will raise 
overall the quality of market maker participation in Nasdaq SmallCap 
securities, thereby promoting competition in the market for these 
securities.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The NASD has neither solicited nor received comments on the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the NASD consents, the Commission will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File Number SR-NASD-95-41 and 
should be submitted by November 13, 1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\

    \11\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-26184 Filed 10-20-95; 8:45 am]
BILLING CODE 8010-01-M