[Federal Register Volume 61, Number 25 (Tuesday, February 6, 1996)]
[Notices]
[Pages 4504-4506]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-2464]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36795; File No. SR-NASD-95-60]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Granting Accelerated Temporary Approval of
Proposed Rule Change To Extend Certain SOES Rules Through July 31, 1996
January 31, 1996.
I. Introduction
On December 19, 1995, the National Association of Securities
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities
and Exchange Commission (``SEC'' or `` Commission'') a proposed rule
change pursuant to Section 19(b)(1) of the Securities Exchange Act of
1934 (``Act'') \1\ and Rule 19b-4 thereunder.\2\ The NASD proposes to
extend through July 31, 1996 certain changes to its Small Order
Execution System (``SOES'') that were originally implemented in January
1994 for a one-year pilot period (``January 1994 Amended SOES
Rules'').\3\ These rules
[[Page 4505]]
subsequently were modified in January 1995 (``January 1995 Amended SOES
Rules''),\4\ further modified in March 1995 (``March 1995 Amended SOES
Rules''),\5\ and most recently extended in September 1995 (``September
1995 Amended SOES Rules'').\6\ The September 1995 Amended SOES Rules
are scheduled to expire on January 31, 1996, and the NASD seeks to
extend these rules until July 31, 1996. Without further Commission
action, the SOES rules and would revert to those in effect prior to
January 1994.
\1\ 15 U.S.C. Sec. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 33377 (Dec. 23, 1993),
58 FR 69419 (Dec. 30, 1993) (approving the Interim SOES Rules on
one-year pilot basis effective January 7, 1994). See also Securities
Exchange Act Release No. 33424 (Jan. 5, 1994) (order denying stay
and granting interim stay through January 25, 1994) and Securities
Exchange Act Release No. 33635 (Feb. 17, 1994) (order denying
renewed application for stay).
The changes contained in the January 1994 Amended SOES Rules
were as follows:
(1) A reduction in the maximum size order eligible for SOES
execution from 1,000 shares to 500 shares;
(2) A reduction in the minimum exposure limit for
``unpreferenced'' SOES orders for five times the maximum order size
to two times the maximum order size, and the elimination of exposure
limits for ``preferenced'' orders;
(3) An automated function for updating market maker quotations
when the market maker's exposure limit has been exhausted (marked
makers using this update function may establish an exposure limit
equal to the maximum order size for that security); and
(4) The prohibition of short sale transactions through SOES.
\4\ Securities Exchange Act Release No. 35275 (Jan. 25, 1995),
60 FR 6327 (Feb. 1, 1995).
The January 1995 Amended SOES Rules excluded the following
feature of the January 1994 Amended SOES Rules:
(1) The prohibition of short sale transactions through SOES.
\5\ Securities Exchange Act Release No. 35535 (Mar. 27, 1995),
60 FR 16690 (Mar. 31, 1995).
The March 1995 Amended SOES Rules Excluded the following two
features of the January 1994 Amended SOES Rules:
(1) A reduction in the maximum size order eligible for SOES
execution from 1,000 to 500 shares; and
(2) The prohibition of short sale transactions through SOES.
(This prohibition also was excluded from the January 1995 Amended
SOES Rules.) See supra, note 4.
\6\ Securities Exchange Act Release No. 36311 (September 29,
1995), 60 FR 52438 (October 6, 1995). The September Amended SOES
Rules were identical to the March 1995 Amended SOES Rules, and
extended the effectiveness of such rules until January 31, 1996.
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Notice of the proposed rule change appeared in the Federal Register
on January 22, 1996.\7\ No comment were received in response to the
Commission release. For the reasons discussed below, this order
approves the proposed rule change until July 31, 1996.
\7\ Securities Exchange Act Release No. 36719 (January 16,
1996), 61 FR 1655 (January 22, 1996).
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II. Description of the Current and Prior Proposals
The NASD proposes to extend until July 31, 1996 the September 1995
Amended SOES Rules. Specifically, the NASD proposes to extend until
July 31, 1996 changes that:
(1) Reduce the minimum exposure limit for ``unpreferenced'' SOES
orders from five times the maximum order size to two times the maximum
order size, and eliminate the exposure limits for ``preferenced'' SOES
orders; and
(2) Maintain the availability of an automated function for updating
market maker quotations when the market maker's exposure limit has been
exhausted (market makers using this update function may establish an
exposure limit equal to the maximum order size for that security).
III. Discussion
The Commission must approve a proposed NASD rule change if it finds
that the proposal is consistent with the requirements of the Act and
the rules and regulations thereunder that govern the NASD.\8\ In
evaluating a given proposal, the Commission examines the record before
it and relevant factors and information.\9\ The Commission believes
that approval of the proposal through July 31, 1996 meets the above
standards. Specifically, the Commission believes that the current
minimum exposure limit and automated quotation update feature are
appropriate while the Commission considers NAqcess, the NASD's latest
proposal for handling small orders from retail customers.\10\
\8\ 15 U.S.C. Sec. 78s(b). The Commission's statutory role is
limited to evaluating the rules as proposed against the statutory
standards. See S. Rep. No. 75, 94th Cong., 1st. Sess., at 13 (1975).
\9\ In the Securities Acts Amendments of 1975, Congress directed
the Commission to use its authority under the Act, including its
authority to approve SRO rule changes, to foster the establishment
of a national market system and promote the goals of economically
efficient securities transactions, fair competition, and best
execution. Congress granted the Commission ``broad, discretionary
powers'' and ``maximum flexibility'' to develop a national market
system and to carry out these objectives. Furthermore, Congress gave
the Commission ``the power to classify markets, firms, and
securities in any manner it deems necessary or appropriate in the
public interest or for the protection of investors and to facilitate
the development of subsystems within the national market system.''
S. Rep. No. 75, 94th Cong., 1st. Sess., at 7 (1975).
\10\ See Securities Exchange Act Release No. 36548 (December 1,
1995), 60 FR 63092 (December 8, 1995). The comment period for the
NAqcess proposal closed on January 26, 1996, and to date the
Commission has received over 250 comments on the proposal. The
Commission's evaluation of the NAqcess proposal may affect its
evaluation of any future submissions relating to SOES.
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The Commission believes that a sufficient basis exists for
approving the NASD's proposal to continue the current operation of
SOES. The system will continue to provide retail investors, through
automation, an opportunity to obtain execution of orders in size up to
1,000 shares, ensuring access to the Nasdaq market.
In addition, as a result of the March 1995 Amended SOES Rules, the
SOES minimum exposure limit was increased from 1,000 shares to 2,000
shares. Moreover, the March 1995 Amended SOES Rules continues the
methodology for calculating a market maker's outstanding exposure limit
that excluded orders executed pursuant to a preferencing arrangement.
Under the SOES Rules prior to the January 1994 Amended SOES Rules, both
preferenced and unpreferenced orders were considered when calculating a
market maker's remaining exposure limit. Thus, in relative terms, the
2,000 share exposure limit potentially provides greater liquidity under
certain conditions compared to the pre-January 1994 Amended SOES Rules'
5,000 share minimum exposure limit.
The Commission continues to believe that the current operation of
SOES has eliminated economically significant restrictions imposed on
order entry firms by the January 1994 Amended SOES Rules. The
Commission believes that while the proposal does not restore the pre-
January 1994 Amended SOES Rules' minimum exposure limit, it provides
customers fair access to the Nasdaq market and reasonable assurance of
timely executions. In this regard, the maximum order size is consistent
with the size requirement prescribed under the Firm Quote Rule \11\ and
NASD rules governing the character of market maker quotations.\12\
Moreover, a market maker's minimum exposure limit for unpreferenced
orders is double its minimum size requirement prescribed under these
rules.
\11\ 17 CFR 240.11Ac1-1(c).
\12\ NASD Manual, Schedules to the By-Laws, Schedule D, Part V,
Sec. 2(a), (CCH) para.1819.
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The Commission also believes that extending the automated update
function is consistent with the Act and, in particular, the Firm Quote
Rule.\13\ The update function provides market makers the opportunity to
update their quotations automatically after executions through SOES;
under the Commission's Firm Quote Rule, market makers are entitled to
update their quotations following an execution and prior to accepting a
second order at their published quotes.\14\
\13\ The SOES automated update function is also consistent with
the NASD's autoquote policy which generally prohibits autoquote
systems, but allows automatic updating of quotations ``when the
update is in response to an execution in the security by that
firm.'' NASD Manual, Schedules to the By-Laws, Schedule D, Part V,
Sec. 2 (CCH) para.1819.
\14\ The Firm Quote Rule requires market makers to execute
orders at prices at least as favorable as their quoted prices. 17
CFR 11Ac1-1(c)(2). The Rule also allows market makers a reasonable
period of time to update their quotations following an execution;
allows market makers to reject an order if they have communicated a
quotation update to their exchange or association; and provides for
a size limitation on liability at a given quote. 17 CFR 240.11Ac1-
1(c)(3)(ii). See also, Securities Exchange Act Release No. 14415
(Jan. 26, 1978), 43 FR 4342 (Feb. 1, 1978).
[[Page 4506]]
In its Order approving the September 1995 Amended SOES Rules, the
Commission noted its concern about the potential for delayed and/or
inferior executions. In that regard, the Commission stated that it
expected the NASD to monitor the extent to which exposure limits are
exhausted, the extent to which the automated quotation update feature
is used, and the effects of these two aspects on liquidity. Moreover,
the Commission stated that it expected the NASD to consider the
possibility of enhancements to eliminate the potential for delayed and/
or inferior executions. The NASD, therefore, submitted a report in
response to the Commission's requests.\15\
\15\ Monitoring Report of Exhaustion of SOES Exposure Limits and
the Usage of Nasdaq Automated Quotation Update Feature, NASD
Economic Research Department, December 18, 1995 (``Monitoring
Report'').
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In the Monitoring Report, the NASD found that from October 2, 1995
to November 22, 1995, the average daily number of occurrences of SOES
exposure limits being exhausted was eighty-three.\16\ The NASD stated
that relative to the average number of market making positions on the
Nasdaq National Market, the average is equivalent to 0.0019 occurrences
per market making position per day or 0.0211 occurrences per stock per
day.\17\ The NASD concluded that, based on these numbers, the impact of
exhaustions on liquidity if negligible.\18\
\16\ The high was 119 occurrences on November 21, 1995, and the
low was 47 occurrences on October 4, 1995.
\17\ These averages were based on averages of 44,062 market
maker positions and 3,932 securities per day.
\18\ The NASD also noted that even when an exhaustion occurred,
it is likely that other market makers were at the inside quote to
provide liquidity to SOES orders.
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The NASD also supplied data regarding the automated quotation
update feature in the Monitoring Report. The NASD stated that the
average daily number of updates using the Nasdaq automated quotation
update feature over the period was 3,394.\19\ The NASD reported that as
of November 21, 1995, the automated quotation update feature was used
by 126 market makers for 10,644 market making positions, or 26 percent
of all active market makers and 24 percent of all Nasdaq National
Market market making positions.\20\
\19\ The high was 5,376 on October 10,1995 and the low was 2,157
on October 4, 1995.
\20\ The NASD noted that these numbers do not take into account
any internal automated quotation update systems that individual
market making firms may employ and therefore, overall automated
quotation update usage on Nasdaq is greater than the NASD's
calculations demonstrate.
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With regard to the Commission's request that the NASD consider the
possibility of enhancements to SOES in order to eliminate the potential
for delayed and/or inferior executions, the NASD, in its Monitoring
Report, stated that the average delay between a SOES market order entry
and order execution is 1.62 seconds.\21\ The NASD concluded that such
delays do not appear to warrant enhancements to SOES.
\21\ The NASD noted that the maximum delay for a recent day was
87 seconds.
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In further support of its proposal, the NASD continues to rely on
the same arguments and justifications previously submitted to the
Commission in support of the amendments to SOES. In the orders
approving the January 1995, March 1995, and September 1995 Amended SOES
Rules, however, the Commission expressed its belief that the data
submitted by the NASD was inconclusive, demonstrating neither
significant improvement to nor serious deterioration in the quality of
the Nasdaq market subsequent to the adoption of the January 1994
Amended SOES Rules.\22\ The information submitted by the NASD since its
initial study, including the Monitoring Report, does not alter the
Commission's original assessment. The Commission, therefore, continues
to believe that the data submitted by the NASD demonstrates neither a
significant improvement to nor serious deterioration in the quality of
the Nasdaq market as a result of the adoption of the January 1994,
January 1995, March 1995, and September 1995 Amended SOES Rules.\23\
Moreover, the Commission believes this is true whether the amended SOES
rules are viewed collectively or individually. Thus, the Commission
finds the data submitted by the NASD to be inconclusive. For the
reasons discussed above, however, the Commission has determined to
approve the proposal to extend the September 1995 Amended SOES Rules
through July 31, 1996.
\22\ See Securities Exchange Act Release Nos. 35275 (Jan. 25,
1995), 60 FR 6327 (Feb. 1, 1995); 35535 (Mar. 27, 1995), 60 FR 16690
(Mar. 20, 1995); 36311 (Sept. 29, 1995), 60 FR 52438 (Oct. 6, 1995).
\23\ Nonetheless, the Commission continues to be interested in
data and studies demonstrating the effect, if any, of the SOES rule
changes on the Nasdaq market.
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IV. Conclusion
As indicated above, the Commission has determined to approve the
extension of the SOES Minimum Exposure Limit Rule and the SOES
Automated Quotation Update Feature through July 31, 1996. In light of
the balance of factors described above, the Commission believes
extension of the reduction in the minimum exposure limit, the
limitation of the exposure limit to unpreferenced orders, and the
addition of an automation quotation update feature are consistent with
the Act.
The Commission, in the exercise of the authority delegated to it by
Congress, and in light of its experience regulating securities markets
and market participants, has determined that approval of these changes
to the SOES Rules until July 31, 1996 is consistent with maintaining
investor protection and fair and orderly markets, and that these goals,
on balance, outweigh possible anti-competitive effects on order entry
firms and their customers.
Accordingly, the Commission finds that the rule change is
consistent with the Act and the rules and regulations thereunder
applicable to the NASD and, in particular, Sections 15A(b)(6),
15A(b)(9), and 15A(b)(11). In addition, the Commission finds that the
rule change is consistent with the Congressional objectives for the
equity markets, set out in Section 11A, of achieving more efficient and
effective market operations, fair competition among brokers and
dealers, and the economically efficient execution of investor orders in
the best market.
The Commission finds good cause for approving the proposed rule
change prior to the 30th day after the date of publication of notice of
filing thereof in the Federal Register. In addition to the reasons
discussed in this order, the Commission believes that accelerated
approval of the NASD's proposal is appropriate given the fact that the
proposal is an extension of the amended SOES Rules that have been in
effect since March 1995; that the information presently before the
Commission leads to the conclusion that the current minimum exposure
limit and automated quotation update function are appropriate features
for SOES while the Commission considers the NASD's NAqcess proposal;
and that without Commission action on or before January 31, 1996, the
SOES rules would revert to those in effect prior to January 1994,
resulting in a temporary lapse in continuity.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the instant rule change SR-NASD-95-60 be, and hereby is, approved,
effective February 1, 1996 through July 31, 1996.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-2464 Filed 2-5-96; 8:45 am]
BILLING CODE 8010-01-M