[Federal Register Volume 61, Number 152 (Tuesday, August 6, 1996)]
[Notices]
[Pages 40869-40870]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-19902]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37502; File No. SR-NASD-96-22]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Accelerated Temporary Approval of 
Proposed Rule Change To Extend Certain SOES Rules Through January 31, 
1997

July 30, 1996.

I. Introduction

    On June 10, 1996, 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 January 31, 1997 certain changes to The Nasdaq Stock Market, 
Inc.'s (``Nasdaq'') 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 subsequently were 
modified in January 1995 (``January 1995 Amended SOES Rules''),\4\ 
further modified in March 1995 (``March 1995 Amended SOES Rules''),\5\ 
extended in September 1995 (``September 1995 Amended SOES Rules''),\6\ 
and further extended in January 1996 (``January 1996 Amended SOES 
Rules'').\7\ The January 1996 Amended SOES Rules are scheduled to 
expire on July 31, 1996, and the NASD seeks to extend these rules until 
January 31, 1997. Without further Commission action, the SOES rules 
would revert to those in effect prior to January 1994.
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    \1\ 15 U.S.C. 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 Amended SOES Rules on a 
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 from five times the maximum order size 
to two times the maximum order size, and the elimination of exposure 
limits for ``preferenced'' orders (``SOES Minimum Exposure Limit 
Rule'');
    (3) 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) (``SOES Automated 
Quotation Update Feature''); 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 feature of the 
January 1994 Amended SOES Rules relating to 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 shares to 500 shares; and
    (2) The prohibition of short sales 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 1995 Amended 
SOES Rules were identical to the March 1995 Amended SOES Rules, and 
extended the effectiveness of such rules until January 31, 1996.
    \7\ Securities Exchange Act Release No. 36795 (January 31, 
1996), 61 FR 4504 (February 6, 1996). The January 1996 Amended SOES 
Rules were identical to the September 1995 and March 1995 Amended 
SOES Rules, and extended the effectiveness of such rules until July 
31, 1996.
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    Notice of the proposed rule change appeared in the Federal Register 
on July 5, 1996.\8\ No comments were received in response to the 
Commission release. For the reasons discussed below, this order 
approves the proposed rule change until January 31, 1997.
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    \8\ Securities Exchange Act Release No. 37377 (June 27, 1996), 
61 FR 35284 (July 5, 1996).
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II. Description of the Current and Prior Proposals

    The NASD proposed to extend until January 31, 1997 the January 1996 
Amended SOES Rules. Specifically, the NASD proposes to extend until 
January 31, 1997 the SOES Minimum Exposure Limit Rule and the SOES 
Automated Quotation Update Feature.

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.\9\ In 
evaluating a given proposal, the Commission examines the record before 
it and relevant factors and information.\10\ The Commission believes

[[Page 40870]]

that approval of the proposal through January 31, 1997 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.\11\
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    \9\ 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. 13 (1975).
    \10\ 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. 7 
(1975).
    \11\ See Securities Exchange Act Release Nos. 36548 (December 1, 
1995), 60 FR 63092 (December 8, 1995); and 37302 (June 11, 1996) 61 
FR 3154 (June 20, 1996). The comment period for the NAqcess 
proposal, as amended, closed on July 26, 1996, and to date the 
Commission has received approximately 600 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.\12\ The system provided and continues to provide retail 
investors, through automation, an enhanced opportunity to obtain 
execution of orders in size up to 1,000 shares and, accordingly, has 
improved access to the Nasdaq market.
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    \12\ In reaching this conclusion, the Commission does not rely 
on the data or economic analysis submitted by the NASD. See 
Securities Exchange Act Release Nos. 35275 (Jan. 25, 1995), 60 FR 
6327 (Feb. 1, 1995); 35535 (March 27, 1995), 60 FR 16690 (March 31, 
1995); 36311 (September 29, 1995), 60 FR 52438 (October 6, 1995); 
and 36795 (January 31, 1996) 61 FR 4504 (February 6, 1996).
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    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 continued 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 \13\ compared to the pre-January 1994 Amended SOES 
Rules' 5,000 share minimum exposure limit.
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    \13\ That is, depending upon the mix of preferenced and 
unpreferenced orders.
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    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 Firm Quote Rule \14\ and the size requirement prescribed under 
the NASD rules governing the character of market maker quotations.\15\ 
Moreover, a market maker's minimum exposure limit for unpreferenced 
orders is double its minimum size requirement prescribed under these 
rules.
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    \14\ 17 CFR 240.11Ac1-1(c).
    \15\ 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.\16\ 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.\17\
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    \16\ 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.
    \17\ 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).
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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 January 31, 1997. 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 
provision for an automatic 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 January 31, 1997 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).
    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 July 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-96-22 be, and hereby is, approved, 
effective August 1, 1996 through January 31, 1997.


    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-19902 Filed 8-5-96; 8:45 am]
BILLING CODE 8010-01-M