[Federal Register Volume 61, Number 218 (Friday, November 8, 1996)]
[Notices]
[Pages 57934-57936]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-28759]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37917; File No. SR-NASD-96-41]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change by the National
Association of Securities Dealers, Inc. Relating to an Extension of the
NASD's Short Sale Rule
November 1, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on October 29, 1996, 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 and order to solicit comments
on the proposed rule change from interested persons and to grant
accelerated approval of the proposed rule change.
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\1\ 15 U.S.C. Sec. 78s(b)(1).
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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 extend the pilot program for its short
sale rule until October 1, 1997. The text of the proposed rule change
is as follows. (Additions are italicized; deletions are bracketed.)
* * * * *
NASD Rule 3350
* * * * *
(1) This section shall be in effect until October 1, 1997 [November
4, 1996].
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 V below. The NASD has prepared summaries, set forth in Sections A,
B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Background and Description of the NASD's Short Sale Rule
On June 29, 1994, the SEC approved the NASD's short sale rule
applicable to short sales \2\ in Nasdaq National Market (``NNM'')
securities on an eighteen-month pilot basis through March 5, 1996.\3\
The NASD's short sale rule prohibits member firms from effecting short
sales at or below the current inside bid as disseminated by Nasdaq
whenever that bid is lower than the previous inside bid.\4\ The Rule is
in effect during normal domestic market hours (9:30 a.m. to 4:00 p.m.,
Eastern Time).
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\2\ 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 NASD Rule
3350(k)(1).
\3\ See Securitieis Exchange Act Release No. 34277 (June 29,
1994), 59 FR 34885 (July 7, 1994) (``Short Sale Rule Approval
Order''). The termination date for the pilot program has
subsequently been extended through November 4, 1996. See Securities
Exchange Act Release Nos. 36171 (August 30, 1995), 60 FR 46651;
36532 (November 30, 1995), 60 FR 62519; and 37492 (July 29, 1996),
61 FR 40693.
\4\ Nasdaq calculates the inside bid or 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, an ``up bid'' is
denoted by a green ``up'' arrow and a ``down bid'' is denoted by a
red ``down'' arrow. Accordingly, absent an exemption from the rule,
a member can not effect a short sale at or below the inside bid for
a security in its proprietary account or a customer's account if
there is a red arrow next to 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.
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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 to 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, although it
cannot take advantage of the exemption from the Rule.
[[Page 57935]]
To be a ``qualified'' market maker, a market maker must satisfy the
Nasdaq Primary Market Maker (``PMM'') Standards. Under the PMM
Standards, a market maker must satisfy at least two of the following
four criteria to be eligible for an exemption from the short sale rule:
(1) The market maker must be at the best bid or best offer as shown on
Nasdaq 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.\5\ If a market maker
is a PMM for a particular stock, there is a ``P'' indicator next to its
quote in that stock.\6\
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\5\ Specifically, the proportionate volume test requires a
market maker to account for volume of at least one-and-a-half times
its proportionate share of overall volume in the security for the
review period. For example, if a security has 10 market makers, each
market maker's proportionate share volume is 10 percent. Therefore,
the proportionate share volume is one-and-a-half times 10, or 15
percent of overall volume.
\6\ In addition, market makers are able to review their status
as PMMs through their Nasdaq Workstation. The review period for
satisfaction of the PMM performance standards is one calendar month.
If a PMM has not satisfied the threshold standards after a
particular review period, the PMM designation will be removed on the
next business day following notice of failure to satisfy the
standards. Market makers may requalify for designation as a PMM by
satisfying the threshold standards in the next review period.
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The ability of a member firm to achieve and maintain PMM status in
80 percent of the NNM issues in which it is registered can also have
the following corollary effects:
a. Existing NNM Securities: if a member firm is a PMM in 80 percent
or more of the securities in which it has registered, the firm 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
member firm is not a PMM in at least 80 percent of its stocks, it may
become a PMM in that stock if it registers in the stock as a regular
Nasdaq market maker and satisfies the PMM qualification standards for
the next review period.
b. Initial Public Offerings (``IPOs''): if a member firm has
obtained PMM status in 80 percent or more of the stocks in which it has
registered, the firm may immediately become a PMM in an IPO by
registering and entering quotations in the issue. However, if the firm:
(1) withdraws from the IPO on an unexcused basis any time during the
calendar month in which the IPO commenced trading on Nasdaq, or (2)
fails to meet the PMM standards for the month in which the IPO
commenced trading on Nasdaq, then the firm is precluded from becoming a
PMM in any other IPO for ten business days following the unexcused
withdrawal or failure to meet the PMM standards (``10-day rule'').\7\
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\7\ The PMM also has provisions applicable to secondary
offerings. Specifically, unless a market maker is 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: (1) 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 (2) the
market maker has satisfied the PMM standards for 40 calendar days.
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c. 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 order stock by registering and entering quotations
in that issue.
In an effort not to constrain the legitimate hedging needs of
options market makers and warrant market makers, the NASD's short sale
rule also contains a limited exception for certain standardized options
market markers and warrant market makers. The NASD's short sale rule
also incorporates seven exemptions contained in SEC Rule 10a-1 that are
relevant to trading of Nasdaq.\8\
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\8\ See NASD Rule 3350(c)(2)-(8).
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2. Proposal To Extend the Short Sale Rule\9\
When the Commission approved the NASD's short sale rule on a
temporary basis, it made specific findings that the Rule was consistent
with Sections 11A, 15A(b)(6), 15A(b)(9), and 15A(b)(11) of the Act.
Specifically, the Commission stated that, ``recognizing the potential
for problems associated with short selling, the changing expectations
of Nasdaq market participants and the competitive disparity between the
exchange markets and the OTC market, the Commission believes that
regulation of short selling of Nasdaq National Market securities is
consistent with the Act.'' \10\ In addition, the Commission stated that
it ``believes that the NASD's short sale bid-test, including the market
maker exemptions, is a reasonable approach to short sale regulation of
Nasdaq National Market securities and reflects the realities of its
market structure.'' \11\
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\9\ The Commission notes that this subsection, as well as the
other portions of Section II of this proposed rule change, contains
the NASD's statements on the basis and purpose of the short sale
rule and its proposal to extend the pilot program, as well as
burdens on competition and comments received.
\10\ See Short Sale Rule Approval Order, supra note 3, 59 FR at
34891.
\11\ Id. 59 FR at 34892.
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Nevertheless, in light of the Commission's concerns with adverse
comments made about the Rule and the Commission's own concerns with the
structure and impact of the Rule,\12\ the Commission determined to
approve the Rule on a temporary basis to afford the NASD and the SEC an
opportunity to study the effects of the Rule and its exemptions. In
particular, before considering any NASD proposal to extend, modify,
permanently implement or terminate the Rule, the Commission requested
that the NASD examine: (1) the effects of the Rule on the amount of
short selling; (2) the length of time that the Rule is in effect (i.e.,
the duration of down bid situations); (3) the amount of non-market
maker short selling permitted under the Rule; (4) the extent of short
selling by market makers exempt from the Rule; (5) whether there have
been any incidents of perceived ``abusive short selling''; (6) the
effects of the Rule on spreads and volatility; (7) whether the behavior
of bid prices has been significantly altered by the Rule; and (8) the
effect of permitting short selling based on a minimum increment of \1/
16\th.
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\12\ When the NASD's short sale rule was first considered by the
Commission, the SEC received 297 comment letters on the proposal,
with 275 comments opposed to the Rule and 122 comments in favor of
the Rule. Those comment letters opposed to the Rule argued that: (1)
the NASD had failed to provide sufficient evidence of the need for a
short sale rule or demonstrate the appropriateness of a short sale
rule based on a ``bid'' test instead of ``tick'' test; (2) the PMM
standards will have negative effects on both market makers and the
Nasdaq market; and (3) the short sale rule is inconsistent with the
requirements of the Act.
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Accordingly, in July 1996, the NASD's Economic Research Department
prepared a study on the economic impact of the NASD's short sale rule
that addressed these issues.\13\ While the NASD believes the study
demonstrates that the short sale rule has not had any adverse market
impacts, the NASD believes further study of the impact of the rule,
particularly the market maker exemption, is needed in order for the
NASD to adequately respond to the SEC's concerns and questions noted in
the Short Sale Rule Approval Order.\14\
[[Page 57936]]
Accordingly, the NASD is proposing to extend its short sale rule until
October 1, 1997, to afford the NASD the opportunity to conduct further
analysis of the impact of the Rule.\15\
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\13\ The Economic Impact of the Nasdaq Short Sale Rule, NASD
Economic Research Department (July 1996) (``Short Sale Study'').
\14\ In July 1996, The NASD submitted a proposal to adopt the
short sale rule on a permanent basis. See Securities Exchange Act
Release No. 37942 (July 29, 1996), 61 FR 40693 (SR-NASD-96-30).
Because the NASD believes additional quantitative analysis is
necessary to evaluate the effects of the Rule, the NASD has
withdrawn this rule filing. Letter from Robert E. Aber, Vice
President and General Counsel, to Katherine England, Assistant
Director, National Market Systems and Over-the-Counter, Commission
(October 29, 1996). The Commission received one comment letter in
regard to the NASD's proposal to adopt the short sale rule on a
permanent basis. Letter from Daniel Parker Odell, Assistant
Secretary, New York Stock Exchange, Inc., to Jonathan G. Katz,
Secretary, Commission (September 6, 1996). The Commission will
consider that letter in connection with any subsequent NASD proposal
for permanent adoption of the short sale rule.
\15\ Specifically, the Commission has requested that the NASD
(1) require exempt market makers to begin reporting short sales, and
(2) provide the Commission with a report examining the data
collected with regard to this requirement including the number of
short sales by exempt market makers and their potential effect on
the purposes of the Rule. In this connection, at its meeting in
November 1996, the Board of Directors of The Nasdaq Stock Market,
Inc. will be considering whether to amend NASD Rule 6301(d)(6) to
require market makers exempt from the Rule to mark their Automated
Confirmation Transaction Service (``ACT'') reports to denote when
they have relied on the market maker exemption.
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The NASD believes the proposed rule change is consistent with
Section 15A(b)(6) 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 foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, and to remove impediments to and perfect the mechanism of a
free and open market. Specifically, the NASD believes that extending
the pilot period for the short sale rule will enhance the quality of
studies analyzing the effectiveness of the Rule and help to ensure that
future regulatory action taken with respect to the Rule is based on a
greater knowledge and understanding of the Rule.
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 the purposes of the Act. The NASD believes the primary
market maker qualification standards are designed in a manner to permit
market makers of all sizes to qualify as primary market makers.
Moreover, it is important to note that market makers that do not meet
the standards are still permitted to remain registered market makers in
the Nasdaq system. In addition, without a short sale rule for the
Nasdaq market, Nasdaq would be adversely impacted in its ability to
compete for listings with exchange markets.
C. Self-Regulatory Organization's Statement on Comment on the Proposed
Rule Change Received From Members, Participants, or Others
Comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
The NASD requests that the Commission find good cause pursuant to
Section 19(b)(2) of the Act \16\ for approving the proposed rule change
prior to the 30th day after publication in the Federal Register.
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\16\ 15 U.S.C. Sec. 78s(b)(2).
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IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
The Commission finds that the proposal to extend the short sale
rule through October 1, 1997 is consistent with the Act and the rules
and regulations promulgated thereunder. Specifically, the Commission
finds that the proposed rule change is consistent with Section
15A(b)(6) \17\ which requires that the NASD rules be designed, among
other things, to facilitate securities transactions and to protect
investors and the public interest.
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\17\ 15 U.S.C. Sec. 78o-3(b)(6).
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The Commission approved the NASD short sale rule in 1994, on a
pilot basis. The purpose of the pilot was to demonstrate that the rule
accomplished its intended purpose and did not impose unnecessary costs
on market participants. In July 1996, the NASD submitted an economic
report on the pilot. While the Short Sale Study provides some data on
the pilot, the Commission believes that the NASD needs to produce
additional and more precise data to justify permanent adoption of the
rule.\18\ Hence the Commission is extending the short sale rule to
provide the NASD with ample time to collect significantly more data and
to determine if the Rule in its current form is appropriate. The data
will aid the NASD and the Commission in determining the benefits and
costs of the short sale rule pursuant to Section 15A(b)(6). The
Commission finds good cause to approve the extension of the short sale
rule pilot prior to the 30th day after the date of publication of the
notice of filing because accelerated approval will avoid disrupting the
market while the NASD and the Commission consider the supplemental data
that will be collected during the extension.
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\18\ Among other matters, the NASD needs to collect short sale
information from exempt market makers and provide a report to the
Commission, as well as measure more precisely the rule's effect on
short sale activity.
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V. Solicitation of Comments
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. Sec. 552, will
be available for inspection and copying in the Commission's Public
Reference Room. Copies of such filing will also be available for
inspection and copying at the principal office of the NASD. All
submissions should refer to the File No. SR-NASD-96-41, and should be
submitted by November 29, 1996.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-NASD-96-41) be, and hereby
is, approved on an accelerated basis through October 1, 1997.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\19\
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\19\ 17 CFR 200.30-3(a)(12) (1996).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-28759 Filed 11-7-96; 8:45 am]
BILLING CODE 8010-01-M