[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]


-----------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. Sec. 78s(b)(1).
---------------------------------------------------------------------------

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).
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \8\ See NASD Rule 3350(c)(2)-(8).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \16\ 15 U.S.C. Sec. 78s(b)(2).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \17\ 15 U.S.C. Sec. 78o-3(b)(6).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \19\ 17 CFR 200.30-3(a)(12) (1996).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-28759 Filed 11-7-96; 8:45 am]
BILLING CODE 8010-01-M