[Federal Register Volume 62, Number 3 (Monday, January 6, 1997)]
[Notices]
[Pages 776-778]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-149]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38092; File No. SR-NASD-96-52]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to the Reporting of Short Sale Transactions by Market Makers Exempt 
from the NASD's Short Sale Rule

December 27, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on December 17, 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 to

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solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 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 amend its Automated Confirmation 
Transaction (``ACT'') Service rules to require all Primary Market 
Makers (``PMMs'') to mark their ACT reports to denote when they have 
relied on the PMM exemption to the NASD's short sale rule.\2\ In order 
to afford NASD members ample time to modify their automated systems to 
comply with the proposed rule change, the NASD proposes to establish an 
effective date for the rule change in a Notice-to-Members announcing 
Commission approval of the proposal, which Notice-to-Members shall be 
published within thirty days of Commission approval of the proposal and 
which effective date shall be no longer than three weeks after the date 
of publication of the Notice. The text of the proposed rule change is 
as follows. (Deletions are bracketed.)
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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).
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* * * * *
NASD Rule 6130
* * * * *
(d) Trade Information To Be Input
    Each ACT report shall contain the following information:
    (1)-(5). No change.
    (6) A symbol indicating whether the transaction is a buy, sell, 
sell short, sell short exempt [*] or cross;
    (7)-(12). No change.

[* The ``sell short'' and ``sell exempt'' indicators must be entered 
for all customer short sales, including cross transactions, and for 
short sales effected by members that are not qualified market makers 
pursuant to Rule 3350.]

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 the NASD's short sale rule 
applicable to short sales 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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    \3\See Securities 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 October 1, 1997, See Securities 
Exchange Act Release Nos. 36171 (August 30, 1995), 60 FR 46651; 
36532 (November 30, 1995), 60 FR 62519; 37492 (July 29, 1996), 61 FR 
40693; and 37919 (November 1, 1996), 61 FR 57934.
    \4\ Nasdaq calculated 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 cannot 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 1/16th 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 involved, 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, although it 
cannot take advantage of the exemption from the rule.
    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.
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    \5\ Specifically, the proportionate volume test requires a 
market maker to account for volume of at least 1\1/2\ 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.
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    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 an NNM security be registering and 
entering quotations in that issue. Otherwise, it may become a PMM in a 
stock only after it has registered in the stock as a regular Nasdaq 
market maker an satisfied the PMM qualification standards for 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 also 
has other corollary effects in market maker registration situations 
involving initial public offerings, secondary offerings, mergers and 
acquisitions.
    In order to enhance the NASD's ability to surveil for compliance 
with the short-sale rule, when the Commission approved the NASD's 
short-sale rule it also approved an NASD proposal to require NASD 
members to append a designator to their ACT reports to denote whether 
their sale transactions were long sales, short sales, or exempt short 
sales. However, market makers exempt from the short-sale rule are not 
required to append ``sell short'' or ``sell short exempt'' to their ACT 
reports.\6\ Accordingly, in order to enhance the NASD's ability to 
surveil for potential abuses of the market maker exemption and examine 
and monitor the market impacts of the market maker exemption, the NASD 
is

[[Page 778]]

proposing to delete the footnote to NASD Rule 6130(d)(6), thereby 
requiring all exempt market makers to mark their ACT reports to denote 
when they have relied on the market maker exemption.\7\ In this 
connection, the NASD also notes that SEC staff has expressed 
preliminary concerns with the fact that the NASD's short sale rule does 
not apply uniformly to all market participants by virtue of the market 
maker exemption. As a result, to justify retention of the market maker 
exemption, SEC staff has indicated that the NASD must, among other 
things, conduct a thorough analysis of the use and effects of the 
market maker exemption.
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    \6\ Specifically, the footnote to NASD Rule 6130(d)(6) provides 
that ``[t]he `sell short' and `sell short exempt' indicators must be 
entered for all customer short sales, including cross transactions, 
and for short sales effected by members that are not qualified 
market makers pursuant to Rule 3350.''
    \7\ In this connection, consistent with SEC statements regarding 
the intraday netting obligations of firms under SEC Rule 3b-3, the 
NASD notes that it will be permissible for firms to conduct a 
``firm-wide netting'' of long and short positions once a day. 
Accordingly, the NASD believes it would be permissible for a Nasdaq 
trading desk to receive a stock position report at the opening and 
net those trades effected by the Nasdaq trading desk against this 
position throughout the day to determine whether particular sale was 
long or short. Of course, if a firm has developed the capability to 
continuously net its positions throughout that day, that firm would 
have to rely on such updated position reports to determine whether a 
particular sale was long or short. See Securities Exchange Act 
Release No. 27938 (April 23, 1990), 55 FR 17949, 17950.
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    The NASD believes the short-sale information that would be gathered 
upon approval of this rule filing would be a necessary and critical 
component of such an analysis of the market maker exemption.
    The NASD believes the proposed rule change is consistent with 
Sections 15A(b)(6) of the Act.\8\ 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 requiring 
exempt market makers to mark their ACT reports to denote when they have 
relied on the market maker exemption will help to enhance the ability 
of NASD Regulation, Inc. to monitor whether market makers are abusing 
the exemption and facilitate the NASD's ability to examine the market 
impacts of the market maker exemption from the short sale rule.
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    \8\ 15 U.S.C. Sec. 78o-3(b)(6).
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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 the proposes of the Act.

C. Self-Regulatory Organization's Statement on Comments 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 proposed rule change be approved on an 
accelerated basis. The NASD believes that good cause exists to 
accelerate approval of the proposal because of the NASD's need to 
commence capturing exempt sales by exempt market makers through ACT for 
a sufficient time in advance of the expiration of the pilot program for 
the rule on October 1, 1997. With the information collected, the NASD's 
Economic Research Department can conduct a meaningful and statistically 
significant study on, among other things, the market impact of the 
market maker exemption from the rule.

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, NW., Washington, DC 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 File No. SR-NASD-96-52, and 
should be submitted by January 27, 1997.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12) (1996).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-149 Filed 1-3-97; 8:45 am]
BILLING CODE 8010-01-M