[Federal Register Volume 62, Number 3 (Monday, January 6, 1997)]
[Notices]
[Pages 778-780]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-150]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38091; File No. SR-NASD-96-55]


Self-Regulatory Organizations; Notice of Proposed Rule Changes by 
the National Association of Securities Dealers, Inc. Relating to 
Primary Market Maker Standards

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 23, 1996, the 
Nasdaq Stock Market, Inc. (``Nasdaq'') filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by Nasdaq. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq, a wholly owned subsidiary of the National Association of 
Securities Dealers, Inc. (``NASD'' or ``Association''), proposes to 
temporarily waive NASD Rule 4612, regarding primary Nasdaq market maker 
standards for the remainder of the current pilot period of the Nasdaq 
Short Sale Rule \2\ or until new primary market maker standards can be 
devised.
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    \2\ On November 1, 1996, the Commission extended the pilot 
period of the NASD Short Sale Rule through October 1, 1997. 
Securities Exchange Act Release No. 37917 (November 1, 1996), 61 FR 
57934 (or approving on an accelerated basis an extension to the 
NASD's Short Sale Rule through October 1, 1997).
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, Nasdaq 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. Nasdaq has prepared summaries, set forth in Sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

[[Page 779]]

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    Nasdaq has evaluated its existing qualification criteria in the 
primary market maker standards rule, Rule 4612 (a) and (b), in light of 
the new SEC rules regarding a Nasdaq market maker's order handling 
obligations (``Order Handling Rules'').\3\ Nasdaq strongly believes 
that because of the potential changes in quotation and trading activity 
in Nasdaq securities when the Order Handling Rules become effective, 
the existing numerical criteria used to qualify a registered market 
maker as a primary market maker will be significantly affected. Because 
the precise effects on market maker quotes and trades are not possible 
to predict until Nasdaq can develop practical experience with new 
patterns of activity under the Order Handling Rules, Nasdaq believes 
that it should attempt to minimize the possible harmful unintended 
consequences that could occur by leaving the current standards in 
place. Accordingly, Nasdaq believes that the existing standards should 
be temporarily suspended on the same schedule for the phase in of the 
Order Handling Rules which commence on January 10, 1997.
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    \3\ These rules include Rule 11Ac1-4, the customer limit order 
display rule and amended Rule 11Ac1-1, amendments to the firm quote 
rule regarding the display of priced orders entered by market makers 
or specialists into electronic communications networks. See 
Securities Exchange Act Release No. 37619 (September 6, 1996); 61 FR 
48290 (Order Handling Rules Adopting Release).
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    Under existing Rule 4612, a registered Nasdaq Market Maker may be 
deemed to be a primary market maker in national market securities if 
the market maker meets two of three criteria: (1) The market maker 
maintains the best bid or best offer as shown on Nasdaq no less than 
35% of the time; (2) a market maker maintains a spread no greater than 
102% of the average dealer spread; and (3) no more than 50% of a market 
maker's quotation changes occur without a trade execution. In addition, 
if a registered market maker meets only one of the above criteria, it 
may nevertheless qualify as a primary market maker if the market maker 
accounts for volume at least 1\1/2\ times its proportionate share of 
overall volume in the stock. The review period for meeting any of these 
criteria is one calendar month.
    Commencing on January 10, 1997,\4\ the Order Handling Rules will go 
into effect. These new rules will require Nasdaq market makers to 
change their quotes when they are in receipt of customer limit orders 
that improve upon their current quotations. Furthermore, under newly 
refined best execution principles enunciated by the SEC, market makers 
will be required to execute orders under different circumstances from 
today. Finally, entities that are not market makers, (e.g., electronic 
communication networks (``ECNs'')), will participate in Nasdaq and may 
have a substantial impact on quotations and executions. Nasdaq believes 
that each of the current criteria will be affected. For example, as to 
the 102% of average dealer spread test, dealer quotes will not be 
driven not merely by the market maker's proprietary interests, but also 
the interests of customers that place limit orders with the market 
maker. Under the new rules, a quote of a market maker driven by a 
customer limit order will be indistinguishable from that of a quote 
driven by a customer order. In addition, the test regarding the 
percentage of time in which the market maker's quote is at the inside 
will also be driven to some extent by customer limit order interest. 
Further, because ECNs will be able to drive the inside price, the 
parameters for this factor may need to be reevaluated. Finally, Nasdaq 
believes that the ``quote change to executed trade ratio test'' will 
also be affected by customer limit orders which may be changed or 
cancelled by the customer without the market maker being involved in an 
execution. At this time, however, Nasdaq believes it is virtually 
impossible to predict with any accuracy precisely how market makers 
will change their quotation and execution patterns.
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    \4\ Nasdaq has requested relief from the January 10, 1997 
commencement date of the Order Handling Rules. Nasdaq seeks to 
commence compliance with the rules on January 13, 1997, because of 
concerns that it would pose an untenable system change risk to 
attempt to rush the introduction of new trading system software 
during the trading week. If the SEC grants the relief sought, the 
commencement date for this proposed rule change would also be 
January 13, 1997. Thus, in the course of the filing on this proposed 
rule change, while Nasdaq refers to January 10, 1997, as the 
commencement date, if the SEC grants the relief requested, the 
actual implementation date would be January 13, 1997.
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    Because of this uncertainty, Nasdaq believes that it is in the 
public investor's best interests to temporarily suspend the operation 
of the primary market maker standards that currently exist. If the 
standards are not suspended, and there is a significant shift in the 
patterns of quotation and executions, Nasdaq believes that market 
makers operating under the existing standards and earning the primary 
market maker designation could conceivably lose that status. Nasdaq 
believes that loss of the designation would mean that market makers 
without the designation would not be permitted to avail themselves of 
the short sale exemption for primary market makers. If a significant 
number of registered market makers were to lose the short sale 
exemption, or if a single market maker that handled a significant 
portion of the order flow in a security were to lose the exemption, 
Nasdaq believes liquidity in that particular stock could be seriously 
harmed.
    Therefore, Nasdaq is proposing that starting on February 1, 1997, 
any market maker making a market in any of the initial 50 stocks 
selected for the first phase of implementation of the Order Handling 
Rules on January 10, 1997, will be able to avail itself of the short 
sale exemption for qualified market makers found in Rule 3350(c)(1). 
Similarly, Nasdaq proposes that as stocks are phased in to the new 
Order Handling Rules, any registered market maker in the stock would be 
deemed to be qualified for purposes of the short sale qualified market 
maker exemption.
    In seeking to temporarily suspend the use of the primary market 
maker qualification criteria, Nasdaq believes that the suspension of 
the criteria is an appropriate balance between the need for limitations 
on the market maker short sale exemption and the potential for loss of 
liquidity and market disruption in a period when new patterns and 
practices of trading are first being developed. Nasdaq believes that 
the period of time in which the Order Handling Rules are first being 
implemented may be a period of uncertainty for market makers and 
investors alike and that the prudent course of action would be to 
identify and eliminate as many potential areas for increasing that 
uncertainty as possible. Nasdaq has identified this issue as a critical 
area of uncertainty and believes that the suspension of the market 
maker qualification standards on a temporary basis is an appropriate 
market quality response. Nasdaq believes that this relief will enable 
Nasdaq market makers to better satisfy investor liquidity demands and 
could help to promote pricing efficiency.
    Nasdaq also plans to develop new standards as soon as practicable 
after the Order Handling Rules become effective and Nasdaq can obtain 
experience with the manner in which the new rules affect market makers. 
Nasdaq plans to obtain the data from January and discuss the practices 
among staff and with the Quality of Markets Committee.
    Nasdaq believes that the proposed rule change is consistent with 
Section

[[Page 780]]

15A(b)(6) of the Act \5\ in that it is designed to prevent fraudulent 
and manipulative acts and facilitates transactions in securities. In 
particular, Nasdaq believes this temporary amendment to the existing 
rule should provide market makers with certainty regarding whether they 
are entitled to an exemption under the rule which should promote market 
efficiency and enhance the orderliness of the market during a 
transition period. Nasdaq further believes the proposed rule change 
should also help in reducing investor confusion at this time and 
thereby promote efficient and fair markets.
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    \5\ 15 U.S.C. 78o-3(b)(6).
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Nasdaq has requested that the Commission find good cause pursuant 
to Section 19(b)(2) \6\ for approving the proposed rule change prior to 
the 30th day after its publication in the Federal Register. The date 
that the Order Handling Rules go into effect and Nasdaq must make 
system changes to accommodate the new regulatory requirements is 
January 10, 1997. Because Nasdaq believes that market makers must be 
provided with information regarding the exemption from the short sale 
rule as soon as possible before February 1, 1997, Nasdaq requests the 
Commission to accelerate the effectiveness of the proposed rule change 
prior to the 30th day after its publication in the Federal Register. 
The alternative is potential confusion and market disruption as market 
makers may be unsure about whether they are in fact eligible to sell 
short in the course of their market making activities.
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    \6\ 15 U.S.C. 78s(b)(2).
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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, 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. 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-96-55, and 
should be submitted by January 16, 1997.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12) (1996).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-150 Filed 1-3-97; 8:45 am]
BILLING CODE 8010-01-M