[Federal Register Volume 62, Number 6 (Thursday, January 9, 1997)]
[Notices]
[Pages 1351-1353]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-445]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38115; File No. SR-NASD-95-54]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by National Association of Securities Dealers, Inc., Relating to
a Modification of the Operation of the Small Order Execution System
During Locked and Crossed Markets
January 3, 1997.
On November 15, 1995,\1\ the National Association of Securities
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities
and Exchange Commission (``Commission'' or ``SEC'') a proposed rule
change pursuant to Section 19(b)(1) of the Securities Exchange Act of
1934 (``Act'') \2\ and Rule 19b-4 thereunder.\3\ The rule change amends
NASD Rule 4730(b)(4) \4\ to provide that during locked or crossed
markets, SOES will execute orders in five-second intervals against a
locked or crossed market maker at the best price, regardless of whether
the market maker entered the quotation locking or crossing the market.
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\1\ The NASD amended the proposed rule change four times
subsequent to its initial filing. Amendment No. 4 filed October 16,
1996, changed the narrative in the proposed rule change. Amendment
No. 3, filed October 2, 1996, replaced Amendment No. 2, which was
filed September 23, 1996. Amendment No. 2, in turn, replaced
Amendment No. 1, which was filed August 5, 1996.
The proposed rule change, as originally submitted, would have
provided market makers with a 15-second grace period following their
receipt of a Small Order Execution System (``SOES'') execution
report during locked and crossed markets in which to update their
quotation in that security before being required to execute another
SOES order in that security. The filing as amended would establish a
5 second grace period between SOES executions in locked and crossed
markets. See letter from Robert E. Aber, Vice President and General
Counsel, The Nasdaq Stock Market to Katherine England, Assistant
Director, Division of Market Regulation, Commission (October 2,
1996).
\2\ 15 U.S.C. Sec. 78s(b)(1).
\3\ 17 CFR 240.19b-4.
\4\ NASD Manual, Marketplace Rules (CCH), Rule 4730.
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Notice of the proposed rule change, together with the substance of
the proposal, was provided by issuance of a Commission release
(Securities Exchange Act Release No. 37845, October 21, 1996) and by
publication in the Federal Register (61 FR 55342, October 25, 1996).
One comment letter was received.\5\ This order approves the proposed
rule change.
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\5\ Letter from Edward J. Johnsen, Vice President & Counsel,
Morgan Stanley & Co. Inc. (``Morgan Stanley''), to Jonathan G. Katz,
Secretary, Commission, dated November 14, 1996.
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I. Description of Rule Change
The rule change approved today modifies SOES to provide that during
[[Page 1352]]
locked or crossed markets, SOES will execute orders in five-second
intervals against a market maker whose quotation is locked or crossed
at the best price, regardless of whether the market maker entered the
quotation locking or crossing the market. Currently, when markets are
not locked or crossed, SOES provides market makers with a 15-second
period of time following their receipt of a SOES execution report to
update their quotation before being required to execute another order
in that security through SOES. The NASD represented in its filing that
when the market for a Nasdaq National Market security is locked or
crossed,\6\ however, SOES is currently designed so that the market
maker whose quotation is locked or crossed and the market maker who has
entered a locking or crossing quotation will have SOES orders
representing shares equal to the SOES minimum exposure limit \7\ or the
firm's exposure limit, whichever is greater, executed by SOES against
the market maker's account without any delay between SOES executions
(``locked and crossed market rule'').\8\ Thus, in such instances,
unlike the operation of SOES during non-locked or crossed markets, the
market maker's account will receive SOES executions without any delay
between executions until its exposure limit is exhausted. In addition,
during locked or crossed markets, SOES orders are executed against
market makers whose quotations are locked or crossed irrespective of
any preference indicated by the SOES order entry firm.
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\6\ Quotations are ``locked'' when the bid price quoted by one
market maker in a security equals the ask price quoted by another
market maker in the same security. Quotations are ``crossed'' when
the bid price quoted by one market maker in a security is greater
than the ask price quoted by another market maker in the same
security.
\7\ The minimum exposure limit for SOES is currently twice the
maximum SOES order size for a given security. Thus, the minimum
exposure limit for a Nasdaq/National Market security in the 1,000-
share tier size is 2,000 shares. The NASD has filed a proposed rule
change that would, among other things, eliminate minimum exposure
limits in SOES. See Securities Exchange Act Release No. 38008
(December 2, 1996), 61 FR 64550 (December 5, 1996) (publishing
notice of filing of SR-NASD-96-43).
\8\ See Rule 4730(b)(4). The Commission notes that Rule
4730(b)(4) currently provides that ``a Market Maker with a quotation
for that security in the Nasdaq System that is causing the locked or
crossed market may have orders representing shares equal to the
minimum exposure limit or the firm's exposure limit, whichever is
greater, executed by SOES for that Market Maker's account at its
quoted price if that price is the best price.'' Rule 4730(b)(4) by
its terms does not apply to market makers whose quotations have been
locked or crossed. The proposed rule would change this distinction
and both types of firms to the Rule.
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The locked and crossed market rule was intended to increase the
accuracy of displayed quotations in NNM securities by providing an
incentive for market makers to reduce the frequency and duration of
locked and crossed markets.\9\
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\9\ See Securities Exchange Act Release No. 25791 (June 9,
1988), 53 FR 22594 (order approving SR-NASD-88-1). The NASD stated
in its filing that prior to the approval of SR-NASD-88-1, SOES would
not execute orders in locked and crossed markets.
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The NASD stated in its filing that the magnitude of SOES orders
received and executed during locked and crossed markets is such that
market makers execute significant volume through SOES before they are
able to rectify locked and crossed markets. The NASD further stated the
rule change was intended to continue to provide market makers an
incentive to update their quotations in locked and crossed markets
while enhancing market makers' ability to react to SOES transactions in
locked and crossed markets.\10\
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\10\ The NASD indicated that many locked and crossed markets
occur after trading halts are lifted or when market makers are
adjusting their quotations in response to material news disclosed
concerning the issuer of the security.
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II. Comments
Morgan Stanley opposes the proposed rule change. It states that the
interval proposed is too short for it to react to a locked or crossed
market. It recommends a 15 second interval at a minimum, but argues
that a SOES market maker whose quotation has been locked or crossed
should not be subject to SOES executions for: (i) 90 seconds after its
quotation has been locked or crossed; or (ii) whatever period of time
is needed for the locking or crossing market maker to notify the NASD,
and for the NASD, in turn, to notify the market maker that its
quotation has been locked or crossed. It also recommends that NASD
provide a market maker whose quotation has been locked or crossed with
a warning window on its screen.
III. Discussion
The Commission finds that the rule change is consistent with the
provisions of Sections 15A(b)(6), 15A(b)(9), 15A(b)(11) and
11A(a)(1)(C) of the Act and Rule 11Ac1-1 (``Quote Rule'')
thereunder.\11\ Among other things, 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, to remove impediments to and perfect the mechanism of a
free and open market and a national market system and in general to
protect investors and the public interest. The Commission believes that
the rule change will remove impediments to and perfect the mechanism of
a free and open market and a national market system by providing Nasdaq
market makers with a brief period to update their quotations during
locked and crossed markets before being subject to a SOES execution.
The Commission recognizes that a locked or crossed market can occur
during unusual market conditions. Consequently, it is not unreasonable
to provide market makers with a very brief period to update their
quotes. At the same time, market makers should have an incentive to fix
a locked or crossed market as quickly as possible in order to correct
the quotation anomaly. Thus, the quote update period for locked and
crossed markets should be as short as possible. The Commission believes
that the rule strikes this balance by encouraging market makers to
remedy quickly locked and crossed markets that occur, given that market
makers will continue to face executions at intervals that are less than
one-third of the length of intervals between unpreferenced SOES
executions during times when markets are not locked or crossed.
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\11\ Section 15A(b)(9) provides that the rules of the NASD must
not impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act. Section 15A(b)(11) directs
the NASD to adopt rules designed to produce fair and informative
quotations, prevent fictitious and misleading quotations, and
promote orderly procedures for collecting and distributing
quotations. Section 11A(a)(1)(C) of the Act states that it is in the
public interest and appropriate for the protection of investors and
the maintenance of fair and orderly markets to assure, among other
things, (i) economically efficient execution of securities
transactions; (ii) fair competition among brokers and dealers; and
(iii) the practicality of brokers executing investor orders in the
best market.
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The Commission does not believe that the alternatives recommended
by Morgan Stanley provide market makers with a sufficient incentive to
remedy locked and crossed markets that occur. Therefore, it disagrees
with Morgan Stanley's argument. The Commission also notes that the
rules change will continue to permit retail investors to have immediate
access to the best prices displayed by Nasdaq market makers on Nasdaq
because SOES will continue to execute trades during locked and crossed
markets. By contrast, Morgan Stanley's suggestion that the NASD not
permit executions against a market maker's quotation that has been
locked
[[Page 1353]]
or crossed until the locking or crossing market maker has notified the
NASD, and the NASD, in turn, has notified the market maker that its
quotation has been locked or crossed, would be highly inefficient and
would be inconsistent with the NASD's statutory mandate that its rules
remove impediments to and perfect the mechanism of a free and open
market. The Commission also notes that each of the alternatives
suggested by Morgan Stanley would inhibit the ability of investors to
obtain executions at a market maker's displayed quotations if it were
implemented. Thus, the Morgan Stanley alternatives do not give due
recognition to the interests of investors or to the interest of the
NASD in discouraging locked and crossed markets.
The 5-second interval between SOES executions during locked and
crossed markets will apply to all SOES users and participants. Although
the proposal will limit to a small extent the ability to investors to
obtain executions in locked and crossed markets by providing a 5-second
interval between executions, the Commission believes that the rule
change appropriately balances the interests of investors and the need
for market makers to have a very brief period to update their
quotations expeditiously in locked or crossed markets. The rule change
also is intended to enhance the production of fair and orderly
quotations in NNM securities. This, in turn, should encourage market
makers to enter more competitive quotations.
The Quote Rule requires that brokers and dealers execute orders to
buy and sell securities at their published quotes unless communicating
a revised bid or offer or unless updating their quotations in response
to an execution. The 5-second interval is intended to provide market
makers with an opportunity to update their quotations in response to an
execution. Market makers who do not so will be required to execute
further transactions at their published bid or offer. \12\ The
Commission notes that if the NASD adopted either alternative suggested
by Morgan Stanley, Nasdaq market makers would not be required to
execute orders to buy and sell securities at their published quotes
even when they are not communicating a revised bid or offer or updating
their quotations in response to an execution. \13\
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\12\ See Securities Exchange Act Release No. 29801 (October 10,
1991), 56 FR 52098 (approving 15-second interval following a market
maker's receipt of a SOES execution report to update its quotation
before being required to execute another order in that security
through SOES).
\13\ Morgan Stanley argues that market makers whose quotes have
been locked or crossed may not always have adequate notice that
their quotation has been locked or crossed. It recommends that the
NASD provide a market maker whose quotation has been locked or
crossed with a warning window on its screen. While the suggestion
has merit, the Commission does not believe that it is a necessary
prerequisite for approving a rule change providing market makers
with five additional seconds to update their quotations.
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IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change SR-NASD-95-54 be, and hereby is,
approved.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority. \14\
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\14\ 17 CFR 200.30-3(a)(12) (1989).
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[FR Doc. 97-445 Filed 1-8-97; 8:45 am]
BILLING CODE 8010-01-M