[Federal Register Volume 62, Number 9 (Tuesday, January 14, 1997)]
[Notices]
[Pages 1942-1945]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-986]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38149; File No. SR-NASD-97-01]
Self-Regulatory Organizations; Notice of Proposed Rule Changes by
the National Association of Securities Dealers, Inc. Relating to
SelectNet Orders
January 10, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on January
8, 1997, the National Association of Securities Dealers, Inc. (``NASD''
or ``Association''), through its subsidiary,
[[Page 1943]]
The Nasdaq Stock Market, Inc., 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 solicit
comments on the proposed rule change from interested persons.
Nasdaq requests the Commission to find good cause pursuant to
Section 19(b)(2) for approving the proposed rule change prior to the
30th day after publication in the Federal Register. The Order Execution
Rules become effective January 20, 1997. The rule change proposed in
this filing is essential to ensure the successful implementation and
operation of Nasdaq's system designed to facilitate the ECN Display
Alternative envisioned by the Order Execution Rules. Accordingly,
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.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule
Pursuant to Section 19(b)(1) under the Securities Exchange Act of
1934 (``Act'') and Rule 19b-4 thereunder, the NASD is submitting this
rule filing to adopt certain rules regarding The Nasdaq Stock Market's
(``Nasdaq'') SelectNet Service to clarify members' obligations
regarding the use of the service as it will operate under the
Commission's new limit order display rule, Rule 11Ac1-4 (``Display
Rule'') and amendments to Rule 11Ac1-1(c)(5) (``ECN Amendment'').\1\
(New Text is italicized.)
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\1\ See Securities Exchange Act Release No. 37619A (September 6,
1996), 61 FR 48290 (September 12, 1996) (``Order Execution Rules
Adopting Release'') adopting Rule 11Ac1-4 and amendments to Rule
11Ac1-1 (``Quote Rule'') (collectively ``Order Execution Rules'').
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* * * * *
Conduct Rules
* * * * *
3300. TRADING
* * * * *
3380. SELECTNET SERVICE
(a) Cancellation of a SelectNet Order
No member shall cancel or attempt to cancel an order, whether
preferenced to a specific market maker or electronic communications
network, or broadcast to all available members, until a minimum time
period of ten seconds has expired after the order to be canceled was
entered. Such ten second time period shall be measured by the Nasdaq
processing system processing the SelectNet order.
(b) Prohibition Regarding The Entry of Conditional Orders
No member shall enter an order into SelectNet that is preferenced
to an electronic communications network covered by Rule 4623 that has
any conditions regarding responses to the order, e.g., preferenced
SelectNet orders sent to electronic communications networks shall not
be all or none, or subject to minimum execution size above a normal
unit of trading, or deemed non-negotiable.
* * * * *
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 November 18, 1996, the NASD and Nasdaq proposed several changes
to their rules and systems to address changes to the Nasdaq Stock
Market stemming from the Commission's adoption of the Order Execution
Rules. \2\ The Display Rule requires the display in a market maker's
quote of certain customer limit orders and the ECN Amendment requires a
market maker to display in its quote any better priced order the market
maker places into an electronic communication network (``ECN'').
Alternatively, the ECN Amendment provides an exception to the market
maker's display obligation that depends upon the ECN itself displaying
its best-priced orders in Nasdaq and allowing brokers and dealers to
access such orders (``ECN Display Alternative'').
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\2\ See Securities Exchange Act Release No. 38008 (December 2,
1996), 61 FR 64550 (December 5, 1996) notice of NASD filing of
proposed rule change, file number 96-43.
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Among the changes to Nasdaq's rules and systems to accommodate
trading in the new environment the Order Execution Rules create, Nasdaq
has proposed a mechanism to allow ECNs to take advantage of the ECN
Display Alternative by providing a linkage to Nasdaq. A critical
portion of Nasdaq's mechanism involves an existing Nasdaq system,
SelectNet, which will be the means by which NASD members that are not
subscribers to a particular ECN may access the ECN's orders that are
being displayed in Nasdaq's quote montage pursuant to the ECN Display
Alternative. To access those orders, NASD members will be permitted to
enter SelectNet preferenced orders, i.e., orders that are directed to a
particular ECN at its displayed price. Under the terms of agreements
Nasdaq will enter into with each ECN choosing to utilize this SelectNet
linkage (``ECN agreements''), the ECN will be required to respond as
soon as possible within seconds to the preferenced order.
In the course of working with ECNs on this access linkage via
SelectNet, Nasdaq and the ECNs have discovered that problems occur when
members entering orders into SelectNet, whether preferenced orders or
broadcast, immediately cancel such orders. In addition, there are
problems when members impose conditions, restrictions or limitations on
the orders entered. For example, an ECN operating an automated response
system develops response difficulties when it receives an all or none
preferenced order. Nasdaq proposes, through this proposed rule change,
to prohibit members from entering conditional orders into SelectNet
when they are preferenced to an ECN. Nasdaq plans to develop system
changes that will prevent the entry of such conditional orders as soon
as possible.
Additionally, the immediate cancellation of an order entered in
SelectNet causes significant problems for the ECN that had received
such order and was attempting to accept that order. All ECNs will be
required, pursuant to performance standards that will be in the ECN
agreements, to operate an automated system for accepting orders via
SelectNet. The ECN automated system must be able to accept the
SelectNet preferenced order and send a message to Nasdaq and to the
ECN's own customer indicating that an execution has occurred. However,
because an execution does not occur until the Nasdaq system processor
receives the ECN acknowledgement that it has in fact accepted the
order, a member's cancellation message may arrive at the Nasdaq
processor first. Consequently, by the time the acceptance message
arrives at Nasdaq's processor for its acknowledgement, the Nasdaq
processor may have already accepted the cancellation. This will result
in Nasdaq rejecting the execution acknowledgement from the ECN and
hence harm the customer of the ECN
[[Page 1944]]
who believed an execution had occurred. Nasdaq believes it is
appropriate, therefore, to require a member that has entered any order
into SelectNet, a preferenced order or broadcast, to wait at least ten
seconds before cancelling that same order. In this manner, the ECN or
market maker operating a rapidly responding system will not be
adversely disadvantaged.
Nasdaq notes that the establishment of a minimum life of an order
at ten seconds is its initial response to a significant concern that it
has had with the use of SelectNet and the rapid cancellation of orders.
The entry of large numbers of preferenced and broadcast orders into
SelectNet that are cancelled within a very short time span creates
serious market quality concerns. Two particular problems occur: (1) the
rapid entry and almost immediate cancellation of SelectNet orders
causes a misleading appearance of activity that is virtually impossible
to access (i.e. ``flickering'' orders); and (2) because of the system
design of SelectNet, the large number of order sent to the SelectNet
window on Nasdaq Workstation II (``NWII'') rapidly scroll off the
screen before a market maker can see the order and react to it (the
``scroll-off'' problem).
Two issues arise because of the many SelectNet orders that are
cancelled almost as soon as they have been entered. First, the market
may be misled by an appearance of significant activity in a particular
issue, when, in fact, very few orders actually are accessible or carry
any real price discovery information. The appearance of massive numbers
of buy or sell orders first showing up on the screen could cause market
makers and other members to believe that significant news on an issue
is causing the order flow, leading market makers to adjust their
quotations and order entry firms to incorrectly make order entry
decisions based on their observation of the heavy influx of orders. The
entry of these particular SelectNet orders is essentially a distracting
and potentially harmful ``noise'' that disrupts the efficient price
discovery process. Indeed, because these orders are so rapidly
cancelled, it appears that many of these orders were not entered with
the intention of being executed.
Additionally, assuming that each order is entered with the
intention that it is to be executed, the almost immediate cancellation
often prevents other market participants from reacting effectively to
the display of customer order interest. Nasdaq believes that the flurry
of SelectNet orders being entered with almost immediate cancellations
is the functional equivalent of the ``flickering quote'' problem.\3\
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\3\ The NASD believes that the Commission has expressed concern
over the value of `ephemeral' quotes, noting that while certain non-
specialists in the trading crowd may make bids or offers that
temporarily change the market's quote for ``an instant in time,''
they do not really become part of the market quote because they are
withdrawn immediately if not accepted. Such price information, if
broadcast to the world via a consolidated quotation system, is
essentially inaccessible, confusing to the market, and ultimately,
potentially misleading. See Securities Exchange Act Release No.
14415 (January 26, 1978), 43 FR 4342, 4345 (February 1, 1978)
release adopting the Quote Rule. See also Securities Exchange Act
Release No. 15771 (April 26, 1979), 44 FR 26067 (May 4, 1979) and
Securities Exchange Act Release No. 18482 (February 11, 1982), 47 FR
7399 (February 19, 1982) adopting amendments to the Quote Rule.
The NASD also maintains that, in determining not to adopt its
price improvement rule, proposed Rule 11Ac1-5, the Commission stated
that the inaccessibility of quotes created pursuant to this proposal
weighed against its adoption at this time. See Order Execution Rules
Adopting Release. Lastly, the NASD notes that in recent news report
that SEC Commissioner Wallman had concerns with flickering quotes
and caused the Commission to rethink its proposed Rule 11Ac1-5
regarding price improvement and a proposed safe harbor mechanism
that would have required members to change their quotes for 30
seconds in an effort to obtain price improvement for market orders
when spreads are wider than a minimum increment. See Bloomberg,
``SEC Commissioner Voices Concern About Nasdaq Access Rule Plan,''
August 14, 1996.
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Nasdaq believes that the immediate cancellation of orders entered
into SelectNet poses problems similar to those caused by flickering
quotations. Essentially, if orders entered through SelectNet are
immediately cancelled they are thus virtually inaccessible and
therefore misleading. If orders entered into SelectNet are to have any
meaning, particularly when they are broadcast to the entire market, it
seems that such orders should have a reasonable minimum period of life
that permits other market participants to access them.
In addition to the problems caused by the basic inaccessibility of
such orders, the unique design by which SelectNet orders are displayed
is adversely effected by the heavy influx of such orders and subsequent
cancellations. The NWII displays SelectNet orders on a four-line window
at the bottom. Each SelectNet order occupies one line of the four-line
window. Thus, when more than four orders are sent to a market maker
through SelectNet, the oldest order scrolls off the display to be
replaced by the newest order. When many SelectNet orders are sent
through the system it causes the SelectNet window to scroll orders up
and off the four-line window. Consequently, it is virtually impossible
for the market maker to effectively interact with the orders. Even if a
market maker were to observe an order that it wanted to interact with,
it is likely that, due to the high rate of SelectNet cancellations, the
order may be cancelled before the market maker is able to act on it.
The scrolling, coupled with the almost immediate cancellation of
orders, leads some market participants to regard SelectNet as a less
viable trading mechanism.
The large influx of orders and cancellations exacts a heavy toll on
the capacity of Nasdaq's host processors and the Enterprise-Wide
Network II (``EWN''). All of the components have had to be upgraded
significantly in the last year, an upgrade driven in significant part
by the amount of traffic caused by the SelectNet Broadcast feature and
the requirement to process the messages generated in entry and
cancellation of SelectNet orders.
Nasdaq believes that the immediate cancellation of SelectNet orders
causes a myriad of problems, any of which warrants the imposition of a
minimum period for the life of a priced order entered into SelectNet.
At this juncture, to prevent harmful market quality effects, Nasdaq
believes that orders entered into SelectNet should be accessible for at
least a 10 second minimum period of time before such order should be
permitted to be cancelled.
Nasdaq has reviewed other possible time periods for examples of
minimum time periods that permit reasonable access. One such example is
drawn from the Commission's proposed price improvement rule which
included a proposed safe harbor.\4\ The proposed safe harbor provided
that to obtain price improvement for a customer's market order when the
spread in the best bid and offer was greater than the smallest quote
increment (e.g., larger than 1/8th), the market maker should change its
quote for 30 seconds to a price better than the current bid or offer to
see if it could obtain a more favorable execution. Another example of a
minimum time period is in the Intermarket Trading System (``ITS'') Plan
where the exchanges and the NASD have agreed to minimum time periods
for orders sent from one market center to another via ITS. ITS rules
specifically provide that orders sent by a specialist or market maker
in one market center to a specialist or market maker in another market
are ``irrevocable'' for either one or two
[[Page 1945]]
minutes, depending on the time period that the sending market
establishes.
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\4\ See Securities Exchange Act Release No. 36310 (September 29,
1995), 60 FR 52792 (October 10, 1995) release proposing Order
Execution Rules which included a proposed price improvement rule.
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Nasdaq notes that once the Order Execution Rules become effective,
experience may determine that the ten second time period is too brief
to effectively address the market quality concerns that present
problems to market markers and investors alike that are seeking to
trade at published prices that are withdrawn before they can be
accessed. Nasdaq will continue to review SelectNet cancellation
patterns to determine whether a longer minimum period is necessary. If
it determines that market quality is being harmed by cancellations that
indicate such orders are ephemeral, not executable or perhaps
fictitious or manipulative Nasdaq will propose additional means to
eliminate the harm. Accordingly, Nasdaq may revisit its initial
determination to establish 10 seconds as the minimum life of a
SelectNet order.
The NASD believes that the proposed rule change is consistent with
Section 15A(b)(6) of the Act and Rule 11Ac-1. 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. Specifically,
by imposing limits on SelectNet orders as proposed herein, Nasdaq
believes the proposal will promote fair and orderly markets and the
protection of investors.
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.
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
Within 35 days of the publication of this notice in the Federal
Register or within such other period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for doing so or (ii) to which
the self-regulatory organization consents, the Commission will:
(A) by order approve the proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
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 the file number in the caption
above and should be submitted by [insert date 21 days from the date of
this publication].
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\5\
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\5\ 17 CFR 200.30-3(a)(12) (1989).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-986 Filed 1-10-97; 12:29 pm]
BILLING CODE 8010-01-M