[Federal Register Volume 62, Number 15 (Thursday, January 23, 1997)]
[Notices]
[Pages 3548-3549]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-1559]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38175; File No. SR-NASD-96-55]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Accelerated Approval and Notice of Filing 
and Order Granting Accelerated Approval of Amendment No. 1 of Proposed 
Rule Change Relating to Primary Market Maker Standards

January 15, 1997.

I. Introduction

    On December 23, 1996, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities 
and Exchange Commission (``Commission'' or ``SEC'') pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 
19b-4 thereunder \2\ a proposed rule change to waive the Nasdaq Primary 
Market Maker standards for the remainder of the current pilot period of 
the Nasdaq Short Sale Rule.\3\ The proposed rule change was published 
for comment in Securities Exchange Act Release No. 38091 (December 27, 
1996), 62 FR 778 (January 6, 1997) (``Notice of Proposed Rule 
Change'').\4\ On January 10, 1997, the NASD submitted Amendment No. 1 
to waive the Nasdaq Primary Market Maker standards on a phase-in 
schedule.\5\ This order approves the proposed rule change, including 
Amendment No. 1, on an accelerated basis.
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    \1\ 15 U.S.C. 78s (b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On November 1, 1996, the Commission extended the pilot 
period of the NASD Short Sale Rule, Rule 3350, through October 1, 
1997. Securities Exchange Act Release No. 37917 (November 1, 1996) 
61 FR 57934 (November 8, 1996).
    \4\ The Nasdaq Board has unanimously approved the filing of the 
proposed rule change regarding the suspension of Primary Market 
Maker standards. See Letter to Holly Smith, Associate Director, 
Division of Market Regulation, SEC, from Eugene A. Lopez, the Nasdaq 
Stock Market, Inc., dated January 9, 1997.
    \5\ See Letter to Holly Smith, Associate Director, Division of 
Market Regulation, SEC, from Robert E. Aber, The Nasdaq Stock 
Market, Inc., dated January 14, 1997.
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II. Description of the Proposal

    The NASD has proposed to suspend the use of the Primary Nasdaq 
Market Maker (``PMM'') qualification criteria found in Rule 4612 (a) 
and (b) of the Nasdaq market maker Requirements of the NASD Rules. 
Under existing Rule 4612, a registered Nasdaq market maker may be 
deemed to be a PMM in a National Market Security 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 PMM 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. 
The PMM qualification criteria is reviewed by Nasdaq to determine which 
Nasdaq market makers will receive the PMM designation. The PMM 
designation allows a Nasdaq market maker to avail itself of the short 
sale exemption under NASD Rule 3350(c)(1). The NASD has proposed, on a 
phase-in basis, to suspend the PMM qualification criteria for Nasdaq 
National Market (``NNM'') securities and, accordingly, deem all 
registered market makers in such securities a PMM.

III. Discussion

    In August 1996, the Commission adopted a new rule and amendments to 
an existing rule that are scheduled to go into effect on January 20, 
1997.\6\ Upon commencement of the Order Execution Rules, over-the-
counter (``OTC'') market makers will be representing certain customer 
limit orders in their quotations and frequently executing customer 
limit orders in a manner very different from today. Moreover, under an 
amendment to the Quote Rule, electronic communications networks 
(``ECNs'') will be entering quotations and executions in the Nasdaq 
Stock Market in a manner which heretofore was reserved for registered 
market makers.\7\ The Commission has acknowledged that the Order 
Execution Rules represent a major change in the way OTC market makers 
display and execute orders in the Nasdaq Stock Market.
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    \6\ See Securities Exchange Act Release No. 37619A (September 6, 
1996), 61 FR 48290 (September 12, 1996) adopting Rule 11Ac1-4 
(``Limit Order Display Rule'') and amendments to Rule 11Ac1-1 
(``Quote Rule'') (collectively the ``Order Execution Rules''). See 
also Securities Exchange Act Release Nos. 38110 (January 2, 1997), 
62 FR 1279 (January 9, 1997) (revising the effective date of the 
Order Execution Rules to January 13, 1997); and 38139 (January 8, 
1997) (revising the effective date of the Order Execution Rules 
until January 20, 1997).
    \7\ Rule 11Ac1-1(c)(5) requires a market maker to display in its 
quote any better priced order the market maker places into an 
electronic communications network (``ECN Amendment''). 
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, entered therein by a market maker 
or specialist, and allowing brokers and dealers to access such 
orders (``ECN Display Amendment'').
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    While the Order Execution Rules are anticipated to contribute to 
more vigorous quotation competition, the additional quotations will 
alter the data used in determining the PMM designation. A quote 
reflecting a customer limit order will be indistinguishable from a 
proprietary quote of a market maker. Inclusion of customer limit orders 
in a market maker's quote can narrow the market maker's spread, as well 
as the number of quotation changes the market maker effects. The 
display of ECN prices into the Nasdaq montage, which also will

[[Page 3549]]

include customer limit orders, will further influence the data that 
Nasdaq calculates in determining a market maker's status as a PMM.
    As a result, the quote conditions on which the PMM standards are 
based will change significantly and will no longer reliably reflect the 
quality of the market provided by the market maker, making the current 
PMM standards unpredictable for market makers. Without such PMM 
designation, a Nasdaq market maker is not permitted to effect a short 
sale in a NNM Security at or below the current best bid when the 
current best bid displayed by Nasdaq is below the preceding best bid in 
the security.\8\
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    \8\ See NASD Rule 3350.
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    The inability of a market maker to predict and obtain the PMM 
designation, and therefore sell short as part of its bona fide market 
making activity, may cause the withdrawal of some market makers thereby 
reducing liquidity and continuity in the market. Moreover, the 
Commission believes that a market maker could be deterred from 
accepting customer limit orders by the risk of losing its PMM 
designation, which consequently could impede the effectiveness of the 
Limit Order Display Rule. The Commission further believes that the 
continued use of the PMM qualification criteria, when the data used is 
not an accurate assessment of the maket marker's own independent 
quotation, would be inequitable and cause an unintended burden on 
competition. The Commission concludes that the suspension of the 
current NASD PMM qualification criteria on a temporary basis is 
consistent with the Act, and for the smooth implementation of the Order 
Execution Rules.
    The Order Execution Rules contain phase-in periods to ensure an 
orderly transition and to permit market participants an opportunity to 
obtain experience over a manageable set of securities.\9\ Consequently, 
the suspension of PMM qualification criteria will also operate on a 
phase-in schedule that parallels the phase-in period of the ECN 
Amendment. On the first business day of the month following each phase-
in period of the ECN amendment, the PMM qualification criteria will be 
suspended and all registered Nasdaq market makers in such securities 
will be designated a PMM. For example, on February 3, 1997 all Nasdaq 
registered market makers in the first fifty securities being phased-in 
under the ECN Amendment, effective January 20, 1997, will be a 
designated PMM.\10\ The Commission expects the NASD to develop new 
standards as soon as practicable after the Order Execution Rules become 
effective. As a result, the Commission is approving the rule change on 
a pilot basis through July 1, 1997.
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    \9\ See Securities Exchange Act Release Nos. 37619A (September 
6, 1996), 61 FR 48290 (September 12, 1996), 38110 (January 2, 1997); 
62 FR 1279 (January 9, 1997); and 38139 (January 8, 1997) (outlining 
the phase-in dates for the Limit Order Display Rule and the ECN 
Amendment).
    \10\ See Letter from S. William Broka, Senior Vice President, 
Trading & Market Service, The Nasdaq Stock Market, Inc., dated 
December 23, 1996.
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IV. Solicitation of Comments on Amendment No. 1

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1 to the proposed rule change. 
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 submissions, all subsequent 
amendments, all written statements with respect to Amendment No. 1 that 
are filed with the Commission, and all written communications relating 
to Amendment No. 1 between the Commission and any persons, other than 
those that may be withheld from the public in accordance with 
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 [insert date 21 days from date of 
publication].

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the Act and the rules and regulations 
thereunder applicable to the NASD, and in particular Sections 
15A(b)(6), 15A(b)(9), and 15A(b)(11). In addition, the Commission finds 
that the rule change is consistent with the Congressional objectives 
for the equity markets, set out in Section 11A, of achieving more 
efficient and effective market operations, fair competition among 
brokers and dealers, and the economically efficient execution of 
investor orders in the best market. The Commission further believes 
that maintaining the existing PMM qualification criteria beyond January 
20, 1997 will likely frustrate the operation of the Order Execution 
Rules. Accordingly, the Commission finds good cause for approving the 
proposed rule change and Amendment No. 1 to suspend the PMM 
qualification criteria prior to the thirtieth day after date of 
publication of notice of filing thereof in the Federal Register.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\11\ that the proposed rule change (NASD-96-55) be and hereby is 
approved, with the first phase-in effective February 1, 1997, until 
July 1, 1997.

    \11\ 15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 300.30-3(a)(12) (1996).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-1559 Filed 1-22-97; 8:45 am]
BILLING CODE 8010-01-M