[Federal Register Volume 62, Number 17 (Monday, January 27, 1997)]
[Notices]
[Pages 3935-3936]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-1868]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38185; File No. SR-NASD-97-01]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Accelerated Partial Temporary Approval of 
Proposed Rule Change Relating to Entry of Certain SelectNet Orders

January 21, 1997.

I. Introduction

    On January 8, 1997, 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 clarify members' 
obligations regarding the use of the SelectNet Service as it will 
operate under the Commission's new limit order display rule, Rule 
11Ac1-4 (``Display Rule'') and amendments to Rule 11Ac1-(c)(5) (``ECN 
Amendment''). The proposed rule change was published for comment in 
Securities Exchange Act Release No. 38149 (January 10, 1996), 62 FR 
1942 (January 14, 1997) (``Notice of Proposed Rule Change''). This 
order temporarily approves the proposed rule change, in part, on an 
accelerated basis.
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    \1\ 15 U.S.C. 78s (b)(1).
    \2\ 17 CFR 240.19b-4.
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II. Description of the Proposal

    The NASD has proposed a new Conduct Rule to prohibit members from 
cancelling or attempting to cancel a broadcast or preferenced order 
entered into SelectNet until a minimum period of ten seconds has 
elapsed, and to prohibit the entry of a preferenced order to electronic 
communications networks that have conditions regarding responses to the 
order.\3\
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    \3\ Rule 3380 is proposed to read (a) Cancellation of a Select 
Net 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 cancelled 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 an 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.
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III. Discussion

    In August 1996, the Commission adopted a new rule and amendments to 
an existing rule that went into effect on January 20, 1997.\4\ Upon 
commencement of the Order Execution Rules, over-the-counter (``OTC'') 
market makers began representing certain customer limit orders in their 
quotations in manner significantly different from previously. Moreover, 
under an amendment to the Quote Rule, electronic communications 
networks (``ECNs'') began entering quotations in the Nasdaq Stock 
Market in a manner which heretofore was reserved for registered market 
makers.\5\
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    \4\ 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 of the Order Execution Rules until 
January 20, 1997).
    \5\ 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 into the consolidated system the best-priced orders 
entered therein by a market maker or specialist, and allowing 
brokers and dealers to access such orders (``ECN Display 
Alternative'').
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    To facilitate the ECN Display Alternative envisioned by the Order 
Execution Rules, Nasdaq has established linkages with four ECNs,\6\ 
which provide these ECNs a means to display their best market makers' 
and specialists' quotes and certain customer quotes in the Nasdaq 
system.\7\ A critical portion of Nasdaq's linkage mechanism involves 
Nasdaq's SelectNet Service (``SelectNet''). The SelectNet linkage 
allows NASD members that are not subscribers to a particular ECN to 
access the ECN's orders that are being displayed in the Nasdaq quote 
montage via a preferenced order in SelectNet directed to a particular 
ECN at its displayed price.\8\
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    \6\ The four ECNs are B-Trade; Instinet; Island; and Terra Nova.
    \7\ ECNs must provide the best prices and sizes that market 
makers and specialists have entered in the ECN to the public 
quotation system for inclusion in the consolidated quotation. See 
Order Execution Rules Adopting Release at 121.
    \8\ See Order Execution Rules Adopting Release at 121, noting 
that the ability of nonsubscribers to access market makers' and 
specialists' orders entered into an ECN is a fundamental requirement 
of the ECN Display Alternative.
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    Each ECN is required, pursuant to an Agreement signed with Nasdaq 
and conditions of letters from Commission staff recognizing the ECN as 
a Display Alternative, to have an automated system designed to respond 
to a preferenced order received via SelectNet within a few seconds. 
Consequently, the ECN has only seconds to accept a preferenced order, 
send the Nasdaq processor an acknowledgement that the order has been 
accepted, and notify its customer of the order's execution. Although an 
ECN, upon accepting a preferenced order, notifies its customer of an 
execution obtained via SelectNet, the execution does not actually occur 
when the ECN accepts the order but rather when the Nasdaq system 
processor receives the ECN acknowledgement that it has accepted the 
order. During the time the Nasdaq

[[Page 3936]]

processor is awaiting the ECN's acknowledgement, Nasdaq could presently 
receive a cancellation message from the broker-dealer that sent the 
preferenced order to the ECN. This will result in the Nasdaq processor 
accepting a cancellation message that was first in time and rejecting 
the ECN's acknowledgment message. Consequently, the ECN would be 
exposed to executions to its counterpart when the SelectNet order is 
cancelled.
    The Commission believes that it is important for the operation of 
the SelectNet linkage with ECNs and the ECN Display Alternative that 
ECNs have a reasonable opportunity to respond to orders preferenced 
through SelectNet before the orders are cancelled. Because of the 
structure of the linkage as currently designed, ECNs are potentially 
exposed to internal customer executions when a cancellation of a 
SelectNet order occurs. The Commission notes that, on the first day of 
the Order Execution Rules, there were instances where ECNs experienced 
delays due to the acceptance of SelectNet preferenced orders that were 
immediately cancelled. Moreover, the cancellation of SelectNet orders 
immediately after entry creates significant additional message traffic 
that can potentially slow the linkage. With respect to SelectNet orders 
not using the ECN linkage, the Commission also notes that SelectNet 
orders preferenced to a particular market maker as a practical matter 
need to be accessible for a minimal length of time in order for 
responses to be generated by that market maker. Otherwise, if the order 
may be in the process of being cancelled, market makers will have less 
incentive to attempt to accept SelectNet orders directed to them. The 
Commission believes it is important that ECNs, as well as market 
makers, have a reasonable basis to conclude that when they accept a 
preferenced order it will not be cancelled during the transmission of 
their response. Therefore, the Commission is approving the proposal for 
preferenced SelectNet orders on a temporary basis, until July 1, 1997, 
to evaluate the effects of the proposal on ECNs, market makers, and 
order entry firms.
    In addition to preferenced orders, orders that are sent to ECNs 
with conditions imposed also create response difficulties on the part 
of ECNs.\9\ Therefore, Nasdaq has proposed to prohibit members from 
entering conditional orders into SelectNet when the orders are 
preferenced to an ECN.\10\ The Commission recognizes that conditional 
preferenced orders involve difficult programming issues in electronic 
trading systems. As a result, the ECNs have been unable to modify their 
systems in preparation for the SelectNet linkage to accept conditional 
orders via SelectNet. Nonetheless, conditional orders are being routed 
to ECNs through the linkage, and these orders are subsequently being 
rejected, causing confusion and unnecessary message traffic. The 
Commission believes that prohibiting members from preferencing 
conditional orders to ECNs will eliminate impediments to the operation 
of the linkage with ECNs. Accordingly, the Commission is temporarily 
approving proposed Rule 3380(b) until July 1, 1997, to reduce the 
immediate impact of these orders to the linkage and allow the 
Commission to better evaluate the impact of the proposal before 
considering the rule change on a permanent basis.
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    \9\ The Commission recently approved an NASD Rule change to 
prohibit the entry of all-or-none orders in the Small Order 
Execution System. See Securities Exchange Act Release No. 38156.
    \10\ For example, an all or none order, an order subject to a 
minimum execution size above a normal unit or trading, or an order 
deemed non-negotiable.
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    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 National Market System, set out in Section 11A of the Exchange 
Act, 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 allowing preferenced orders to be entered into SelectNet 
and immediately cancelled impedes the operation of the Order Execution 
Rules, specifically the ECN Display Alternative. Accordingly, the 
Commission finds good cause for approving the proposed rule change, in 
part, on a temporary basis until July 1, 1997, 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-97-01) be and hereby is 
approved on a temporary basis, in part, effective January 21, 1997, 
until July 1, 1997.
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    \11\ 15 U.S.C. 78s(b)(2)( 1998).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12) (1996).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-1868 Filed 1-24-97; 8:45 am]
BILLING CODE 8010-01-M