[Federal Register Volume 62, Number 60 (Friday, March 28, 1997)]
[Notices]
[Pages 14950-14953]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-7871]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38430; File No. SR-NASD-96-48]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Changes by the National Association of Securities Dealers, Inc. 
Relating to: (1) Rule 4770 of the SOES Rules, Regarding the Fees 
Charged for Executions and Cancellation of Orders Entered in SOES, and 
(2) Rule 7010, Related to Charges for Orders and Cancellation of Orders 
Entered Into SelectNet

March 21, 1997.
    On December 16, 1996, the Nasdaq Stock Market, Inc. (``Nasdaq''), a 
wholly owned subsidiary of the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association''), filed with the Securities 
and Exchange Commission (``SEC'' or ``Commission'') a proposed rule 
change pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934 (``Act'')\1\ and Rule 19b-4 thereunder.\2\ The rule change amends 
NASD Rule 4770 of the Small Order Execution System (``SOES'') Rules, 
regarding the fees charged for execution and cancellation of orders 
entered in SOES, and amends, NASD Rule 7010, related to charges for 
execution and cancellation of orders entered into SelectNet. Notice of 
the proposed rule change, together with the substance of the proposal, 
was provided by issuance of a Commission release and by publication in 
the Federal Register.\3\ Forty-four comment letters were received. The 
Commission is approving the proposed rule change.
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    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 38084 (December 24, 
1996), 62 FR 780 (January 6, 1997).
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I. Description of Rule Change

    The NASD and Nasdaq have evaluated the current fee structures for 
SOES and the SelectNet system that will be changed to accommodate the 
new SEC rules regarding a Nasdaq market maker's order handling 
obligations, i.e., Rule 11Ac1-4 (the customer limit order display rule) 
and amended Rule 11Ac1-1 (amendments to the quote rule regarding the 
display of priced orders entered by market makers or specialists into 
electronic communications networks (``ECNs'')) (collectively, the 
``Order Handling Rules'').\4\ The NASD and Nasdaq have determined, as 
explained below, to restructure SOES and SelectNet fees because of 
charges to their operation as addressed in recently approved NASD 
proposed rule changes stemming from the SEC's new rules.
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    \4\ See Securities Exchange Act Release No. 37619A (September 6, 
1996), 61 FR 48290 (September 12, 1996) (Order Handling Rules 
Adopting Release).
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A. SOES Fees

    SOES is Nasdaq's small order execution system in which orders of 
1,000 shares or less are automatically executed against available 
Nasdaq market makers. In a separate rule filing, the Commission \5\ 
approved on a temporary basis for a limited number of stocks, changes 
allowing market makers to comply with new obligations to display 
customer limit orders in their quotations and to execute orders at such 
quotes only up to actual displayed size, as opposed to an artificial 
``tier size.'' In addition, among other changes, the Commission 
approved a proposal to allow market makers to enter customer market and 
marketable limit orders into SOES, unlike the previous SOES Rules, 
which prohibited market maker entry of such orders, unless the market 
makers self-preference those orders, i.e., direct them to themselves.
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    \5\ See Securities Exchange Act Release No. 38156 (January 10, 
1997), 62 FR 2415 (January 16, 1997) (publishing approval of SR-
NASD-96-43).
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    Because the Order Handling Rules change the current approach to 
market maker quoting in Nasdaq securities from a pure dealer-driven 
quote to a more order-driven quote, the NASD and Nasdaq believe that 
the disparate application of the current SOES fee structure to the 
market maker should be changed to take into account the new process by 
which quotes are established and orders are executed. Accordingly,

[[Page 14951]]

the NASD and Nasdaq proposed to establish a charge assessed against 
both sides to the transaction regardless of the size of the 
transaction--both the order entry firm and the market maker will be 
charged for the execution in SOES. Under the new fee structure, if an 
order entry firm or a market maker were to enter an order of 1,000 
shares into SOES, and that order was executed against a single market 
maker, the firm entering the order (whether a market maker or order 
entry firm) would be assessed $0.50 and the market maker executing the 
order would be assessed $0.50. If a SOES order entered by an order 
entry firm were executed against multiple market makers, the order 
entry firm would be charged a single $0.50 fee while each market maker 
participating in the executions would also be charged a $0.50 fee.
    The NASD and Nasdaq proposed this charge against both parties to an 
execution in recognition of the significant market structure changes 
caused by the SEC rules, the respective use of Nasdaq facilities to 
support SOES operations by both market makers and order entry firms, 
and the significant benefits that both sides of the trade receive in 
the new trading environment in SOES. In the past, the quotations 
represented solely market maker proprietary interest. In the new 
environment, market makers may be displaying a priced order under the 
customer limit order display rule. Because market makers may be quoting 
a particular price to attract order flow, it is appropriate to assess 
them a reasonable fee for using SOES to obtain executions.
    The NASD and Nasdaq believe that the fee structure is fair and 
reasonable in that it is similar to transaction charges assessed in the 
securities industry for automatic executions. SOES provides members 
with an economically efficient means of accessing public quotations and 
executing securities transactions at the published prices. Moreover, 
Nasdaq and the NASD believe that the new fee structure equitably 
allocates charges to both sides of the transaction that are utilizing 
the system, both of whom benefit from the execution and both of whom 
consume resources in utilizing the system. In this new trading 
environment, there is no reason to allocate all of the costs in 
operating SOES to the market maker. Instead, the more equitable 
allocation of costs is to charge both the order entry firm and the 
order execution firm. In this way, both parties to the transaction are 
allocated the costs that Nasdaq incurs in developing and operating this 
system.\6\
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    \6\ Under NASD Rules, members are permitted to either absorb the 
costs assessed, or to pass the fee along to the ultimate customer.
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B. SOES and SelectNet Cancellation Fees

    The NASD and Nasdaq also proposed a new fee related to 
cancellations entered into SOES and SelectNet.\7\ Orders entered into 
either system that are canceled would be charged $0.25 each. Neither 
SOES nor SelectNet currently have an order cancellation fee. Nasdaq, 
however, has taken note of the significant number of orders in both 
systems that are canceled, sometimes with seconds of order entry. By 
way of example, on one day, approximately 161,400 SelectNet orders were 
entered, of which approximately 125,600 were canceled. Only 19,000 were 
executed. In SOES, of approximately 100,000 orders entered, 30,000 
typically are canceled.\8\ Moreover, many cancellations occur within a 
30 second period after order entry. For example, on November 8, 1996, 
the heaviest user of SelectNet entered 70,000 orders, and canceled a 
total of almost 64,000 orders, of which 30,000 were canceled within 30 
seconds of order entry. Such use of the system requires that Nasdaq be 
configured to handle heavy SOES and SelectNet use without resulting 
executions. In recognition that order cancellations consume significant 
system resources, Nasdaq proposed a cancellation fee to allocate 
equitably the communications and systems costs associated with the 
Nasdaq network among all firms that utilize the system.
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    \7\ It should be noted that SelectNet fees otherwise will remain 
as currently structured. The SelectNet transaction fee applies to 
both sides of the transaction. Moreover, the fee will apply to all 
parties using the system, including electronic communications 
networks whose priced orders are accessed by NASD members entering 
orders into SelectNet.
    \8\ Data from November 20, 1996.
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II. Summary of Comments

    The Commission received a total of forty-four comment letters on 
the proposal. These letters were from Instinet Corporation 
(``Instinet''),\9\ Singer Zamansky LLP (``Singer''),\10\ Momentum 
Securities, Inc. (``Momentum''),\11\ Grossman & Co. (``Grossman''),\12\ 
David K. Whitcomb (``Whitcomb''),\13\ and A.J. Michaels & Co., LTD 
(``A.J. Michaels'').\14\ The remaining thirty-nine comment letters were 
from Castle Securities (``Castle'') and its associated persons, all of 
which stated their agreement with the Whitcomb Letter.\15\ The NASD 
addressed the comments in a letter to the staff.\16\
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    \9\ Letter from Charles R. Hood, Senior Vice President and 
General Counsel, Instinet Corporation, to Jonathan G. Katz, 
Secretary, SEC, dated January 10, 1997 (``Instinet Letter'').
    \10\ Letter from Linda Lerner, Esq., Singer Zamansky LLP, to 
Jonathan G. Katz, Secretary, SEC, dated January 16, 1997 (``Singer 
Letter'').
    \11\ Letter from Elizabeth Erwin, President, Momentum 
Securities, to Jonathan G. Katz, Secretary, SEC, dated January 27, 
1997 (``Momentum Letter'').
    \12\ Letter from Dennis Grossman, President, Grossman & Co. 
Investment Management, to Jonathan G. Katz, Secretary, SEC, dated 
January 27, 1997 (``Grossman Letter'').
    \13\ Letter from David K. Whitcomb, Professor of Finance, 
Graduate School of Management, Rutgers University, to Jonathan G. 
Katz, Secretary, SEC, dated January 17, 1997 (``Whitcomb Letter'').
    \14\ Letter from Michael F. Frey, President, A.J. Michaels & 
Co., LTD., to Jonathan G. Katz, Secretary, SEC, dated January 29, 
1997 (``A.J. Michaels Letter'').
    \15\ Letters from Michael T. Studer, Mary B. Nolan, Leslie S. 
Roth, Raymond Snediker, Melissa Goez, Noel Meeks, Ray Postle, Teresa 
Herbert, Wycliffe Falconer, Victor Soare, Glenn Perkins, Edward R. 
Namer, Daniel Ledven, Ira Karaba, William W. Curran, M. Hammarstron, 
George Herbert, Celestine Pugliese, Louis A. Farley, Fausto 
Pugliese, Llewlyn Reid, Frank Ferrar, Robert Stewell, Robert 
Robertson, Christine Achatz, Georgene Deluca, Joseph Giordano, Frank 
Giraco, Paul Giraldi, Dale Morisco, Shakespeare Newsome, Charlie 
Rauch, Cindy Sarelis, Nick Abadiotakis, Harry W. Zacher, Jr., Walter 
K. Gartner, Charles S. Kafeiti, Tony S. Kafeiti, and Steven Diaz to 
Jonathan G. Katz, Secretary, SEC, all dated January 28, 1997.
    \16\ Letter from Robert E. Aber, General Counsel, Nasdaq, to 
Ivette Lopez, Esq., Assistant Director, Division of Market 
Regulation, SEC, dated March 3, 1997 (``Nasdaq Letter'').
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A. SOES Order Entry Fee

    Several commenters objected to the $0.50 fee on the entry of an 
order into SOES because Nasdaq did not justify the fee on the basis of 
Nasdaq's cost of running the system.\17\ Nasdaq responded that the 
shift in the fees is a reallocation of the $1.00 SOES fee previously 
approved by the Commission as reasonable in relation to the operation 
of the SOES system.\18\ Nasdaq further states that while allocating the 
$1.00 fee to market makers only may have been justified when the quotes 
represented only a market maker's interest, because the quotation that 
an order entry firm is accessing through SOES on behalf of its customer 
may now represent an order from another customer, it is not reasonable 
to impose a fee that favors one set of customers over another.\19\
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    \17\ See Singer Letter, Momentum Letter, Grossman Letter, and 
A.J. Michaels Letter.
    \18\ See Nasdaq Letter.
    \19\ Id.
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    Several commenters expressed the concern that the reallocation of 
fees may harm customers that currently use SOES to obtain executions 
because it will be more costly to execute their orders

[[Page 14952]]

through SOES.\20\ Nasdaq responds that it has acted to properly balance 
the fee structure to minimize the likelihood that one set of customers 
may obtain an unfair advantage over another set of customers. Nasdaq 
also notes that nothing in the fee proposal requires an order entry 
firm that is being assessed a fee to pass that fee on to its ultimate 
customer.\21\ Several commenters noted the negative impact on their 
profits of the fees if they do not pass them along to their 
customers.\22\ Nasdaq responds that this argument is not sufficient 
justification for allocating the fee only to market makers and their 
limit order customers.\23\
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    \20\ See Singer Letter, Momentum Letter, and Grossman Letter.
    \21\ See Nasdaq Letter.
    \22\ See Grossman Letter.
    \23\ See Nasdaq Letter.
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    Several commenters argued that order entry customer costs will 
increase because fees will be based on each execution that the customer 
receives, and because SOES orders may be executed against multiple 
market makers those customers will have to pay $0.50 for each such 
execution.\24\ Nasdaq states that this assertion is based on an 
erroneous reading of the proposal, and notes that customers will be 
charged $0.50 only for each total order that is executed. Commenters 
also argued that overall costs to customers may increase because 
customer orders executed through SOES may be partially filled, with the 
result that the remainder of the order must be executed through 
SelectNet at an additional fee.\25\ Nasdaq acknowledges that customers 
that use multiple systems will incur charges for such use, but believes 
that firms choosing to use multiple systems to obtain executions should 
have to pay a reasonable fee for using each system.\26\
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    \24\ See Singer Letter.
    \25\ See Singer Letter, A.J. Michaels Letter.
    \26\ See Nasdaq Letter.
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B. SOES and SelectNet Cancellation Fee

    Commenters criticized the $0.25 ``cancellation'' fee for SOES and 
SelectNet orders as an unfair charge, and in particular criticized 
Nasdaq's example of the number of cancellations by a specific firm on a 
particular day without regard to whether this was an average day, or 
one with an unusually high number of cancellations.\27\ Nasdaq 
reiterated its belief that those that use a system in such a way as to 
place a burden on that system should be required to pay for that 
use.\28\ Nasdaq stated that cancellations create traffic in Nasdaq's 
network and computer processors, and, accordingly, those system users 
that cancel orders should be required to pay for that use.\29\
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    \27\ See Singer Letter, A.J. Michaels Letter.
    \28\ See Nasdaq Letter.
    \29\ Id.
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C. SelectNet Fees for ECNs

    Instinet objected to the NASD's statement in the notice of proposed 
rule change regarding the imposition of SelectNet charges on ECNs.\30\ 
Specifically, the NASD stated that the $2.50 per trade SelectNet fee 
will apply to all parties using the system, including ECNs whose priced 
orders are accessed by NASD members entering orders into SelectNet. 
Instinet indicated that in making this statement, the NASD has made a 
unilateral decision that is inconsistent with the Commission's 
directives to self-regulatory organizations in implementing the Order 
Handling Rules to ``work expeditiously with ECN's * * * to develop 
rules or understandings of general applicability'' in constructing a 
means for compliance with the ECN Display Alternative.\31\ Nasdaq 
responds that in the course of negotiating contracts with ECNs that 
have sought to display their orders in Nasdaq pursuant to the ECN 
Linkage, Nasdaq has discussed the matter of fees with the ECNs and 
arrived at a temporary arrangement regarding SelectNet fees when ECNs 
execute orders directed to them through the SelectNet Linkage. Nasdaq 
states, however, that because ECNs are operated by broker-dealers that 
are NASD members, ECN's sponsors are subscribers to Nasdaq's services 
(including SelectNet) and are thus subject to general NASD rules, 
including the fee structure. Nasdaq further states that the footnote 
was intended to indicate that the SelectNet fee applies to all NASD 
members that use the service, unless other arrangements are arrived 
at.\32\
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    \30\ See Instinet Letter.
    \31\ Order Handling Rules Adopting Release, supra note 4 at 96.
    \32\ See Nasdaq Letter.
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to the NASD and Nasdaq and, in particular, the 
requirements of Section 15A, and the rules and regulations thereunder. 
Specifically, the Commission believes that the proposed rule change is 
consistent with Section 15A(b)(5) of the Act, which requires that ``the 
association provide for the equitable allocation of reasonable dues, 
fees, and other charges among members * * * and other persons using any 
facility or system which the association operates or controls;'' with 
Section 15A(b)(6), which requires that the rules of the association be 
``designed 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 with 
Section 15A(b)(9) of the Act, which requires that the rules of the 
association ``not impose any burden on competition not necessary or 
appropriate in furtherance of [the Act].''
    The Commission finds that the NASD and Nasdaq's changes to the 
current SOES fee structure are consistent with the Act. Specifically, 
the Commission agrees that the significant changes in the process by 
which quotes are established and orders are executed resulting from the 
Commission's Order Handling Rules \33\ and the NASD's changes to SOES 
and the SelectNet recently approved by the Commission \34\ warrant a 
review of SOES and SelectNet fees. In the dynamic environment created 
by the Commission's Order Handling Rules, the Commission finds that it 
is reasonable for the NASD to reallocate SOES and SelectNet charges to 
account for the new source of quotes and the manner in which the 
systems are being used. The Commission finds the proposed fee of $0.50 
to the order entry firm and each market maker participating in the 
execution of a transaction is an equitable allocation of fees to both 
sides of the transaction for their use of SOES facilities. The 
Commission does not believe that the fees inequitably distinguish 
between market makers and other NASD members, such as order entry 
firms. The Commission notes that both the market maker and the order 
entry firm benefit from an execution through SOES at the market maker's 
quote. Moreover, under the Order Handling Rules, customer orders could 
be on both sides of a SOES transaction, and so it is equitable to 
charge both customers for the execution services. While the NASD could 
have designed its fees in a variety of ways, the Commission finds that 
the approach adopted results in a non-discriminatory and equitable 
allocation of fees among market makers and other SOES users. Finally, 
the Commission also finds that the fee does not impose a burden on 
competition not necessary or appropriate in furtherance of the Act.

[[Page 14953]]

Anyone using SOES, whether a market maker displaying its own quotes or 
a customer limit order, or an order entry firm, who effects a 
transaction will have to pay $0.50 per order. The cost of using SOES 
will be the same for all users.
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    \33\ See Order Handling Rules Adopting Release, supra note 4.
    \34\ See supra note 5.
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    The Commission also finds the institution of a charge of $0.25 for 
each cancellation entered into SOES and SelectNet to be consistent with 
the Act. The broadcast of orders that are subsequently cancelled 
creates the need for increased system capacity in order to ensure the 
smooth and efficient operation of SOES and SelectNet. The Commission 
finds that the $0.25 fee imposes a portion of the cost of maintaining 
system capacity to handle large numbers of cancellations to those firms 
that create the need for such capacity. The Commission finds that the 
cancellation fee does not impose a burden on competition not necessary 
or appropriate in furtherance of the Act. All users of the two systems 
will bear the same cost for cancellation of orders.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-NASD-96-48) be, and hereby is, 
approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 97-7871 Filed 3-27-97; 8:45 am]
BILLING CODE 8010-01-M