[Federal Register Volume 62, Number 76 (Monday, April 21, 1997)]
[Notices]
[Pages 19373-19377]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-10222]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38512; File No. SR-NASD-97-25]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the National 
Association of Securities Dealers, Inc. Relating to an Extension of the 
Pilot for the NASD's Rule Permitting Market Makers To Display Their 
Actual Quotation Size

April 15, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on 
April 11, 1997, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association'') 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. For the 
reasons discussed below, the Commission is granting accelerated 
approval of the extension.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD proposes to extend the effectiveness of NASD Rule 
4613(a)(1)(C) until July 18, 1997.\1\ NASD Rule 4613(a)(1)(C) provides 
that market makers in the first fifty Nasdaq securities subject to the 
Commission's Limit Order Display Rule are allowed to quote their actual 
quote size (``Actual Size Rule''). The text of the proposed rule change 
is as follows. (Additions are italicized; deletions are bracketed.)
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    \1\ The NASD has concurrently requested that the pilot for the 
Actual Size Rule be expanded to apply to 100 additional Nasdaq 
securities and extended until December 19, 1997. See Securities 
Exchange Act Release No. 38513 (April 15, 1997).
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* * * * *
NASD Rule 4613  Character of Quotations
(a) Two-Sided Quotations
    (1) No change.
    (A)-(B) No change.
    (C) As part of a pilot program implemented by The Nasdaq Stock 
Market, during the period January 20, 1997 through at least [April] 
July 18, 1997, a registered market maker in a security listed on The 
Nasdaq Stock Market that became subject to mandatory compliance with 
SEC Rule 11Ac1-4 on January 20, 1997 must display a quotation size for 
at least one normal unit of trading (or a larger multiple thereof) when 
it is not displaying a limit order in compliance with SEC Rule 11Ac1-4, 
provided, however, that a registered market maker may augment its 
displayed quotation size to display limit orders priced at the market 
marker's quotation.
    (2) Except as provided in subparagraph (a)(1)(C) above, [E]each 
member registered as a Nasdaq market maker in Nasdaq National Market 
equity securities shall display size in its quotations of 1,000, 500, 
or 200 shares and the following guidelines shall apply to determine the 
applicable size requirement:
    (A)-(C) No change.
* * * * *

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 III 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

1. Introduction and Background
    On August 29, 1996, the Commission promulgated a new rule, the 
Limit Order Display Rule \2\ and adopted amendments to the Quote Rule 
\3\ which together are designed to enhance the quality of published 
quotations for securities and promote competition and pricing 
efficiency in U.S. securities markets (these rules are collectively 
referred to

[[Page 19374]]

hereinafter as the ``Order Execution Rules'').\4\ With respect to 
securities included on Nasdaq (``Nasdaq securities''), the Order 
Execution Rules are being implemented according to a phased-in 
implementation schedule. Fifty Nasdaq securities became subject to the 
rules on January 20, 1997 (``first fifty''); fifty more securities 
became subject to the rules on February 10, 1997 (``second fifty''); 
and an additional fifty securities became subject to the rules on 
February 24, 1997. The remaining Nasdaq securities will become subject 
to the rules according to time tables established by the Commission.\5\
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    \2\ 17 CFR 240.11Ac1-4.
    \3\ 17 CFR 240.11Ac1-1.
    \4\ See Securities Exchange Act Release No. 37619A (September 
56, 1997), 61 FR 48290 (September 12, 1996) (``Order Execution Rules 
Adopting Release'')
    \5\ See, e.g., Securities Exchange Act Release No. 38490 (April 
9, 1997).
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    In particular, the SEC's Limit Order Display Rule requires the 
display of customer limit orders, that: (1) are priced better than a 
market maker's quote; \6\ or (2) add to the size associated with a 
market marker's quote when the market maker is at the best price in the 
market.\7\ By virtue of the Limit Order Display Rule, investors now 
have the ability to directly advertise their trading interest to the 
marketplace, thereby allowing them to complete with market maker 
quotations and affect the size of bid-ask spreads.\8\ The Order 
Execution Rules also included amendments to the SEC's Quote Rule, the 
most significant of which requires market makers to display in their 
quote any better priced orders that the market maker places into an 
electronic communications network (``ECN'') such as SelectNet or 
Instinet (``ECN Rule''). Alternatively, instead of updating its quote 
to reflect better priced orders entered into an ECN, a market maker may 
comply with the display requirements of the ECN rule through the ECN 
itself, provided the ECN: (1) ensures that the best priced orders 
entered by market makers into the ECN are included in the public 
quotation; and (2) provides brokers and dealers access to orders 
entered by market makers into the ECN, so that brokers and dealers who 
do not subscribe to the ECN can trade with those orders (``ECN Display 
Alternative'').
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    \6\ For example, if a market maker's quote in stock ABCD is 10-
10\1/4\ (1000  x  1000) and the market maker receives a customer 
limit order to buy 200 shares at 10\1/8\, the market maker must 
update its quote to 10\1/8\-10\1/4\ (200  x  1000).
    \7\ For example, if a market maker receives a customer limit 
order to buy 200 shares of ABCD at 10 when its quote in ABCD is 10-
10\1/4\ (1000  x  1000) and the NBBO for ABCD is 10-10\1/8\, the 
market maker must update is quote to 10-10\1/4\ (1200  x  1000).
    \8\ There are eight exceptions to the immediate display 
requirement of the Limit Order Display Rule: (1) customer limit 
orders executed upon receipt; (2) limit orders placed by customers 
who request that they not be displayed; (3) limit orders for odd-
lots; (4) limit orders of block size (10,000 shares or $200,000); 
(5) limit orders routed to a Nasdaq or exchange system for display; 
(6) limit orders routed to a qualified electronic communications 
network for display; (7) limit orders routed to another member for 
display; and (8) limit orders that are all-or-none orders. See Rule 
11Ac1-4(c).
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    In order to facilitate implementation of the SEC's Order Execution 
Rules and reflect the order-driven nature of the Nasdaq market that was 
to be brought about by the implementation of these rules, the 
Commission approved, on January 10, 1997, a variety of amendments to 
NASD Rules pertaining to Nasdaq's Small Order Execution System 
(``SOES'') and the SelectNet Service (``SelectNet'').\9\ In particular, 
one of the NASD Rule changes approved by the Commission provides on a 
temporary basis that Nasdaq market makers in the first fifty securities 
subject to the Commission's Limit Order Display rule are required to 
display a minimum quotation size of one normal unit of trading when 
quoting solely for their own proprietary account (i.e., the Actual Size 
Rule).\10\ For Nasdaq securities outside of the first fifty, the 
minimum quotation size requirements remained the same.\11\
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    \9\ See Securities Exchange Act Release No. 38156 (January 10, 
1997), 62 FR 2415 (January 16, 1997) ( order partially approving SR-
NASD-96-43 and approving the Actual Size Rule on a pilot basis) 
(``Actual Size Rule Approval Order'').
    \10\ Thus, the Actual Size Rule does not effect a market maker's 
obligation to display the full size of a customer limit order. If a 
market maker is required to display a customer limit order for 200 
or more shares, it must display a quote size of at least 200 shares 
absent an exception from the Limit Order Display Rule.
    \11\ In particular, NASD Rule 4613(3)(2) requires each market 
maker in a Nasdaq issue other than those in the first fifty to enter 
and maintain two-sided quotations with a minimum size equal or 
greater than the applicable SOES tier size for the security (e.g., 
1000, 500 or 200 shares for Nasdaq National Market issues and 500 or 
100 shares for Nasdaq SmallCap Market issues) (``Mandatory Quote 
Size Requirement'').
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    The NASD submitted the proposal for the Actual Size Rule because it 
believed, and continues to believe, that the new order-driven nature of 
Nasdaq brought about by the Limit Order Display Rule obviates the 
regulatory justification for minimum quote size requirements because 
investors now have the capability to display their own orders on 
Nasdaq. The NASD originally imposed the Mandatory Quote Size 
Requirements to ensure an acceptable level of market liquidity and 
depth in an environmental where Nasdaq market makers were the only 
market participants who could impact quotation prices. Now that the 
Limit Order Display Rule permits investors to directly impact quoted 
prices, however, the NASD believes it is appropriate to treat Nasdaq 
market makers in a manner equivalent to exchange specialists and not 
subject them to minimum quote size requirements when they are not 
representing customer orders. In sum, with the successful 
implementation of the SEC's Order Executive Rules, the NASD believes 
that Mandatory Quote Size Requirements impose unnecessary regulatory 
burdens on market makers.
    At the same time, the NASD does not believe that implementation of 
the Actual Size Rule in an environment where limit orders are displayed 
has or will compromise the quality of the Nasdaq market. First, the 
display of customer limit orders enhances the depth, liquidity, and 
stability of the market and contributes to narrower quoted spreads, 
thereby mitigating the effects of the loss of displayed trading 
interest, if any, by market makers, Second, removing artificial quote 
size requirements may lead to narrower market maker spreads, thereby 
reducing investors' transaction costs. Third, permitting market makers 
to quote in size commensurate with their own freely-determined trading 
interest will enhance the pricing efficiency of the Nasdaq market and 
the independence and competitiveness of dealers quotations. Fourth, 
removing quotation size requirements will facilitate greater quote size 
changes, thereby increasing the information content of market maker 
quotes by facilitating different quote sizes from dealers who have a 
substantial interest in the stock at a particular time and those who do 
not.
    Indeed, in its order approving the Actual Size Rule, the Commission 
noted that it ``preliminarily believes that the proposal will not 
adversely affect market quality and liquidity'' \12\ and that it 
``believes there are substantial reasons * * * to expect that reducing 
market makers' proprietary quotation size requirements in light of the 
shift to a more order-driven market would be beneficial to investors.'' 
\13\ In addition, the Commission stated that, ``based on its experience 
with the markets and discussions with market participants, [it] 
believes that decreasing the required quote size will not result in a 
reduction in liquidity that will hurt investors.'' \14\
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    \12\ See Actual Size Approval Order, supra note 8, 62 FR at 
2425.
    \13\ Id. 62 FR at 243.
    \14\ Id. 62 FR at 2424.
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    Nevertheless, in light of concerns raised by commentators opposed 
to the Actual Size Rule regarding the potential adverse impacts of the 
rule on market

[[Page 19375]]

liquidity and volatility, the Commission originally determined to 
approve the rule on a three-month pilot basis to afford the Commission 
and the NASD an opportunity to gain practical experience with the rule 
and evaluate its effects. The factors identified by the Commission to 
be considered in this evaluation include, among others, the impact of 
reduced quotation sizes on liquity, volatility and question 
spreads.\15\
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    \15\ See 62 FR 2415 at 2425.
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    As detailed below, the NASD has concluded that implementation of 
the SEC's Order Execution Rules has significantly improved the quality 
of the Nasdaq market by creating a market structure where customer 
limit provide liquidity and effectively compete with market maker 
quotations. In this type of environment, the NASD believes the 
regulatory necessity for the Mandatory Quote Size Requirements no 
longer exists. Accordingly, the NASD is proposing to extend the pilot 
of the Actual Size Rule until July 18, 1997.
2. Economic Analysis of the Actual Size Rule \16\
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    \16\ See 62 FR 2415 at 2425.
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    Research conducted by the NASD's Economic Research Department 
indicates three general findings concerning implementation of the SEC's 
Order Execution Rules and the Actual Size Rule: (1) The SEC's Order 
Execution Rules have dramatically improved the quality of the Nasdaq 
market, particularly with respect to the size of quoted spreads; (2) 
among those securities subject to the SEC's Order Execution Rules, 
there is no appreciable difference in market quality between those 
securities subject to the Actual Size Rule and those securities subject 
to Mandatory Quote Size Requirements; \17\ and (3) implementation of 
the Actual Size Rule has not resulted in any significant diminution of 
the ability of investors to receive automated executions through SOES, 
SelectNet, or proprietary systems operated by broker-dealers. 
Accordingly, as the case with 100-share minimum quotation size 
requirements applicable to exchange specialists in order-driven 
markets, the NASD believes the Actual Size Rule has not harmed 
investors or the quality of the Nasdaq market.
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    \17\ The first fifty securities include Nasdaq's top ten issues 
by dollar volume plus 40 issues chosen from Nasdaq's top 500 issues: 
8 ranked between 11 and 1000; 8 ranked between 101 and 200; 8 ranked 
between 201 and 300; 8 ranked between 301 and 400; 8 ranked between 
401 and 500. The second fifty securities include the ten Nasdaq 
stocks ranked between 11 and 20 by dollar volume plus 40 stocks 
chosen from Nasdaq's top 500 stocks in the same manner explained 
above. The ten largest Nasdaq stocks in the first fifty have no 
comparable peer group among Nasdaq stocks and the next ten largest 
Nasdaq stocks (i.e., Nasdaq stocks ranked 11-20 in size) included in 
the second fifty are also not comparable to the ``bottom 40'' within 
the first fifty stocks and the ``second forty'' stocks are those 
stocks that are the ``bottom 40'' within the second fifty stocks.
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    While some market participants may maintain that the Actual Size 
Rule should be abandoned because it has not had a demonstrably positive 
market impact, the NASD believes that the Rule should be retained 
because it eliminates an unnecessary regulatory requirement and, 
moreover, it has not had any adverse market impacts. In particular, 
with respect to the first fifty securities, the NASD believes that 
competitive forces in the marketplace, be they the result of displaying 
customer limit orders or market maker competition for order flow, have 
driven the Nasdaq market to perform the same as of the artifical 1,000 
share minimum quotation size requirement was in place.\18\ As a result, 
given that the market performs the same with or without the Actual Size 
Rule, the NASD believes it is far preferable for the protection of 
investors and the efficiency of the capital formation process to 
promote a regulatory environment for Nasdaq that achieves its results 
through aggressive competition rather than artificial regulatory fiat. 
In sum. in light of the performance of the first fifty securities, the 
NASD believes there is no regulatory basis to justify the retention of 
artificial quotation size requirements for Nasdaq market makers.
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    \18\ Some market participants may assert that the lack of 
difference in performance between the first forty securities and the 
second forty is attributable to the operation of several features of 
SOES. Specifically, these market participants may claim that the 
SOES Auto-Refresh Feature, which refreshes a market quote to the 
applicable SOES tier size once its quote has been completely 
decremented, along with the ``No Decrementation'' and ``Supplemental 
Size'' feature of SOES, artificially increase the number of 1000-
share quotes in the first fifty securities. The ``No 
Decrementation'' feature of SOES allows a market maker to provide 
that its quote shall not be decremented after the execution of SOES 
orders. To use this feature, a market maker's quote size must be 
equal to the applicable SOES tier size. The ``Supplemental Size'' 
feature of SOES allows a market maker to establish a ``supplemental 
size'' that is used to automatically replenish a market maker's 
quote once it has been completely decremented. When a market maker's 
quote is replenished from the supplemental size, it is replenished 
to 1000 shares. In order to use this feature, a market maker must 
initially enter a quote size equal to or greater than the applicable 
SOES tier size. The NASD notes that market maker use of each of 
these system features is completely voluntary and they are available 
for all Nasdaq securities. Accordingly, the NASD believes it would 
be inaccurate to assert that these SOES features have obfuscated the 
impact of the Actual Size Rule.
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    a. Implementation of the SEC's Order Execution Rules Has Resulted 
in Significant Benefits to Investors and Enhanced the Quality of the 
Nasdaq Market.
    The NASD's analysis of the markets for the first 150 Nasdaq 
securities subject to the SEC's Order Execution Rules shows that: \19\
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    \19\ Statistics concerning the first 150 Nasdaq securities 
subject to the Order Execution Rules reflect a comparison of the 
markets for these securities for the 20 trading days before January 
20, 1997 and the 24 trading days after February 24, 1997.
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     Quoted spreads have narrowed 32.3%; \20\ effective spreads 
have narrowed 24.6%; and actual dollar spreads have narrowed 31.8% \21\
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    \20\ A quoted spread is the difference between the inside bid 
and ask. The individual dollar spreads used to calculate the average 
for a given stock are weighted by the amount of time each spread was 
in effect for the day, i.e., the spread's duration.
    \21\ An effective spread is measured by taking the absolute 
difference between a transaction price and the bid-ask midpoint, 
multiplied by two. Each effective spread is weighted by the share 
volume of the associated transaction. An actual spread is measured 
by taking the transaction price minus the bid-ask midpoint for 
market maker sells, and the bid-ask midpoint minus the transaction 
price for market maker buys. The figure is multiplied by two to 
compare the quoted spread, and the average is volume-weighted.
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     Average dealer spreads have narrowed 3.8%.
     The amount of time the inside spread was equal to an \1/8\ 
increased 104.9%, meaning that quoted spreads in these securities were 
equal to their narrowest quote increment 47.8% of the time. In 
addition, inside spreads were equal to or less than a \1/4\ 77.1% of 
the time.
     The average number of market makers per stock increased 
5.6%, or 1.1 market makers per stock.
     The maximum quoted depth of any single market maker at the 
inside bid or offer increased 37.2%.
     There has been a noticeable increase in the number of 
quotation updates greater than 1,000 shares. In particular, whereas 
before implementation of the Actual Size Rule market makers virtually 
never displayed sizes greater than 1,000 shares, since the rule has 
been in effect, 6.3% of all market maker quote updates have been for 
greater than 1,000 shares.
    b. The Market Behavior of the ``First Forty'' Securities is Very 
Similar to the Market Behavior of the ``Second Forty'' Securities.
    While the data set forth above indicates that implementation of the 
SEC's Order Execution Rules have been associated with dramatically 
narrower spreads and improvements in other indicia of market quality, 
the NASD believes that the similar performance of the second forty 
securities to the first forty securities indicates that the Actual

[[Page 19376]]

Size Rule did not impair the markets for these securities. In 
particular, a comparison of the first forty securities and the second 
forty securities reveals that: \22\
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    \22\ The comparison of the first forty securities and the second 
forty securities is based on an analysis of the 31 trading days 
after February 10, 1997.
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     Dollar quoted spreads decreased 33.8% for the first forty 
securities and 33.7% for the second forty.
     Effective spreads decreased 26.6% for the first forty 
securities and 27.4% for the second forty.
     Actual dollar spreads decreased 30.5% for the first forty 
securities and 33% for the second forty.
     Dealer dollar spreads decreased 7.4% for the first forty 
securities and 4.9% for the second forty.
     The average number of market makers for the first forty 
securities increased 4.1% and the average for the second forty 
increased 2.7%.
     10% of the quote updates by market makers in the first 
forty securities were for 100 shares, as compared to 5.7% for the 
second forty.
     66.5% of the quote updates by market makers in the first 
forty securities were for 1,000 shares, as compared to 77.5% for the 
second forty.
     6.0% of the quote updates by market makers in the first 
forty securities were for greater than 1,000 shares, as compared to 
6.2% for the second forty.
     By one measure of market liquidity, the amount of 
transaction volume required to move the bid-ask midpoint (``BAM''),\23\ 
liquidity for both groups of securities appears to have diminished at 
narrower price movements, but less so for larger price movements.\24\ 
Specifically, the amount of stock needed to move the BAM \1/16\ to an 
\1/8\ decreased 26.5% for the first forty securities and 21.3% for the 
second forty. In addition, the amount of stock needed to move the BAM 
an \1/8\ to a \1/4\ decreased 11.7% for the first forty and 4.9% for 
the second forty. It is interesting to note, however, that the 
performance of the two groups begins to diverge for larger BAM 
movements. Specifically, the amount of stock needed to move the BAM \3/
8\ to a \1/2\ increased .2% for the first forty, but decreased 4.5% for 
the second forty. Similarly, the amount of stock needed to move the BAM 
greater than a \1/2\ increased 6.1% for the first forty, but decreased 
1.1% for the second forty.
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    \23\ Under this analysis, volume is summed for each day until 
the BAM has moved away from the starting BAM (the ``base'') by a 
specific amount. Once this occurs, the base BAM is reassigned and 
volume is summed again until the bid-ask midpoint has moved again by 
the specified amount. For example, consider the calculation of 
``Volume Per $.125 to $.25 Movement in the BAM.'' If the bid-ask 
midpoint is 20 for ABCD security at the beginning of the day, the 
algorithm will sum volume until the bid-ask midpoint has moved to at 
least $20.125 but less than $20.25, or at most $19.75 but at least 
$19.875. If such a movement should occur, the algorithm will note 
the total volume and use it as one observation in final 
calculations. Volume is defined as net volume transacted by market 
makers in a principle capacity with a non-market maker or another 
market maker acting as agent. All transactions in which two market 
makers trade as agent or two non-market makers trade are excluded 
from the calculations. If market makers (in aggregate) are net 
sellers (buyers) before an increase (decrease) in the BAM, then this 
occurrence is included in the above analysis. If, however, market 
makers are net sellers (buyers) before a decrease (increase) in the 
BAM, then this ``counter-intuitive'' occurrence is excluded from 
this analysis. ``Counter-intuitive'' cases accounted for about 35% 
of the total events analyzed.
    \24\ Because customer limit orders can now affect the inside 
market under the Display Rule, the NASD believes it would be 
expected that liquidity would decrease with respect to smaller price 
movements.
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     By two measures, volatility in the first forty securities 
has declined since implementation of the Actual Size Rule. However, by 
two other measures volatility increased.\25\ Specifically, for the 
first forty securities, the percentage change in the range of trade 
prices decreased 6.6% \26\ and the percentage change in the standard 
deviation of trade prices declined .78%.\27\ On the other hand, the 
percentage change in the range of the BAM increased 3.44% \28\ and the 
percentage change in the standard deviation of the BAM increased 
1.7%.\29\ In comparison, for the second forty securities, the 
percentage change in the range of trade prices increased 8.5%; the 
percentage change in the standard deviation of trade prices increased 
18.68%; the percentage change in the range of the BAM increased 24.52%; 
and the percentage change in the standard deviation of the BAM 
increased 25.82%. While it may appear that volatility did not increase 
in the first forty to the same extent that it did for the second forty, 
once differences in volume between the two groups are controlled or 
``normalized,'' these apparent differences in volatility decline 
significantly.
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    \25\ In this connection, it is also important to note that 
volatility for stocks included in the top 1,000 Nasdaq stocks that 
were not subject to the Order Handling Rules increased as well. 
Specifically, the standard deviation of the BAM increased 12.8% for 
this group of stocks.
    \26\ Range of the trade price measures the range of price 
movement over a day as a percentage of the day's highest price. The 
calculation takes the difference between the day's highest 
transaction price and the day's lowest transaction price, divided by 
the highest transaction price.
    \27\ Standard deviation of price measures the ``bounce'' in 
trade price over the course of a day. Technically, it is the 
standard deviation of the logarithm of prices observed during a 
given day. The use of logarithms results in a measure that 
represents the volatility of price relative to the level of price.
    \28\ Range of the Bid-Ask Midpoint is calculated by taking the 
difference between the day's high value of the bid-ask midpoint 
minus the low value, divided by the high value.
    \29\ Standard deviation of the Bid-Ask Midpoint measures the 
``bounce'' in the bid-ask midpoint over the course of a day. It uses 
the same calculation as the standard deviation of price, 
substituting the bid-ask midpoint for trade price.
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    c. Implementation of the Actual Size Rule Has Not Resulted in Any 
Diminution in the Ability of Investors To Receive Automated Executions 
Through SOES, SelectNet, or Other Proprietary Systems Operated by 
Broker Dealers.
    The NASD believes that the following statistics indicate that 
implementation of the Actual Size Rule has not diminished the ability 
of small investors to receive automated executions through SOES up to 
the size of their SOES orders.\30\
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    \30\ The statistics concerning SOES accessibility are based on 
the 20 trading days following February 10, 1997.
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     For the top ten Nasdaq stocks, 99% of SOES volume and 99% 
of SOES trades were executed at one price. Thus, for all but 1% of SOES 
orders, investors received SOES executions at the price and size they 
desired. Similarly, for the first forty securities, 98% of SOES volume 
and 98% of SOES trades received an execution at one price.
     For the top ten Nasdaq stocks, the aggregate depth of all 
market makers at the inside was less than 1,000 shares 2.7% of the 
time. Similarly, for the first forty securities, the aggregate depth of 
all market makers at the inside was less than 1,000 shares 7.85% of the 
time.
     For the top ten stocks, the aggregate depth of all market 
makers at the inside was less than 500 shares 1.6% of the time. 
Similarly, for the first forty securities, the aggregate depth of all 
market makers at the inside was less than 500 shares 4.3% of the time.
    Moreover, SOES volume and SelectNet volume in the first fifty 
securities indicates that the Actual Size Rule has had no impact on the 
ability of investors to receive executions through SOES or SelectNet. 
In fact, as detailed below, volume in both these systems has increased 
since implementation of the Actual Size Rule.\31\
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    \31\ The statistics concerning SOES volume and SelectNet volume 
are based on the 31 trading days following February 10, 1997.
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     The average daily share volume through SOES increased 1.08 
million shares a day, or 8.8%.
     The average daily dollar volume through SOES increased 
$44.53 million a day, or 4.6%.
     The average daily share volume through SelectNet increased 
5.29 million shares a day, or 176.8%.

[[Page 19377]]

     The average daily dollar volume through SelectNet 
increased $303.18 million a day, or 140.3%.
    Finally, the NASD notes that several NASD members operate their own 
automated trading systems that guarantee execution of customer orders 
up to the applicable SOES tier size or greater. The NASD estimates that 
these systems accommodate a significantly large number of the customer 
accounts participating in the Nasdaq market. Based on an informal 
survey of several of these firms, the NASD is aware of no instances 
where a firm has significantly changed the execution guarantees 
provided through its automated execution system.
3. Statutory Basis
    For the reasons noted above, the NASD believes the proposed rule 
change is consistent with Sections 11A(a)(1)(C), 15A(b)(6), 15A(b)(9), 
and 15A(b)(11) of the Exchange Act. Section 11A(a)(1)(C) provides that 
it is in the public interest to, among other things, assure the 
economically efficient execution of securities transactions and the 
availability to brokers, dealers, and investors of information with 
respect to quotations for and transactions in securities. 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. 
Section 15A(b)(9) requires that rules of an Association not impose any 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act. Section 15A(b)(11) requires the NASD 
to, among other things, formulate rules designed to produce fair and 
informative quotations.

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 Exchange 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. 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 May 12, 1997.

IV. Commission's Findings and Order Granting Accelerated Approval of 
the Proposed Rule Change

    The Commission finds that the NASD's proposal is consistent with 
the Act and the rules and regulations thereunder applicable to a 
national securities association. Specifically, the Commission finds 
that the proposed rule change is consistent with Section 15A(b)(9) in 
that it permits Nasdaq market makers to quote in 100 share increments 
for an additional three months in a manner equivalent to exchange 
specialists. This has not resulted in significant reductions in Nasdaq 
market quality to date. In addition, consistent with Section 
15A(b)(11), the Actual Size Rule is designed to produce accurate and 
informative quotations that disclose the true trading interest of the 
market maker.
    The Commission approved the Actual Size Rule on a three-month pilot 
basis so that the effects of the rule could be assessed. The Commission 
continues to believe that a reduction in the quotation size requirement 
reduces the risks that market makers must take, and should encourage 
them to maintain competitive prices even in the changing market 
conditions resulting from the Order Execution Rules. Although the 
economic analysis from the NASD has not indicated any notable 
detrimental effects, the Commission believes that the proposed rule 
change will benefit the markets by providing more experience with the 
rule before a decision is made regarding permanent approval. 
Accordingly, the Commission believes that the pilot should be extended 
beyond the April 18, 1997 expiration date. The Commission, therefore, 
finds good cause for approving the proposed rule change prior to the 
thirtieth day after the date of publication of notice of filing thereof 
in the Federal Register.
    The Commission requests that the NASD continue to evaluate the 
effects of the reduction in the minimum quotation size for those Nasdaq 
stocks included in the pilot.
    Specifically, the NASD should continue its analysis of: (1) The 
number of market makers in each of the 50 securities, and any change in 
the number over time; (2) the average aggregate dealer and inside 
spread by stock over time; (3) the average spread for each market maker 
by stock; (4) the average depth by market maker (including limit 
orders), and any change in the depth over time; (5) the fraction of 
volume executed by a market maker who is at the inside quote per stock; 
and (6) a measure of volume required to move the price of each security 
one increment (to determine the overall liquidity and volatility in the 
market for each stock).
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\32\ that the proposed rule change, SR-NASD-97-25, be and 
hereby is approved.

    \32\ 15 U.S.C. Sec. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\33\
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    \33\ 17 CFR 200.30-3(a)(12) (1989).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-10222 Filed 4-18-97; 8:45 am]
BILLING CODE 8010-01-M