[Federal Register Volume 62, Number 130 (Tuesday, July 8, 1997)]
[Notices]
[Pages 36595-36597]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-17669]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38794; File No. SR-NASD-97-01]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Permanent Approval to Proposed Rule 
Change Relating to Entry and Cancellation of SelectNet Orders

June 30, 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 the obligations 
of NASD members regarding the use of the SelectNet Service. 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''). The Commission subsequently 
approved a portion of this proposed rule change on a temporary 
basis.\3\ No comments were received on the Notice of Proposed Rule 
Change. The Commission is now approving the proposed rule change in its 
entirety on a permanent basis.
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    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 38185 (January 21, 
1997), approving until July 1, 1997, a new Conduct Rule to prohibit 
members from cancelling or attempting to cancel a preferenced order 
entered into SelectNet until a minimum period of ten seconds has 
elapsed and from entering conditional orders preferenced to 
electronic communications networks (``ECNs'').
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II. Description of the Proposal

    The NASD has proposed a new Conduct Rule, Rule 3380, to prohibit 
members from cancelling or attempting to cancel a broadcast or 
preferenced order entered into Nasdaq's SelectNet Service 
(``SelectNet'') until a minimum period of ten seconds has elapsed 
(``10-second rule'').\4\ The Commission temporarily approved the 10-
second rule with respect to SelectNet

[[Page 36596]]

preferenced orders,\5\ but deferred action on the proposed 10-second 
rule with respect to SelectNet broadcast orders. Consequently, there is 
currently no minimum time that must elapse before a SelectNet broadcast 
order can be cancelled. The Commission is now permanently approving the 
10-second rule with respect to both preferenced and broadcast orders.
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    \4\ Conduct Rule 3380(a) is proposed to read: 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.
    \5\ See Securities Exchange Act Release No. 38185 (January 21, 
1997), 62 FR 3935 (January 27, 1997).
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    Conduct Rule 3380 has also been proposed by the NASD to prohibit 
the entry into SelectNet of any order covered by Rule 4623 that is 
preferenced to an ECN with conditions regarding the response to the 
order (e.g., all or none orders or non-negotiable orders) \6\ This 
proposal was previously approved on a temporary basis and is now being 
approved on a permanent basis.
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    \6\ NASD Rule 4623 concerns the operation of electronic 
communications networks. Conduct Rule 3380(b) is proposed to read: 
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 new Rule 11Ac1-4 (``Limit 
Order Display Rule'') and amendments to Rule 11Ac1-1 (``Quote Rule'') 
that went into effect on January 20, 1997.\7\ Under an amendment to the 
Quote Rule, some ECNs are now entering quotations in the Nasdaq Stock 
Market in a manner which heretofore was reserved for registered market 
makers.\8\ To facilitate the ECN Display Alternative envisioned by the 
Order Execution Rules, Nasdaq has established linkages with four ECNs 
utilizing the SelectNet system.\9\ The ECNs thereby have a mechanism to 
display their best market makers' as well as other customers' quotes 
into the public quotation stream.\10\ A critical portion of the Nasdaq 
SelectNet linkage is that it allows NASD members that are not 
subscribers to a particular ECN to access the ECN's priced orders that 
are being displayed in the Nasdaq quote montage. An NASD member 
accesses an ECN's displayed order by entering a preferenced order into 
SelectNet directed to a particular ECN at its displayed price.\11\
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    \7\ See Securities Exchange Act Release No. 37619A (September 6, 
1996), 61 FR 48290 (September 12, 1996) (``Adopting Release'') 
adopting the Limit Order Display Rule and amendments to the Quote 
Rule (collectively the ``Order Execution Rules'').
    \8\ 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'').
    \9\ The four ECNs are B-Trade; Instinet; Island; and Terra Nova 
Trading System.
    \10\ Under the ECN Display Alternative, 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, supra note 7.
    \11\ See Order Execution Rules Adopting Release at 121, supra 
note 7, noting that the ability of non-subscribers to access market 
makers' and specialists' orders entered into an ECN is a fundamental 
requirement of the ECN Display Alternative.
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    The Commission believes that it is important to the successful 
operation of the ECN Display Alternative via the SelectNet linkage that 
the ECNs be afforded a reasonable opportunity to respond to orders 
preferenced through SelectNet before those orders are cancelled. 
Because of the current design of the SelectNet linkage, ECNs may 
execute a subscriber order based on the receipt of a SelectNet 
preferenced order and subsequently receive a cancellation of that 
SelectNet preferenced order. In addition, cancellations of SelectNet 
orders immediately after entry creates significant additional message 
traffic that may hinder the operation of the linkage.
    Likewise, the Commission believes that SelectNet orders preferenced 
to a particular market maker must also be accessible for a minimal 
length of time to allow for responses to be generated by that market 
maker. The existing possibility that SlectNet orders may be immediately 
cancelled, decreases market makers' incentive to attempt to accept 
SelectNet orders directed to them. Therefore, it is important that 
market makers have a reasonable period to ensure that when they accept 
a SelectNet preferenced order it will not be cancelled during the 
transmission of their acceptance.
    The NASD has stated that, since the implementation of the 10-second 
rule for preferenced SelectNet orders, cancellations of such orders has 
declined by 43.8%.\12\ At the same time, SelectNet share volume as a 
percentage of total Nasdaq share volume has increased by 502.3%. 
According to the NASD, the percentage of that volume attributable to 
preferenced orders has increased 142%.\13\ Thus, the requirement that a 
preferenced SelectNet order have a minimum life of 10 seconds has not 
limited the use of preferenced orders in SelectNet.
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    \12\ See Letter to Katherina A. England, Assistant Director, 
Division of Market Regulation, SEC, from Thomas R. Gira, Associate 
General Counsel, The Nasdaq Stock Market, Inc., dated June 26, 1997.
    \13\ Id.
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    The Commission believes that the implementation of the 10-second 
rule for preferenced orders has not hindered, and may have improved, 
the operation of SelectNet. This is illustrated by the increase in 
SelectNet volume since the 10-second rule went into effect. Thus, the 
Commission is approving the 10-second rule on a permanent basis with 
respect to SelectNet preferenced orders.
    The Commission is also extending the 10-second rule to SelectNet 
broadcast orders. The Limit Order Display Rule requires the public 
display of certain customer limit orders and the ECN Amendment requires 
the public display of market maker's and specialist's better priced 
orders. While the Order Execution Rules have improved transparency, 
they have also resulted in increased quotation traffic on Nasdaq. The 
Commission believes, however, that the quotation traffic resulting from 
the entry of broadcast orders into SelectNet that are immediately 
cancelled does not improve transparency. In fact, the Commission 
believes that the entry of a broadcast order that is subsequently and 
immediately cancelled creates artificial transparency, which is 
contrary to the goals of the Order Execution Rules. The appearance of 
activity in a security and the multiple quotation changes caused by 
broadcast orders that are immediately cancelled only serve to mislead 
the market. Moreover, orders that are entered into SelectNet 
exclusively for the sole purpose of generating quotation traffic are 
not contributing to price discovery. As the NASD has explained, 
SelectNet orders are displayed on a four line window in the Nasdaq 
Workstation II. The constant inputting of broadcast orders that are 
immediately cancelled causes the SelectNet screen to flicker or scroll 
so rapidly that market makers can not effectively review any SelectNet 
orders. The constant flickering of orders on the SelectNet may hinder 
the execution of legitimate SelectNet orders.
    The Commission believes that a minimum life of ten seconds for a 
SelectNet broadcast order would ensure that these orders are accessible 
long enough to contribute to the price discovery process and to afford 
other SelectNet participants the opportunity to react. The Commission, 
therefore, is approving the proposal to require that a broadcast order 
can not be cancelled until a minimum period of ten seconds

[[Page 36597]]

has expired. In addition to the problems caused by immediately 
cancelled orders, orders that are sent to ECNs with conditions imposed 
also create response difficulties for ECNs.\14\ Therefore, Nasdaq has 
proposed to prohibit members from entering conditional orders into 
SelectNet when those orders are preferenced to an ECN.\15\ The 
Commission temporarily approved Conduct Rule 3380(b), prohibiting the 
entry of conditional order preferenced to an ECN, to eliminate 
impediments to the operation of the linkage with ECNs. The Commission 
acknowledges that conditional preferenced orders involve difficult 
programming issues and that the ECNs have been unable to modify their 
systems to accept conditional orders via the SelectNet linkage. The 
Commission continues to believe that this impediment to the operation 
of the linkage should be avoided and therefore is approving Conduct 
Rule 3380(b) on a permanent basis.
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    \14\ The Commission earlier this year 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 (January 10, 1997), 62 FR 2415 (January 16, 1997).
    \15\ 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 on broadcast orders to be entered 
into SelectNet and immediately cancelled impedes the operation of the 
Order Execution Rules.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change (NASD-97-01) be and hereby is 
approved. The 10-second minimum life requirement for a preferenced 
order in SelectNet is effective immediately and the 10-second minimum 
life requirement for a broadcast order in SelectNet shall be effective 
July 7, 1997. The prohibition of conditional orders preferenced to ECNs 
is effectively immediately.

    \16\ 15 U.S.C. Sec. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulations, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12) (1966).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-17669 Filed 7-7-97; 8:45 am]
BILLING CODE 8010-01-M