[Federal Register Volume 62, Number 131 (Wednesday, July 9, 1997)]
[Notices]
[Pages 36855-36858]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-17938]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38804; File No. SR-NASD-97-46]


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 
Effectiveness of the NASD's Excess Spread Rule Until September 30, 1997

July 1, 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 
July 1, 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 and is 
approving the proposal on an accelerated basis.

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

    The NASD proposes to amend NASD Rule 4613(d) to extend the 
effectiveness of its current excess spread rule applicable to Nasdaq 
National Market (``NNM'') securities through September 30, 1997. The 
excess spread rule applicable to NNM securities provides that a 
registered market maker in a security listed on The Nasdaq Stock Market 
(``Nasdaq'') shall be precluded from being a registered market maker in 
that issue for twenty (20) business days if its average spread in the 
security over the course of any full calendar month exceeds 150 percent 
of the average of all dealer spreads in such issue for the month. The 
text of the proposed rule change is as follows. (Additions are 
italicized; deletions are bracketed.)
* * * * *
NASD Rule 4613  Character of Quotations
* * * * *
    (d) Reasonably Competitive Quotations
    A registered market maker in a Nasdaq National Market security will 
be withdrawn as a registered market maker and precluded from re-
registering as a market maker in such issue for 20 business days if its 
average spread in the security over the course of any full

[[Page 36856]]

calendar month exceeds 150 percent of the average of all dealer spreads 
in such issue for the month. This subparagraph shall not apply to 
market makers in Nasdaq SmallCap securities.
    (1) If a registered market maker has not satisfied the average 
spread requirement set forth in this subparagraph (d) for a particular 
Nasdaq National Market security, its registration in such issue shall 
be withdrawn commencing on the next business day following the business 
day on which the market maker was sent notice of its failure to comply 
with the requirement. A market maker may request reconsideration of the 
withdrawal notification. Requests for reconsideration will be reviewed 
by the Market Operations Review Committee, whose decisions are final 
and binding on the members. A request for reconsideration shall not 
operate as a stay of the withdrawal or toll the twenty business day 
period noted in subparagraph (d) above.
    (2) Grounds for requests for reconsideration shall be limited to 
claims that Nadsaq's calculation of the market maker's average spread 
for the month was in error.
    (3) This subparagraph (d) shall be in effect until September 30, 
1997 [July 1, 1997].

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 IV 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

    Prior to January 20, 1997, Nasdaq's Excess Spread Rule provided 
that registered market makers in Nasdaq securities could not enter 
quotations that exceeded 125 percent of the average of the three 
narrowest market maker spreads in that issue, provided, however, that 
the maximum allowable spread could never be less than \1/4\ of a point 
(``125% Excess Spread Rule''). The Rule was originally designed to 
bring a measure of quality to the Nasdaq market by preventing firms 
from holding themselves out as market makers without having a 
meaningful quote in the system. Despite the regulatory objectives 
underlying the rule, however, many market participants believed the 
rule produced a variety of unintended consequences that undermined the 
integrity of Nasdaq. Most notably, the SEC found in its 21(a) Report on 
the NASD and Nasdaq that ``the interdependence of quotes mandated by 
the rule may deter market makers from narrowing their dealer spreads, 
because, once the spread is tightened, the rule in some instances 
precludes a market maker from widening the spread to earlier levels.\1\ 
As a result the SEC found that the Excess Spread Rule created an 
economic incentive for market makers to discourage one another from 
narrowing their quotes, thereby interfering with the ``free flow of 
prices in the market and imped[ing] attempts by the market to reach the 
optimal competitive spread.'' \2\ Accordingly, the SEC requested that 
the NASD ``modify the rule to eliminate its undesirable effects, or to 
repeal it.'' \3\
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    \1\ See Appendix to Report Pursuant to Section 21(a) of the 
Securities Exchange Act of 1934 Regarding the NASD and The Nasdaq 
Stock Market (``21(a) Report''), SEC, August 8, 1996, at p. 98.
    \2\ Id. at p. 99.
    \3\ Id.
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    In response to the SEC's 21(a) Report, the NASD submitted a 
proposal that was approved by the SEC that amended the Excess Spread 
Rule on a pilot basis through July 1, 1997.\4\ Under the revised Excess 
Spread Rule, a registered market maker in a Nasdaq security is 
precluded from being a registered market maker in that issue for twenty 
business days if its average spread in the security over the course of 
any full calendar month exceeded 150 percent of the average of all 
dealer spreads in such issue for the month (``150% Excess Spread 
Rule'').\5\
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    \4\ See Securities Exchange Act Release No. 38180 (January 16, 
1997), 62 FR 3725 (``Pilot Program Approval Order'').
    \5\ On February 28, 1997, the SEC approved the NASD's proposal 
to exclude Nasdaq Small-Cap Securities from the Excess Spread Rule. 
This rule change was necessary because, unlike with Nasdaq National 
Market securities, Nasdaq does not presently calculate and display 
through the Nasdaq system the average spread of all market makers in 
a particular issue or a comparison of the size of an individual 
market maker's quoted spread relative to the average spread of all 
market makers. Thus, Nasdaq does not presently afford market makers 
in SmallCap securities with any indication as to whether they are 
satisfying the requirements of the 150% Excess Spread Rule. Market 
makers in Nasdaq National Market securities are able to assess 
whether they are satisfying the 150% Excess Spread Rule on a daily 
basis through use of the ``Primary Market Maker (PMM) Window'' of 
Nasdaq Workstation II. Under the NASD's instant proposal, Nasdaq 
SmallCap securities would continue to be excluded from the Excess 
Spread Rule. See Securities Exchange Act Release No. 38354 (February 
28, 1997), 62 FR 11245.
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    In formulating the 150% Excess Spread Rule, Nasdaq Committees and 
Nasdaq staff felt that it was important to strike a reasonable balance 
between the need to eliminate any constraints that the Excess Spread 
Rule places on firms to adjust their quotations and the need to avoid 
fostering a market environment where registered market makers can 
maintain inordinately wide spreads and still receive the benefits of 
being a market maker (e.g., affirmative determination exemption and 
preferential margin treatment). Nasdaq also believed it was critical to 
transform the Excess Spread Rule into a performance standard used to 
determine market maker eligibility, instead of a strict regulatory 
requirement applicable to every quote update in a Nasdaq security, 
violations of which were punishable by disciplinary action. In 
addition, Nasdaq believed it was important to eliminate the 125% Excess 
Spread Rule prior to implementation of the SEC's order handling rules. 
Specifically, because Nasdaq believed that spreads would likely narrow 
as a result of the display of customer limit orders, Nasdaq believed 
that the average of the three narrowest market maker spreads would 
commensurately narrow after implementation of the SEC's rules. As a 
result, Nasdaq believed that concerns with the interdependence of 
market maker quotations would be exacerbated unless the rule was 
amended.
    While the Commission approved the 150% Excess Spread Rule on a 
pilot basis, in its approval order for the new rule, the SEC states 
that ``[a]lthough the amended excess spread rule may reduce some of the 
anticompetitive concerns outlined in the 21(a) Report, the Commission 
believes that the amendment * * * may not completely satisfy the NASD's 
obligations under the Commission's Order with regard to the excess 
spread rule. Specifically, it may not remove completely the 
anticompetitive incentives for market makers to refrain from narrowing 
quotes because the market makers' quotation obligation continues to be 
dependent to some extent upon quotations of other market makers in the 
stock.'' \6\
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    \6\ Pilot Program Approval Order, supra note 4, 62 FR at 3726.
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    Based on experience with the 150% Excess Spread Rule, the Nasdaq 
Board recently concluded that the Rule has helped to ensure that market 
makers maintain at least a minimal level of commitment to their issues, 
without contributing to or fostering the same unintended consequences 
created by the former 125% Excess Spread Rule.

[[Page 36857]]

Accordingly, the Nasdaq Board approved a resolution to implement the 
150% Excess Spread Rule for all Nasdaq securities on a permanent basis. 
On June 26, 1997, the Board of Governors of the NASD ratified the 
resolution adopted by the Nasdaq Board. The NASD's filing requesting 
permanent approval of the 150% Excess Spread Rule will be submitted to 
the Commission in the very near future. Accordingly, in the interim 
before the Commission has had an opportunity to solicit comment and 
take action on the NASD's proposal for permanent approval of the Rule, 
the NASD is proposing that the pilot program for the Rule be extended 
until September 30, 1997.
    Nasdaq and the NASD believes that the proposed rule change is 
consistent with Sections 15A(b)(6), 15A(b)(9), 15A(b)(11) and 
11A(a)(1)(C) of the Exchange Act. Among other things, 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(b0(9) 
provides that the rules of the Association may not impose any burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act. Section 15A(b)(11) empowers the NASD to adopt 
rules governing the form and content of quotations relating to 
securities in the Nasdaq market. Such rules must be designed to produce 
fair and informative quotations, prevent fictitious and misleading 
quotations, and promote orderly procedures for collecting and 
distributing quotations. 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. Specifically, because 
Nasdaq and the NASD believe the 150% Excess Spread Rule has helped to 
ameliorate the adverse consequences that the former 125% Excess Spread 
Rule had on the competitiveness and independence of quotations 
displayed on the Nasdaq market, Nasdaq and the NASD believe the 
proposal to extend the pilot program for the Rule for an additional 
three months is consistent with the Exchange Act. In particular, Nasdaq 
and the NASD believe that the 150% Excess Spread Rule promotes the 
integrity of quotations on the Nasdaq market and enhances competition 
among market makers, thereby contributing to greater market liquidity, 
improved price discovery, and the best execution of customer orders. At 
the same time, while Nasdaq and the NASD believe the 150% Excess Spread 
Rule has removed a constraint on market maker quote movements, Nasdaq 
and the NASD also believe that the Rule has helped to ensure that all 
registered market makers are providing some threshold level of market 
making support in their issues. Nasdaq and the NASD also believe that 
the 150% Excess Spread Rule has helped to avoid fostering a market 
environment where registered market makers can maintain inordinately 
wide spreads and still receive the benefits of being a market maker. 
Accordingly, the NASD and Nasdaq believe that it would be consistent 
with all of the above-cited sections of the Act for the Commission to 
approve an extension of the effectiveness of the 150% Excess Spread 
Rule for an additional three months while the Commission considers 
permanent approval of the Rule.

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 file number SR-NASD-97-46 and 
should be submitted by July 30, 1997.

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

    The Commission has determined to approve the extension of the 150% 
Excess Spread Rule pilot until September 30, 1997. As noted previously, 
the Commission had identified anticompetitive concerns associated with 
the 125% Excess spread Rule in place prior to January 20, 1997. The 
NASD has an obligation, pursuant to the 21(a) Report, to eliminate 
these concerns on or before August 8, 1997. The Commission, in the 
Pilot Program Approval Order, recognized that the 150% Excess Spread 
Rule may reduce, to some degree, the Commission's concerns regarding 
the 125% Excess Spread Rule. Although the Commission has not yet 
considered whether the 150% Excess Spread Rule is sufficient to satisfy 
the NASD's obligations under the Commission's Order on a permanent 
basis, the Commission believes that the current rule should continue to 
operate on a temporary basis while the issue is examined.\7\ 
Consequently, an extension will ensure that the Rule remains in effect 
on an uninterrupted basis until the Commission has had an opportunity 
to fully evaluate the NASD's permanent solution regarding the excess 
spread rule.\8\
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    \7\ As mentioned in the Pilot Program Approval Order, one of the 
alternatives for a permanent solution could be elimination of the 
excess spread rule in its entirety.
    \8\ As noted above, the NASD has until August 8, 1997, to comply 
with this undertaking.
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    In addition, the Commission believes that the temporary rule can 
remain limited to National Market securities. Due to Nasdaq's current 
systems limitations, market makers in Nasdaq SmallCap securities are 
unable to monitor compliance with the Rule. However, the NASD has 
stated that it anticipates that market makers in Nasdaq SmallCap 
securities will be subject to the same excess spread requirements, if 
any, as market makers in Nasdaq National Market securities when a 
permanent resolution is reach.
    Accordingly, the Commission finds that the NASD's proposal is 
consistent with Sections 11A and 15A of the Exchange Act and the rules 
and regulations thereunder applicable to the

[[Page 36858]]

NASD and, in particular, Sections 11A(a)(1)(C), 15A(b)(6), 15A(b)(9), 
and 15A(b)(11). Further, the Commission finds good cause for approving 
the proposed rule change prior to the thirtieth day after the day of 
publication in the Federal Register. In addition to the reasons 
discussed above, the Commission believes that accelerated approval of 
the NASD's proposal is appropriate given the fact that the proposal is 
a temporary extension of the 150% Excess Spread Rule that has been in 
effect since January 1997. An uninterrupted application of the 150% 
Excess Spread Rule for a short period of time should be less disruptive 
to market makers while the NASD prepares its proposal regarding market 
maker standards.\9\
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    \9\ The Commission notes that a failure to extend the 150% 
Excess Spread Rule would result in no excess spread standard for 
Nasdaq market makers. Without deciding that the 150% Excess Spread 
Rule is preferable to no excess spread standard, the Commission 
concludes that it is not unreasonable to continue the pilot 
uninterrupted for a short period to allow the Commission to reach a 
conclusion on this matter.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act, that the proposed rule change (SR-NASD-97-46) is approved 
through September 30, 1997.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-17938 Filed 7-8-97; 8:45 am]
BILLING CODE 8010-01-M