[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be withdrawn as a registered market maker and precluded from re-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