[Federal Register Volume 62, Number 162 (Thursday, August 21, 1997)]
[Notices]
[Pages 44503-44506]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-22183]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38936; File No. SR-NASD-97-42]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc. To Amend
NASD Rule 2320(g) To Provide Authority to the Staff of NASD Regulation
To Grant Exemptions From Such Provision
August 14, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on June 17,
1997, the National Association of Securities Dealers, Inc. (``NASD'' or
``Association'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by the self-regulatory
organization. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
NASD Regulation is proposing to amend NASD Rule 2320(g) to provide
authority to the staff of NASD Regulation to grant exemptions from such
provision. Below is the text of the proposed rule change. Proposed new
language is in italics.
Rule 2320. Best Execution and Interpositioning
(g) (1) In any transaction for or with a customer pertaining to the
execution of an order in a non-Nasdaq security (as defined in the Rule
6700 Series), a member or person associated with a member, shall
contact and obtain quotations from three dealers (or all dealers if
three or less) to determine the best inter-dealer market for the
subject security.
(g)(2) The staff, upon written request, after taking into
consideration all relevant factors, may exempt any transaction or
classes of transactions, either unconditionally or on specified terms
from any or all of the provisions of this paragraph if it determines
that such exemption is consistent with the purpose of this rule, the
protection of investors, and the public interest. Any decision whether
to grant such an exemption may be appealed to the National Business
Conduct Committee.
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 self-regulatory organization
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 self-regulatory organization
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. Purpose
NASD Rule 2320(g) (``The Three Quote Rule'' or ``Rule'') originally
was adopted on May 2, 1988 \1\ as an amendment to the NASD's best
execution interpretation (``Interpretation of the Board of Governors--
Execution of
[[Page 44504]]
Retail Transactions in the Over-the-Counter Market'') under Article
III, Section 1 of the NASD's Rules of Fair Practice (currently NASD
Rules).\2\ The amendment expanded a member's best execution obligation
to customers by setting forth additional requirements for customer
transactions in non-Nasdaq securities. In particular, the amendment
requires members that execute transactions in non-Nasdaq securities on
behalf of customers to contact a minimum of three dealers (or all
dealers if three or less) and obtain quotations in determining the best
inter-dealer market. Under the best execution interpretation, each
member is generally required to use reasonable diligence to ascertain
the best inter-dealer market for a security, and to buy or sell in that
market so that the resultant price to the customer is as favorable as
possible under prevailing market conditions.\3\
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\1\ See Securities Exchange Act Release No. 25637 (May 2, 1988),
53 FR 16488 (May 9, 1988).
\2\ The Best Execution Interpretation in Article III, Section 1
of the NASD's Rules of Fair Practice was converted into new NASD
Rule 2320 in connection with the NASD's Manual revision project. See
Securities Exchange Act Release No. 36698 (January 11, 1996), 61 FR
1419 (January 19, 1996).
\3\ See NASD Rule 2320(a).
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The Three Quote Rule was adopted in connection with the NASD's
efforts to develop a nationwide automated market surveillance program
for non-Nasdaq, over-the-counter (``OTC'') securities (commonly
referred to as ``pink sheet'' stocks). Concurrent with these
activities, the NASD proposed and the Commission approved new Schedule
H to the NASD's By-Laws, which established an electronic system of
mandatory price and volume reporting for the over-the-counter non-
Nasdaq securities.\4\ The Three Quote Rule was designed to create a
standard to help assure that members would fulfill their best execution
responsibilities to customers in non-Nasdaq securities, especially
transactions involving relatively illiquid securities with non-
transparent prices.
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\4\ New Schedule H of the By-laws required NASD members
executing principal transactions in non-Nasdaq securities to report
price and volume data for the days on which their sales or purchases
exceeded 50,000 shares or $10,000. In 1993, member obligations under
Schedule H were modified or eliminated as a result of the NASD
adopting real-time reporting of transactions for non-Nasdaq
securities. See Securities Exechange Act Release No. 32647 (July 16,
1993) , 58 FR 39262 (July 22, 1993).
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OTC Bulletin Board Developments: On May 1, 1990, the Commission
issued an order approving the operation of the NASD's OTC Bulletin
Board Display Service (``OTC Bulletin Board'') for a pilot term of one
year.\5\ The NASD introduced the OTC Bulletin Board to allow NASD
eligible members to enter, update and retrieve quotation information on
a real-time basis in non-Nasdaq securities.\6\
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\5\ On March 31, 1997, the SEC granted permanent approval of the
OTC Bulletin Board. See Securities Exchange Act Release No. 38456
(March 31, 1997), 62 FR 16635 (April 7, 1997) .
\6\ See Securities Exchange Act Release No. 27975 (May 1, 1990),
55 FR 19123 (May 8, 1990).
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Since the establishment of the OTC Bulletin Board, significant
market, regulatory and technology related improvements have occurred in
the non-Nasdaq marketplace. In particular, the NASD has implemented
enhancements to the OTC Bulletin Board to increase the reliability of
information contained therein. These changes include: requiring that
all priced quotations entered by market makers in domestic securities
be firm for at least one trading unit;\7\ calculating inside quotes for
individual securities and disseminating this information through
vendors; and establishing larger minimum-size requirements for market
makers' quotes in domestic securities. Most recently, in July, 1993,
the Commission approved an NASD rule change to implement real-time
trade reporting for members' over-the-counter transactions in certain
non-Nasdaq equity securities,\8\ and in April, 1994, the NASD commenced
real-time dissemination of transaction reports via the Nasdaq network
and the networks of commercial vendors, providing member firms and
their customers access to last-sale price and volume information for
these securities throughout the business day.
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\7\ See Securities Exchange Act Release No. 29261 (May 31,
1991), 56 FR 29297 (June 26, 1991).
\8\ See Securities Exchange Act Release No. 32647 (July 16,
1993), 58 FR 39262 (July 22, 1993).
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The OTC Bulletin Board meets the requirements of an ``automated
quotation system'' as the characteristics of such system are described
in Section 17B of the Act.\9\ As such, the OTC Bulletin Board has
assisted member broker-dealer in complying with certain disclosure
regulations under Section 15(g) of the Act (Penny Stock Rules),\10\ and
has deterred fraudulent and manipulative trading practices in Penny
Stocks \11\ due to, among other things, real-time transaction
reporting. Due to the technological improvements to the OTC Bulletin
Board, the NASD's surveillance capabilities have been enhanced, among
other things, to permit computerized analyses of market makers'
quotation entries and reported transactions.
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\9\ On October 15, 1990, the Securities Enforcement Remedies and
Penny Stock Reform Act of 1990 (``Reform Act'') was signed into law.
Among other things, the Reform Act amended the Exchange Act by
adding new Section 17B, which requires the Commission to facilitate
the development of one or more automated quotation systems for the
collection and dissemination of information for all penny stocks.
\10\ See Rules 15g-1 through 15g-9 under the Act, 17 CFR
240.15g-1 through 240.15g-90.
\11\ Penny Stock is defined under Rule 3a51-1 of the Act, 17 CFR
240.3a51-1.
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Application of the Three Quote Rule
Some members who are active dealers in the non-Nasdaq market have
questioned the value of the Three Quote Rule in various situations in
which it is claimed that adherence to the requirement may not assure
the satisfaction of the best execution obligation and, in fact, may
hinder satisfaction of the obligation because of the time delays
involved in contacting and collecting quotations from three separate
dealers. Some member broker-dealers have questioned whether the Three
Quote Rule should continue to apply to all customer transactions in
non-Nasdaq securities due to the technological and regulatory
improvements to the non-Nasdaq marketplace, and, in particular, to the
OTC Bulletin Board, over the past seven years.
Certain Non-Nasdaq Securities Quoted on the OTC Bulletin Board
NASD Regulation believes that general exemptive authority under the
Rule may be appropriate to provide some flexibility to respond to
changing market conditions and respond to particular fact situations.
NASD Regulation has not yet determined, however, whether any particular
class of transactions should be exempted. Based on the technological
and regulatory improvements made to the OTC Bulletin Board market,
arguably certain classes of transactions on the OTC Bulletin Board may
warrant an exemption from the requirements of the Three Quote Rule if
it can be demonstrated that the Rule could serve as an impediment to
satisfying the best execution obligation. For example, certain customer
agency orders in domestic equity securities may pose different issues
and concerns than trades in the same securities in which the member
firm acts as principal in effecting a transaction with its customer.
Facts to be considered in determining whether to grant an exemptive
request could include: (1) The number of firms publishing firm
quotations and the period of time during which such quotations were
published; (2) the size of the customer order in relation to the
minimum size of the market makers' quotations; (3) the transaction
volume of the security in question; and (4) the number of dealers
publishing quotations through an electronic quotation medium in
comparison to dealers in the security that do not publish such quotes.
[[Page 44505]]
Certain Foreign Securities Listed on a Foreign Exchange
Questions have been raised about the application of the Three Quote
Rule to the execution of customer transactions in securities that are
traded on certain foreign exchanges, but not United States exchanges.
Because the Three Quote Rule applies to transactions in all non-Nasdaq
securities,\12\ which are defined to exclude securities traded only on
a ``national securities exchange,'' the rule by its terms applies to
transactions effected on any foreign exchange.\13\ For example, where a
member firm's customer places an agency order to buy or sell a foreign
security listed on a foreign exchange, the Three Quote Rule would
require that the member broker-dealer contact at least three dealers
and obtain quotations prior to executing the agency trade.\14\ In some
circumstances, it is argued, the exchange market may constitute the
best market for the securities that are listed on that market, and the
time delay involved in contacting three dealers in advance of a
customer transaction could hinder obtaining the best execution for the
customer.
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\12\ Non-Nasdaq security is defined in NASD Rule 6710 as ``any
equity security that is neither included in the Nasdaq Stock Market
nor traded on any national securities exchange * * *.''
\13\ The term ``national securities exchange'' is not defined in
NASD rules, but the requirements to qualify are set forth in
Sections 6(a) and 19(a) of the Act.
\14\ If a transaction is subject to the Three Quote Rule (NASD
Rule 2320(g)), then for books and records purposes NASD Rule
3110(b)(2) requires that ``a person associated with a member shall
indicate on the memorandum for each transaction in a non-Nasdaq
security * * * the name of each dealer contacted and the quotation
received to determine the best inter-dealer market.''
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Nature of Customer
The nature of particular classes of customers may be another factor
in determining whether an exemption is appropriate. In some
circumstances, for example, an institutional customer may prefer not to
inform or broadcast to other intermediaries or market professionals its
particular intent to buy or sell a particular non-Nasdaq security.
Under these circumstances, when a member broker-dealer contacts three
other dealers in collecting quotations, as required by the Rule, in
certain markets, this activity may trigger or invite additional market
activity by the parties contacted or others that may affect the market
price of the subject security.
Procedures in Exercising Exemptive Authority
It is important to note that the grant of an exemption to the Three
Quote Rule would not limit a member's best execution obligation. The
staff expects that the range of circumstances in which exemptions may
be granted would be limited to those circumstances in which it can be
shown that the Three Quote Rule would in fact hinder a member's best
execution obligation.
The Office of the General Counsel of NASD Regulation would be
responsible for strict compliance with discharging this exemptive
authority. Member broker-dealers would be instructed to submit all
requests for exemptions to the Office of General Counsel, NASD
Regulation, and would be required to limit the requests to actual
contemplated transactions or situations. The staff will not provide
exemptions in response to hypothetical situations or transactions. The
request should be detailed and include all relevant information
necessary for the staff to reach a determination on the request. If a
particular exemption involves a particular class of transactions or
class of customers that may be relevant to other member broker-dealers,
the staff will also publish such results to the membership through a
Notice to Members or similar publication or broadcast.
Staff determination will be subject to review by the National
Business Conduct Committee.
2. Statutory Basis
NASD Regulation believes that the proposed rule change is
consistent with Sections 11A(a)(1)(C),\15\ 15A(b) (6),\16\ and 15A(b)
(9) \17\ of the 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. 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, and 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 Act.
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\15\15 U.S.C. 78k-1(a)(1)(C).
\16\15 U.S.C. 78o-3(b)(6).
\17\15 U.S.C. 78o-3(b)(9).
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B. Self-Regulatory Organization's Statement on Burden on Competition.
NASD does not believe that the proposed rule change will impose any
inappropriate burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were either solicited or received.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the publication of this notice in the Federal
Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve the proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. In particular, the Commission
wishes to solicit comment on whether an exemption from the three quote
rule should be available on an individual market maker basis, or
whether an exemption should only be available for all market makers in
a particular security or class of securities. Also, the Commission is
soliciting comment on the ability of market makers to monitor and
report on the quality of their customers' executions in securities that
have been exempted from the Three Quote Rule. 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 at 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
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submissions should refer to File No. SR-NASD-97-42 and should be
submitted by September 11, 1997.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-22183 Filed 8-20-97; 8:45 am]
BILLING CODE 8010-01-M