[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

[[Page 44506]]

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