[Federal Register Volume 62, Number 209 (Wednesday, October 29, 1997)]
[Notices]
[Pages 56217-56219]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-28627]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39266; File No. SR-NASD-97-42)]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Granting Approval to Proposed Rule Change to Amend
NASD Rule 2320(g) to Provide Authority to the Staff of NASD Regulation
to Grant Exemptions From Such Provision
October 22, 1997.
I. Introduction
On June 17, 1997, the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association'') submitted to the Securities and
Exchange commission (``Commission''), pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule
19b-4 thereunder,\2\ a proposed rule change to amend NASD Rule 2320(g)
to provide the staff of NASD Regulation authority to grant exemptions
from such provision.
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\1\ 15 U.S.C. 78s(b)(1)
\2\ 17 CFR 240.19b-4.
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Notice of the proposed rule change, together with the substance of
the proposal, was published for comment in Securities Exchange Act
Release No. 38936 (August 14, 1997), 62 FR 44503 (August 21, 1997). Two
comment letters were received on the proposal.\3\
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\3\ See letter from Leonard Mayer, President, Mayer &
Schweitzer, Inc., to Jonathan G. Katz, Secretary, Commission, dated
September 12, 1997 (``Mayer letter''), and letter from Paul
Chalmers, Senior Vice President, International Trading, Canaccord
Capital, to Jonathan G. Katz, Secretary, Commission, dated September
17, 1997 (``Canaccord letter'').
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II. Description
NASD Rule 2320(g) (``The Three Quote Rule'' or ``Rule'') was
adopted on May 2, 1998 \4\ as an amendment to the NASD's best execution
interpretation \5\ under Article III, Section 1 of the NASD's Rules of
Fair Practice.\6\ 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, and 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\ See Securities Exchange Act Release No. 25637 (May 2, 1988),
53 FR 16488 (May 9, 1988).
\5\ ``Interpretation of the Board of Governors--Execution of
Retail Transactions in the Over-the-Counter Market.''
\6\ The best execution interpretation in Article III, Section 1
of the NASD's Rules of Fair Practice was converted into 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.)
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The Rule expanded a member's best execution obligation to customers
by setting forth additional requirements for customer transactions in
non-Nasdaq securities. In particular, the Rule requires members that
execute transactions in non-Nasdaq securities on behalf of customers to
contact a minimum of three dealers (or all dealers if there are three
or less) to obtain quotations to enable them to determine the best
inter-dealer market. Each member is generally required to use
reasonable diligence to ascertain this 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.\7\
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\7\ See NASD Rule 2320(a).
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Concurrent with these activities, the Commission also approved
Schedule H to the NASD's By-Laws, which established an electronic
system of mandatory price and volume reporting for the OTC non-Nasdaq
securities.\8\ 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.\9\ 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.\10\
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\8\ 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 Exchange Act Release No. 32647 (July 16, 1993), 58 FR
39262 (July 22, 1993).
\9\ 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).
\10\ 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.\11\ In
[[Page 56218]]
particular, the NASD has implemented enhancements to the OTC Bulletin
Board to increase the reliability of information contained therein.
Most recently, in July 1993, the Commission approved an NASD rule
change to implement real-time trade reporting for members' OTC
transactions in certain non-Nasdaq equity securities,\12\ and in April
1994, the NASD commenced realtime dissemination of transaction reports
through 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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\11\ These changes include: requiring that all priced quotations
entered by market makers in domestic securities be firm for at least
one trading unit (see Securities Exchange Act Release No. 29261 (May
31, 1991), 56 FR 29297 (June 26, 1991)); 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.
\12\ 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 Ware described
in Section 17B of the Exchange Act.\13\ As such, the OTC Bulletin Board
has assisted NASD broker-dealers in complying with certain disclosure
regulations under Section 15(g) of the Exchange Act (``the Penny Stock
Rules'').\14\ The OTC Bulletin Board was also designed to help deter
fraudulent and manipulative trading practices in penny stocks, \15\ in
part through real-time transaction reporting. Technological
improvements to the OTC Bulletin Board have enhanced the NASD's
surveillance capabilities to, among other things, permit computerized
analyses of market markers' quotation entries and reported
transactions.
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\13\ 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 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 penny stocks.
\14\ See Rules 15g-1 through 15g-9 under the Exchange Act, 17
CFR 240.15g-1 through 240.15g-9.
\15\ ``Penny Stock'' is defined under Rule 3a51-1 of the
Exchange Act, 17 CFR 240.3a51-1.
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The proposed change to Rule 2320(g) will provide for general
exemptive authority under the Rule. The NASD Regulation staff, upon
written request and taking into consideration all relevant factors,
will be able to exempt from Rule 2320 any transaction or class of
transactions, either unconditionally or on specified terms, if the
exemption is consistent with the purposes of the Rule, protection of
investors and the public interest. The decision may be appealed to the
National Business Conduct Committee (``NBCC''). NASD Regulation has not
yet determined whether any particular class of transactions should be
exempted.
The NASD noted in its filing that the staff could consider, in
determining whether to grant an exemptive request: (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.
The NASD also stated that it expects 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 (``the
Office'') will be responsible for strict compliance with discharging
this exemptive authority. Member broker-dealers will be instructed to
submit all requests for exemptions to the Office and will be required
to limit the requests to actual contemplated transactions or
situations. The NASD Regulation 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 NASD
Regulation staff will also publish such results to the membership
through a Notice to Members or similar publication or broadcast. NASD
Regulation staff determinations will be subject to review by the NBCC.
III. Summary of Comments
The Commission received two comment letters on the proposal, both
of which supported the proposal. One commenter supported the ability of
the NASD Regulation staff to have discretionary authority to grant,
where appropriate, exemptions from the Three Quote Rule both for a
particular fact situation or as to a class of securities or
transactions.\16\ Both commenters agreed that in certain situations the
Three Quote Rule may hinder, rather than help, a firm in meeting its
best execution obligations. One commenter stated that, in particular,
the exemption should be available for foreign securities and agreed
with the reasoning in the proposing release.\17\
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\16\ See Mayer letter, supra note 3.
\17\ See Canaccord letter, supra note 3.
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IV. Discussion
The Commission believes that the proposed rule change is consistent
with Sections 15A(b)(6) \18\ and 15A(b)(9) \19\ of the Exchange Act.
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 Exchange Act.\20\
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\18\ 15 U.S.C. 78o-3(b)(6).
\19\ 15 U.S.C. 78O-3(b)(9).
\20\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
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The Commission believes that the proposed rule change is consistent
with the Exchange Act because it will give NASD Regulation the
authority to grant exemptions from the Three Quote Rule in situations
where complying with the rule would hinder, rather than assist, best
execution. The Commission believes that providing general exemptive
authority under the Rule is appropriate in order to provide flexibility
to respond to changing market conditions and to particular fact
situations,\21\ as well as instances when certain classes of
transactions or certain securities on OTC Bulletin Board may warrant an
exemption from the Three Quote Rule.
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\21\ In its proposal, the NASD stated that some member broker-
dealers who are active in the non-Nasdaq market claim that adherence
to the three quote requirement may, in certain situations, have a
negative impact on a member's ability to satisfy its best execution
obligations, due to time delays involved in contacting and
collecting quotations from three separate dealers. In addition, the
NASD noted that some members question whether the Three Quote Rule
should continue to apply to all customer transactions in non-Nasdaq
securities in light of the technological and regulatory improvements
to the non-Nasdaq marketplace and to the OTC Bulletin Board, over
the past seven years. However, there are many non-Nasdaq securities
that only trade in the Pink Sheets.
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The Commission notes that one situation where exemptive relief
might be applied would be trading in certain foreign securities.\22\ In
some
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circumstances the foreign 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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\22\ The Three Quote Rule applies to transactions in all non-
Nasdaq securities. A 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 * * *.
Therefore, the rule by its terms applies to transactions effected on
any foreign exchange. 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 Exchange Act.
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The Commission believes that the exemptive process provided by the
rule change is reasonable under the Exchange Act. The Commission
stresses that the NASD Regulation staff would not be able to grant an
exemption (either for a particular market maker in a particular
security, or for all market makers in a particular security or a class
of securities) unless a market maker can demonstrate that adherence to
the Rule could serve as an impediment to satisfying its best execution
obligations with regard to a particular situation. The NASD Regulation
Staff will not provide exemptions in response to hypothetical
situations. The Commission also notes that if a particular exemption
involves a particular class of transactions or class of customers that
may be relevant to other member broker-dealers. The NASD Regulation
staff will also publish such results to the membership through a Notice
to Members or similar publication or broadcast. Further, the Commission
notes that the grant of an exemption to the Three Quote Rule should not
in any way limit a member's best execution obligation. Finally, the
NASD Regulation staff determinations are subject to review by the
NBCC.\23\
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\23\ After the NASD gains experience with this exemptive
authority, the Commission expects the NASD to codify, to the extent
possible, exceptions to the Rule. In particular, the NASD should
amend the rule to incorporate exemptions provided to broad classes
or types of transactions.
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\24\ that the proposed rule change (SR-NASD-97-42) is
approved.
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\24\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\25\
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\25\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 97-28627 Filed 10-28-97; 8:45 am]
BILLING CODE 8010-01-M