[Federal Register Volume 63, Number 32 (Wednesday, February 18, 1998)]
[Notices]
[Pages 8242-8244]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-3998]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39637; File No. SR-NASD-98-05]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the National Association of 
Securities Dealers, Inc., Relating to Modifications to the Small Order 
Execution System

February 10, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on January 28, 1998, the 
National Association of Securities Dealers, Inc. (``NASD'' or 
``Association'') filed with the Securities and Exchange Commission 
(``Commission'') through its wholly owned subsidiary, Nadsaq Stock 
Market, Inc. (``Nasdaq''), the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by Nasdaq. 
Nasdaq has designated this proposal as one that effects a change in an 
existing order-entry or trading system of a self-regulatory 
organization under Section 19(b)(3(A) of the Act and Rule 19b-4(e)(5) 
thereunder, which renders the rule effective upon the Commission's 
receipt of this filing. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq is proposing to amend Rule 4730(b)(10) to address problems 
associated with the rejection of orders in the Small Order Execution 
System (``SOES'') when there is no market maker at the inside quote. 
Below is the text of the proposed rule change. Proposed new language is 
in italics; there are no deletions.

4730. Participant Obligations is SOES

    (a) No Change.

[[Page 8243]]

    (b) Market Makers.
    (1)-(9) No Change.
    (10) In the event that there are no SOES market makers at the best 
bid (offer) disseminated by Nasdaq, market orders to sell (buy) entered 
into SOES will be held in queue until executable, or until 90 seconds 
has elapsed, after which such orders will be rejected and returned to 
their respective order entry firms.
    (c) No Change.
* * * * *

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 Nasdaq 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 Nasdaq 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

    When the SEC Order Handling Rules were implemented in January of 
1997, Nasdaq modified the SOES execution process to reject orders back 
to the entering firm when an electronic communications network 
(``ECN'') or an unlisted trading privilege (``UTP'') participant was 
alone creating the Nasdaq inside quote in a Nasdaq National Market 
security.\2\ This was necessary because ECNs were unable, at the time, 
to participate in an automatic execution system such as SOES. ECNs 
asserted that to do so might expose them to the risk of double 
executions, because if an order available through an ECN is also 
accessible through SOES, it may be subject to two executions: one from 
within the ECN and another from market participants using SOES. This in 
turn could cause the ECN to take a principal position, which is 
inconsistent with the ECN's role of acting solely as agent on behalf of 
its customers.
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    \2\ See Exchange Act Release No. 38156 (January 10, 1997) 62 FR 
2415 (January 16, 1997) (order partially approving File No. SR-NASD-
96-43).
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    This has resulted in an unintended consequence, however, which has 
caused significant concern. Specifically, an ECN quote that effectively 
halts executions in SOES for a security also allows the ECN customer 
entering that order to essentially control the inside price and 
potentially create an advantage in SOES for this customer (or other 
customers using SOES) by jumping ahead of other SOES orders that might 
have executed first in that issue if they had not been rejected. This 
has become problematic because instances have been observed where the 
ECN changes its quote almost immediately, before it can be assessed 
through either SelectNet or its own internal system. Once this quote 
disappears and a new dealer inside has been established, new SOES 
orders enter the system which then execute as the first order against 
the first market maker at the new inside price.
    Nasdaq plans to implement the following solutions to this potential 
problem. When an ECN or UTP participant is alone at the inside in a 
Nasdaq National Market security, executable SOES orders that are in 
queue or received at that moment will be held for a specified period of 
time. This ``hold time,'' initially set at 90 seconds, is the maximum 
life of an order. Holding the queued orders for 90 seconds will give 
other market makers time to adjust their quotes to create a new inside, 
join the ECN at their price, or allow the ECN to move away from the 
inside. If one of these conditions is met and the order is still 
executable, it will execute. If any of these conditions do not occur, 
however, the order will time out, under normal time-out processing, and 
be returned to the entering firm at the end of the 90-second maximum 
life of the order. Nasdaq SmallCap securities will continue to execute 
against the next available SOES market maker at the ECN price.
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of Section 15A(b)(6) and 15A(b)(11) of the Act \3\ in 
that it would facilitate the more orderly and equitable processing of 
customer orders entered into SOES, and eliminates the potential for 
participants to intentionally or unintentionally create an advantage 
among participants who access SOES.
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    \3\ 15 U.S.C. 78o-3(b)(6) and (b)(11).
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    Section 15A(b)(6) requires that the rules of a registered national 
securities association are designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principals 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; and are not designed to 
permit unfair discrimination between customers, issuers, brokers, or 
dealers.
    Section 15A(b)(1) requires that the rules of a registered national 
securities association be designed to produce fair and informative 
quotations, prevent fictitious or misleading quotations and to promote 
orderly procedures for collecting, distributing, and publishing 
quotations.

B. Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The rule change has become effective pursuant to Section 
19(b)(3)(A) of the Act and Rule 19b-4(e)(5) thereunder,\4\ because the 
foregoing proposed rule change effects a change in an existing order-
entry or trading system of a self-regulatory organization that:
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    \4\ 17 CFR 240.19b-4(e)(5).
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    (1) does not significantly affect the protection of investors or 
the public interest, (2) does not impose any significant burden on 
competition, and (3) does not have the effect of limiting the access to 
or availability of the order-entry or trading system. In particular, 
investors and the public should benefit as the appropriate priority of 
SOES orders will be preserved, placing competitors on a more level 
playing field and protecting their access to the order-entry system.\5\ 
Notwithstanding that this rule change is effective immediately upon 
filing, Nasdaq will nonetheless delay implementation of the proposed 
rule change until at least February 23, 1998, and at least 7 days after 
notice of such rule change on the Nasdaq Trader Web Site.\6\ Nasdaq 
will provide notice to market participants of the exact date of 
implementation prior to the effective date. At any time within 60 days 
of the filing of such rule change, the Commission may summarily

[[Page 8244]]

abrogate such rule change if it appears to the Commission that such 
action in necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the Act.
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    \5\ In reviewing this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \6\ http://www.nasdaqtrader.com.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the forgoing, including whether the proposed rule 
change is consistent with the Act. 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 
NASDAQ. All submissions should refer to File No. SR-NASD-98-05 and 
should be submitted by March 11, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-3998 Filed 2-17-98; 8:45 am]
BILLING CODE 8010-01-M