[Federal Register Volume 63, Number 75 (Monday, April 20, 1998)]
[Notices]
[Pages 19547-19549]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-10339]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39857; File No. SR-NASD-97-20]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 1 to the Proposed Rule Change by the National Association 
of Securities Dealers, Inc. Relating to the Elimination of the 
Prohibitions Against NASD Members Accepting Stop Orders and Stop Limit 
Orders in Exchange-Listed Securities

April 14, 1998.

I. Introduction

    On March 10, 1997, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association'') submitted to the Securities and 
Exchange Commission (``SEC'' or ``Commission''), pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 
19b-4 thereunder,\2\ a proposal to amend paragraph (i) of NASD Rule 
6440, ``Trading Practices,'' to (1) allow members to accept stop orders 
\3\ in eligible securities; \4\ and (2) eliminate the requirement that 
the stop price equal the limit price in order for a member to accept a 
stop limit order \5\ in an eligible security.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ A buy stop order is an order to buy which becomes a market 
order when a transaction takes place at or above the stop price. 
Conversely, a sell stop order is an order to sell which becomes a 
market order when a transaction takes place at or below the stop 
price. See NASD Rule 6440(i)(1).
    \4\ Under NASD Rule 6410(d), ``eligible securities'' means all 
common stocks, preferred stocks, long-term warrants, and rights 
entitling the holder to acquire an eligible security, listed or 
admitted to unlisted trading privileges on the American Stock 
Exchange (``Amex'') or the New York Stock Exchange (``NYSE''), and 
securities listed on the regional stock exchanges which 
substantially meet the original listing requirements of the Amex or 
the NYSE.
    \5\ A buy stop limit order is an order to buy that becomes a 
limit order at the limit price when a transaction occurs at the stop 
price. Conversely, a sell stop limit order is an order to sell that 
becomes a limit order at the limit price when a transaction occurs 
at the stop price.
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    Notice of the proposed rule change was published for comment and 
appeared in the Federal Register on March 28, 1997.\6\ No comment 
letters were received on the proposal. On April 1, 1997, the NASD filed 
Amendment No. 1 to the proposed rule change.\7\ In

[[Page 19548]]

addition, the NASD submitted a letter describing the surveillance 
procedures it will use to monitor the handling of stop orders and stop 
limit orders.\8\ This order approves the NASD's proposal, as amended.
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    \6\ See Securities Exchange Act Release No. 38429 (March 21, 
1997) 62 FR 14953.
    \7\ See Letter from Robert E. Aber, Vice President and General 
Counsel, NASD, to Katherine England, Assistant Director, National 
Market System and Over-the-Counter Regulation, Division of Market 
Regulation (``Division''), Commission, dated April 1, 1997 
(``Amendment No. 1''). In Amendment No. 1, the NASD corrected a 
typographical error in NASD Rule 6440(i)(2). Specifically, NASD Rule 
6440(i)(2) stated that when a transaction occurs at the stop price, 
a stop limit order to buy or sell becomes a limit order at the stop 
price. Amendment No. 1 revises NASD Rule 6440(i)(2) to state that 
when a transaction occurs at the stop price, a stop limit order to 
buy or sell becomes a limit order at the limit price.
    \8\ See Letter from Thomas R. Gira, Vice President, NASD 
Regulation, Inc., to Katherine England, Assistant Director, National 
Market System and Over-the-Counter Regulation, Division, Commission, 
dated February 27, 1998.
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II. Description of the Proposal

    The NASD proposes to amend NASD Rule 6440 to eliminate current 
restrictions on the ability of NASD members to accept stop orders and 
certain stop limit orders in eligible securities. Currently, NASD Rule 
6440(i)(1) prohibits NASD members from accepting stop orders in 
eligible securities, and NASD Rule 6440(i)(2) allows members to accept 
stop limit orders in eligible securities where the stop price and the 
limit price are the same. The NASD proposes to amend NASD Rule 6440(i) 
to: (1) allow members to accept stop orders in eligible securities; and 
(2) eliminate the requirement that the stop price must equal the limit 
price in order for a member to accept a stop limit order in an eligible 
security. In addition, the proposal clarifies that NASD members are not 
obligated to accept stop orders or stop limit orders.
    The NASD believes there is no economic or regulatory reason to 
preclude or restrict investors from placing stop orders or stop limit 
orders in eligible securities. In this regard, the NASD notes that 
there are no comparable restrictions on the placement of stop orders or 
stop limit orders in securities listed on The Nasdaq Stock Market 
(``Nasdaq''). The NASD believes that investors in the third market \9\ 
also should be able to receive the benefits and protections that result 
from placing stop orders and stop limit orders. In particular, the NASD 
believes that the placement of stop orders and stop limit orders will 
help investors to implement their investment strategies and manage 
their portfolios.
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    \9\ The third market is the over-the-counter market for 
exchange-listed securities.
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to the NASD and, in particular, the requirements 
of Section 15A(b)(6) in that it is designed to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market, and, in general, to protect 
investors and the public interest.\10\ Specifically, the Commission 
believes that it is reasonable for the NASD to amend its rules to allow 
members to: (1) accept stop orders in eligible securities; and (2) 
accept stop limit orders in eligible securities where the limit price 
differs from the stop price. The Commission also believes that it is 
reasonable for the NASD to clarify its rules to indicate that members 
are not obligated to accept stop orders or stop limit orders.
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    \10\ In approving this rule change, the Commission 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 amending NASD Rule 6440(i)(1) to 
permit members to accept stop orders in eligible securities will extend 
the benefits and protections associated with stop orders to 
transactions in the third market. In general, an investor enters a stop 
sell order in a stock whose price has increased substantially in order 
to protect his or her profit if the stock's price declines; similarly, 
an investor with a short position may enter a stop buy order to limit 
his or her losses if the stock's price increases.\11\ The Commission 
believes that allowing NASD members to accept stop orders in eligible 
securities will extend these benefits to investors trading eligible 
securities in the third market and provide them with additional 
flexibility in implementing their trading strategies. The Commission 
notes that NASD members currently may accept stop orders in securities 
that are not eligible securities (generally, securities listed on 
Nasdaq), as well as stop limit orders in eligible securities.\12\ The 
NASD represents that it has not experienced any problems in connection 
with the use of stop orders for non-eligible securities or with the use 
of stop limit orders for eligible securities.\13\
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    \11\ See Securities Exchange Act Release No. 29063 (April 10, 
1991) 56 FR 15652 (April 17, 1991) (order approving File No. SR-
Amex-90-31) (``Amex Approval Order'').
    \12\ See NASD Rule 6440(i)(2).
    \13\ Telephone conversation between Thomas R. Gira, Vice 
President, NASD Regulation, and Yvonne Fraticelli, Attorney, Office 
of Market Supervision, Division, Commission, on April 2, 1998.
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    The Commission believes that the NASD has developed procedures that 
will allow it to monitor the handling of stop orders and stop limit 
orders in eligible securities.\14\ In addition to protections afforded 
by market surveillance, the Commission believes that the NASD's 
surveillance procedures will help to detect and deter efforts by market 
makers to use stop orders to manipulate the price of stock. Several 
characteristics of the trading in the third market minimize the 
likelihood that NASD market makers would be able to manipulate the 
price of an eligible security through their handling of stop orders. In 
this regard, the Commission notes, first, that a limited amount of the 
trading of eligible securities occurs in the third market.\15\ Second, 
the exchanges, rather than the third market, are the primary price 
discovery markets for eligible securities; third market makers usually 
base their quotations on the primary market quote.\16\ Third, there are 
multiple third market makers (as opposed to a single exchange 
specialists) for each eligible security. The Commission believes that 
these factors, taken together, would make it difficult for a third 
market maker to manipulate the price of an eligible security through 
the use of stop orders.
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    \14\ The Commission has had a continuing interest in potential 
manipulation and trading abuses in connection with elections of stop 
orders by exchange specialists. See e.g., Division of Trading and 
Exchanges, SEC, Stop Orders (1963) (detailing various problems 
associated with the execution of stop orders); Securities Exchange 
Act Release No. 24021 (January 21, 1987) 52 FR 3370 (February 3, 
1987) (order approving File No. SR-Amex-84-32); and Amex Approval 
Order, supra note 10. These abuses typically involved exchange 
specialists electing stop orders through principal transactions at 
price levels either well above the market price in the case of stop 
buy orders or well below the market price in the case of sell stop 
orders. See Amex Approval Order, supra note 10. As discussed more 
fully infra, the Commission believes that the NASD has adequately 
addressed the potential problems that may arise in connection with 
the handling of stop orders.
    \15\ In 1993, the third market garnered 7.4% of reported NYSE 
volume and 9.3% of the reported trades. See Division, Commission, 
Market 2000: An Examination of Current Equity Market Developments 
(January 1994) (``Market 2000 Study'') at II-11.
    \16\ See Market 2000 Study, supra note 16, at II-8.
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    The Commission also believes that it is reasonable for the NASD to 
amend NASD Rule 6440(i)(2) to allow members to accept stop limit orders 
in eligible securities where the stop price differs from the limit 
price in order to provide investors with additional flexibility in 
using stop limit orders. A stop limit order, which must be executed at 
the limit price or better, is designed to

[[Page 19549]]

guarantee that an order receives an execution at no worse than the 
limit price. However, if the market drops below the limit price of a 
sell stop order before the order can be executed, it is possible that 
the order will be executed. For example, if an investor enters a sell 
stop limit order where the stop price and the limit price are 34, then 
the investor's order may be executed only at 34 or better and may not 
be executed at all if the market moves below 34 before the order can be 
executed. However, if the investor is able to enter a sell order with a 
stop price of 34 and a limit price of 32, then the investor's order may 
be executed at 32 or better. Accordingly, by permitting investors to 
place orders where the limit price differs from the stop price, the 
NASD's proposal will increase the opportunities for execution of 
investors' orders and will allow investors to tailor their orders to 
reflect their objectives and strategies.
    The Commission also believes that it is reasonable for the NASD to 
amend NASD Rule 6440(i) to clarify that members are not obligated to 
accept stop orders or stop limit orders. Currently, NASD Rule 
6440(i)(2) states that members may accept stop limit orders in eligible 
securities. The NASD proposes to add language to NASD Rule 6440(i)(2) 
indicating that members are not obligated to accept stop limit 
orders.\17\ Because this is a clarification of the NASD's existing 
policy, it does not raise new regulatory issues.
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    \17\ Similarly, NASD Rule 6440(i)(1), as amended, will state 
that a member may, but is not obligated to, accept a stop order in 
an eligible security.
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    The Commission finds good cause for approving Amendment No. 1 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. Amendment No. 1 
corrects a typographical error in NASD Rule 6440(I)(2). Specifically, 
NASD Rule 6440(i)(2) stated that when a transaction occurs at the stop 
price, a stop limit order to buy or sell becomes a limit order at the 
stop price. Amendment No. 1 revises NASD Rule 6440(i)(2) to state that 
when a transaction occurs at the stop price, a stop limit order to buy 
or sell becomes a limit order at the limit price. Because Amendment No. 
1 corrects the text of the NASD's rule, the Commission finds that it is 
consistent with Sections 6(b) and 19(b)(2) of the Act to approve 
Amendment No. 1 on an accelerated basis.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether Amendment No. 1 
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 NASD. All 
submissions should refer to File No. SR-NASD-97-20 and should be 
submitted by May 11, 1998.

V. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-NASD-97-20) is approved, and 
that Amendment No. 1 is approved on an accelerated basis.

    \18\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-10339 Filed 4-17-98; 8:45 am]
BILLING CODE 8010-01-M