[Federal Register Volume 64, Number 77 (Thursday, April 22, 1999)]
[Notices]
[Pages 19844-19849]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-10019]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41296; File Nos. SR-NASD-99-11 and SR-NASD-98-17]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. To 
Modify Its Small Order Execution System and SelectNet Service; 
Reopening of Comment Period on Nasdaq's Limit Order Book Proposal (SR-
NASD-98-17)

April 15, 1999.
    On February 5, 1999, the National Association of Securities 
Dealers, Inc. (``NASD''), through its wholly-owned subsidiary, The 
Nasdaq Stock Market, Inc. (``Nasdaq''), filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') proposed rule changes 
to modify its Small Order Execution System and SelectNet Service.\1\ 
The Commission is publishing this notice to solicit comments on the 
proposed rule changes from interested persons.
---------------------------------------------------------------------------

    \1\ The notice was filed pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''), 15 U.S.C. 78s(b)(1), and 
Rule 19b-4 thereunder, 17 CFR 250.19b-4. Items I, II, and III were 
prepared by Nasdaq.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD, through Nasdaq, is proposing rule changes that: (1) Re-
establish SelectNet as an order delivery and negotiation system for 
Nasdaq National Market (``NNM'') securities; and (2) make numerous 
changes to the current rules relating to the trading of NNM securities, 
including: (a) Establishing a larger maximum automatic execution order 
entry size of 9,900 shares for NNM securities; (b) allowing market 
makers to use Nasdaq's proposed automatic execution system on a 
proprietary basis for transactions involving NNM securities; (c) 
reducing time delays between system executions against the same market 
maker from 17 to 5 seconds; and (d) enabling system interaction with a 
market maker's reserve size in NNM securities. The resulting new system 
will be referred to as the Nasdaq National Market Execution System 
(``NNMS''). In addition, as discussed below, Nasdaq is proposing to 
eliminate the NO Decrementation (``NO DEC'') and preferencing functions 
for NNM quotes and orders. The current voluntary automatic execution 
system for Nasdaq SmallCap issues will continue to operate as it does 
today. Nasdaq views NNMS as an interim approach to improving the Nasdaq 
market pending final approval by the Commission of Nasdaq's previously 
proposed Integrated Order Delivery and Execution System (SR-NASD-98-
17).\2\
---------------------------------------------------------------------------

    \2\ Because this filing is related to File No. SR-NASD-98-17 
regarding the NASD's proposal to establish a central limit order 
book, the Commission also is seeking comment on that proposal at 
this time. NASD 98-17 was published in the Federal Register on March 
12, 1998. See Securities Exchange Release No. 39718 (March 4, 1998), 
63 FR 12124 (March 12, 1998). The comment period was subsequently 
extended to May 8, 1998. See Securities Exchange Act Release No. 
39794 (March 25, 1998), 63 FR 15471 (March 31, 1998).
---------------------------------------------------------------------------

    The NASD also proposes to modify several rules found in the NASD 
Rule Series 4600 and throughout the NASD Manual. In particular, Rule 
4613 (Character of Quotations) will be amended to eliminate the 
references to Small Order Execution System (``SOES'') ``Tier Sizes for 
the NNM'' of market makers. Other rules referencing SOES will be 
rescinded or conformed accordingly, including Rule 4611(f) 
(Registration as a Nasdaq Market Maker), Rule 4619 (Withdrawal of 
Quotations and Passive Market Making), Rule 4620 (Voluntary Termination 
of Registration), Rule 4632 (Trade Reporting), Rule 4618(c) (Clearance 
and Settlement), and Rule 4700 Series (SOES).

II. Self-Regulatory Organization's Statement of the purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, Nasdaq included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any

[[Page 19845]]

comments it received on the proposed rule change. The text of these 
statements may be examined at the places specified in Item IV below. 
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

1. Purpose
    The central purpose of these rule changes is to encourage and 
assist market professionals to provide liquidity by increasing their 
ability to manage the receipt and execution of the dramatically 
increased volume of orders prevalent in today's Nasdaq market. In their 
simplest form, the proposed rules provide for the automatic execution 
of all orders in NNM securities of 9,900 shares or less against a newly 
expanded universe of available trading interest to consist of all 
market makers' displayed quotes and reserve sizes. the rules will also 
allow Nasdaq to continue to provide, through SelectNet, a negotiation 
facility that maintains all of the benefits of modern communications 
technology and automated market services. Finally, the proposed system 
can be created and made functional quickly and with a minimum of 
reprogramming, factors that are particularly important given the 
upcoming Year 2000 moratorium.\3\
---------------------------------------------------------------------------

    \3\ Beginning June 30, 1999, NASD will implement a self-imposed 
Year 2000 moratorium on itself preventing any system changes to SOES 
and SelectNet Service. Per telephone conversation between Thomas P. 
Moran and John F. Malitzis, Office of General Counsel, Nasdaq, and 
Heather Traeger, Division of Market Regulation, SEC, on April 14, 
1999.
---------------------------------------------------------------------------

Background

    Nasdaq's SOES was developed in 1984 to provide a simple and 
efficient means to execute small agency orders at the inside quote, 
report trades for public dissemination, and send trades to clearing for 
comparison and settlement.\4\ Trading is done automatically and is 
negotiation free. In response to the October 1987 market break, SOES 
was enhanced in several respects to provide individual investors with 
guaranteed liquidity and assured access to market makers in times of 
market disruption. In particular, SOES participation was made mandatory 
for all market makers in NNM securities.
---------------------------------------------------------------------------

    \4\ See Securities Exchange Act Release No. 21743 (February 12, 
1985), 50 FR 7432 (February 22, 1985) (order approving rule change 
describing SOES).
---------------------------------------------------------------------------

    In January 1988, the Commission approved the NASD's Order 
Confirmation Transaction (``OCT'') Service (later renamed SelectNet). 
The Service was intended to provide an alternative to telephone contact 
among trading desks for negotiating trades.\5\ The Service also was 
developed to provide additional communication options and electronic 
access to Nasdaq's trade reporting, order comparison and settlement 
facilities.\6\
---------------------------------------------------------------------------

    \5\ See Securities Exchange Act Release No. 25263 (January 11, 
1988), 53 FR 1430 (January 19, 1988) (order approving OCT Service, 
on a temporary, accelerated basis). See also, Securities Exchange 
Act Release No. 25523 (March 28, 1988), 53 FR 10965 (April 4, 1988) 
(order extending temporary approval of SelectNet) and Securities 
Exchange Act Release No. 25690 (May 11, 1988), 53 FR 17523 (May 17, 
1988) (order permanently approving OCT).
    \6\ The Service was enhanced and renamed SelectNet in 1990. See 
Securities Exchange Act Release No. 28636 (November 21, 1990), 55 FR 
49732 (November 30, 1990). In 1992, the service was expanded to add 
pre-opening and after-hours sessions, so that today, SelectNet is 
available for members to negotiate and execute orders from 9:00 a.m. 
until 5:15 p.m. (ET). See Securities Exchange Act Release No. 30581 
(April 14, 1992), 57 FR 14596 (April 21, 1992).
---------------------------------------------------------------------------

    SelectNet is an electronic, screen-based order routing system that 
allows market makers and order entry firms (collectively referred to as 
``participants'') to negotiate securities transactions in Nasdaq 
securities through computer communications rather than relying on the 
telephone. Unlike SOES, SelectNet offers the opportunity to negotiate 
for a larger size or a price superior to the current inside. In 
addition, participants may provide that an order or counter-offer will 
be in effect for anywhere from 3 to 99 minutes, specify a day order, or 
indicate whether price or size are negotiable or whether a specific 
minimum quantity is acceptable. Participants may accept, price improve, 
counter, or decline a SelectNet order. Once agreement is reached, the 
execution is ``locked in'' and reported to the tape for public 
dissemination and sent to clearing for comparison and settlement.
    SelectNet currently allows subscribers to direct, or ``preference'' 
orders to specified market makers or to broadcast orders to all market 
participants. Although SelectNet is an order delivery service, rather 
than an order execution service, Nasdaq believes that preferenced 
SelectNet order presented to a market maker at its displayed quote 
generally gives rise to liability under Exchange Act Rule 11Ac1-1 
(``Firm Quote Rule'') for the market maker to execute the transaction 
at that price.\7\ Under the rules proposed today, preferencing in 
SelectNet would still be allowed subject to the oversized order entry 
requirement discussed later in this filing.
---------------------------------------------------------------------------

    \7\ There are two exceptions to the Firm Quote Rule: (1) prior 
to the receipt of the order, the market maker has communicated to 
its exchange or association a revised quotation size or revised bid 
or offer or (2) prior to the receipt of the order, the market maker 
is in the process of effecting a transaction in a security when an 
order in the same security is presented, and immediately after the 
completion of such transaction, the market maker communicates to its 
exchange or association a revised quotation size or revised bid or 
offer.
---------------------------------------------------------------------------

    Nasdaq also designated SelectNet as the link to Electronic 
Communications Networks (``ECNs'') in conjunction with the Act's Order 
Handling Rules.\8\ Specifically, an amendment to SEC Rule 11Ac1-1 now 
requires an OTC market maker to make publicly available any superior 
prices that the market maker privately quotes through an ENC. A market 
maker may comply with this requirement by either changing its quote to 
reflect the superior price or delivering better priced orders to an 
ECN, provided that the ECN disseminates these priced orders to the 
public quotation system and provides broker-dealers equivalent access 
to these orders. The SelectNet linkage was implemented to facilitate 
these dissemination and access requirements.\9\ SelectNet will continue 
to perform this function in the new trading environment proposed in 
this filing.
---------------------------------------------------------------------------

    \8\ SelectNet is also used by UTP Exchanges (as defined below) 
to access Nasdaq market makers. See Securities Exchange Act Release 
No. 38191 (January 22, 1997), 62 FR 4562 (January 30, 1997).
    \9\ See Securities Exchange Act Release No. 38156 (January 10 
,1997), 62 FR 2415 (January 16, 1997) (order approving changes 
related to implementation of the SEC Order Handling Rules).
---------------------------------------------------------------------------

    While SOES and SelectNet provide valuable services to market 
participants for the ultimate benefit of investors, there is a long-
standing problem of potential ``dual laibility'' for a market maker's 
displayed quote which is directly attributable to the maintenance of 
two separate execution systems operating independently and 
simultaneously. Multiple access points to a market maker's quote, 
thorugh a combination of SOES and SelectNet as well as through a firm's 
internal order receipt/execution and telephone access facilities, can 
routinely subject market makers to unintended double liability for 
orders that reach their quote at or near the same time through 
disparate, asynchronous systems. In turn, the potential for unexpected 
and increased order liability reduces market maker incentives to commit 
capital and display larger quote sizes, which could deprive the Nasdaq 
market of valuable liquidity. Nasdaq's new automated execution 
environment is designed to remedy these problems.

[[Page 19846]]

Nasdaq's New Trading Environment

    To deal with the significant and ongoing problem of dual liability, 
Nasdaq is proposing modifications to its negotiation and automatic 
execution systems. Under the proposal, SelectNet, through rule and 
system changes, would be re-established as a non-liability, order 
delivery and negotiation system for NNM securities. Moreover, SOES, the 
current automatic execution system for small orders from public 
customers, will be recast for the trading of NNM securities through the 
following changes: (1) increasing for NNM securities the maximum order 
size to 9,900 shares; (2) allowing market makers to enter proprietary 
orders into the new system and to obtain automatic execution for their 
proprietary and agency orders in NNM securities; (3) reducing the 
current 17-second delay between executions against the same market 
maker to 5 seconds; and (4) enabling NNM orders to interact 
automatically with market makers' displayed size and reserve size, 
including a market maker's Agency Quotes.\10\ Nasdaq believes that this 
combination of rule changes will expeditiously reduce ``double hit'' 
liability in the most active Nasdaq securities while dramatically 
increasing the speed of executions and enhancing access to the full 
depth of a security's trading interest by all market participants.
---------------------------------------------------------------------------

    \10\ Nasdaq recently filed a proposal with the Commission that 
would permit the separate display of customer orders by market 
makers in Nasdaq through a market maker agency identification symbol 
(``Agency Quote''). See Securities Exchange Act Release No. 41128 
(March 2, 1999), 64 FR 12198 (March 11, 1999). (``SR-NASD-99-09.'') 
The Commission subsequently extended the comment period for that 
proposal until June 1, 1999. Securities Exchange Act Release No. 
41243 (April 1, 1999), 64 FR 17428 (April 9, 1999).
---------------------------------------------------------------------------

Changes to SelectNet

    Specifically, SelectNet's transformation to an order delivery and 
negotiation system will be accomplished through rule changes 
prohibiting the use of SelectNet for the entry of any preferenced 
orders directed to market makers in NNM securities unless such orders 
are at least one normal unit of trading (i.e., 100 shares) in excess of 
the displayed amount of the NNMS market makers's quote to which they 
are directed (``over-sized order requirement''). In addition, such 
orders must also be designated as wither: (1) ``All-or-None'' (``AON'') 
of a size that is at least 100 shares greater than the displayed amount 
of the NNMS market maker's quote to which the order is directed; or (2) 
a ``Minimum Acceptable Quantity'' order (``MAQ'') with an MAQ value of 
at least 100 shares greater than the displayed amount of the NNMS 
market maker's quote to which the order is directed. SelectNet itself 
will be programmed to reject preferenced messages violating this 
mandate.\11\ In Nasdaq's view, these changes will ensure that market 
makers are not subject to potential dual liability arising under the 
Firm Quote Rule as the result of the duplicative receipt of liability 
orders through asynchronous systems. Recipients of oversized NNM 
SelectNet orders would still have the option to execute or initiate 
electronic negotiation in response to the message.\12\
---------------------------------------------------------------------------

    \11\ SelectNet will continue to accept orders of any size 
(subject to the current 999,999 shares system limit) for Nasdaq 
SmallCap securities.
    \12\ This is not to be understood to prohibit liability for each 
of potentially two quotes displayed by market makers under the 
Agency Quote proposal contained in SR-NASD-99-09.
---------------------------------------------------------------------------

    As described below, national securities exchanges trading under 
grants of unlisted trading privilege (``UTP Exchanges'') will continue 
to use SelectNet as their primary linkage with Nasdaq. ECNs will have 
the ability to be accessed through the SelectNet linkage, or fully 
participate in the NNMS and be subject to automatic execution, through 
NNMS, against their quote. Taken together, these changes will ensure 
for NNM securities that SelectNet regains its place as the order 
delivery and negotiation system that it was originally intended to be.

Order Entry Parameters

    For NNM securities, the system proposed today becomes the Nasdaq 
market's primary trading and execution medium. The proposed NNMS system 
transforms the currently operating execution system for small orders 
from public customers into a more efficient, automated facility for the 
handling of all NNM orders of 9,900 shares or less entered for 
execution against an expanded trading interest accessible through both 
displayed and reserve size quotes. The proposed system will execute 
automatically against market makers' proprietary and agency quotes as 
more fully described below.
    First, the maximum order size for NNM securities entered into NNMS 
will be increased to 9,900 shares from current order size maximums 
(e.g., 1000, 500 or 200 shares). Second, market makers will be allowed 
to use NNMS on a proprietary basis, including being able to obtain 
automatic execution for orders sent to other NNMS participants, when 
trading NNM securities. Third, the current 17-second interval delay 
between automatic executions against the same market maker will be 
reduced to 5 seconds in NNMS. Fourth, Nasdaq will design NNMS to permit 
interaction of orders against a market maker's ``reserve size'' 
(including a market maker's posted agency quote) after yielding 
priority to displayed quotes at the same price. Additionally, market 
makers will be given the option of having their quote automatically 
refreshed from that reserve to a size level of their choosing. If no 
particular size is designated by the market maker, the quote will be 
automatically refreshed by NNMS at a 1000 share displayed size 
level.\13\
---------------------------------------------------------------------------

    \13\ See NASD Rule 4710(g) and proposed rules 4701(g) and 
4710(d)(3).
---------------------------------------------------------------------------

Reserve Size

    The proposed reserve size functionality in the NNMS will yield 
priority to all other displayed quotes at the same price level, so that 
the system will execute against displayed size in time priority and 
then against the reserve size in time priority. To encourage the 
display of appropriate order size, NNMS will require a market maker 
using NNMS's reserve-size functionality to display a minimum of 100 
shares in its Proprietary Quote. Moreover, displayed Proprietary Quotes 
at the inside of the market that are to be refreshed at the same price 
level must be refreshed at 1000 or more shares for a market maker to be 
permitted to continue using reserve size. Market makers wishing to 
refresh and display at the same inside price at a size less than 1000 
shares will be able to do so but will not be permitted to use NNMS's 
reserve size feature.\14\
---------------------------------------------------------------------------

    \14\ This restriction will not apply for interim executions 
against a market maker's unupdated quote. For example, should a 
market maker displaying an initial quotation of 1000 shares with 
5000 shares in reserve be automatically accessed by NNMS for 300 
shares in displayed size, that market maker will still be allowed to 
continue to display its remaining 700 shares and keep 5000 available 
in reserve size. Should the market maker subsequently update either 
its displayed or reserve sizes, or its quoted price, the market 
maker will be obligated to increase its displayed size to 1000 
shares to continue to use NNMS's reserve size feature.
---------------------------------------------------------------------------

    For example, in a situation where there are three market makers, 
ranked in time priority A, B, C, each at the best bid and each 
displaying 1,000 shares and all with 5,000 shares in reserve, the 
system will handle the order as follows: if a 9,000 share market order 
is entered, the proposed system would automatically first take out the 
displayed 3,000 shares. It then would take out the entire 5,000 share 
reserve size of market maker A (``MMA'') and 1,000 shares of market 
maker B's (``MMB'') 5,000 share reserve size in

[[Page 19847]]

time priority, filling the order and leaving MMB with 4,000 shares in 
reserve size and market maker C (``MMC'') with 5,000 shares in reserve 
size.\15\ MMA's quote would be completely decremented and drop from the 
inside market. Since MMB's total displayed and reserve quote would not 
be completely decremented (4,000 reserve share size remaining) it would 
retain its time priority and, assuming it remains the best bid, remain 
at the top of the quote montage and have its displayed size refreshed 
from its remaining reserve size. For MMB to continue quoting shares in 
reserve size, MMB would have to have selected a 1,000 share or greater 
refresh size. MMC, based on its 5,000 share reserve size remainder, 
would retain the number two slot in the montage and would have the 
option of having its displayed quote automatically refreshed from 
reserve to a size level of its choosing. MMC would be subject to a 
1,000 share or greater display refresh minimum to be allowed to 
continue to quote reserve size. MMA's fully exhausted quote will have 
the option of being automatically refreshed away from the inside market 
using Nasdaq's automatic quote update function. If a specific, 
predetermined automatic quote refresh amount is not selected, the NNMS 
system will refresh a market maker's displayed quote from reserve size 
to a 1,000 share display level.
---------------------------------------------------------------------------

    \15\ Like Nasdaq's other automatic execution systems, NNMS will 
impose a $0.50 per side fee for each execution. To reduce user costs 
and facilitate the use of NNMS's reserve size functionality, a 
simultaneous and instantaneous execution against an NNMS 
participant's displayed and reserve size will be treated for billing 
purposes as a single execution.
---------------------------------------------------------------------------

    As always, failure to update a fully exhausted quote will result in 
the system placing the market maker's quote in a ``closed'' state that, 
if not updated within 5 minutes, will be cause for suspension of the 
market maker's quote for 20 business days.\16\
---------------------------------------------------------------------------

    \16\ Market makers will still have the ability, through Nasdaq's 
automatic quote update facility, to pre-select a tick value and have 
Nasdaq refresh their proprietary quote away from the inside market. 
This capability would not apply to a market maker's Agency Quote 
because that quotation represents agency interest and will not be 
required to be two-sided. If a market maker's quote is refreshed to 
a different price or size level, another order will not be delivered 
to that market maker for 5 seconds after that quote is refreshed at 
the new price or size level.
---------------------------------------------------------------------------

No Decrementation

    In addition, Nasdaq is also proposing to eliminate the NO DEC 
feature for NNM securities, which currently allows continuous 
executions against a market maker's quote at the same price without 
decrementing the quoted size. Nasdaq believes that the NO DEC feature 
is increasingly less important now that market makers can manage their 
quote by displaying their actual size, and will become even less 
important in a market where market makers are given the ability to 
refresh their quote at a size they determine. Nasdaq also believes that 
NO DEC inhibits quote competition among market participants and 
discourages the full display of trading interest. Moreover, given the 
larger order sizes and faster executions that can be expected from the 
new trading system, Nasdaq submits that a continuation of NO DEC in 
NNMS could inadvertently expose market participants to inappropriate 
levels of order liability. Finally, NO DEC provides no benefits in 
conjunction with Nasdaq's proposed Agency Quote concept in that such 
agency quotes will represent the full and complete trading interest of 
the customer and are inconsistent with the unlimited and constant 
exposure to orders indicated by the use of NO DEC.

SOES Preferencing

    Similarly, Nasdaq is also proposing to eliminate the existing SOES 
preferencing feature for NNM securities as being inconsistent with the 
processing of orders in time priority as contemplated in the proposed 
new trading environment. Preferencing in an automatic execution system 
also reduces market maker incentives to aggressively compete for orders 
by showing the full size and true price of their trading interest. 
Moreover, a continuation of preferencing may place Agency Quotes of 
public customers at a disadvantage. Nasdaq believes that these factors, 
especially when combined with the proposed elimination of potential 
dual liability though SelectNet and the current ability of market 
makers to display their actual size, clearly militate in favor of 
discontinuing preferencing in NNMS.

UTP Exchange Participation

    UTP Exchanges will continue to have access to the full range of 
SelectNet's capabilities as their primary linkage with Nasdaq. UTP 
exchanges will continue to receive, and be obligated to execute, 
preferenced SelectNet liability orders. Additionally, UTP Exchanges 
will retain their ability to send SelectNet preferenced liability 
orders to market makers. While Nasdaq notes that a market maker may 
still have dual liability in situations where a market maker is 
accessed by a UTP Exchange via SelectNet and simultaneously by an NNMS 
market maker of order entry firm via the NNMS system, Nasdaq believes 
that such dual liability is manageable in the current trading 
environment. Nasdaq will continue to monitor this issue and will 
propose amendments to the NNMS system and the UTP Plan if significant 
problems arise.

ECN Participation

    ECNs will have two options for participation in the NNCS System, 
and the manner in which they choose to participate shall be governed by 
an addendum to the Nasdaq Workstation II Subscriber Agreement of 
ECNs.\17\
---------------------------------------------------------------------------

    \17\ The manner in which ECNs currently participate in the 
Nasdaq market place is governed, in part, by the Nasdaq Workstation 
agreement as amended for ECNs, which all ECNs must sign. See Rule 
4623(b)(3). Under the proposed rules for the NNMS system, this 
practice would not change.
---------------------------------------------------------------------------

    First, an ECN would be allowed to participate in Nasdaq in 
substantially the same manner as they do today (``Order Entry ECN''). 
That is, market participants would continue to be able to access ECNs 
via the SelectNet linkage and would continue to be able to send 
preferenced SelectNet messages of any size (up to 999,999 shares) and 
with any conditions to such ECNs (i.e., the oversized order requirement 
for a preferenced SelectNet order would not apply to ECNs under this 
first option). ECNs that choose to have the capability to ``reach out'' 
and access other market maker quotes (including Agency quotes) could do 
so by requesting order-entry capability in the NNMS system. The ECN 
also could send preferenced SelectNet orders to NNMS market makers 
subject to the oversized order restrictions described in this 
filing.\18\
---------------------------------------------------------------------------

    \18\ This would allow ECNs to access market makers through two 
systems, but would limit dual liability that market makers currently 
face because they will only be receiving orders requiring them to 
execute from NNMS.
---------------------------------------------------------------------------

    Second, an ECN could choose to participate fully in the NNMS system 
(``Full-Participant ECN''). Under this option, the ECN would agree to 
provide automatic execution for orders received from other NNMS 
participants through the NNMS system by the ECN. As with the first 
option, Full-Participant ECNs could use the NNMS system to obtain 
automatic execution of orders they send to NNMS market makers or other 
Full-Participant ECNs.
    Given time and technology constraints affecting some ECNs, Nasdaq 
feels that on an interim basis ECNs should have options as to the 
manner in which to participate in Nasdaq's new system. Thus, Nasdaq is 
not proposing at this time to mandate that all ECNs register as Full-
Participant ECNs, but will reconsider this issue in the future.

[[Page 19848]]

Nasdaq SmallCap

    For Nasdaq SmallCap securities, the trading rules for automatic 
execution will remain the same as they are today. Thus, participation 
in the automatic execution system for SmallCap will continue to be 
voluntary, and be available only for the small orders of public 
customers. Maximum order size limits will remain in effect as well as 
the prohibition against splitting larger orders to avoid those limits. 
Restrictions on access by market professionals will likewise be 
maintained.\19\ After Nasdaq has had experience with the NNMS system, 
it will consider whether the functionality of the system should be made 
available for SmallCap trading.
---------------------------------------------------------------------------

    \19\ See NASD Notice to Members 88-61. Nasdaq notes that is 
recently filed, in response to concerns raised by SEC staff, a rule 
proposal to eliminate the ``five-minute presumption'' outlined in 
Notice to Members 88-61. See Securities Exchange Act Release No. 
41015 (February 4, 1999), 64 FR 6415 (February 9, 1999).
---------------------------------------------------------------------------

Other, Technical Modifications

    Finally, several rules found in NASD Rule Series 4600 and 
throughout the NASD Manual will be modified in technical, non-
substantive ways. In particular, Rule 4613 (Character of Quotations), 
will be amended to eliminate the references to SOES Tier Sizes for the 
NNM quotations of market makers. Other rules referencing SOES will be 
rescinded or conformed accordingly, including Rule 4611(f) 
(Registration as a Nasdaq Market Maker), Rule 4619 (Withdrawal of 
Quotations and Passive Market Making), Rule 4620 (Voluntary Termination 
of Registration), Rule 4632 (Trade Reporting), Rule 4618(c) (Clearance 
and Settlement) and the Rule 4700 Series (SOES).
    Nasdaq submits that the above proposals can obtain many of the 
market benefits of a full integration of Nasdaq systems in a timely and 
efficient manner, while still maintaining SelectNet as a negotiation 
system and as the approved link between Nasdaq, ECNs and UTP exchanges. 
Most importantly, Nasdaq's proposals leverage its existing technology 
platform to significantly reduce the negative market impacts resulting 
from multiple executions from non-integrated systems as quickly as 
possible, with a minimum of burdensome reprogramming for all market 
participants during the crucial period of time leading up to the 
approaching year 2000 moratorium. The proposals also provide order 
entry firms and their public customers increased benefits from enhanced 
access through larger NNM order entry size parameters, quicker 
executions, and the ability to interact with the non-displayed reserve 
size of NNM market makers resulting in improved overall market 
efficiency.
2. Statutory Basis
    Nasdaq believes that the proposed rule change are consistent with 
Section 15A(b)(6) of the Act \20\ in that the proposed rule changes are 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in the 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.
---------------------------------------------------------------------------

    \20\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    Nasdaq believes that the proposal also is consistent with Section 
11A(a)(1)(C),\21\ in which Congress found that it is in the public 
interest and appropriate for the protection of investors and the 
maintenance of fair and orderly markets to assure: (1) economically 
efficient execution of securities transactions; (2) fair competition 
among brokers and dealers; (3) the availability to brokers, dealers and 
investors of information with respect to quotations and transactions in 
securities; (4) the practicability of brokers executing investors' 
orders in the best market; and (5) an opportunity for investors' orders 
to be executed without the participation of a dealer. Specifically, 
Nasdaq believes that this proposal, combined with Nasdaq's Agency 
Quote, which is also pending with the Commission, will provide a 
mechanism for the more efficient display and automatic execution of 
customer limit orders. Thus, the Nasdaq believes the proposed rule 
change is consistent with Section 11A and the SEC's Order Handling 
Rules,\22\ and in particular the Display Rule.\23\
---------------------------------------------------------------------------

    \21\ 15 U.S.C. 78k-l(a)(1)(C).
    \22\ See Securities Exchange Act Release No. 37619A (September 
6, 1996), 61 FR 48290 (September 12, 1996) ( adopting release of 
Order Handling Rules).
    \23\ 17 CFR 240.11Ac1-4.
---------------------------------------------------------------------------

(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.

(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

    Within 35 days of the date of 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 such 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, including whether the proposed rule 
change is consistent with the Act. As discussed, Nasdaq has proposed 
modifications to SOES and Select Net as interim measures pending 
Commission action on its Integrated Order Delivery and Execution 
System, commonly known as its limit order book proposal (SR-NASD 98-
17). Nasdaq has also proposed its agency quote display structure (SR-
NASD 99-09) as an interim measure pending its limit order book 
proposal. Both the SOES/SelectNet modifications and the agency quote 
display could significantly modify the existing Nasdaq market in ways 
that some may consider less desirable than the results of the proposed 
limit order book. Because these proposals are largely alternatives to 
each other, market participants should have the chance to formally 
comment on the limit order book proposal in light of the SOES/SelectNet 
and agency quote proposals. Therefore , the Commission is formally 
reopening the comment period on the limit order filing, and requesting 
additional comments on this proposal.
    In response to prior comments on the impact of the limit order book 
filing, Nasdaq has discussed operating the limit order book on a pilot 
basis. A pilot would provide experience with the book and allow Nasdaq 
and the Commission to better gauge the impact of the book on the Nasdaq 
market. The Commission specifically requests comment on whether the 
proposal should be

[[Page 19849]]

approved on a pilot basis. If so, how should a pilot be structured? To 
gain a realistic assessment of the book, should the pilot include a 
limited number of securities across a range of the NNM market, or 
should it include securities representing a substantial portion of the 
trading market. For example, should the pilot include 250 securities, 
of which 20 were from the Nasdaq top 100 securities, and the rest were 
chosen from different quintiles of NNM securities? Or should the pilot 
comprise 1000 securities including the Nasdaq top 100 securities and 
the remainder chosen from quintiles of NNM securities? Or would a 
different pilot be more appropriate? In addition, how long should a 
pilot last? Would six months, or one year, provide sufficient 
information to evaluate a pilot? Would a pilot of this length and 
breadth potentially harm the Nasdaq market on a lasting basis?
    Persons making written submissions on either filing should file six 
copies thereof with the Secretary, Securities and Exchange Commission, 
450 Fifth Street, N.W., Washington, D.C. 20549-0609. 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-99-11 (including those 
comments specifically addressing File No. SR-NASD-98-17) and should be 
submitted by June 1, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\24\
---------------------------------------------------------------------------

    \24\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Jonathan G. Katz,
Secretary.
[FR Doc. 99-10019 Filed 4-21-99; 8:45 am]
BILLING CODE 8010-01-M