[Federal Register Volume 64, Number 95 (Tuesday, May 18, 1999)]
[Notices]
[Pages 27016-27018]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-12458]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41390; File No. SR-NASD-99-20]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to Firm Quotation Requirements

May 12, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 20, 1999, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association''), through its wholly owned subsidiary, 
Nasdaq Stock Market, Inc. (``Nasdaq''), filed with the Securities and 
Exchange Commission (``Commission'' or ``SEC'') the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by the NASD. 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).
    \2\ 17 CFR 240.19b-4.
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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 NASD Rule 4613(b), ``Firm 
Quotations,'' and IM-4613, ``Autoquote policy,'' to require a market 
maker to disseminate an inferior quote whenever the market maker fails 
to execute the full size of an incoming order that is at least one 
normal unit of trading greater than the market maker's published 
quotation size. The proposal also will prohibit the use of automatic 
quote updating in such circumstances. Below is the text of the proposed 
rule change. Proposed new language is in italics.
4613. Character of Quotations
    (a) No changes.
    (b) Firm Quotations.
    (1) A market maker that receives an offer to buy or sell from 
another member of the Association shall execute a transaction for at 
least a normal unit of trading at its displayed quotations as 
disseminated in The Nasdaq Stock Market at the time of receipt of any 
such offer. If a market maker displays a quotation for a size greater 
than a normal unit of trading, it shall, upon receipt of an offer to 
buy or sell from another member of the Association, execute a 
transaction at least at the size displayed.

[[Page 27017]]

    (2) If a market maker, upon receipt of an offer to buy or sell from 
another member of the Association in any amount that is at least one 
normal unit of trading greater than its published quotation size as 
disseminated in The Nasdaq Stock Market at the time of receipt of any 
such offer, executes a transaction in an amount of shares less than the 
size of the offer, then such market maker shall, immediately after such 
execution, display a revised quotation at a price that is inferior to 
its previous published quotation. The failure of a market maker to 
execute the offer in an amount greater than its published quotation 
size shall not constitute a violation of subparagraph (b)(1) of this 
rule.
    (c)-(e) No changes.
IM-4613. Autoquote Policy
    (a) No changes.
    (b) Exceptions to the General Prohibition--Automated updating of 
quotations is permitted when: (1) the update is in response to an 
execution in the security by that firm (such as execution of an order 
that partially fills a market maker's quotation size), and is in 
compliance with Rule 4613(b)(2); (2) it requires a physical entry (such 
as a manual entry to the market maker's internal system which then 
automatically forwards the update to Nasdaq); (3) the update is to 
reflect the receipt, execution, or cancellation of a customer limit 
order; or (4) an electronic communications network as defined in SEC 
Rule 11Ac1-1(a)(8) is required to maintain a two-sided quotation in 
Nasdaq for the purpose of meeting Nasdaq system design requirements.
* * * * *

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 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

    Nasdaq is proposing to modify NASD Rule 4613(b) to require a market 
maker, when presented with an order that is at least one normal unit of 
trading greater than the market maker's published quotation size, to 
immediately move its published quotation to an inferior price if the 
market maker fails to execute the full size of the order presented. 
Nasdaq seeks this modification to correct an inefficient market 
situation wherein multiple small orders are required to accomplish the 
objectives of a single larger order. Such inefficiencies occur whenever 
a market maker enters a minimum quotation size, receives an order 
larger than its quoted size, fills the order only up to its quoted size 
(as currently required under NASD Rule 4613(b)), and remains at the 
inside quote prepared to accept another order at the minimum quotation 
size.
    The following example illustrates this scenario:
    Market maker #1 (``MM1'') is bidding ABCD security at $10 for 100 
shares. Order Entry Firm #1 (``OE1'') sends a preferenced SelectNet 
order to MM1 to sell 1,000 shares of ABCD at $10. MM1 partially 
executes OE1's 1,000 share order by buying \3\ 100 shares of ABCD, and 
does not move its quotation. Assuming MM1 is alone at the inside, OE1 
may be compelled to resend multiple SelectNet messages to MM1, 
potentially resulting in a total of ten transactions, to complete its 
1,000 share order.
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    \3\ Although the initial proposal mistakenly used the word 
``selling'' in this example, Nasdaq corrected this error. Telephone 
conversation among Scott W. Anderson, Attorney, Nasdaq, and Yvonne 
Fraticelli, Special Counsel, Division of Market Regulation 
(``Division''), SEC, and Joseph Morra, Attorney, Division, SEC, on 
April 29, 1999.
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    In this example, according to Nasdaq, MM1 has acted in conformity 
with NASD Rule 3320, ``Offers at Stated Prices,'' IM-3320, ``Firmness 
of Quotations,'' NASD Rule 4613(b), and SEC Rule 11Ac1-1, as they are 
currently written, by executing a presented order up to its published 
quotation price and size. However, it is apparent the MM1 was willing 
to buy more than the 100 shares displayed. Requiring OE1 to send 
repeated SelectNet messages (or make multiple telephone calls) to MM1 
results in increased transaction costs to MM1, OE1, and, eventually, 
the public customer. Moreover, this situation impedes the price 
discovery process which would occur through transactions with other 
market makers at varying prices and precludes other market makers from 
positioning and executing large orders.
    Nasdaq believes that this scenario creates an inefficient 
marketplace wherein multiple identical small orders must be executed in 
place of a single larger order. This quotation and trading activity 
ultimately degrades market quality and imposes increased costs and 
burdens on other market participants seeking to executive customer and 
proprietary orders. Nasdaq also believes that this situation leads to 
increased instances of locked and crossed markets and hinders price 
continuity.
    For example, if MM1 is bidding 100 shares at $20, and MM2 wishes to 
lower its offer (currently $20\1/16\) to $20, MM2 would send MM1 a 
SelectNet message for 100 shares (or more) in an attempt to exhaust 
MM1's quote. MM2, after making multiple attempts to take out MM1 by 
sending SelectNet messages, may thereafter move its quote to $20, 
thereby locking the market. MM1's actions, in Nasdaq's view, create 
questions of market integrity.\4\
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    \4\ Nasdaq notes that the NASD recently amended NASD Rule 4623, 
``Electronic Communication Networks,'' to prohibit ECNs from 
engaging in similar behavior. See Exchange Act Release No. 40455 
(September 22, 1998), 63 FR 51978 (September 29, 1998) (Order 
approving File No. SR-NASD-98-01).
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    Nasdaq believes that the proposed rule change will effectuate the 
display by market makers of their true and intended quotation size. 
When a market maker is presented with an order larger than its 
displayed size and completes the order only at its displayed size, this 
presents a clear indication that the market maker's interest in trading 
at that price level has been depleted. The market maker would then 
adjust its quotation to an inferior price level, thereby permitting 
another market maker to assume the priority position.
    Nasdaq also proposes to modify IM-4613(b) to mandate compliance 
with proposed NASD Rule 4613(b)(2). IM-4613(a) generally prohibits the 
use of ``autoquote'' mechanisms to automatically generate a new quote 
that would keep a market maker's quote away from the best market. IM-
4613(b)(1) provides an exception to this rule that permits the use of 
autoquote functions when the update is in response to an execution in 
the security by that firm. Nasdaq proposes to revise IM-4613(b)(1) to 
require that the market maker comply with proposed NASD Rule 4613(b)(2) 
by allowing the market maker to automatically update its quote only 
after fully executing the incoming order. If the order is not executed 
in full, the autoquote functionality must be discontinued and the quote 
moved to an inferior price level.
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of Section 15A(b)(6),\5\

[[Page 27018]]

15A(b)(11),\6\ and Section 11A of the Act.\7\ Section 15A(b)(6) 
requires that the rules of a registered national securities association 
be 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 regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, to remove impediments to and 
perfect that mechanism of a free and open market and a national market 
system, and, in general, to protect investors and the public interest. 
These rules may not be designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers. Section 15A(b)(11) 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. Section 
11A(a)(1)(C) provides 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.
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    \5\ 15 U.S.C. 78o-3(b)(6).
    \6\ 15 U.S.C. 78o-3(b)(11).
    \7\ 15 U.S.C. 78k-1.
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    Nasdaq believes that the proposed rule promotes the objectives of 
Sections 15A(b)(6) and (11) and Section 11A of the Act by producing 
fair and informative quotations and the economically efficient 
execution of securities transactions. Nasdaq believes that the proposed 
rule will encourage market makers to display quotes at their true and 
intended size, thereby providing increased transparency, fewer 
transactions and resultant expenses, and a more fair and efficient 
marketplace, benefiting market participants and public customers.

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 data 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. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW, Washington, DC 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-99-20 and should 
be submitted by June 8, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-12458 Filed 5-17-99; 8:45 am]
BILLING CODE 8010-01-M