[Federal Register Volume 64, Number 124 (Tuesday, June 29, 1999)]
[Notices]
[Pages 34835-34836]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-16446]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41543; File No. SR-NASD-99-20]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the National Association of Securities Dealers, Inc. Relating
To Firm Quotation Requirements
June 22, 1999.
I. Introduction and Background
On April 20, 1999, the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association''), through its wholly owned
subsidiary, the Nasdaq Stock Market, Inc. (``Nasdaq''), filed with the
Securities and Exchange Commission (``Commission'' or ``SEC'') a
proposed rule change pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder.\2\ The
proposed rule change would 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 would prohibit the use of automatic quote updating in such
circumstances.
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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 was published for comment in the
Federal Register on May 18, 1999.\3\ The Commission received four
comment letters regarding the proposal.\4\ This order approves the
proposed rule change.
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\3\ See Securities Exchange Act Release No. 41390 (May 12, 1999)
64 FR 27016.
\4\ See Letter from Richard Y. Roberts, Esquire, Thelen Reid &
Priest LLP, on behalf of the Electronic Traders Association
(``ETA'') to Jonathan Katz, Secretary, SEC, dated June 8, 1999
(``ETA Letter''); Letter from Gerald S. Putnam, Chief Executive
Officer, Archipelago, LLC to Jonathan G. Katz, Secretary, SEC dated
June 8, 1999 (``Archipelago Letter''), Letter from Mike Cormack,
Manager, Equity Trading, American Century Investment Management
(``ACIM'') to Jonathan Katz Secretary, SEC, dated June 3, 1999
(``ACIM Letter''); Letter from Matthew W. Johnson, Managing
Director, Lehman Brothers, to Jonathan G. Katz, Secretary, SEC,
dated June 9, 1999 (``Lehman Letter'').
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II. Description of the Proposal
Nasdaq proposes 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.
According to Nasdaq, the proposal is designed to correct the
inefficiencies that arise when a market participant must use multiple
small orders to accomplish the objectives of a single large order. In
this regard, Nasdaq notes that a market participant may be required to
enter multiple small orders when 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 $10 for 100 shares of ABCD.
Order Entry Firm # (``OE1'') sends a preferenced SelectNet order to MM1
to sell 1000 shares of ABCD at $10, MM1 partially executes OE1's 1000-
share order by buying 100 shares of ABCD, and does not move its
quotation. Assuming MM1 is alone at the inside (i.e. at the best bid),
OE1 may be compelled to send multiple SelectNet messages to MM1,
potentially resulting in a total of ten transactions to complete its
1000-share order.
Nasdaq maintain that although MM1 has complied with NASD Rule 3320,
``Offers at Stated Prices,'' IM-3320, ``Firmness of Quotations,'
current NASD Rule 4613(b), and Exchange Act Rule 11Ac1-1 \5\ executing
a presented order up to its published quotation price and size, it is
apparent that MMI was willing to buy more than the 100 shares
displayed. Nasdaq believes that MM1's actions result in increased
transaction costs, impede the price discovery process, and preclude
other market makers from positiving executing large orders.
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\5\ 17 CFR 240.11Ac1-1 (requiring a broker-dealer to execute
orders at prices at least as favorable as its published quotation in
an amount up to its published quotation size).
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In addition, Nasdaq believes that MM1's actions may hinder price
continuity and lead to increased instances of locked and crossed
markets. For example, if MM1 is bidding 100 shares at $20, and MM2
wishes to lower its offer from $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. After sending multiple SelectNet messages to take out MM1,
MM2 may move its quote to $20, thereby locking the market.\6\
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\6\ The Commission notes that market makers are required to use
reasonable means to avoid locking and crossing the market. See
Securities Exchange Act Release No. 40455 (September 22, 1998), 63
FR 51987 (September 29, 1998) (order approving File No. SR-NASD-98-
01).
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Nasdaq states that the proposal is designed to effectuate the
display of a market maker's true and intended quotation size. Nasdaq
believes that when a market maker receives an order larger than the
market maker's displayed size and completes the order only at its
displayed size, the market maker has indicated clearly that its
interest in trading at that price level has been depleted. Accordingly,
the proposal will require a maket maker that has partially filled an
incoming order that is greater than the market maker's displayed size
to adjust its quote to an inferior price level.
Nasdaq 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 generate automatically 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 update automatically its quote only
after fully executed the incoming order. If the order is not executed
in full, the autoquote functionality must be discontinued and the
market maker must revise its quote to an inferior price level.
III. Summary of Comments
The Commission received four comment letters regarding the
proposal.\7\ All four commenters generally supported the proposed rule
change. One commenter argued, for example, that the proposal will
increase
[[Page 34836]]
efficiency by providing a mechanism that will assist the marketplace in
expeditiously assesing the size of trading interest by market
participants.\8\ Another commenter maintained that the proposal will
reduce the long-standing problem associated with market makers who
inhibit price discovery and market liquidity of remaining at the inside
bid or offer for extended periods of time. The commenter also stated
that the proposal will reduce transction costs, allow for more orderly
executions of trades, and increase transparency in the marketplace.\9\
A third commenter believed that the proposed represents a sound
solution to a inefficient market situation, but urged the Commission
and the NASD to review the continuing need for the autoquote policy
contained in IM-4613.\10\
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\7\ See Supra Note 4.
\8\ See Archipelago Letter Supra note 4.
\9\ See Lehman Letter, supra note 4.
\10\ See ETA Letter, supra note 4.
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The Commission finds that the proposed rule change is consistent
with the Act and the rules and regulations applicable to the NASD. In
particular, the Commission finds that the proposal is consistent with
the requirements of Sections 15A(b)(6), 15A(b)(11), and Section
11A(a)(1)(C) of the Act.\11\ 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 impedments 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)(11) requires
that the rules of a registered national securities association be
designed to produce fair and informative quotations, prevent fictious
or misleading quotations, and to promote orderly procedures for
collecting, distributing, and publishing quotations. In Section
11A(a)(1)(C), 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 of securities transactions; (2) fair competition among
brokers and dealers; (3) the availability of 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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\11\ 15 U.S.C. 78o-3(b)(6), 15 U.S.C. 78o-3(b)(11), and 15
U.S.C. 78k-1.
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Specifically, the Commission finds that the proposal to amend NASD
Rule 4613 by requiring that a market revise its quotation 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 quote size is
consistent with Sections 15A(b)(6), 15A(b)(11), and 11A(a)(1)(C) of the
Act because it will encourage market makers to display quotations that
accurately reflect their trading interest, thereby producing more
informative quotation information and increasing market transparency.
Increased transparency, in turn, will enhance the integrity of the
market and facilitate price discovery by helping market participants
asesss the supply and demand for securities.
In addition, the Commission finds that the proposal may help to
reduce instances of locked and crossed markets which may occur,
according to Nasdaq, when a market maker is unable to exhaust the bid
or offer of another market maker after sending the market maker
multiple SelectNet messages.\12\ The Commission believes that continued
locking and crossing of the market can negatively impact market
quality.\13\ By reducing the frequency of locked and crossed markets,
the Commission believes that the proposal should improve market quality
and help to maintain a fair and orderly market, to the benefit of all
market participants.
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\12\ As noted above, market makers are required to use
reasonable means to avoid locking and crossing the market. See
Securities Exchange Act Release No. 40455, supra note 6.
\13\ Id.
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The Commission also finds that the proposal could help to reduce
the transaction costs that arise currently when a market participant
must execute multiple small orders rather than a single large order
because a market maker does not trade to the full extent of its
interest at its displayed price in a single transaction. By reducing
transaction costs, the proposal should help to provide for the
economically efficient execution of securities transactions, consistent
with Section 11A(a)(1)(C) of the Act.
The Commission finds that the amendment to IM-4613 is appropriate
and consistent with the Act because it will help to effectuate
compliance with NASD Rule 4613, as amended. Specifically, IM-4613, as
amended, will allow a market maker to update automatically its quote
only after executing an incoming order in full. If the market maker
fails to execute fully the incoming order, the market maker must
discontinue the autoquote functionality and revise its quotation to
disseminate an inferior price. Accordingly, IM-4613, as amended, will
help to ensure that a market maker does not automatically update its
quote to remain at the inside after it has failed to execute fully an
incoming order that is greater than the market maker's published quote
size.
V. Conclusion
The Commission finds that the proposed rule change is consistent
with the Act, in general, and in particular, with Sections 15A(b)(6),
15A(b)(11), and Section 11A of the Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\14\ that the proposed rule change (SR-NASD 99-20) be, and hereby
is, approved.\15\
\14\ 15 U.S.C. 78s(b)(2).
\15\ In approving the proposal, the Commission has considered
the rule's impact on efficiency, competition, and capital formation.
15 U.S.C. 78c(f).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\16\
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\16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-16446 Filed 6-28-99; 8:45 am]
BILLING CODE 8010-01-M