[Federal Register Volume 64, Number 202 (Wednesday, October 20, 1999)]
[Notices]
[Pages 56554-56560]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-27308]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42003; File No. SR-NASD-99-57]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change and Amendment No. 
1 by National Association of Securities Dealers, Inc. Relating to the 
Extension of Certain Nasdaq Services and Facilities Until 6:30 p.m. 
Eastern Time

October 13, 1999.
    Pursuant to Section 19(b)(1) of the Securities Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 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'') the proposed rule change as 
described in Items I and II below, which Items have been prepared by 
Nasdaq. On October 13, 1999, Nasdaq submitted Amendment No. 1 to the 
proposed rule change.\3\ The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons. 
For the reasons discussed below, the Commission is granting accelerated 
approval of the proposed rule change and Amendment No. 1 on a pilot 
basis through March 1, 2000.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Letter to Belinda Blaine, Associate Director, Division of 
Market Regulation (``Division''), Commission, from Thomas P. Moran, 
Assistant General Counsel, Nasdaq, dated October 12, 1999 
(``Amendment No. 1''). In Amendment No. 1, Nasdaq proposes to amend 
the initial filing to request that the Commission approve its 
proposed extended hours trading session on a pilot basis beginning 
on October 25, 1999, through March 1, 2000. Nasdaq also explains in 
Amendment No. 1 how certain concerns regarding calculation of a 4 
p.m. closing price will be addressed and how the Manning Rule will 
apply.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Pursuant to the provisions of Section 19(b)(1) under the Act,\4\ 
Nasdaq is filing a proposed rule change to establish a pilot program 
extending the availability of several Nasdaq services and facilities 
until 6:30 p.m. Eastern Time. In addition, Nasdaq is proposing to 
extend the applicability of NASD Interpretive Material 2110-2 (the 
``Manning Rule'') until 6:30 p.m. Eastern Time. Below is the text of 
the proposed rule change.

[[Page 56555]]

Proposed new language is italicized; proposed deletions are in 
brackets.
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    \4\ 15 U.S.C. 78s(b)(1).
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* * * * *

IM-2110-2. Trading Ahead of Customer Limit Order

(a) General Application \5\
    To continue to ensure investor protection and enhance market 
quality, the Association's Board of Governors is issuing an 
interpretation to the Rules of the Association dealing with member 
firms' treatment of their customer limit orders in Nasdaq securities. 
This interpretation, which is applicable from 9:30 a.m. to 6:30 p.m. 
Eastern Time, will require members acting as market makers to handle 
their customer limit orders with all due care so that market makers do 
not ``trade ahead'' of those limit orders. Thus, members acting as 
market makers that handle customer limit orders, whether received from 
their own customers or from another member, are prohibited from trading 
at prices equal or superior to that of the limit order without 
executing the limit order. [,provided that, prior to September 1, 1995, 
this prohibition shall not apply to customer limit orders that a member 
firm receives from another member firm and that are greater than 1,000 
shares.] Such orders shall be protected from executions at prices that 
are superior but not equal to that of the limit order. In the interests 
of investor protection, the Association is eliminating the so-called 
disclosure ``safe harbor'' previously established for members that 
fully disclosed to their customers the practice of trading ahead of a 
customer limit order by a market-making firm.1

    \5\ On September 9, 1999, the NASD filed a proposed rule 
change (SR-NASD-99-44), which became effective upon filing pursuant 
to Section 19(b)(3)(A) of the Act and Rule 19b-4(f)(1) thereunder, 
modifying IM-2110-2 (exclusion of limit orders marketable at the 
time of receipt). A non-substantive amendment was filed on September 
24, 1999. This filing incorporates the amendments filed in SR-NASD-
99-44.
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    1 ``For purposes of the pilot program expanding the 
operation of certain Nasdaq transaction and quotation reporting 
systems and facilities in SR-NASD-99-57 during the period from 4 
p.m. to 6:30 p.m. Eastern Time, members may generally limit the life 
of a customer limit order to the period of 9:30 a.m. to 4 p.m. 
Eastern Time. If a customer does not formally assent (``opt-in'') to 
processing of their limit order(s) during the extended hours period 
commencing after the normal close of the Nasdaq market, limit order 
protection will not apply to that customer's order(s).''
* * * * *
(b) Exclusion for Limit Orders That Are Marketable at Time of Receipt
    No Change.

4617. Normal Business Hours

    A Nasdaq market marker shall be open for business as of 9:30 a.m. 
Eastern Time and shall close no earlier than 4 p.m. Eastern Time. 
Should a market maker wish to voluntarily remain open for business 
later than 4 p.m. Eastern Time, it shall so notify the Nasdaq Market 
Operations via a Nasdaq terminal and shall close only on the hour or 
the half hour, but no later than 6:30 p.m. Eastern Time. Nasdaq market 
makers whose quotes are open after 4 p.m. Eastern Time shall be 
obligated to comply, while their quotes are open, with all NASD Rules 
that are not by their express terms, or by an official interpretation 
of the Association, inapplicable to any part of the 4 p.m. to 6:30 p.m. 
Eastern Time period.

4630. Reporting Transactions in Nasdaq National Market Securities

4632. Transaction Reporting

(a) When and How Transactions Are Reported
    (1)-(3) No Change.
    (4) Transaction Reporting Outside Normal Market Hours. (A) Last 
sale reports of transactions in designated securities executed between 
8 a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT 
within 90 seconds after execution and shall be designated as ``.T'' 
trades to denote their execution outside normal market hours. 
Additionally, last sale reports of transactions in designated 
securities executed between the hours of 4 p.m. and [5:15] 6:30 p.m. 
Eastern Time shall be transmitted through ACT within 90 seconds after 
execution; trades executed and reported after 4 p.m. Eastern Time shall 
be designated as ``.T'' trades to denote their execution outside normal 
market hours. Transactions not reported within 90 seconds must include 
the time of execution on the trade report.
    (B) Last sale reports of transactions in designated securities 
executed outside the hours of 8 a.m. and [5:15] 6:30 p.m. Eastern Time 
shall be reported as follows:
    (i) No Change.
    (ii) Last sale reports of transactions executed between [5:15] 6:30 
p.m. and midnight Eastern Time shall be transmitted through ACT on the 
next business day (T+1) between 8 a.m. and [5:15] 6:30 p.m. Eastern 
Time, be designated ``as/of'' trades to denote their execution on a 
prior day, and be accompanied by the time of execution. The party 
responsible for reporting on T+1, the trade details to be reported, and 
the applicable procedures shall be governed, respectively, by 
paragraphs (b), (c), and (d) below.
    (5)-(8) No Change.

4640. Reporting Transactions in Nasdaq Small Cap--Market Securities

4642. Transaction Reporting

(a) When and How Transactions Are Reported
    (1)-(3) No Change.
    (4)(A) Last sale reports of transactions in designated securities 
executed between 8 a.m. and 9:30 a.m. Eastern Time shall be transmitted 
through ACT within 90 seconds after execution and shall be designated 
as ``.T'' trades to denote their execution outside normal market hours. 
Additionally, last sale reports of transactions in designated 
securities executed between the hours of 4 p.m. and [5:15] 6:30 p.m. 
Eastern Time shall be transmitted through ACT within 90 seconds after 
execution; trades executed and reported after 4 p.m. Eastern Time shall 
be designated as ``.T'' trades to denote their execution outside normal 
market hours. Transactions not reported within 90 seconds must include 
the time of execution on the trade report.
    (B) Last sale reports of transactions executed outside the hours of 
8 a.m. and [5:15] 6:30 p.m. Eastern Time shall be reported as follows:
    (i) No Change.
    (ii) Last sale reports of transactions executed between [5:15] 6:30 
p.m. and midnight Eastern Time shall be transmitted through ACT on the 
next business day (T+1) between 8 a.m. and [5:15] 6:30 p.m. Eastern 
Time, be designated ``as/of'' trades to denote their execution on a 
prior day, and be accompanied by the time of execution. The party 
responsible for reporting on T+1, the trade details to be reported, and 
the applicable procedures shall be governed, respectively, by 
paragraphs (b), (c), and (d) below.
    (5)-(8) No Change.

4650. Reporting Transactions in Nasdaq Convertible Debt Securities

4652. Transaction Reporting

(a) When and How Transactions Are Reported
    (1)-(3) No Change.
    (4) Transactions Reporting Outside Normal Market Hours. (A) Last 
sale reports of transactions in designated securities executed between 
8 a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT 
within 90 seconds after execution and shall be designated as ``.T'' 
trades to denote their

[[Page 56556]]

execution outside normal market hours. Additionally, last sale reports 
of transactions in designated securities executed between the hours of 
4 p.m. and [5:15] 6:30 p.m. Eastern Time shall be transmitted through 
the ACT system within 90 seconds after execution; trades reported after 
4 p.m. Eastern Time shall be designated as ``.T'' trades to denote 
their execution outside normal market hours. Transactions not reported 
within 90 seconds must include the time of execution on the trade 
report.
    (B) Last sale reports of transactions in designated securities 
executed outside the hours of 8 a.m. and [5:15] 6:30 p.m. Eastern Time 
shall be reported as follows:
    (i) No Change.
    (ii) Last sale reports of transactions executed between [5:15] 6:30 
p.m. and midnight Eastern Time shall be transmitted through ACT on the 
next business day (T+1) between 8 a.m. and [5:15] 6:30 p.m. Eastern 
Time, be designated ``as/of'' trades to denote their execution on a 
prior day, and be accompanied by the time of execution. The party 
responsible for reporting on T+1, the trade details to be reported, and 
the applicable procedures shall be governed, respectively, by 
paragraphs (b), (c), and (d) below.
    (5)-(7) No Change.

6600. Reporting Transactions in Over-the-Counter Equity Securities

6620. Transaction Reporting

(a) When and How Transactions Are Reported
    (1)-(2) No Change.
    (3) Transaction Reporting Outside Normal Market Hours. (A) Last 
sale reports of transactions in OTC Equity Securities executed between 
8 a.m. and 9:30 a.m. Eastern Time shall be transmitted through ACT 
within 90 seconds after execution and shall be designated as ``.T'' 
trades to denote their execution outside normal market hours. Last sale 
reports of transactions in OTC Equity Securities executed between the 
hours of 4 p.m. and [5:15] 6:30 p.m. Eastern Time shall also be 
transmitted through ACT within 90 seconds after execution; trades 
executed and reported after 4 p.m. Eastern Time shall be designated as 
``.T'' to denote their execution outside normal market hours. 
Transactions not reported within 90 seconds must include the time of 
execution on the trade report.
    (B) Last sale reports of transactions ins OTC Equity Securities 
executed outside the hours of 8 a.m. and [5:15] 6:30 p.m. Eastern Time 
shall be reported as follows:
    (i) No Change.
    (ii) Last sale reports of transactions ins ADRs, Canadian issues, 
or domestic OTC Equity Securities that are executed between [5:15] 6:30 
p.m. and midnight Eastern Time shall be transmitted through ACT on the 
next business day (T+1) between 8 a.m. and [5:15] 6:30 p.m. Eastern 
Time, be designated ``as/of'' trades to denote their execution on a 
prior day, and be accompanied by the time of execution. The party 
responsible for reporting on T+1, the trade details to be reported, and 
the applicable procedures shall be governed, respectively, by 
paragraphs (b), (c), and (d) below; and
    (iii) No Change.
    (4)-(6) 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, 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 III 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

    Trading securities outside of normal market hours is not a new 
phenomenon. Nasdaq presently makes available several systems until 
until 5:15 p.m. Eastern Time to facilitate trading after the close of 
the Nasdaq market at 4 p.m. Eastern Time. Recently, however, several 
alternative trading systems have initiated their own after-hours 
trading sessions. As such, there are now several different market 
venues available for trading after 4:00 p.m. Eastern Time. Presently 
there is no facility available to aggregate the activity in these 
various markets, making it difficult for market participants to 
determine the best prices available. Furthermore, information regarding 
transactions executed on these different markets is currently not 
widely available to investors, depriving them and other market 
participants of full, verifiable information on which to base trading 
decisions.
    To remedy this situation, Nasdaq is proposing to establish a pilot 
program to extend, effective October 25, 1999 through March 1, 2000, 
the availability of its trade reporting and quotation dissemination 
facilities until 6:30 p.m. Eastern Time to encourage the collection and 
public dissemination of securities transactions taking place after the 
4 p.m. close of the Nasdaq market. these facilities are presently 
available until 5:15 p.m. Eastern Time. At the outset, Nasdaq wishes to 
stress that the above proposals are made in response to requests from 
other market participants that wish to expand their trading activity in 
the hours after the regular close of the Nasdaq market. It is Nasdaq's 
view that the importance of bringing increased transparency in the form 
of more visible quotes and transaction reports to the time period after 
the Nasdaq market's close imposes an obligation on Nasdaq to make 
available these systems and services as quickly as possible. Nasdaq 
remains committed to working with the Commission and other primary 
markets to carefully evaluate the complex issues surrounding any future 
expansion of regular market trading hours. Under the pilot proposal, 
Nasdaq will extend to 6:30 p.m. Eastern Time the operating hours of the 
following services: (1) SelectNet Service (``SelectNet''); (2) 
Automated Confirmation Transaction Service (``ACT''); (3) Nasdaq 
Quotation Dissemination Service (``NQDS''); and (4) Nasdaq Trade 
Dissemination Service (``NTDS''). The posting of quotations and trading 
of securities by NASD members during the period of time after Nasdaq's 
normal market close and before 6:30 p.m. Eastern Time shall be 
voluntary.
    Under the pilot, any Nasdaq market maker that chooses to post 
quotations and trade during the 4 p.m. to 6:30 p.m. Eastern Time period 
shall be obligated to post firm two-sided quotations when opening and 
making its market, but may enter or leave the market on the hour or 
half-hour up to 6:30 p.m. Eastern Time. NASD member firms that do not 
choose to open their market and instead send customer or proprietary 
orders to other market participants for display and/or execution (or 
that choose to hold those orders until the next day's regular trading 
session) will likewise not be obligated to post firm two-sided 
quotes.\6\ Regardless of an NASD member's quotation activity, all 
transactions in Nasdaq National Market, SmallCap, Convertible Debt and 
over-the-counter equity securities executed between the hours 8 a.m. 
and 6:30 p.m. Eastern Time

[[Page 56557]]

must be reported to ACT within 90 seconds.
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    \6\ Nasdaq market makers that do not elect to open their quotes 
would still be obligated to trade report transactions during the 4 
p.m. to 6:30 p.m. Eastern Time period consistent with current trade 
reporting rules applicable during regular market hours.
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    Along with the expanded operating times of the above systems and 
services, Nasdaq also wishes to make clear to members which NASD Rules 
will be in force during the extended SelectNet and ACT sessions. Except 
as modified by this filing, only those rules that are limited by their 
express terms, or by an official interpretation of the Association, to 
a specific time period outside of the 4 p.m. to 6:30 p.m. Eastern Time 
period shall not be in force during the extended SelectNet/ACT/NQDS/
NTDS sessions. Towards that end, Nasdaq is proposing to modify NASD 
rule 4617 (Normal Business Hours) to make clear to Nasdaq market makers 
who voluntarily open their markets after the close that, except as 
modified by this filing, they are obligated to conduct their business 
during the extended SelectNet/ACT/NQDS/NTDS sessions in conformity with 
all NASD Rules whose applicability is not limited to specific times 
outside the 4 p.m. to 6:30 p.m. Eastern Time period. In addition, 
Nasdaq's Board of Directors, at its meeting on October 6, 1999, 
approved a proposal to amend NASD IM-2110-2 (also known as the 
``Manning Rule'') to extend its applicability until 6:30 p.m. Eastern 
Time. The Manning Rule prohibits an NASD member firm which is holding a 
customer limit order from trading from that member's market making 
proprietary account at a price that would satisfy the customer's limit 
order without executing that customer limit order. This interpretation 
previously applied only during regular Nasdaq market hours.\7\
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    \7\ See NASD Notice to Members 95-67.
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    NASD's Short Sale Rule,\8\ however, will not initially be 
applicable beyond normal market hours. In NASD Notice to Members 94-68, 
the NASD limited the Short Sale Rule's applicability to normal market 
hours (9:30 a.m. to 4 p.m. Eastern Time). In addition, technological 
constraints currently prevent Nasdaq from calculating a best bid/offer 
during the period between 4 p.m. and 6:30 p.m. Eastern Time. As a 
result, Nasdaq cannot provide the last bid directional arrow that is 
relied on by market participants to remain in compliance with the rule. 
Nasdaq believes that it will be technologically possible to calculate 
and provide an inside quote for the extended SelectNet session by on or 
about December 6, 1999. During the interim, Nasdaq will evaluate after-
the-close trading activity to determine whether an extension of the 
Short Sale Rule to the 4 p.m. to 6:30 p.m. Eastern Time period is 
appropriate. Prior to the provision of an inside quote, NASD members 
will, however, continue to be required to make affirmative 
determinations that they will receive delivery of a security from their 
customers or that the member can borrow the security on behalf of the 
customer for delivery by settlement date before accepting short sale 
orders during the extended SelectNet and ACT sessions.\9\
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    \8\ NASD Rule 3350.
    \9\ See NASD Rule 3370.
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    Finally, given the importance of timely trade reporting for 
transparency purposes, Nasdaq's trade reporting rules for NMS, 
SmallCap, Convertible Debt, and over-the-counter equity securities 
(Rules 4632, 4642, 4652, 6620) will be modified to mandate 90 second 
ACT trade reporting for all transactions in these securities executed 
after Nasdaq's regular market close and before 6:30 p.m. Eastern Time. 
Nasdaq staff will continue to initiate trading halts \10\ and 
adjudicate clearly erroneous trade disputes in the extended SelectNet 
and ACT sessions using the same standards and methods as employed 
during normal market hours.\11\ Nasdaq's MarketWatch and NASD 
Regulation's Market Regulation Department will be staffed to provide 
oversight of trading and quotation activity up to 7 p.m. Eastern Time.
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    \10\ Nasdaq notes that this trading halt authority will be 
limited to individual stocks only and will be undertaken in 
consultation with other primary markets operating after 4 p.m. 
Eastern Time. Market-wide trading halt rules currently in effect 
rely solely on percentage-based declines in the Dow Jones Industrial 
Average (``DJIA''), a narrow index that does not contain any Nasdaq 
stocks and which will not be calculated after the 4 p.m. close. In 
the event that a circuit breaker halt, triggered during regular 
market hours, prevents a normal close of U.S. primary markets, 
Nasdaq proposes that no extended SelectNet or ACT sessions be 
commenced that day.
    \11\ Nasdaq has also been informed by the staff of NASD 
Regulation, Inc. of its view that nothing in the instant proposals 
modifies or limits an NASD member's obligation to comply with the 
rules of NASD Regulation's Order Audit Trail System (``OATS'') when 
reporting trading activity taking place between 4 p.m. and 6:30 p.m. 
Eastern Time. Nasdaq's MarketWatch and NASD Regulation's Market 
Regulation Department will be staffed to provide oversight of 
trading and quotation activity up to 7 p.m. Eastern Time.
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    Amendment No. 1. Among other things, Nasdaq's Amendment No. 1 
addresses issues concerning the dissemination of regular session 
closing price reports under the pilot program. Specifically, the 
Amendment confirms that systems operations until 6:30 p.m. Eastern Time 
will not interfere with the ability of investors to obtain 4 p.m. 
closing prices in Nasdaq securities. Closing prices are currently 
disseminated by vendors shortly after the 4 p.m. close even though the 
Nasdaq systems operate until 5:15 p.m. Eastern Time; systems operations 
until 6:30 p.m. Eastern Time will not change this practice. Trades 
effected after 4 p.m. Eastern Time will continue to be designated as 
``.T'' trades that do not affect closing price in the relevant 
security.
    Amendment No. 1 also describes how Nasdaq will address issues 
involving the use of closing prices for NAV calculations by mutual 
funds. In particular, under the Nasdaq proposal, certain specialized 
closing price reports for non-OTC Bulletin Board and foreign ordinary 
issues, as well as some American Depository Receipts (``ADRs''), will 
not be issued by Nasdaq in time to permit funds to report their NAVs to 
Nasdaq's Mutual Fund Quotation Service (``MFQS'') by that system's 5:50 
p.m. Eastern Time deadline. Accordingly, Nasdaq has indicated that it 
will post an electronic file with this closing price information on the 
OTC Bulletin Board web site between 5:20 p.m. and 5:40 p.m. Eastern 
Time (with an internal goal of posting by 5:30 p.m. Eastern Time).
    In addition, some funds and vendors have raised general concerns 
about what they perceived to be lack of time to modify and test their 
systems before the planned introduction of inside quotations up to 6:30 
p.m. Eastern Time. Amendment No. 1 indicates that, in response to these 
concerns, Nasdaq has pushed back the planned start-up date for 
distributing after-hours inside quotations from November 1 to December 
6, 1999. While Nasdaq acknowledges that this later start-up date will 
not satisfy every concern raised by vendors and funds, Nasdaq believes 
that the delay until December 6 should provide sufficient time for 
essential systems modifications and testing. Nasdaq states that it will 
continue to work with vendors and the mutual fund industry on these 
issues.
    Amendment No. 1 also clarifies how the Manning Rule will apply 
during the extended hours of the pilot from 4 p.m. to 6:30 p.m. Eastern 
Time. Nasdaq confirms in Amendment No. 1 that, on October 6, 1999, the 
Board of Directors of Nasdaq approved the expansion of the 
applicability of the Manning Rule to 6:30 p.m. Eastern Time. Nasdaq 
also clarifies the application of the Manning Rule after 4 p.m. Eastern 
Time by adding a footnote to IM-2100-2(a) discussing the handling of 
customer limit orders if the customer does not formally opt-in to 
processing limit orders during the extended hours period.
    Based on the above, Nasdaq believes that the proposed rule changes 
are consistent with the provisions of Section 15A(b)(b) of the Act in 
that they are designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of

[[Page 56558]]

trade, and to foster cooperation and coordination with persons engaged 
in regulating, clearing, settling, and processing information with 
respect to, and facilitating transactions in securities.

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. SRO's Statement on Comments on the Proposed Rule Change Received 
From Members, Participants, or Others

    Although written comments were not solicited, Nasdaq has received 
four letters from market participants expressing concerns relating to 
the proposed rule change.\12\ Nasdaq has addressed these comment 
letters in Amendment No. 1.
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    \12\ Letter to Richard G. Ketchum, President, NASD, from Craig 
S. Tyle, General Counsel, Investment Company Institute, dated 
September 24, 1999; Letter to Richard G. Ketchum, President, NASD, 
and Patrick J. Campbell, Chief Operating Officer and Executive Vice 
President, The Nasdaq-Amex Market Group, Inc., from Jenni Neumann, 
Senior Vice President, Global Database Management, Bridge 
Information Systems, dated September 27, 1999; Letter to Richard G. 
Ketchum, President, NASD, from David Byrnes, Senior Vice President, 
Americas Information Management Group, Reuters Information, dated 
September 28, 1999; and Letter to Richard G. Ketchum, President, 
NASD, from Thomas J. Higgins, Principal and Treasurer of the 
Vanguard Funds, The Vanguard Group, dated September 29, 1999.
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III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing including whether the proposed rule 
change, as amended, 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-99-57 and should be submitted by November 10, 1999.

IV. Commission's Findings and Order Granting Accelerated Approval 
of the Proposed Rule Change

    For the reasons discussion below, the Commission finds that the 
proposed rule change, as amended, is consistent with the requirements 
of the Act and the rules and regulations thereunder applicable to the 
NASD and, in particular, the requirements of Sections 11A and 15A.\13\
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    \13\ In approving this rule, 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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    Specifically, the Commission believes that the proposed rule change 
as amended furthers the goals of the national market system as 
reflected in Sections 11A(a)(1)(C)(iii) and (iv) of the Act.\14\ 
Congress found in those provisions that it is in the public interest 
and appropriate for the protection of investors and the maintenance of 
fair and orderly markets to assure the availability to brokers, 
dealers, and investors of information with respect to quotations for 
and transactions in securities, and to assure the practicability of 
brokers executing investors' orders in the best market. Section 
11A(a)(1) further found that the linking of all markets for qualified 
securities through communication and data processing facilities would 
foster efficiency, enhance competition, increase the information 
available to brokers, dealers, and investors, facilitate the offsetting 
of investors' orders, and contribute to best execution of such 
orders.\15\ The proposed rule change as amended will assure the 
availability of information with respect to quotations and transactions 
because it makes Nasdaq's systems, which are used by market 
participants to communicate quotes and orders and to report trades, 
available until 6:30 p.m. Eastern Time. Currently, there is not 
consolidated source of information on trades and quotations after 5:15 
p.m. Eastern Time, making it difficult for investors to determine the 
best prices available. Nasdaq's proposal will enhance transparency by 
requiring that transactions in NMS, SmallCap, Convertible Debt, and 
over-the-counter equity securities that take place up to 6:30 p.m. 
Eastern Time be reported within 90 seconds. In addition, to the extent 
that a market maker chooses to participate in the after-hours session, 
its quotations will be disseminated through NQDS. As a result, 
investors will be better able to evaluate prices before entering their 
order after primary trading hours. In sum, by providing the 
consolidated quotation display and last sale tape for transactions 
taking place between 4 p.m. and 6:30 p.m. Eastern Time, Nasdaq's 
proposal should enhance investor protection and confidence because it 
will give market participants more complete information upon which to 
base trading decisions.
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    \14\15 U.S.C. 78k-1(a)(1)(C) (iii) and (iv).
    \15\ 15 U.S.C. 78k-1(a).
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    The Commission also believes that the proposed rule change is 
consistent with Section 15A of the Act \16\ in that it is 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 the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest. The proposed rule change 
accomplishes these objectives by making Nasdaq's systems available to 
market participants who choose to offer trading to customers outside of 
traditional market hours, by providing for greater transparency, and by 
linking the various market participants engaged in trading during those 
hours through SelectNet.
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    \16\ 15 U.S.C. 78o-3.
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    Amendment No. 1 also confirms that the extended trading pilot will 
not interfere with the ability of investors to obtain 4 p.m. closing 
prices in Nasdaq securities. Moreover, Nasdaq has outlined measures 
that it has taken to address specific concerns of vendors and the 
mutual fund industry concerning the availability of closing prices for 
NAV calculations and the need for sufficient time to modify and test 
their systems before the planned introduction of inside quotations 
after 4 p.m. Eastern Time. While Nasdaq acknowledges that these 
measures will not satisfy every concern raised by vendors and funds, 
the delay until December 6th for the dissemination of after-hours 
inside quotations should provide sufficient time for essential systems 
modifications and testing. Nasdaq has indicated that it will continue 
to work with vendors and the mutual fund industry on these issues. In 
light of the need for improved transparency during the after-hours 
session, and Nasdaq's willingness to continue to work with vendors and 
mutual funds to ensure an orderly extension of price reporting, the 
Commission believes that Nasdaq's

[[Page 56559]]

determination to proceed with its pilot on schedule is reasonable.
    In addition, the proposed rule change as amended furthers the 
objectives of Section 15A of the Act by specifically extending rules 
designed to protect investors beyond the traditional market hours while 
Nasdaq's systems are operating. For example, the Manning Rule 
previously did not apply after 4 p.m. Eastern Time. Originally, the 
NASD believed Manning obligations should not apply after 4 p.m. Eastern 
Time because the after-hours market was fundamentally different from 
the regular market.\17\ With the advent of on-line retail trading and 
other technological advances, however, the nature of the after-hours 
market is changing. In particular, the increasing presence of retail 
customers during the after-hours market has led the NASD to reconsider 
the application of the Manning Rule between 4 p.m. and 6:30 p.m. 
Eastern Time. Accordingly, upon approval of the pilot, members acting 
as market makers during these hours will be required to handle their 
customer limit orders with due care so that they do not trade ahead of 
those limit orders. Members acting as market makers that handle 
customer limit orders, whether received from their own customers or 
from another member, will be prohibited from trading at prices equal or 
superior to that of the limit order without executing the limit order. 
The Commission believes that the application of the protections of the 
Manning and other NASD rules during after-hours trading will 
significantly enhance investor protection.\18\
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    \17\ See, e.g., NASD Notice to Members 95-67.
    \18\ The Commission believes that the clarification of the 
application of the Manning Rule in Amendment No. 1 provides further 
enhancement of investor protection. In addition, the Nasdaq staff 
has indicated that a rule proposal is being developed for 
consideration by the appropriate Boards that would require that 
member firms establish procedures to have customers ``opt-in'' to 
having their order(s) processed during any period outside of the 
9:30 a.m. to 4 p.m. regular trading session for Nasdaq.
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Commission Rules

    The Commission has received inquiries from market participants 
seeking clarification regarding which Commission rules apply to NASD 
members who choose to trade after 4 p.m. Eastern Time while Nasdaq's 
systems are in operation. The Commission wishes to clarify that, by 
their terms, SEC Rules 11Ac1-1(c)(2) (the ``Firm Quote Rule''), 11Ac1-
1(c)(5) (the ``ECN Display Alternative''), 11Ac1-4 (the ``Limit Order 
Display Rule'') and Rule 301(b) (``Regulation ATS'') apply to NASD 
member firms that choose to trade between 4 p.m. and 6:30 p.m. Eastern 
Time.\19\
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    \19\ 17 CFR 240.11Ac1-1(c)(2), 17 CFR 240.11Ac1-1(c)(5), 17 CFR 
240.11Ac1-4, 17 CFR 242.301(b). For a complete discussion of these 
rules and the definitions of the terms used in the following 
discussion, see the applicable Commission releases.
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    In general, SEC Rule 11Ac1-1(b)(1)(ii) requires an association to 
disseminate the best bid, offer, and quotation sizes for subject 
securities whenever ``last sale information with respect to reported 
securities is reported [by a member acting in the capacity of an OTC 
market maker] pursuant to an effective transaction reporting plan.'' 
\20\ NASD members, including OTC market makers, who choose to trade 
from 4 p.m. to 6:30 p.m. Eastern Time will be required to report last 
sale information pursuant to the NASD's rules, and the NASD will 
disseminate quotes during this time period. These procedures, in turn, 
trigger the Commission's Firm Quote Rule, which generally obligates OTC 
market makers to execute any order to buy or sell a subject security, 
other than an odd-lot order, presented to it by another broker or 
dealer, or any other person belonging to a category of persons with 
whom such responsible broker or dealer customarily deals, at a price at 
least as favorable to such buyer or seller as the responsible broker's 
or dealer's published bid or published offer.
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    \20\ 17 CFR 240.11Ac1-1(b)(1)(ii).
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    Similarly, the reporting of last sale information to the NASD 
triggers the ECN Display Alternative. Under the ECN Display 
Alternative, an order entered by a market maker into an electronic 
communications network (``ECN'') that widely disseminates the order is 
deemed to be a bid or offer to be communicated to the market maker's 
association for at least the minimum quotation size required by the 
Association's rules if the priced order is for the account of the 
market maker, or the actual size of the order up to the minimum 
quotation size required if the priced order is for the account of a 
customer. The ECN Display Alternative deems the market maker to be in 
compliance with this requirement if the ECN displays the market maker's 
order in Nasdaq.\21\
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    \21\ Therefore, if an ECN is receiving OTC market maker orders 
before 6:30 p.m. Eastern Time, the ECN must transmit those orders 
through SelectNet for display in the Nasdaq montage, or the OTC 
market maker must post the quote separately in its own quote line in 
the montage in order to be in compliance with the ECN Display 
Alternative.
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    In addition, the Limit Order Display Rule is not limited to regular 
trading hours, but also applies to OTC market makers that choose to 
participate in after-hours trading sessions. Simply put, the Limit 
Order Display Rule requires an OTC market maker to publish immediately 
a bid or offer that reflects the price and full size of each customer 
limit order that improves the bid or offer of the OTC market marker, or 
that reflects the full size of the customer limit order that is priced 
equal to the bid or offer of the OTC market maker or the national best 
bid or offer, and represents more than a de minimis change in the size 
of the OTC market maker's bid or offer.\22\
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    \22\ There are certain exceptions to the Limit Order Display 
Rule. Those exceptions would continue to apply during an after-hours 
trading session. See SEC Rule 11Ac1-4(c), 17 CFR 240.11Ac1-4(c).
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    Regulation ATS also applies to market participants who choose to 
operate from 4 p.m. to 6:30 p.m. Eastern Time. Currently, any 
alternative trading system that has five percent or more of the average 
daily trading volume in a security must display its best orders in that 
security in the public quotation stream during regular trading hours. 
Although there may be some confusion as to whether average ``daily'' 
trading volume includes trades executed outside of normal market hours, 
the calculation alternative trading systems must make regarding volume 
includes all trades executed during the twenty-four hours that 
constitute a day. Any alternative trading system that meets the five 
percent threshold must therefore display its orders in the public 
quotation stream whenever the public quotation systems make display 
possible.
    The Commission is aware that there has been confusion among market 
participants as to the applicability of these rules after 4 p.m. 
Eastern Time. Consequently, the Commission has issued a no-action 
letter to the NASD relieving market participants from complying with 
Rules 11Ac1-1(c)(5) (the ECN Display Alternative), 11ac1-4 (the Limit 
Order Display Rule), Rule 301(b) (Regulation ATS), and the NASD's 
Manning Rule until November 2, 1999.\23\ This temporary relief is 
designed to give market participants (including ECNs) time to make the 
system changes necessary to comply with these rules during the 4 p.m. 
to 6:30 p.m. Eastern Time period.\24\ The Commission emphasizes, 
however, that broker-dealers continue to have a duty of best execution 
for their customer's orders during these hours.
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    \23\ Under the terms of this no-action letter, firms are not 
relieved from their obligation to comply with the Firm Quote Rule 
(Rule 11Ac1-1(c)(5), 17 CFR 240.11Ac1-1(c)(5)).
    \24\ See Letter to Robert E. Aber, General Counsel, Nasdaq, from 
Robert L.D. Colby, Deputy Director, Division, Commission, dated 
October 12, 1999.

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[[Page 56560]]

    Nasdaq has requested that the Commission find good cause pursuant 
to Section 19(b)(2) of the Act \25\ for approving the proposed rule 
change prior to the 30th day after publication in the Federal Register. 
The Commission finds good cause for granting accelerated approval for 
the proposed rule change because the Nasdaq pilot will benefit 
investors by improving the transparency of the current after-hours 
market and assisting broker-dealers in fulfilling their duty of best 
execution for their customer orders.
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    \25\ 15 U.S.C. 78s(b)(2).
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    The Commission further believes that good cause exists 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. The first item covered in Amendment No. 1 merely 
changes the date for implementation of the after-hours trading session 
as a pilot program from October 11, 1999 to October 25, 1999. The 
Commission believes that delaying the implementation date will provide 
Nasdaq and its member firms with additional time to make any necessary 
systems changes. The second and third items of Amendment No. 1 address 
how the Manning Rule will apply during the extended hours of the pilot 
from 4 p.m. to 6:30 p.m. Eastern Time. In the second item, Nasdaq 
confirmed that, on October 6, 1999, the Board of Directors of Nasdaq 
approved the expansion of the applicability of the Manning Rule to 6:30 
p.m. Eastern Time. In the third item, Nasdaq clarified the application 
of the Manning Rule after 4 p.m. Eastern Time by adding a footnote to 
IM-2110-2(a) discussing the handling of customer limit orders if the 
customer does not formally opt-in to processing limit orders during the 
extended-hours period. The Commission believes that the Manning Rule's 
customer limit order protections should be provided to customers who 
opt-in to having their orders processed in the extended-hours period, 
and that, therefore, there is good cause for accelerating the approval 
of these items in Amendment No. 1. The Commission notes that the 
remaining items discussed in Amendment No. 1 clarify how Nasdaq will 
continue to make certain trade information available to the mutual fund 
industry. These clarifications further ensure that the pilot program 
will provide protection to investors who participate in the market 
through mutual funds. Accordingly, the Commission believes that there 
is good cause for accelerating the approval of all of the items in 
Amendment No. 1.
    While extended operation of some key Nasdaq trade reporting and 
quotation dissemination systems will significantly improve the current 
trading environment after the major markets close, the Commission 
recognizes that Nasdaq's pilot program does not yet include some 
features that would be essential for a full after-hours trading 
session. Specifically, Nasdaq's pilot does not require registered 
market makers in Nasdaq securities to participate in after-hours 
trading from 4 p.m. to 6:30 p.m. Eastern time and does not envision the 
use of the Small Order Execution System (``SOES'') during this period. 
In Nasdaq's view, its market will not be open during the hours of the 
pilot. The Commission believes that, before Nasdaq opens its market for 
extended trading, it would need to incorporate additional market 
integrity and investor protection features.\26\
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    \26\ See, e.g., n. 18, supra.
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    In addition, the Commission has expedited approval of this proposal 
with the understanding that the systems limitations that currently 
prevent the calculation of the best bid and offer for Nasdaq stocks 
after 4 p.m. Eastern Time will be addressed expeditiously. Such 
calculations will be necessary for the Nasdaq's Short Sale Rule to 
apply to trading during the 4:30 p.m. to 6:30 p.m. Eastern Time period. 
The Commission expects that Nasdaq will make every reasonable effort to 
work with the vendors and the mutual fund community to implement the 
systems enhancements needed for calculating the inside quote as soon as 
possible.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-NASD-99-57), including 
Amendment No. 1, is approved as a pilot program through March 1, 2000.

    \27\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-27308 Filed 10-19-99; 8:45 am]
BILLING CODE 8010-01-M