[Federal Register Volume 64, Number 233 (Monday, December 6, 1999)]
[Notices]
[Pages 68125-68136]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-31527]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42166; File No. SR-NASD-99-53]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. and 
Amendment Nos. 1 and 2 Thereto Relating to the Establishment of the 
Nasdaq Order Display Facility and Modifications of the Nasdaq Trading 
Platform

November 22, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'' or ``Exchange Act''),\1\ and Rule 19b-4

[[Page 68126]]

thereunder,\2\ notice is hereby given that on October 1, 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 (``SEC'' or ``Commission'') the proposed rule change as 
described in Items, I, II, and III below, which Items have been 
prepared by Nasdaq. On October 26, 1999, Nasdaq filed Amendment No. 1 
to the proposal.\3\ On October 29, 1999, Nasdaq filed Amendment No. 2 
to the proposal.\4\ 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.
    \3\ See letter from Thomas P. Moran, Assistant General Counsel, 
NASD Regulation, to Richard Strasser, Assistant Director, Division 
of Market Regulation (``Division''), Commission (October 26, 1999) 
(``Amendment No. 1''). In Amendment No. 1, the NASD makes technical 
and clarifying amendments to the proposed which are incorporated in 
this notice. Additionally, the NASD amended the proposed rule 
language to clarify that certain provisions of the proposal are 
contingent upon other proposals that are pending before the 
Commission.
    \4\ See letter from John F. Malitzis, Assistant General Council, 
NASD Regulation, to Richard Strasser, Assistant Director, Division, 
Commission (October 29, 1999) (``Amendment No. 2''). Amendment No. 2 
clarifies that the Nasdaq staff has consulted the NASD Regulation 
staff with respect to the proposal rule change pursuant to the Plan 
of Allocation and Delegation of Functions by NASD to Subsidiaries.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Nasdaq proposes to enhance its quotation montage by creating a new 
venue for the display of trading interest, called the Nasdaq Order 
Display Facility. Additionally, this proposed rule change would 
substantially modify the proposed Nasdaq National Market System 
(``NNMS'').\5\
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    \5\ See Exchange Act Release No. 41296 (April 15, 1999), 64 FR 
19844 (April 22, 1999) (Notice for File No. SR-NASD-99-11 proposing 
to functionally integrate the Small Order Execution System 
(``SOES'') and SelectNet to become the foundation of the NNMS.) 
(hereafter ``SR-NASD-99-11'' or ``SOES/SelectNet Integration'').
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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 my 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
    Nasdaq proposes to enhance its quotation montage and current 
trading platforms, SelectNet and SOES. This proposed rule change is 
contingent, and would expand upon Nasdaq's proposals to (1) establish 
agency quotations;\6\ and (2) functionally integrate SOES and SelectNet 
that are currently pending before the Commission.\7\ In particular, 
Nasdaq proposes the following changes.
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    \6\ See Exchange Act Release No. 41128 (March 2, 1999), 64 FR 
12198 (March 11, 1999) (Notice for SR-NASD-99-09 proposing to permit 
market makers to have a second market maker ID (``MMID'') for the 
purpose of separately displaying agency and proprietary quotes.) 
(Hereafter ``SR-NASD-99-09'' or ``Agency Quote Proposal'').
    \7\ See note 5, above.
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A. New Nasdaq Order Display Facility

    Under the proposal, Nasdaq will add a new display to the Nasdaq 
Workstation II (``NWII'') called the Nasdaq Order Display Facility, 
which would show the best bid/best offer in Nasdaq and two price levels 
away, accompanied by the aggregate size at each price level of the 
``displayed'' trading interest of market makers, electronic 
communication networks (``ECN''), and Unlisted Trading Privilege 
(``UTP'') Exchanges.\8\ As explained in greater detail below, Nasdaq 
market makers and ECN's that are NASD members (``Nasdaq Quoting Market 
Participants'') will be able to display their quotes/orders anonymously 
at these price levels in the Nasdaq Order Display Facility, which 
should encourage the display of greater trading interest.
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    \8\ A ``UTP Exchange'' is an exchange that is a signatory to the 
Joint Self-Regulatory Organization Plan Governing the Collection, 
Consolidation and Dissemination Of Quotation and Transaction 
Information For Exchange-Listed Nasdaq/National Market System 
Securities Traded On Exchanges On An Unlisted Trading Privilege 
Basis (``UTP Plan'' or ``Nasdaq UTP Plan''). As of September 1, 
1999, there were four members of the Nasdaq UTP Plan. In addition to 
the NASD, the UTP Plan participants included the Boston Stock 
Exchange, the Chicago Stock Exchange (``CHX''), and the Philadelphia 
Stock Exchange. Of these, only the CHX has established an interface 
with the NASD/Nasdaq. The Cincinnati Stock Exchange is currently in 
the process of becoming a member of the UTP Plan and the Pacific 
Exchange has indicated its intent to commence this process.
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B. Enhanced Electronic Access to the Best Price in Nasdaq

    Under the proposal, market participants would be able to 
electronically access the best prices in the Nasdaq Order Display 
Facility using a substantially modified and enhanced version of 
Nasdaq's proposed NNMS trading platform. Specifically, Nasdaq would 
provide order delivery or automatic execution against the best prices 
displayed in the Nasdaq Order Display Facility based on the manner in 
which the market participant receiving the order participates in 
Nasdaq. Nasdaq would continue to offer market participants the ability 
to electronically negotiate transactions with specific market makers.

C. Delivery of Multiple Quotes/Orders to Nasdaq

    Under the proposal, Nasdaq would allow (but not require) Nasdaq 
Quoting Market Participants to give the Nasdaq system multiple quotes/
orders at single as well as multiple price levels. These markets 
participants may submit multiple agency and principal quotes/orders at 
multiple price levels, instead of a single quote at one price level. 
The proposed system will be able to accommodate the Agency Quote 
concept proposed in SR-NASD-99-09.\9\ Nasdaq would display such trading 
interest on the NWII consistent with the parameters (price, anonymity/
attribution) of the quotes/orders and the current market. Although 
Nasdaq would accept multiple quotes/orders at various price levels 
which may be displayed on a non-attributed basis in the Nasdaq Order 
Display Facility if within the top three price levels in Nasdaq, the 
Nasdaq Quotation Montage would display one MMID per ECN and market 
maker.\10\ This functionality should allow Nasdaq to assist market 
participants with the management of their back book. Nasdaq believes 
that this functionality should, in turn, make it easier for ECNs to 
participate in automatic execution, and will assist Nasdaq Quoting 
Market Participants in complying with the SEC's Order Handling Rules 
(``Order Handling Rules'' or ``OHR''). Nasdaq also believes that this 
functionality will reduce the potential for the market to trade through 
orders that a market maker or ECN is holding in its back book.
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    \9\ See note 6, above.
    \10\ If SR-NASD-99-09 is approved, however, a market maker would 
also be able to display one Agency Quote MMID in the Nasdaq 
Quotation Montage. UTP Exchanges would continue to transmit to, and 
display in, Nasdaq a single, two-sided quotation.
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D. Order Collector Facility

    Under the proposal, Nasdaq will create an Order Collector Facility 
(``OCF''), which would serve as a single

[[Page 68127]]

point of order entry and single point of delivery of Liability Orders 
and executions.\11\ Specifically, to access the best-priced quotes/
orders, a market participant would be required to enter an order into 
the OCF, which would deliver either an automatic execution or a 
Liability Order to the next market maker, ECN, or UTP Exchange 
(``Quoting Market Participant'') in the queue. The OCF would determine 
whether to deliver an order or an execution based on the manner in 
which the market participant receiving the order participates in the 
Nasdaq market (e.g., automatic execution for market makers, automatic 
execution for ECNs that agree to participate in the automatic-execution 
functionality of the system, order delivery for ECNs that choose to 
take order delivery, and order delivery for UTP Exchanges). Nasdaq 
believes that this should ensure efficient and expeditious routing of 
orders and executions, while eliminating the potential for dual 
liability that market markers currently face in Nasdaq. The proposed 
changes described herein build upon those proposed in SR-NASD-99-11 and 
would create the next generation Nasdaq trading platform.\12\ By 
creating the OCF as the single point of order entry and the single 
point of delivery of executions and orders, Nasdaq believes that the 
proposal should fully integrate its two current trading systems, 
SelectNet and SOES, from the end user's perspective.
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    \11\ For purposes of this filing, the term ``Liability Order'' 
shall mean an order to which an ECN, market maker, or UTP Exchange 
Specialist, owes a firm quote obligation under Exchange Act Rule 
11Ac1-1 (``Liability Order''). See 17 CFR 240.11Ac1-1.
    \12\ See note 5, above.
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E. Other Enhancements/Rule Changes

    Other enhancements that Nasdaq is proposing to its current trading 
environment include the addition of an odd-lot processing facility, and 
the modification of current procedures that apply to a market maker's 
failure to update its quote after being decremented to zero (commonly 
referred to as ``SOESed-out-of-the-Box'' in the present system 
architecture).
1. Background
    As an equity market, Nasdaq collects, aggregates and displays pre-
trade information simultaneously to all market participants. This pre-
trade information currently takes the form of a quote, which represents 
a single (or an aggregate of same-priced) agency or principal order(s). 
Nasdaq also provides trading platforms through which market 
participants may access the liquidity displayed in the Nasdaq 
marketplace.
    Nasdaq believes that the manner in which it currently collects, 
aggregates and displays pre-trade information is not functionally 
optimized presently, thus limiting the efficiency of Nasdaq's execution 
services and increasing the relative cost of using those services. This 
is due, in part, to the way market participants transmit pre-trade 
information to Nasdaq. Presently, Nasdaq Quoting Market Participants 
(i.e., ECNs and market makers who are NASD members) transmit quotation 
information to Nasdaq, which may represent multiple agency or principal 
orders that the participant has aggregated into a single quote, or may 
represent only a single agency order or principal order. When Nasdaq 
receives a quote, it cannot discern whether that quote represents a 
single order or multiple orders at one price. Also, Nasdaq Quoting 
Market Participants can only send Nasdaq a single, two-sided principal 
quote (although in the future market makers may also be able to send a 
single, one or two-sided Agency Quote to Nasdaq). Nasdaq believes that 
the current inability of Nasdaq Quoting Market Participants to submit 
to Nasdaq quotes or orders at multiple price levels has made compliance 
with the OHR \13\ difficult, because participants cannot leave their 
limit orders with Nasdaq for display when required by SEC rules.\14\ 
Nasdaq also believes that during fast market conditions this inability 
to display a customer limit order without adjusting the Nasdaq Quoting 
Market Participant's quote has resulted in limit orders being traded 
through because the Nasdaq Quoting Market Participant cannot transmit 
to Nasdaq quickly enough a revised quote representing such limit order.
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    \13\ See Exchange Act Release No. 37619A (September 6, 1996), 61 
FR 48290 (September 12, 1996).
    \14\ See Exchange Act Rules 11Ac1-1, 17 CFR 240.11Ac1-1 (``Firm 
Quote Rule'') and 11Ac1-4, 17 CFR 240.11Ac1-4 (``Limit Order Display 
Rule'').
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    Nasdaq believes that these developments, in turn, have led to the 
proliferation of ECNs, which accept multiple price levels of orders and 
display those orders when they become the best market in the ECN. 
Nasdaq believes that while this has assisted market makers in meeting 
their quotation and limit order display obligations under the OHR,\15\ 
it has led to increased fragmentation of pre-trade information. 
Moreover, with the recent adoption of Rule 3b-16 under the Act \16\ and 
the implementation of Regulation ATS,\17\ alternative trading systems 
(``ATS'') that currently participate as ECNs in Nasdaq and are NASD 
members/broker-dealers, may now register as exchanges and directly 
compete for Nasdaq market share, as well as company listings. In short, 
Nasdaq believes that the revolutionary changes in U.S. equity markets 
spurred by dramatic shifts in the regulatory landscape and plummeting 
technology costs have introduced novel challenges to Nasdaq. Nasdaq 
believes that it is critical that Nasdaq be able to compete on the same 
terms and offer the same services as it competitors. Nasdaq believes 
that to do otherwise would render meaningless the concepts of fair 
competition among markets and equal regulation, which would be contrary 
to the clear mandates and proscriptions of the Exchange Act.
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    \15\ See id.
    \16\ 17 CFR 240.3b-16.
    \17\ See Exchange Act Release No. 40760 (Dec. 8, 1998), 63 FR 
70844 (Dec. 22, 1998) (``Regulation ATS'').
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    To address the issue of fragmentation as well as the competitive 
concerns, Nasdaq proposes to modify the display in the NWII and 
Nasdaq's trading platforms. This proposed rule change builds upon, and 
is contingent on the functional integration of SOES/SelectNet proposed 
in SR-NASD-99-11 and should result in a substantially enhanced NNMS 
trading platform. This proposed rule change also incorporates the 
concept of a market maker agency quote proposed in SR-NASD-99-09.
2. Nasdaq Order Display Facility
    Today, the NWII presentation is split into two primary display 
components. The top portion of the NWII contains, among other things: 
(1) the Market Minder Window, which allows market participants to 
monitor price activity (inside bid/offer and last sale) of selected 
stocks; and (2) the Dynamic Quote Window, which shows for a particular 
stock the inside bid and offer, the last sale, change in price from 
previous close, daily high and low, volume, and the short sale arrow 
indicator. The bottom portion of the NWII contains the ``Nasdaq 
Quotation Montage.'' The Nasdaq Quotation Montage shows for a 
particular stock two columns (one for bid, one for offer), under which 
is listed the MMIDs for each registered market maker, ECN, and UTP 
Exchange in the stock and the corresponding quote (price and size) next 
to the related MMID. Nasdaq ranks the bids and offers along with the 
corresponding MMID in price/time priority. Accordingly, the market 
participant at the best bid who is first in time appears first in the 
montage, the

[[Page 68128]]

market participant at the best bid (or the next best bid) who is next 
in time is ranked second, and so forth.
    Market makers are required to submit a two-sided principal 
quote,\18\ and ECNs that participate in Nasdaq may submit a one or two-
sided quote.\19\ UTP Exchanges that have an interface with Nasdaq are 
required under the UTP Plan to submit to Nasdaq to two-sided quote, 
which represents the exchange specialist's best quote in the stock at 
issue. While a market maker's quoted price and size is attributed to 
the market maker by the corresponding MMID, this may not represent the 
market maker's best price if the market maker has placed a better 
priced order into an ECN that complies with the Display Alternative in 
Exchange Act Rule 11Ac1-4.\20\ Accordingly, market maker may be 
displaying in the Nasdaq Quotation Montage a proprietary bid of $20 
when the market is $20 1/8 to 20 1/4, but the market maker may be 
displaying in a qualifying ECN a bid of $20 1/16. The $20 1/16 quote 
may only be seen by subscribers of the ECN in which the market maker 
has placed the order and is not visible to the Nasdaq system or Nasdaq 
market participants unless and until $20 1/16 becomes the best bid in 
the ECN or the best bid price moves in Nasdaq to $20 1/16.
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    \18\ See NASD Rule 4613.
    \19\ See NASD Rule 4623.
    \20\ Exchange Act Rule 11Ac1-4 requires an OTC market maker to 
make publicly available any superior prices that the market maker 
privately quotes through an ECN. A market maker may comply with this 
requirement by changing its quote to reflect the superior price or, 
in the alternative, may deliver better priced orders to an ECN 
provided that the ECN meets the ``Display Alternative'' in Exchange 
Act Rule 11Ac1-4(c)(5). The Display Alternative states that a market 
maker is not required to update its quote in Nasdaq if it is 
displaying a better-priced order in an ECN if the ECN disseminates 
these priced orders to the public quotation system and provides 
broker-dealers equivalent access to these orders. Nasdaq market 
makers currently utilize SelectNet to access ECN quotes. 
Additionally, other investor protection rules, such as the Manning 
Rule, will continue to apply to this facility.
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    a. Enhanced Display of Trading Interest. Nasdaq proposes to add the 
Nasdaq Order Display Facility, which would be displayed in the top 
portion of the NWII. Nasdaq would retain the Nasdaq Quotation Montage 
and the functionality it currently provides--the display of market 
maker, ECN and UTP Exchange attributable quotes ranked in price/time 
priority. The Nasdaq Order Display Facility would display the three 
best price levels in Nasdaq on both the bid and offer side of the 
market. Each price level will be updated and will display the aggregate 
size of ``displayed'' trading interest (``attributable'' and ``non-
attributable,'' as explained below) at each price level.
    Nasdaq Quoting Market Participants would be required to designate a 
quote/order as ``attributable'' or ``non-attributable,'' \21\ and would 
be able to indicate a reserve size for the quote/order.\22\ If an order 
is ``attributable,'' the price and size of the order would be displayed 
next to the Nasdaq Quoting Market Participant's MMID in the Nasdaq 
Quotation Montage (assuming this is the Quoting Market Participant's 
best-priced attributable order). Attributable orders or quotes would be 
displayed in the Nasdaq Order Display Facility as part of the aggregate 
trading interest when the price of the quote/order is within the best 
three price levels (on either side of the market) in Nasdaq.
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    \21\ A Nasdaq Quoting Market Participant must designate a quote/
order as either attributable or non-attributable. For purposes of 
this filing, both attributable and non-attributable quotes/orders 
are considered ``displayed orders'' since they are displayed in the 
Nasdaq system and have the potential for being viewed in the NWII by 
market participants.
    \22\ The ``reserve size'' feature allows a Nasdaq market maker 
on ECN, or a customer of either to display publicly part of the full 
size of its order or interest with the remainder held in reserve on 
an undisplayed basis to be displayed in whole or in part as the 
displayed part is executed.
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    Alternatively, if a Nasdaq Quoting Market Participant designates a 
quote/order as ``non-attributable,'' it will be displayed in the Nasdaq 
Order Display Facility as part of the aggregate trading interest when 
the price of the quote/order is within the best three price levels. 
That order or quote would not, however, be displayed in the Nasdaq 
Quotation Montage next to the Quoting Market Participant's MMID. Thus, 
Nasdaq believes that Nasdaq Quoting Market Participants would be able 
to use a Nasdaq facility to display trading interest to the market 
anonymously, without attribution to its MMID, and still be in 
compliance with Exchange Act Rules 11Ac1-1 and 11Ac1-4.\23\
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    \23\ 17 CFR 240.11Ac1-1 and 17 CFR 11Ac1-4.
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    Market markers be required to publish in the Nasdaq Quotation 
Montage a two-sided quote that is attributed to its MMID. \24\ Nasdaq 
believes, however, that the Nasdaq Order Display Facility meets the 
requirements of Exchange Act Rule 11Ac1-4. \25\ Thus, Nasdaq believes 
it would be consistent with Exchange Act Rule 11Ac1-4 \26\ for a Nasdaq 
market marker to give the system a non-attributable principal quote/
order that is priced better than its attributable quote/order displayed 
in the Nasdaq Quotation Montage and display that non-attributable 
quote/order only in the Nasdaq Order Display Facility without updating 
its attributable quote/order in the Nasdaq Quotation Montage.\27\ 
Nasdaq also believes it would also be consistent with Exchange Act 
Rules 11 Ac1-1 and 11Ac1-4 \28\ for a market maker that receives a 
customer limit order that is priced better than the market marker's 
attributable quote/order in the Nasdaq Quotation Montage, to designate 
that limit order as non-attributable and display it only in the Nasdaq 
Order Display Facility. Nasdaq notes that this arrangement and 
treatment of the limit order must be consistent with the market maker's 
best execution obligations and understanding with the customer.
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    \24\ See proposed NASD Rule 4613(d). Additionally, Nasdaq will 
display in the Nasdaq Quotation Montage only one MMID (two sided) 
and one Agency MMID (one or two sided) for each market maker and one 
MMID per ECN. See proposed NASD Rule 4707.
    \25\ 17 CFR 240.11Ac1-4.
    \26\ Id.
    \27\ Nasdaq believes that the Nasdaq Order Display Facility 
meets the requirements of the Display Alternative, Exchange Act Rule 
11Ac1-4(c)(5). That is, if a market maker displays in the Nasdaq 
Order Display Facility a non-attributable principal or agency 
interest that is priced better than its attributable quote/order in 
Nasdaq Quotation Montage, this would be consistent with Exchange Act 
Rule 11Ac1-4(c)(5) because the better-priced non-attributable quote/
order will be displayed in Nasdaq once it is at the best bid/best 
offer or two price levels away. Additionally, the prices in the 
Nasdaq Order Display Facility will be accessible through Nasdaq's 
traditional execution systems, thus providing equivalent access to 
the quote. Nasdaq notes that if a market marker were to place an 
order into a qualifying ECN, that order would not be displayed in 
Nasdaq until it was at the top of the ECN's file. In the proposed 
Nasdaq system, however, the market maker's order in the Nasdaq order 
Display Facility will be displayed when it is within the best three 
price levels on either side of the market.
    The NASD believes that the Nasdaq Order Display Facility reduces 
fragmentation and increases transparency in that quotes/orders that 
might not be displayed to the market because they are in an ECN and 
not at the top of the ECN's book, may now be displayed in Nasdaq.
    \28\ 17CFR 240.11Ac1-1 and 17 CFR 240.11Ac1-4.
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    b. Reserve Size. This proposal also would permit Nasdaq market 
makers and ECNs to use reserve size. Reserve size, under the proposal, 
would work in virtually the same manner as proposed in SR-NASD-99-
11.\29\ Specifically, reserve size could apply to a market maker's 
principal or agency quote, and the market maker would be required to 
display (either as attributable or non-attributable) 1,000 shares. 
Reserve size would replenish displayed size (attributable or non-
attributable) by at least 1,000 shares (or a greater default amount) 
once displayed size is decremented to zero. Reserve size along with 
displayed (both attributable and non-attributable) size would be 
accessible through Nasdaq's trading

[[Page 68129]]

platform. Reserve size, however, would not be displayed in either the 
Nasdaq Order Display Facility or the Nasdaq Quotation Montage. As 
described in the Order Execution Algorithm section of this filing, 
Nasdaq would access reserve size after all displayed size at a given 
price in the Nasdaq market is exhausted.
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    \29\ See proposed NASD Rule 4710. Also see note 5, above.
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    Next, a special MMID (to be named in the future, but for purposes 
of this filing ``SIZE'') that represents the aggregate size of the 
best-priced non-attributable bid quotes/orders and separately the best-
priced non-attributable offer quotes/orders in the system would be 
displayed in the Nasdaq Quotation Montage, along with the other MMIDs 
for the Quoting Market Participants displaying attributable size. There 
would be one ``SIZE'' MMID for the bid and the offer side of the 
market.\30\ Nasdaq believes that the ``SIZE'' MMID is necessary to 
properly calculate and disseminate the Nasdaq best bid and best offer 
(``BBO'') along with the accompanying market center over Nasdaq Level 1 
Service and National Quotation Data Service (``NQDS'').\31\
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    \30\ The aggregate size of the best bid/best offer displayed in 
the Nasdaq Order Display Facility will equal the sum of the 
individual sizes of the MMIDs at the best bid/best offer displayed 
in the Nasdaq Quotation Montage and the size of the SIZE MMID when 
that MMID is at the best bid/best offer.
    \31\ Nasdaq Level 1 Service provides the inside bid/offer 
quotations and identifies the market center at the best bid/best 
offer based on an algorithm set out in the Nasdaq UTP Plan. See NASD 
Rule 7010 and Nasdaq UTP Plan, Section VI, Paragraph C, Subparagraph 
1. NQDS provides individual market maker quotes, Level 1 Service, 
and last sale information. See id. The SIZE MMID will be used in 
determining the best bid/best offer and corresponding market center 
for purposes of Level 1 and UTP.
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    Nasdaq would also provide a ``Summary Scan'' functionality as part 
of the Nasdaq Order Display Facility. The Summary Scan feature would be 
a query-only functionality that would provide a look at the total 
displayed size (attributable and non-attributable) for all levels below 
the three price levels in the Nasdaq Order Display Facility. The 
Summary Scan would anonymously display interest (attributable and non-
attributable) at each price level on both sides of the market, but 
would not be dynamically updated.
    In essence, under the proposal the Nasdaq Quotation Montage would 
represent all trading interest that a Quoting Market Participant wishes 
to attribute to its MMID. This section may be viewed as a way for 
Quoting Market Participants to advertise their trading interests, which 
may be at the inside market or one or more ticks away. This section 
should be useful for market participants who wish to trade a block or 
large size at a price that is one or more ticks away from the market. 
The Nasdaq Order Display Facility would allow Nasdaq Quoting Market 
Participants to display size to the market anonymously, which should 
minimize certain risks that a market participant encounters when large 
size is attributable to its MMID. By allowing for the anonymous display 
of size to the market and by providing a facility that Nasdaq believes 
complies with the OHR, Nasdaq believes that the Nasdaq Order Display 
Facility should encourage Nasdaq Quoting Market Participants to show 
greater size and thereby increase transparency. Finally, Nasdaq 
believes that reserve size should benefit the market by allowing Nasdaq 
Quoting Market Participants to show the Nasdaq system back-book trading 
interest, but not the market in general. This feature should minimize 
potential market impact of displaying very large size, while enhancing 
liquidity since reserve size will be electronically accessible.
    Below is a schematic of the proposed modified display of the 
NWII.\32\
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    \32\ The description of the proposed modified display of the 
NWII that follows was submitted by the NASD pursuant to a telephone 
conversation between John F. Malitzis, Assistant General Counsel, 
NASD Regulation and Marc McKayle, Attorney, Division, Commission on 
November 19, 1999.


[[Page 68130]]

[GRAPHIC] [TIFF OMITTED] TN06DE99.000



    In the above schematic, there are 9,000 shares at the inside bid of 
$20. The Nasdaq Quotation Montage shows three Nasdaq Quoting Market 
Participants--MMA, showing market maker A's proprietary quote, MMB@, 
showing market maker B's agency quote, and ECN1--with attributable 
orders/quotes having a total size of 3,300 shares. The Nasdaq Quotation 
Montage also shows the SIZE MMID, which is displaying non-attributable 
orders/quote with a total size of 5,700 shares. Thus, the total number 
of attributable and non-attributable orders/quotes at the inside bid is 
9,000 shares. The system rolls up into the Nasdaq Order Display 
Facility (in the top portion of the NWII) the total number of 
attributable and non-attributable orders, and shows in the top box an 
aggregate of 9,000 shares at $20 (the inside bid).
    At the $19.95 level on the bid side of the market, the Nasdaq 
Quotation Montage shows four Nasdaq Quoting Market Participants--MMB, 
ECN2, ECN3, and MMC@--displaying attributable orders/quotes having a 
total size of 3,100 shares. The Nasdaq Order Display Facility in the 
top portion of the NWII shows that there are a total of 15,000 shares 
at the $19.95 level, of which 3,100 are attributable orders/quotes 
(which are identified in the Nasdaq Quotation Montage by MMID). The 
remaining 11,900 shares represent non-attributable orders/quotes at the 
$19.95 level which are not displayed in the Nasdaq Quotation Montage; 
and/or attributable orders/quotes residing in the system for Nasdaq 
Quoting Market Participants who are displaying a superior priced 
attributable order/quote (e.g., MMA, who is at the inside bid of $20, 
could also have an attributable order/quote at the $19.95 level, which 
is aggregated into the second box in the Nasdaq Order Display Facility, 
but is not displayed next to MMA's MMID unit MMA's $20 attributable 
order/quote is filled). There is no SIZE MMID at $19.95 because such an 
MMID would only display the best priced non-attributable orders/quotes, 
which on the bid side of the market in the above schematic are 
currently priced at $20 (i.e., there is only one SIZE MMID for each 
side of the market, and it displays the best priced non-attributable 
orders on each side). If $19.95 became the best bid, the SIZE MMID 
would be displayed in the Nasdaq Quotation Montage and would show all 
non-attributable orders/quotes at that price level.
3. Order Collector Facility
    To further enhance the Nasdaq trading platform, Nasdaq proposes to 
implement an OCF which would do the following: (1) transmit to Nasdaq 
multiple quotes/orders and/or quotes/orders at multiple price levels by 
Nasdaq Quoting Market Participants; (2) provide a unified point of 
entry of orders into the Nasdaq system to access quotes/orders 
displayed (as either attributable or non-attributable) in both the 
Nasdaq Order Display Facility and the Nasdaq Quotation Montage; and (3) 
provide a single point of delivery to Quoting Market Participants of 
Liability Orders, which should eliminate all potential for dual 
liability. Nasdaq believes that this proposed provision should 
substantially enhance and modify its current architectures as well as 
the NNMS trading platform proposed in SR-NASD-99-11, by overlaying the 
OCF with the enhanced architecture to create a single point of order 
entry and delivery for the end user.
    a. Entry of Quotes/Orders. Nasdaq proposes to allow Nasdaq Quoting 
Market Participants to transmit multiple quotes/orders and quotes/
orders at multiple price levels, which the system would manage and 
display in Nasdaq (in the Nasdaq Order Display Facility

[[Page 68131]]

and/or in the Nasdaq Quotation Montage) consistent with an order's/
quote's parameters.
    As noted previously, Nasdaq believes that Nasdaq Quoting Market 
Participants encounter certain difficulties in managing their books, 
because participants currently may only transmit a single quote (which 
may represent a single order or an aggregate of principal/agency 
interest at a single price). Nasdaq believes that, in addition to the 
problems Nasdaq Quoting Market Participants ace, this limitation also 
raises competitive concerns and limitations for Nasdaq and the services 
it provides.
    To remedy this situation, Nasdaq proposes to allow certain Nasdaq 
Quoting Market Participant to give Nasdaq multiple principal and agency 
orders or quotes at single as well as multiple price levels.\33\ Nasdaq 
would time stamp each quote/order upon receipt, and the time stamp will 
determine the quote's/order's ranking for automated execution purposes. 
Additionally, as noted above, a Nasdaq Quoting Market Participant would 
designate a quote/order as either attributable or non-attributable, and 
could designate a reserve size. Nasdaq will aggregate in its system all 
of a Nasdaq Quoting Market Participant's attributable and non-
attributable quotes/orders at a particular price level, which would 
thereafter be disseminated into the Nasdaq Order Display Facility and/
or the Nasdaq Quotation Montage. For no-attributable quotes/orders, 
Nasdaq would display the aggregate size of such quotes/orders in the 
Nasdaq Order Display Facility when the quotes/orders fall within the 
three top price levels (on either side of the market) in Nasdaq. For 
attributable quotes/orders, Nasdaq would display the aggregate size of 
such quotes/orders in the Nasdaq Quotation Montage, once the quote(s)/
order(s) at a particular price level becomes the market maker's best 
attributable bid or offer in the bottom portion of the montage. (As 
noted previously, market makers would still only display one MMID, and 
possibly an agency MMID, in the Nasdaq Quotation Montage.)\34\ Nasdaq 
Quoting Market Participants would have the option to forward their 
``top of file'' as a single quote, instead of multiple quotes/orders at 
multiple price levels, as they do today. That is, a market maker could 
continue to send only its best bid/best offer to Nasdaq, and an ECN 
could continue to send Nasdaq only its top of file and be accessed via 
order delivery.
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    \33\ This functionality will not be available to Quoting Market 
Participants who are not NASD members (e.g., UTP Exchanges/Non-NASD 
member ATSs).
    \34\ If a market participant has an Agency Quote, attributable 
quote/order or quotes/orders will be displayed once the quotes/
orders at a particular price level become the market participant's 
best Agency Quote.
---------------------------------------------------------------------------

    For example, assume if MMA sends Nasdaq five 1,000 share 
attributable buy orders at $20 and two 1,000 share non-attributable buy 
odes at $20, for total interest of 7,000 shares to buy at $20. Assume 
further than $20 becomes the best bid and MMA is alone at the inside 
bid. Nasdaq would aggregate all of the orders in the system and display 
them as follows: 7,000 shares in the Nasdaq Order Display Facility; 
5,000 shares (the attributable portion) in the Nasdaq Quotation Montage 
next to MMA's MMID; and 2,000 (the non-attributable portion) in the 
``SIZE'' MMID.
    Nasdaq believes that the ability to transmit to Nasdaq multiple 
orders at varying prices (instead of displaying interest under a single 
quote) should provide many benefits to Nasdaq market makers and ECNs. 
First, it should ensure compliance with the OHR, and in particular the 
Limit Order Display and Firm Quote Rules.\35\ Additionally, Nasdaq 
believes that it prevents any chance that a Nasdaq Quoting Market 
Participant, because of system delays and/or fast moving markets will 
miss a market because the participant is unable to quickly transmit to 
Nasdaq a revised quote (which may represent a limit order). 
Additionally, Nasdaq intends to include in the new system a ``request a 
cancel'' functionality. Under this feature where a Nasdaq Quoting 
market Participant will be required to request Nasdaq to cancel an 
order before the order is removed from the Nasdaq system.\36\ The 
request to cancel feature, along with the ability to leave orders with 
Nasdaq, should benefit ECNs by allowing them to participate in 
automatic execution while minimizing the potential for double liability 
or taking on a proprietary position.\37\
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    \35\ See Exchange Act Rules 11Ac1-1, 17 CFR 240.11Ac1-1, (``Firm 
Quote Rule'') and 11Ac1-4, 17 CFR 240.11Ac1-4, (``Limit Order 
Display Rule'').
    \36\ If the order has already been executed or is in the process 
of being executed, the request to cancel may be declined.
    \37\  Nasdaq represents that ECNs do not currently participate 
in SOES because of the potential for dual liability and assuming 
proprietary positions. For example, if an ECN were to match orders 
between two subscribers and contemporaneously receive an execution 
from SOES against its quote, the ECN would be required to honor both 
the internal execution and the SOES execution, effectively requiring 
the ECN to take on a proprietary position. Dual liability does not 
arise in SelectNet because that system delivers an order (message) 
which can be declined if the ECN, after scanning its book, 
determines that the quote in Nasdaq was taken out by an internal 
execution. (An ECN cannot decline a SOES execution because the 
system delivers an execution, as opposed to an order.) Under this 
proposal, an ECN has the ability to give quotes/orders to Nasdaq. If 
an internal subscriber wanted to access an order in an ECN that is 
also being displayed in Nasdaq, the ECN could request a cancel 
before effecting the internal match. If the request to cancel were 
declined because the order was already executed in Nasdaq, the ECN 
could decline his/her internal customer and avoid dual liability.
---------------------------------------------------------------------------

    As another benefit, when an Nasdaq Quoting Market Participant is at 
the best bid/best offer, Nasdaq would provide for internal matching of 
a Nasdaq Quoting market Participant's agency (or principal) orders 
against the participant's quotes/order before the order is sent into 
the Nasdaq system. For example, if MMA sends all of its quotes/orders 
to Nasdaq and is at the best bid of $20 showing (attributable and non-
attributable) 4,000 shares, and the MMA sends Nasdaq a 1,000 share 
market sell order from one of its customers, Nasdaq would execute the 
market sell order against the market maker's bid, instead of sending 
the order to the Quoting Market Participant that otherwise would be 
next in the queue to receive the market sell order.
    b. Access to Displayed Quotes/Orders. 1. Order Entry Parameters. 
Currently, to access quotes via automatic execution, a market 
participant may enter an order into SOES if the order is for a public 
customer and meets maximum order size requirements.\38\ If an order is 
not SOES-eligible, a market participant may use SelectNet if the market 
participant wishes to access a quote of an ECN or UTP Exchange, or if 
the market participant wishes to use the negotiation features of 
SelectNet. Presently, SOES and SelectNet are not integrated and operate 
asynchronously. Notwithstanding, Nasdaq's proposal to integrate 
SelectNet and SOES, those systems would continue to operate on separate 
platforms.\39\ From an end-user's perspective, a market participant 
would still have to operate and manage two separate systems. For 
example, market participants would have to first determine the type of 
order they wish to enter (liability versus non-liability) and/or to 
whom they wish to send the order (market maker, ECN, or UTP Exchange), 
and then decide which system (NNMS, the automated execution system, or 
SelectNet) into which to enter the order. In addition, the proposal to 
integrate the functionality of SOES and SelectNet (SR-NASD-99-11) does 
not entirely eliminate the potential for dual

[[Page 68132]]

liability.\40\ Specifically, because UTP Exchanges needed a method of 
delivering Liability Orders to Nasdaq market makers, Nasdaq proposed in 
the SOES/SelectNet Integration to permit UTP Exchanges to send 
SelectNet Liability Orders to market participants that participate in 
the NNMS on an automatic execution basis. The OCF should eliminate all 
potential for double liability because it would serve as the single 
point of order entry and the single point of delivery of all Liability 
Orders (as well as Non-Liability Orders) and executions.
---------------------------------------------------------------------------

    \38\ See NASD Rule 4730(c).
    \39\ See note 5, above.
    \40\ To eliminate the potential for dual liability (e.g. receipt 
of a SelectNet Liability Order followed immediately by the delivery 
of a SOES execution against a market maker's quote), Nasdaq proposed 
to limit SelectNet so that only non-Liability Orders could be 
delivered to those market participants who participate in the NNMS 
and are subject to automatic execution (i.e., market makers and ECNs 
that agree to accept automatic executions). See SR-NASD-99-11. To 
send a Liability Order to a market maker, a market participant would 
use the NNMS system, which would route the order to the next market 
maker in the queue. Market participants would still use SelectNet to 
access quotes of ECNs that do not participate in NNMS and to direct 
non-Liability Orders to a particular market maker. See NASD Rule 
4730(c).
---------------------------------------------------------------------------

    To access quotes in Nasdaq, order entry firms, market makers, ECNs, 
or UTP Exchanges, would enter either a directed or non-directed order 
into the OCF. The order could be of any size, up to 999,999 shares 
(there would be a separate odd-lot process), and would be required to 
indicate whether it is a buy, sell, sell short, or sell short exempt 
order.\40\ The order would be required to be priced or be a market 
order.
---------------------------------------------------------------------------

    \41\ Although Nasdaq is proposing to eliminate the rule limiting 
the size of orders that may be entered into the NNMS, the system in 
the short term would only be able to deliver an execution up to 
9,900 shares. However, if a market participant enters an order into 
the system that is eligible for automatic execution and exceeds the 
system size limit of 9,900, the OCF would break the order up into 
multiples of 9,900 shares and execute the orders as such.
---------------------------------------------------------------------------

2. Non-Directed Orders
    If a market participant wishes to immediately access the best 
prices in Nasdaq, the market participant would be required to enter a 
non-directed order into the OCF. A non-directed order, is one that the 
market participant entering the order into the system does not send/
route to a particular Quoting Market Participant. A non-directed order 
must be designated as a market order or a marketable limit order and 
will be considered a ``Liability Order'' and treated as such by the 
receiving market participant.\42\ Upon entry, the OCF would ascertain 
who the next Quoting Market Participant in the queue to receive an 
order is and, depending on how that receiving Quoting Market 
Participant participates in Nasdaq (i.e., automatic execution versus 
order delivery), the OCF would deliver either an execution or a 
Liability Order.\43\ While market makers will continue to be required 
to take automatic executions via the NNMS, the OCF will accommodate 
ECNs that have the option, but are not required, to participate in the 
system's automatic execution functionality.
---------------------------------------------------------------------------

    \42\ If a non-directed limit order is marketable when entered 
into the system but subsequently becomes non-marketable because of a 
change in the inside market, the system will hold the order for 90 
seconds rather than immediately returning the order to the 
participant who entered it. If within that 90 seconds the order once 
again becomes marketable, the system will send the order to the next 
Quoting Market Participant in the queue. At any time within that 90 
seconds, the participant who entered the order can obtain the status 
of the order and request a cancel of such order.
    If an order is a sell short that is not exempt from NASD Rule 
3350 and the market moves from an up-bid to a down-bid after the 
order is entered but before delivery or execution, the system will 
return the order to the participant who entered it. Sell-short 
exempt orders (i.e., those entered by primary market makers) may be 
entered into the system for execution.
    \43\ For example, if MMA and ECN1 (non-automatic execution 
participant) are at the inside bid each displaying 1,000 shares at 
$20, and OE Firm A enters a market order to sell 1,000 shares, 
assuming that MMA is first in time priority, the OCF will deliver an 
execution of 1,000 shares to MMA. If another market order to sell 
1,000 shares is then entered into the system, the OCF will deliver a 
Liability Order to ECN1. If ECN1 had opted to take automatic 
executions, the OCF would have delivered an execution to ECN1.
---------------------------------------------------------------------------

    a. Quote Decrementation of Non-Directed Orders. For a Nasdaq 
Quoting Market Participant accepting automatic executions (i.e., a 
market makers and ECN choosing to participate in the system's 
automatic-execution functionality) the system would deliver an 
execution up to the size displayed by the participant and, if the order 
has not been filled by other displayed orders, to the participant's 
reserve size. The system would automatically decrement the aggregate 
quote in the Nasdaq Order Display Facility by the size of the delivered 
execution, and the Nasdaq Quoting Market Participant's quote in the 
Nasdaq Quotation Montage if the quote/order is attributable. Displayed 
(attributable or non-attributable) size would be replenished from 
reserve size for Nasdaq Quoting Market Participants accepting automatic 
executions, if the participant's displayed size is decremented to zero 
and the market participant has reserve size. If an ECN accepts 
automatic executions and has its attributable quote/order exhausted to 
zero without updating or transmitting of another attributable quote/
order to Nasdaq, Nasdaq would zero out the one side of the quote that 
is exhausted. If both the bid and offer size of the ECN's market were 
reduced to zero without the ECN updating or transmitting another 
attributable quote/order, the ECN would be placed into an excused 
withdrawal state and restored once the ECN transmitted to Nasdaq 
revised attributable quotes/orders. Nasdaq believes that this is 
necessary to ensure that Quoting Market Participants that do not 
provide timely executions due to equipment or other failures do not 
hold up the market and cause queuing of orders within the Nasdaq 
system.\44\
---------------------------------------------------------------------------

    \44\ If an ECN's quote/order has been zeroed out and placed into 
an excused withdrawal state and the ECN has non-attributable quotes/
orders in Nasdaq, the system will continue to provide access to 
those orders from non-directed orders as described in this filing.
---------------------------------------------------------------------------

    For Quoting Market Participants not participating in automatic 
executions--ECNs that wish to accept order delivery and UTP Exchanges 
that only participate in order delivery--Nasdaq would deliver an order 
of a size up to the participant's displayed and reserve size (if 
applicable). Nasdaq would automatically decrement the participant's 
quote by the size of the delivered order, but Nasdaq would not deliver 
another order to such Quoting Market Participant until the Quoting 
Market Participant has processed the order by providing a complete or 
partial fill of the order. If the Quoting Market Participant declines 
or partially fills the order, Nasdaq would send the order (or remaining 
portion thereof) back into the system for immediate delivery to the 
next available Quoting Market Participant. In addition, if the Quoting 
Market Participant declines or partially fills the order without 
immediately transmitting a revised quote/order at an inferior price, or 
if the participant fails to respond in any manner within five seconds 
of order delivery, Nasdaq would immediately reroute the order to the 
next Quoting Market Participant in the queue. For ECNs, the system 
would zero out the ECN's quotes/orders at that price level on that side 
of the market, and the ECN's quote/order would remain at zero unless 
the ECN transmits to Nasdaq a revised attributable quote/order or the 
ECN has other attributable quotes/orders in the system.\45\
---------------------------------------------------------------------------

    \45\ For UTP Exchanges, Nasdaq will place the side of the quote 
that was being accessed, at the lowest bid or highest offer price 
for 100 shares.
---------------------------------------------------------------------------

    b. Quote Refresh and Revised SOESed-Out-of-the-Box Procedures. As 
noted previously, market makers will be required to maintain a two-
sided, attributable principal quote (other than its Agency Quote) in 
Nasdaq at all times. To assist with this requirement, market makers 
would be able to use the Quote Refresh (``QR'') functionality

[[Page 68133]]

feature of the proposed NNMS.\46\ QR allows a market maker to designate 
a refresh size (with a default refresh size of 1,000 shares) and price 
(i.e., a tick amount away from the price of its decremented quote) to 
which it wishes to refresh if its quoted size is decremented to zero. 
If a market maker utilizing QR but has an attributable quote/order in 
the system that is priced at or better than the quote/order that would 
be created by the QR, Nasdaq would display the better-priced 
attributable quote/order, not the QR-produced quote/order.\47\ If a 
market maker is not utilizing QR and the market maker has given Nasdaq 
multiple attributable quotes/orders, Nasdaq would display the market 
maker's next best-priced attributable quote/order when its attributable 
quote/order is decremented to zero.
---------------------------------------------------------------------------

    \46\ The parameters for QR are the same as for the NNMS. 
Accordingly, when a market maker's principal attributable quote 
(both displayed and reserve) is exhausted to zero, the system will 
refresh the market maker's price on the bid or offer side of the 
market, whichever is decremented to zero, by an interval designated 
by the market maker and the market maker's size to a level 
designated by the market maker. When the market maker's quote is 
refreshed, the QR will refresh the market maker's attributable 
quote/order (not the non-attributable quote) to a default size of 
1,000 shares or an amount designated by the market maker. See note 
5, above.
    \47\ For example, MMA's $20 bid is decremented to zero and MMA 
has set an QR of \1/4\ (meaning the quote will be updated to $19\3/
4\--\1/4\ point away from the decremented $20 bid price). If MMA has 
an attributable buy quote/order for 19\15/16\, the system will 
display that order instead of the $19\3/4\. Alternatively, if MMA 
has no other attributable quote/order in the system or it MMA's next 
best attributable quote/order is priced inferior to the QR price of 
$19\3/4\ (e.g., $19\1/2\), the system will display the QR-produced 
quote of $19\3/4\.
---------------------------------------------------------------------------

    If a market maker's quote/order is decremented to zero and does not 
update its principal quote/order via QR, transmit a revised 
attributable quote/order to Nasdaq, or have another principal (i.e., 
non-Agency Quote) attributable quote/order in the system, Nasdaq would 
place the market maker's quote (both sides) in a closed state for three 
minutes. At the end of that time, if the market maker has not 
voluntarily updated or withdrawn its quote from the market, Nasdaq 
would refresh the market maker's quote/order to 100 shares at the 
lowest market maker bid and highest market maker offer currently being 
displayed in that security and reopen the market maker's quote. Nasdaq 
believes that in the proposed electronic environment, five minutes--the 
current grace period--is too long a period to have a quote closed on 
the Nasdaq screen. Nasdaq also believes that restoring the quote at the 
lowest ranked bid or highest ranked offer price will ensure that market 
makers maintain continued participation in the market and are available 
to provide liquidity in a manner consistent with their market making 
obligations.\48\
---------------------------------------------------------------------------

    \48\ Under current NASD Rule 4730, a market maker whose quote is 
decremented to zero and fails to restore its quote in the allotted 
time will be deemed to have withdrawn as a market maker (``SOESed-
Out-of-the-Box''). Subject to certain specified exceptions, the 
market maker is prohibited from re-entering quotations in that 
security for twenty (20) business days. The NNMS Rules contain a 
virtually identical procedure, called ``Timed Out of the Box'' See 
note 5, above.
---------------------------------------------------------------------------

    c. Order Execution Algorithm. In general, Nasdaq would execute non-
directed orders against Quoting Market Participant's quotes/orders 
based on price/time priority. As noted above, each quote/order when 
entered into Nasdaq would receive a time stamp. Nasdaq would execute 
all orders at the best bid/best offer in general time priority based on 
the time stamp of the quote/order, subject to the following specific 
procedures.
    First, the system would attempt to match orders entered by a Nasdaq 
Quoting Market Participant against its own quote/order if the Nasdaq 
Quoting Market Participant is at the best bid/bet offer. Thus, the 
system would try to match a Nasdaq Quoting Market Participant's orders 
and quotes/orders that are in the system if the participant is at the 
BBO and receives a market or marketable limit order on the other side 
of the market.
    Second, after completing this process (when applicable), the 
proposed NNMS would first execute against displayed quotes/orders 
(attributable and non-attributable) of market makers and ECNs that 
participate in the automatic-execution functionality of the system, in 
time priority based on the entry time of the quotes/orders from these 
market makers and ECNs.\49\ (There should be no interval delay between 
the delivery of executions against the quotes/orders of a market maker 
or ECN that participate in automatic execution (assuming the market 
maker or ECN has size to access), because all Nasdaq Quoting Market 
Participants may quote their actual size and may give Nasdaq multiple 
quotes/orders and price levels.)
---------------------------------------------------------------------------

    \49\ Time priority would be based on the Nasdaq system time 
stamp for the individual quote/order.
---------------------------------------------------------------------------

    Third, the NNMS would execute against the displayed quotes/orders 
(attributable and non-attributable) of ECNs that participate in the 
order-delivery functionality of the NNMS. This too would be based on 
time priority of quotes/orders entered by ECNs that accept order 
delivery. The system then will execute against reserve size of market 
makers and ECNs that participate in the automatic-execution 
functionality of the NNMS (in time priority), and then against the 
reserve size of ECNs that participate in the order-delivery 
functionality of the system.
    Fourth, once displayed and reserve size in Nasdaq is exhausted, the 
system would attempt to access the quotes of UTP Exchanges, again in 
time priority based on the entry time of the UTP Exchanges' quotes 
(assuming there is more than one UTP Exchange in the stock at that 
price level). Similar to the Intermarket Trading System (``ITS''), the 
system would first attempt to probe and sweep the Nasdaq market before 
sending an order to another market center.\50\
---------------------------------------------------------------------------

    \50\ See e.g., Section 8(a)(v) of the ITS Plan.
---------------------------------------------------------------------------

    Last, the system would then move to the next price level. There 
would be a five-second delay before the Nasdaq system would attempt to 
execute any orders in its system at that time. Orders held during this 
five-second period would then be executed in time priority, up to the 
available size, at that next price level. The five-second interval 
delay would not impact the processing of directed orders. Requests to 
cancel orders would also be accepted during the five-second delay. This 
delay will give market participants time to adjust their quotes and 
trading interests before the market moves precipitously through 
multiple price levels, which may occur when there is news, rumors, or 
significant market events. Nasdaq believes that the delay is a modest 
and reasonable attempt to limit volatility.
    d. Directed Orders. The Nasdaq Quotation Montage would serve, in 
part, as a method for Quoting Market Participants to advertise their 
buying or selling interest. To access a specific quote/order in the 
Nasdaq Quotation Montage, a market participant would enter into the OCF 
a ``directed order'' to begin the negotiation process with a particular 
Quoting Market Participant. A directed order is one that is routed by 
the market participant entering the order to specific MMID. To limit 
the possibility for dual liability, a directed order would have to be 
designated as: (1) All-or-None (``AON'') and at least 100 shares 
greater than the size of the displayed quote/order of the market 
participant to which the order is directed; or (2) a Minimum Acceptable 
Quantity order (``MAQ'') with a MAQ value of at least 100 shares 
greater than the displayed amount of the quote/order of the participant 
to which the order is directed. If a Quoting Market Participant is at 
the inside or is displaying (attributable or non-attributable) interest

[[Page 68134]]

in the Nasdaq Quotation Montage and receives a directed, non-Liability 
Order that it wants to fill, to avoid double execution, it may request 
a cancel of its displayed quote/order in Nasdaq before it fills the 
non-Liability Order. Nasdaq will not decrement a quote/order upon the 
delivery of a directed, non-Liability Order.
    e. Locked/Crossed Markets. Nasdaq believes with the implementation 
of the OCF, locked and crossed markets should be virtually eliminated. 
Specifically, if a Quoting Market Participant enters an order that 
would lock or cross the market, the OCF would not display the order as 
a quote/order, but instead the order would be treated as a marketable 
limit order and entered into the OCF as a non-directed Liability Order 
for execution in time priority. For locked market situations, the 
orders would be routed to the Quoting Market Participant(s) next in the 
queue who would be locked, and the order would be executed at the price 
of the locking quote/order. For crossed market situations, the crossing 
order would be entered into the system and routed to the next Quoting 
Market Participant(s) in queue, and the order would be executed at the 
price of the displayed quote/order that would have been crossed. Once 
the lock/cross is cleared, if the Quoting Market Participant's order is 
not completely filled, the OCF would reformat the order and display it 
as a quote/order on behalf of the entering Quoting Market 
Participant.\51\
---------------------------------------------------------------------------

    \51\ If the market moves and the order no longer is locking/
crossing, the OCF will return the order and format it as a quote/
order for display in Nasdaq.
---------------------------------------------------------------------------

    Assuming, for example, that the inside market is $20 to $20\1/16\, 
1,000 by 1,000, and MMA is at the inside bid, if MMC attempts to enter 
into the system an offer quote/order of $20 for 4,000 shares, the 
system would format MMC's quote/order as an order, route it to MMA 
(assuming MMA is first in the queue and there are no other marketable 
orders in the queue ahead of MMC's order), and execute MMC's order 
against MMA's quote/order at $20 for 1,000 shares. Presuming the next 
market participant on the bid side is quoting at $19\15/16\ and since 
there are 3,000 shares remaining in MMC's order, the OCF would reformat 
the remaining portion of the order and display it as a quote/order 
(consistent with the order's parameters), thereby establishing a new 
inside of $19\15/16\ bid and $20 offer.
    As a second example, if MMC attempts to enter into the system an 
offer quote/order of $19\15/16\ for 1,000 shares when MMA is at the 
best bid of $20, the system would format MMC's quote/order as an order, 
route it to MMA, and execute MMC's order against MMA's quote/order at 
$20 for 1,000 shares, thus giving price improvement to MMC's order.
    Finally, if the market is locked or crossed at 9:30 a.m., Nasdaq 
would clear out the locked and/or crossed quotes by executing the 
oldest bid (offer) against the oldest offer (bid) which it is 
marketable against, at the price of the oldest quote/order. Nasdaq 
would begin processing non-directed market and marketable limit orders 
that are in the queue.\52\
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    \52\ Prior to the opening, Nasdaq would continue to process 
``trade or move'' messages, as proposed in SR-NASD-99-23. See 
Exchange Act Release No. 41473 (June 2, 1999), 64 FR 31335 (June 10, 
1999).
---------------------------------------------------------------------------

F. UTP Exchange Participation

    National securities exchanges trading pursuant to grants of UTP 
would be able to enter orders into the OCF. Similar to today, UTP 
Exchanges would continue to receive, and be obligated to execute, 
Liability Orders. Specifically, when a UTP Exchange is next in queue to 
receive a non-directed Liability Order, Nasdaq would deliver the order 
to the UTP Exchange up to the size of the UTP Exchange's quote. The 
system would decrement the UTP Exchange's quote by an amount equal to 
the size of the delivered order. As described in the decrementation 
procedures above, if a UTP Exchange declines or partially fills the 
order, Nasdaq would send the order (or remaining portion thereof) back 
into the system for immediate delivery to the next available Quoting 
Market Participant. In addition, if the UTP Exchange declines or 
partially fills the order without immediately transmitting a revised 
quote/order at an inferior price, or if the UTP Exchange fails to 
respond in any manner within 5 seconds of order delivery, Nasdaq would 
presume equipment failure and immediately reroute the order to the next 
Quoting Market Participant in the queue. The system would then place 
the side of the UTP Exchange's quote that was being assessed, at the 
lowest bid or highest offer price for 100 shares.
    UTP Exchanges would be free to provide automatic executions against 
their quotations. Additionally, if a UTP Exchange wishes to access the 
best Nasdaq market, the UTP Exchange could enter a non-directed 
Liability Order into the OCF. the OCF would be programmed to send the 
next Quoting Market Participant an order for delivery, not automatic 
execution, regardless of whether the receiving Quoting Market 
Participant participates in automatic execution. UTP Exchanges would 
also be able to direct non-Liability Orders for negotiation to 
particular market makers. Finally, as is the case today, UTP Exchanges 
would only be able to submit a single, two-sided attributable quote, 
and would not be able to utilize reserve size or QR.

G. ECN Participation

    As is the case today, ECNs who are NASD members would have the 
choice of taking order delivery or participating in automatic 
execution. Regardless, ECNs in Nasdaq would have full access to the OCF 
for order entry and order delivery. Specifically, ECNs who are NASD 
members would be able to designate quotes/orders as attributable/non-
attributable, and would be able to transmit multiple quotes/orders at 
multiple prices. ECNs would be able to utilize the system's reserve 
size feature for quotes/orders. ECN participation in Nasdaq would 
continue to be governed by rule and private contract.

H. Odd-Lot Processing

    Under this provision of the proposal, Nasdaq would accept and 
execute orders less than one normal unit of trading, i.e., odd-lot 
orders or orders less than one round lot (i.e. 100 shares for 
equities). The system would provide a separate mechanism for processing 
and executing these orders as distinct from normal units of trading. 
Nasdaq would hold odd-lot orders in a separate file and automatically 
execute such odd-lots against all registered market makers in round 
robin rotation whenever the odd-lot order becomes marketable.\53\ For 
example, if a member enters a market order for 50 shares into the 
system, it would immediately and automatically execute the order at the 
inside price against the market maker that is first in rotation for 
execution of such orders, regardless of the market maker's quoted 
price. The automatic execution would not decrement the market maker's 
displayed size. Additionally, if a mixed lot is entered into the 
system, to ensure continuity of price, once the round-lot portion is 
executed, the odd-lot portion would be executed against the next market 
maker in rotation at the round-lot portion price.
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    \53\ An odd-lot order becomes marketable when the best price in 
Nasdaq moves to the price of the odd-lot limit order. Odd-lot orders 
that are marketable at entry or become marketable will execute 
against the first market maker in rotation for odd-lot processing at 
the best price or at the odd-lot order's price.
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I. Nasdaq SmallCap

    Nasdaq proposes to use the expanded NNMS system and the Nasdaq 
Order Display Facility for all Nasdaq

[[Page 68135]]

securities, including SmallCap securities. Nasdaq sees no reason to 
continue to have separate systems for its listed securities. 
Additionally, from a technological perspective, it is very costly and 
difficult to run two separate platforms. As such, Nasdaq proposes to 
delete the current SOES rules that apply to SmallCap.
2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent, in 
general, with the provisions of Section 15A of the Act, and in 
particular, Sections 15A(b)(2),\54\ 15A(b)(6),\55\ and 15A(b)(11),\56\ 
and Section 11A of the Act,\57\ in that the proposed rule change is 
designed to enhance the protection of investors and provide for the 
fairest and most efficient mechanism for transactions in the market for 
Nasdaq securities. Section 15A(b)(2) \58\ requires the Association to 
be organized to enforce compliance by its members and associated 
persons with the provisions of the Act, the rules thereunder, and the 
rules of the Association. Section 15A(b)(6) \59\ 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 the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest; and are not designed to 
permit unfair discrimination between customers, issuers, brokers, or 
dealers. The proposed rule change represents a significant effort to 
provide for an integrated order delivery and execution system where all 
market participants and investors may be brought together in a signal 
system and where all orders are processed and distributed in a fair and 
orderly fashion to achieve immediate or rapid executions at the best 
available price.
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    \54\ 15 U.S.C. 78o-3(b)(2).
    \55\ 15 U.S.C. 78o-3(b)(6).
    \56\ 15 U.S.C. 78o-3(b)(11).
    \57\ 15 U.S.C. 78k-1.
    \58\ 15 U.S.C. 78o-3(b)(6).
    \59\ 15 U.S.C. 78o-3(b)(6).
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    Nasdaq believes that the system will provide many benefits to 
Nasdaq market makers, ECNs, and order entry firms. First, the system 
through the OCF should eliminate, in total, the potential for double 
execution and double liability that market makers currently face. 
Second, market makers' regulatory burdens should be reduced because the 
Nasdaq believes that Nasdaq Order Display Facility will comply with the 
display alternative in Rule 11Ac1-4 under the Act.\60\ Thus, market 
makers should be able to display their principal and agency interest 
anonymously in the Nasdaq Order Display Facility without changing their 
attributable quote in Nasdaq and still comply with Rules 11Ac1-1 and 
11Ac1-4 under the Act.\61\ Moreover, the potential that a limit order 
on a Nasdaq Quoting Market Participant's back book would be traded 
through (or not be displayed as required by Rule 11Ac1-4 under the Act) 
should be minimized because Nasdaq market makers and ECNs would be able 
to give the system multiple orders. Thus, Nasdaq believes that the 
proposed rule change is consistent with Section 11A(a)(1)(B) of the 
Act, \62\ and Rule 11A thereunder,\63\ which sets forth findings of 
Congress that new data processing and communications techniques create 
the opportunity for more efficient and effective market operations.
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    \60\ See 17 CFR 240.11Ac1-4.
    \61\ See 17 CFR 240.11 Ac1-1 and 17 CFR 240.11 Ac1-4.
    \62\ 15 U.S.C. 78k-1(a)(1)(B).
    \63\ See 17 CFR 240.11A.
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    In a similar vein, the Nasdaq believes that the Order Display 
Facility should reduce fragmentation and increase transparency. The 
Nasdaq believes that the Nasdaq Order Display Facility is consistent 
with Section 15A(b)(11),\64\ which 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. Specifically, Nasdaq market makers and ECNs 
would no longer be limited to displaying to the market their best bid 
and best offer quotes. If the proposal is approved, market makers and 
ECNs would be able to display in Nasdaq multiple levels of trading 
interest and varying prices. This interest would be electronically 
accessible if/when the trading interest falls within the best three 
prices on either side of the market. While a market maker or ECN 
currently can only display one level of trading interest (on either 
side of the market) to the market at any one point in time, the 
proposal would enable market makers and ECNs to display (and 
electronically access) three price levels of trading interest in the 
Nasdaq Order Display Facility. Order entry firms would benefit from the 
proposal because they would be able to view and electronically access 
these additional levels of trading interest. Thus, Nasdaq believes that 
the proposal should enhance liquidity and transparency, while reducing 
fragmentation.
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    \64\ 15 U.S.C. 78o-3(b)(11).
---------------------------------------------------------------------------

    Finally, the Nasdaq believes that the proposed rule change is 
consistent with Section 11A(a)(1)(C) of the Act,\65\ which states that 
it is in the public interest and appropriate for the protection of 
investors and the maintenance of fair and order 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. 
As noted above, the OCF should integrate Nasdaq's current trading 
systems from an end user's prospective, substantially enhance these 
systems, and provide a single point of entry and delivery of Liability 
Orders. The OCF should also encourage ECNs to participate in automatic 
execution because the potential for incurring a proprietary position 
due to double executions should be minimized by the proposed new 
functionality (i.e., the ability to give Nasdaq multiple quotes/
orders.) Nasdaq believes that this proposal advances all the goals of 
Section 11A of the Act \66\ by providing an integrated order delivery 
and execution system, enhanced display of agency and principal trading 
interest via the Nasdaq Order Display Facility, and by increasing the 
opportunity for market participants to participate in, and investors to 
receive, automatic execution. Thus, the Nasdaq believes that the 
proposal is designed to provide maximum transparency and efficient 
executions at the best price for the benefit of all investors and 
market participants.
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    \65\ 15 U.S.C. 78k-1(a)(1)(C).
    \66\ 15 U.S.C. 78k-1.
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    Nadaq 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.

[[Page 68136]]

(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. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-
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-99-53 and should 
be submitted by December 27, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\67\
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    \67\ 17 CFR 20.30-3(a)(12).
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Johathan G. Katz,
Secretary.
[FR Doc. 99-31527 Filed 12-6-99; 8:45 am]
BILLING CODE 8010-01-M