[Federal Register Volume 65, Number 62 (Thursday, March 30, 2000)]
[Notices]
[Pages 16981-16993]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-7840]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42573; File No. SR-NASD-99-53]


Self-Regulatory Organizations; Notice of Filing of Amendment No. 
4 to Proposed Rule Change by National Association of Securities 
Dealers, Inc. Relating to the Establishment of Nasdaq Order Display 
Facility and to Modifications of the Nasdaq Trading Platform

March 23, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder, \2\ notice is hereby given 
that on March 23, 2000, 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 (``Commission'') Amendment No. 4 to the proposed rule change 
as described in Items I, II, and III below, which Items have been 
prepared by Nasdaq. The proposed rule change and Amendment Nos. 1 and 2 
were published for comment in the Federal Register on December 6, 
1999.\3\ On March 16, 2000, Nasdaq filed Amendment No. 3 to the 
proposal.\4\ The Commission is publishing this notice to solicit 
comments on Amendment No. 4 to the proposed rule change from interested 
persons.\5\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 42166 (Nov. 22, 
1999), 64 FR 69125.
    \4\ See letter from Richard G. Ketchum, President, NASD, to 
Belinda Blaine, Associate Director, Division of Market Regulation 
(``Division''), Commission (March 15, 2000) (``Amendment No. 3''). 
In Amendment No. 3, the NASD responded to comment letters and 
submitted substantive, clarifying, and technical amendments to the 
proposal.
    \5\ This 19b-4 filing, representing Amendment No. 4 to SR-NASD-
99-53, reflects the substantive amendments proposed in Amendment No. 
3 to the filing, and contains some technical changes and clarifying 
information that the Commission has requested.
---------------------------------------------------------------------------

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

    Nasdaq and the NASD propose the following amendments in response to 
comment letters submitted to the Commission regarding the proposal as 
originally noticed. The amended rule language is as follows: \6\
---------------------------------------------------------------------------

    \6\ The amended rule language contained in this notice reflects 
the Commission's recent approval of SR-NASD-99-11, regarding the 
establishment of the Nasdaq National Market System (``NNMS''). See 
Securities Exchange Act Release No. 42344 (January 14, 2000), 65 FR 
3987 (January 25, 2000) (Order for File No. SR-NASD-99-11 
functionally integrating the Small Order Execution System (``SOES'') 
and SelectNet system to become the foundation of the NNMS.) In 
addition, the amended rule language replaces, in the entirety, the 
rule language contained in the original filing, as well as Amendment 
Nos. 1, 2 and 3.
---------------------------------------------------------------------------

    Proposed additions are italicized and proposed deletions are placed 
in [brackets].
4720. SelectNet Service--Deleted
* * * * *
4611. Registration as a Nasdaq Market Maker
    (a)-(e) No Change.
    (f) Unless otherwise specified by the Association, each Nasdaq 
market maker that is registered as a market maker in a Nasdaq[National 
Market security]-listed security shall also at all times be registered 
as a market maker in the Nasdaq National Market Execution System (NNMS) 
with respect to that security and be subject to the NNMS Rules as set 
forth in the Rule 4700 Series. [Participation in the Small Order 
Execution System (SOES) shall be voluntary for any Nasdaq market maker 
registered to make a market in a Nasdaq SmallCap security.]
    (g) No Change.
* * * * *
4613. Character of Quotations
(a) Two-Sided Quotations
    (1) For each security in which a member is registered as a market 
maker, the member shall be willing to buy and sell such security for 
its own account on a continuous basis and shall enter and maintain a 
two-sided quotation[s] (``Principal Quote''), which is attributed to 
the market maker by a special maker participant identifier (``MMID'') 
and is displayed in the Nasdaq Quotation Montage [in The Nasdaq Stock 
Market] at all times, subject to the procedures for excused withdrawal 
set forth in Rule 4619.
    (A) A registered market maker in a Nasdaq-listed security [listed 
on The Nasdaq Stock Market] must display a

[[Page 16982]]

quotation size for at least one normal unit of trading (or a larger 
multiple thereof) when it is not displaying a limit order in compliance 
with SEC Rule 11Ac1-4, provided, however, that a registered market 
maker may augment its displayed quotation size to display limit orders 
priced at the market maker's quotation. Unless otherwise designated, a 
``normal unit of trading'' shall be 100 shares.
    (2) No Change.
    (b) Agency Quote--Amendments Pending Pursuant to SR-NASD-99-09.
    (c)-(e) No Change.
IM-4613. Autoquote Policy--No Change
4618. Clearance and Settlement
    (a)-(b) No Changes.
    (c) All transactions through the facilities of the Nasdaq National 
Market Execution System[, SOES, and SelectNet services] shall be 
cleared and settled through a registered clearing agency using a 
continuous net settlement system.
* * * * *
4619. Withdrawal of Quotations and Passive Market Making
    (a)-(b) No Change.
    (c) Excused withdrawal status may be granted to a market maker that 
fails to maintain a clearing arrangement with a registered clearing 
agency or with a member of such an agency and is withdrawn from 
participation in the Automated Confirmation Transaction service, 
thereby terminating its registration as a market maker in Nasdaq 
issues. Provided however, that if the Association finds that the market 
maker's failure to maintain a clearing arrangement is voluntary, the 
withdrawal of quotations will be considered voluntary and unexcused 
pursuant to Rule 4620[, the Rules for the Small Order Execution System, 
as set forth in the Rule 4750 Series,] and the Rule 4700 Series 
governing the Nasdaq National Market Execution System.
    (d) No Change.
* * * * *
4620. Voluntary Termination of Registration
    (a) A market maker may voluntarily terminate its registration in a 
security by withdrawing its Principal [quotations] Quote from The 
Nasdaq Stock Market. A market maker that voluntarily terminates its 
registration in a security may not re-register as a market maker in 
that security for twenty (20) business days. Withdrawal from 
participation as a market maker in a Nasdaq [National Market]-listed 
security in the Nasdaq National Market Execution System shall 
constitute termination of registration as a market maker in that 
security for purposes of this Rule; provided, however, that a market 
maker that fails to maintain a clearing arrangement with a registered 
clearing agency or with a member of such an agency and is withdrawn 
from participation in the Automated Confirmation Transaction System and 
thereby terminates its registration as a market maker in Nasdaq-listed 
[National Market and SmallCap] issues may register as a market maker at 
any time after a clearing arrangement has been reestablished and the 
market maker has complied with ACT participant requirements contained 
in Rule 6100.
* * * * *
4632. Transaction Reporting
    (a)-(d) No Change.
    (e) Transactions Not Required To Be Reported.
    The following types of transactions shall not be reported:
    (1) transactions executed through the Computer Assisted Execution 
System (CAES), or the facilities of the Nasdaq National Market 
Execution System (``NNMS'')[, or the SelectNet service];
    (2)-(6) No Change.
    (f) No Change.
4642. Transaction Reporting
    (a)-(d) No Change.
    (e) Transactions Not Required To Be Reported.
    The following types of transactions shall not be reported:
    (1) Transactions executed through the Computer Assisted Execution 
System (CAES)[; the Small Order Execution System (SOES) or the 
SelectNet service] or facilities of the Nasdaq National Market 
Execution System (``NNMS'').
    (2)-(5) No Change.
    (f) No Change.
* * * * *
4700. NASDAQ NATIONAL MARKET EXECUTION SYSTEM (NNMS)
4701. Definitions--Unless stated otherwise, the terms described below 
shall have the following meaning.

    [(d)] (a) The term ``active NNMS securities'' shall mean those NNMS 
eligible securities in which at least one NNMS Market Maker is 
currently active in NNMS.
    [(i)] (b) The term ``Agency Quote'' shall mean the quotation that a 
registered NNMS Market Maker is permitted to display pursuant to the 
requirements of NASD Rule 4613(b).
    (c) The term ``Attributable Quote/Order'' shall have the following 
meaning:
    (i) For NNMS Market Makers and NNMS ECNs, a bid or offer Quote/
Order that is designated for display (price and size) next to the 
participant's MMID in the Nasdaq Quotation Montage once such Quote/
Order becomes the participant's best attributable bid or offer.
    (ii) For UTP Exchanges, the best bid and best offer quotation with 
price and size that is transmitted to Nasdaq by the UTP Exchange, which 
is displayed next to the UTP Exchange's MMID in the Nasdaq Quotation 
Montage.
    [(h)] (d) The term ``Automated Confirmation Transaction'' service 
or ``ACT'' shall mean the automated system owned and operated by The 
Nasdaq Stock Market, Inc. which compares trade information entered by 
ACT Participants and submits ``locked-in'' trades to clearing.
    [(g)] (e) The term ``automatic refresh size'' shall mean the 
default size to which an NNMS Market Maker's quote will be refreshed 
pursuant to NASD Rule 4710(b)(2), if the market maker elects to utilize 
the Quote Refresh Functionality and does not designate to Nasdaq an 
alternative refresh size. The [maximum] automatic refresh size default 
[size] shall be 1,000 shares.
    (f) The term ``Directed Order'' shall mean an order that is entered 
into the system by an NNMS participant that is directed to a particular 
Quoting Market Participant.
    (g) The term ``Displayed Quote/Order'' shall mean both Attributable 
and Non-Attributable (as applicable) Quotes/Orders transmitted to 
Nasdaq by Quoting Market Participants.
    (h) The term ``Firm Quote Rule'' shall mean SEC Rule 11Ac1-1.
    (i) The term ``Liability Order'' shall mean an order that when 
delivered to a Quoting Market Participant imposes an obligation to 
respond to such order in a manner consistent with the Firm Quote Rule.
    (j) The term ``limit order'' shall mean an order to buy or sell a 
stock at a specified price or better.
    (k) The term ``market order'' shall mean an unpriced order to buy 
or sell a stock at the market's current best price.
    (l) The term ``marketable limit order'' shall mean a limit order 
that, at the time it is entered into the NNMS, if it is a limit order 
to buy, is priced at the current inside offer or higher, or if it is a 
limit order to sell, is priced at the inside bid or lower.
    (m) The term ``mixed lot'' shall mean an order that is for more 
than a normal unit of trading but not a multiple thereof.

[[Page 16983]]

    (n) The term ``Non-Attributable Quote/Order'' shall mean a bid or 
offer Quote/Order that is entered by a Nasdaq Quoting Market 
Participant and is designated for display (price and size) on an 
anonymous basis in the Nasdaq Order Display Facility.
    (o) The term ``Non-Directed Order'' shall mean an order that is 
entered into the system by an NNMS participant and is not directed to 
any particular Quoting Market Participant.
    (p) The term ``Non-Liability Order'' shall mean an order that when 
delivered to a Quoting Market Participant imposes no obligation to 
respond to such order under the Firm Quote Rule.
    [(a)] (q) The term ``Nasdaq National Market Execution System,'' 
[or] ``NNMS,'' or ``system'' shall mean the automated system owned and 
operated by The Nasdaq Stock Market, Inc. which enables NNMS 
Participants to execute transactions in active NNMS authorized 
securities; to have reports of the transactions automatically forwarded 
to the National Market Trade Reporting System, if required, for 
dissemination to the public and the industry, and to ``lock in'' these 
trades by sending both sides to the applicable clearing corporation(s) 
designated by the NNMS Participant(s) for clearance and settlement; and 
to provide NNMS Participants with sufficient monitoring and updating 
capability to participate in an automated execution environment.
    [(c)] (r) The term ``NNMS eligible securities'' shall mean 
designated Nasdaq-listed [National Market (NNM)] equity securities.
    (s) The term ``NNMS ECN'' shall mean a member of the Association 
that meets all of the requirements of NASD Rule 4623, and that 
participates in the NNMS with respect to one or more NNMS eligible 
securities.
    (i) The term ``NNMS Auto-Ex ECN'' shall mean an NNMS ECN that 
participates in the automatic-execution functionality of the NNMS 
system, and accordingly executes Non-Directed Orders via automatic 
execution for the purchase or sale of an active NNMS security at the 
Nasdaq inside bid and/or offer price.
    (ii) The term ``NNMS Order-Delivery ECN'' shall mean an NNMS ECN 
that participates in the order-delivery functionality of the NNMS 
system, accepts delivery of Non-Directed Orders, and provides an 
automated execution of Non-Directed Orders (or an automated rejection 
of such orders if the price is no longer available) for the purchase or 
sale of an active NNMS security at the Nasdaq inside bid and/or offer 
price.
    [(b)] (t) The term ``NNMS Market Maker'' shall mean a member of the 
Association that is registered as a Nasdaq Market Maker and as a Market 
Maker for purposes of participation in NNMS with respect to one or more 
NNMS eligible securities, and is currently active in NNMS and obligated 
to execute orders through the automatic-execution functionality of the 
NNMS system for the purchase or sale of an active NNMS security at the 
Nasdaq inside bid and/or [ask] offer price.
    [(e)] (u) The terms ``NNMS Participant'' shall mean [either] an 
NNMS Market Maker, NNMS ECN, UTP Exchange, or NNMS Order Entry Firm 
registered as such with the Association for participation in NNMS.
    [(f)] (v) The term ``NNMS Order Entry Firm'' shall mean a member of 
the Association who is registered as an Order Entry Firm for purposes 
of participation in NNMS which permits the firm to enter orders [of 
limited size] for execution against NNMS Market Makers.
    (w) The term ``Nasdaq Quotation Montage'' shall mean the portion of 
Nasdaq WorkStation presentation that displays for a particular stock 
two columns (one for bid, one for offer), under which is listed in 
price/time priority the MMIDs for each NNMS Market Maker, NNMS ECN, and 
UTP Exchange registered in the stock and the corresponding quote (price 
and size) next to the related MMID.
    (x) The term ``Nasdaq Quoting Market Participant'' shall include 
only the following: (1) NNMS Market Makers; or (2) NNMS ECNs.
    (y) The term ``odd-lot order'' shall mean an order that is for less 
than a normal unit of trading.
    (z) The term ``Quote/Order'' shall mean a single quotation or shall 
mean an order or multiple orders at the same price submitted to Nasdaq 
by a Nasdaq Quoting Market Participant that is displayed in the form of 
a single quotation. When this term is used in connection with a UTP 
Exchange, it shall mean the best bid and/or the best offer quotation 
transmitted to Nasdaq by the UTP Exchange.
    (aa) The term ``Quoting Market Participant'' shall include any of 
the following: (1) NNMS Market Makers; (2) NNMS ECNs; and (3) UTP 
Exchange Specialists.
    (bb) The term ``Reserve Size'' shall mean the system-provided 
functionality that permits a Nasdaq Quoting Market Participant to 
display in its Displayed Quote/Order part of the full size of a 
proprietary or agency order, with the remainder held in reserve on an 
undisplayed basis to be displayed in whole or in part after the 
displayed part is executed.
    (cc) The term ``Nasdaq Order Display Facility'' shall mean the 
portion of Nasdaq WorkStation presentation that displays without 
attribution to particular Quoting Market Participant's MMID the three 
best price levels in Nasdaq on both the bid and offer side of the 
market and the aggregate size of Attributable and Non-Attributable 
Quotes/Orders at each price level.
    (dd) The term ``UTP Exchange'' shall mean any registered national 
securities exchange that has unlisted trading privileges in Nasdaq 
National Market securities pursuant 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 (``Nasdaq UTP Plan'').
4705. NNMS Participant Registration
    (a) Participation in NNMS as an NNMS Market Maker requires current 
registration as such with the Association. Such registration shall be 
conditioned upon the NNMS Market Maker's initial and continuing 
compliance with the following requirements:
    (1) execution of an NNMS Participant application agreement with the 
Association;
    (2) membership in, or access arrangement with, a clearing agency 
registered with the Commission which maintains facilities through which 
NNMS compared trades may be settled;
    (3) registration as a market maker in The Nasdaq Stock Market 
pursuant to the Rule 4600 Series and compliance with all applicable 
rules and operating procedures of the Association and the Commission;
    (4) maintenance of the physical security of the equipment located 
on the premises of the NNMS Market Maker to prevent the improper use or 
access to Nasdaq systems, including unauthorized entry of information 
into NNMS; and
    (5) Acceptance and settlement of each NNMS trade that NNMS 
identifies as having been effected by such NNMS Market Maker, or if 
settlement is to be made through another clearing member, guarantee of 
the acceptance and settlement of such identified NNMS trade by the 
clearing member on the regularly scheduled settlement date.
    (b) Pursuant to Rule 4611(f), participation as an NNMS Market Maker 
is required for any Nasdaq market maker

[[Page 16984]]

registered to make a market in an NNMS security.
    (c) Participation in NNMS as an NNMS Order Entry Firm requires 
current registration as such with the Association. Such registration 
shall be conditioned upon the NNMS Order Entry Firm's initial and 
continuing compliance with the following requirements:
    (1) execution of an NNMS Participant application agreement with the 
Association;
    (2) membership in, or access arrangement with, a clearing agency 
registered with the Commission which maintains facilities through which 
NNMS compared trades may be settled;
    (3) compliance with all applicable rules and operating procedures 
of the Association and the Securities and Exchange Commission;
    (4) maintenance of the physical security of the equipment located 
on the premises of the NNMS Order Entry Firm to prevent the improper 
use or access to Nasdaq systems, including unauthorized entry of 
information into NNMS; and
    (5) acceptance and settlement of each NNMS trade that NNMS 
identifies as having been effected by such NNMS Order Entry Firm or if 
settlement is to be made through another clearing member, guarantee of 
the acceptance and settlement of such identified NNMS trade by the 
clearing member on the regularly scheduled settlement date.
    (c) Participation in NNMS as an NNMS ECN requires current 
registration as an NASD member and shall be conditioned upon the 
following:
    (1) the execution of an NNMS Participant application agreement with 
the Association.
    (2) compliance with all requirements in NASD Rule 4623 and all 
other applicable rules and operating procedures of the Association and 
the Securities and Exchange Commission;
    (3) membership in, or access arrangement with, a clearing agency 
registered with the Commission which maintains facilities through which 
NNMS compared trades may be settled;
    (4) maintenance of the physical security of the equipment located 
on the premises of the NNMS ECN to prevent the improper use or access 
to Nasdaq systems, including unauthorized entry of information into 
NNMS; and
    (5) acceptance and settlement of each trade that is executed 
through the facilities of the NNMS, or if settlement is to be made 
through another clearing member, guarantee of the acceptance and 
settlement of such identified NNMS trade by the clearing member on the 
regularly scheduled settlement date.
    [(d)] (e) The registration required hereunder will apply solely to 
the qualification of an NNMS Participant to participate in NNMS. Such 
registration shall not be conditioned upon registration in any 
particular eligible or active NNMS securities.
    [(e)] (f) Each NNMS Participant shall be under a continuing 
obligation to inform the Association of noncompliance with any of the 
registration requirements set forth above.
    (g) The Association and its subsidiaries shall not be liable for 
any losses, damages, or other claims arising out of the NNMS or its 
use. Any losses, damages, or other claims, related to a failure of the 
NNMS to deliver, display, transmit, execute, compare, submit for 
clearance and settlement, or otherwise process an order, Quote/Order, 
message, or other data entered into, or created by, the NNMS shall be 
absorbed by the member, or the member sponsoring the customer, that 
entered the order, Quote/Order, message, or other data into the NNMS.

4706  Order Entry Parameters

    (a) Non-Directed Orders--An NNMS Participant may enter a Non-
Directed Order into the NNMS in order to access the best bid/best offer 
as displayed in Nasdaq. A Non-Directed Order must be a market or 
marketable limit order, must be a round lot or a mixed lot, and must 
indicate whether it is a short sale, short-sale exempt, or long sales. 
If after entry but before delivery, a Non-Directed Order becomes non-
marketable, the system will hold the order for 90 seconds, after which 
the order will be returned to the NNMS participant entering the order. 
The system will not process a Non-Directed Order to sell short if the 
execution of such order would violate NASD Rule 3350. Limit orders may 
be entered into the system prior to the market's open, but will be held 
in queue, and if not marketable on the open, will be returned to the 
participant entering the order. Non-Directed Orders will be processed 
as described in Rule 4170(b). The NNMS shall not accept Non-Directed 
Orders that are All-or-None or have a minimum size of execution.
    (b) Directed Orders--A participant may enter a Directed Order into 
the NNMS to access a specific Attributable Quote/Order displayed in the 
Nasdaq Quotation Montage. A Directed Order must be a Non-Liability 
Order, and as such, at the time of order entry must be designated as: 
(i) an ``All-or-None'' order (``AON'') that is at least one normal unit 
of trading (e.g., 100 shares) in excess of the Attributable Quote/Order 
of the Quoting Market Participant to which the order is directed; or 
(ii) a ``Minimum Acceptable Quantity'' order (``MAQ''), with a MAQ 
value of at least one normal unit of trading in excess of Attributable 
Quote/Order of the Quoting Market Participant to which the order is 
directed. A Directed Order may have a time in force of 1 to 99 minutes.
    (c) Entry of Agency and Principal Orders--NNMS Participants are 
permitted to enter into the NNMS both agency and principal orders for 
delivery and execution processing.
    (d) Order Size--Any round or mixed lot order up to 999,999 shares 
may be entered into the NNMS for normal execution processing. Odd-lot 
orders, and the odd-lot portion of a mixed lot, are subject to a 
separate execution process, as described in Rule 4710(e).
    (e) Open Quotes--The NNMS will only deliver an order or an 
execution to a Quoting Market Participant if that participant has an 
open quote.
    (f) Odd-Lot Orders--The system will accept odd-lot orders for 
processing through a separate facility. Odd-lot orders must be Non-
Directed Orders, and may be market, marketable limit or limit orders. 
The system shall accept odd-lot orders at a rate no faster than one 
order per/second from any single participant. Odd-lot orders, and the 
odd-lot portion of a mixed lot order, shall be processed as described 
in Rule 4170(e).

4707  Entry and Display of Quotes/Orders

    (a) Entry of Quotes/Orders--Nasdaq Quoting Market Participants may 
enter Quotes/Orders into the NNMS subject to the following requirements 
and conditions: 
    (1) Nasdaq Quoting Market Participants shall be permitted to 
transmit to the NNMS multiple principal and agency Quotes/Orders at a 
single as well as multiple price levels. Such Quote/Order shall 
indicate whether its is an ``Attributable Quote/Order'' or ``Non-
Attributable Quote/Order,'' and the amount of Reserve Size (if 
applicable).
    (2) Upon entry of a Quote/Order into the system, the NNMS shall 
time-stamp it, which time-stamp shall determine the ranking of the 
Quote/Order for purposes of processing Non-Directed Orders as described 
in Rule 4710(b).
    (3) Consistent with Rule 4613, an NNMS Market Maker is obligated to 
maintain a two-sided Attributable Quote/Order (other that an Agency 
Quote) at all times, for at least one normal unit of trading.
    (4) Nasdaq Quoting Market Participants may continue to transmit to

[[Page 16985]]

the NNMS only their best bid and best offer Attributable Quotes/Orders. 
Notwithstanding NASD Rule 4613 and subparagraph (a)(1) of this rule, 
nothing in these rules shall require a Nasdaq Quoting Market 
Participant to transmit to the NNMS multiple Quotes/Orders.
    (b) Display of Quotes/Orders in Nasdaq--The NNMS will display a 
Nasdaq Quoting Market Participant's Quotes/Orders as follows:
    (1) Attributable Quotes/Orders--The price and size of a Nasdaq 
Quoting Market Participant's best priced Attributable Quote/Order on 
both the bid and offer side of the market will be displayed in the 
Nasdaq Quotation Montage under the Nasdaq Quoting Market Participant's 
MMID, and also will be displayed in the Nasdaq Order Display Facility 
as part of the aggregate trading interest at a particular price when 
the price of such Attributable Quote/Order falls within the best three 
price levels in Nasdaq on either side of the market. Upon execution or 
cancellation of the Nasdaq Quoting Market Participant's best-priced 
Attributable Quote/Order on a particular side of the market, the NNMS 
will automatically display the participant's next best Attributable 
Quote/Order on that side of the market.
    (2) Non-Attributable Quotes/Orders--The price and size of a Nasdaq 
Quoting Market Participant's Non-Attributable Quote/Order on both the 
bid and offer side of the market will be displayed in the Nasdaq Order 
Display Facility as part of the aggregate trading interest at a 
particular price when the price of such Non-Attributable Quote/Order 
falls within the best three price levels in Nasdaq on either side of 
the market. A Non-Attributable Order will not be displayed in the 
Nasdaq Quotation Montage under the Nasdaq Quoting Market Participant's 
MMID. Non-Attributable Quotes/Orders that are the best priced Non-
Attributable bids or offers in the system will be displayed in the 
Nasdaq Quotation Montage under an anonymous MMID, which shall represent 
and reflect the aggregate size of all Non-Attributable Quotes/Orders in 
Nasdaq at that price level. Upon execution or cancellation of a Nasdaq 
Quoting Market Participant's Non-Attributable Quote/Order, the NNMS 
will automatically display a Non-Attributable Quote/Order in the Nasdaq 
Order Display Facility (consistent with the parameters described above) 
if it falls within the is within the best three price levels in Nasdaq 
on either side of the market.
    (c) Reserve Size--Reserve Size shall not be displayed in Nasdaq, 
but shall be electronically accessible as described in Rule 4710(b).
    (d) Summary Scan--The ``Summary Scan'' functionality, which is a 
query-only non-dynamic functionality, displays without attribution to 
Quoting Market Participants' MMIDs the aggregate size of Attributable 
and Non-Attributable Quotes/Orders for all levels (on both the bid and 
offer side of the market) below the three price levels displayed in the 
Nasdaq Order Display Facility.
4710. Participant Obligations in NNMS
(a) Registration
    Upon the effectiveness of registration as a NNMS Market Maker or, 
NNMS ECN, NNMS Order Entry Firm, the NNMS participant may commence 
activity within NNMS for exposure to orders or entry of orders, as 
applicable. The operating hours of NNMS may be established as 
appropriate by the Association. The extent of participation in Nasdaq 
by an NNMS Order Entry Firm shall be determined solely by the firm in 
the exercise of its ability to enter orders into Nasdaq.
(b) [Market Makers] Obligations to and Processing of Non-Directed 
Orders
    (1) [An NNMS Market Maker] General Provisions--A Quoting Market 
Participant in an NNMS Security shall be subject to the following 
requirements for Non-Directed Orders:
    (A) For each NNM security in which it is registered [as an NNMS 
Market Maker, the market maker], a Quoting Market Participant must 
accept and execute individual Non-Directed orders against its quotation 
including its Agency Quote (if applicable), in an amount equal to or 
smaller than the combination of the Displayed [quotation] Quote/Order 
and Reserve Size (if applicable) of such [quotation(s)] Quote/Order, 
when the Quoting Market Participant is at the best bid/best offer in 
Nasdaq. [For purposes of this rule, the term ``reserved size'' shall 
mean that a NNMS Market Maker or a customer thereof wishes 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. To utilize the 
reserve size function, a minimum of 1,000 shares must initially be 
displayed in the market maker's quote (including the Agency Quote), and 
the quotation must be refreshed to 1,000 shares consistent with 
subparagraph (b)(2)(A) of this rule.] Quoting Market Participants shall 
participate in the NNMS as follows:
    (i) NNMS Market Makers and NNMS Auto-Ex ECNs shall participate in 
the automatic-execution functionality of the NNMS, and shall accept the 
delivery of an execution up to the size of the participant's Displayed 
Quote/Order and Reserve Size.
    (ii) NNMS Order-Delivery ECNs shall participate in the order-
delivery functionality of the NNMS, and shall accept the delivery of an 
order up to the size of the NNMS Order-Delivery ECN's Displayed Quote/
Order and Reserve Size. The NNMS Order-Delivery ECN shall be required 
to execute such order in a manner consistent with the Firm Quote Rule.
    (iii) UTP Exchanges shall participate in the NNMS as described in 
subparagraph (f) of this rule and as otherwise described in the NNMS 
rules and the UTP Plan.
    (B) Processing of Non-Directed Orders--Upon entry of a Non-Directed 
Order into the system, the NNMS will ascertain who the next Quoting 
Market Participant in queue to receive an order is and shall deliver an 
execution to NNMS Quoting Market Participants that participate in the 
automatic-execution functionality of the system, or shall deliver a 
Liability Order to Quoting Market Participants that participate in the 
order-delivery functionality of the system. Non-Directed Orders entered 
into the NNMS system shall be delivered to or automatically executed 
against Quoting Market Participants' Displayed [quotations] Orders/
Quotes and Reserve Size, including Agency Quotes (if applicable), in 
price[/] and then time priority, subject to the following processing. 
For Quotes/Orders [quotations] at the same price level, the NNMS system 
will attempt to access interest in the system in the following priority 
and order:
    (i) Displayed Quotes/Orders of NNMS Market Makers, NNMS ECNs that 
do not charge a quote-access fee to non-subscribers, and Non-
Attributable agency quotes/orders of UTP Exchanges (as permitted by 
subparagraph (f) of this rule), in time priority between such 
participants;
    (ii) Displayed Quotes/Orders of NNMS ECNs that charge a quote-
access fee to non-subscribers, in time priority between such 
participants;
    (iii) Reserve Size of NNMS Market Makers and NNMS ECNs that do not 
charge a quote-access fee to non-subscribers, in time priority between 
such participants;
    (iv) Reserve Size of NNMS ECNs that charge a quote-access fee to 
non-subscriber, in time priority between such participants; and

[[Page 16986]]

    (v) Principal Quotes/Orders of UTP Exchanges, in time priority 
between such participants[yield priority to all Displayed quotations 
over reserve size, so that the system will execute against Displayed 
quotations in time priority and then against reserve size in time 
priority].
    The following exceptions shall apply to the above execution 
parameters. First, if a Nasdaq Quoting Market Participant enters a Non-
Directed Order into the system, before sending such Non-Directed Order 
to the next Quoting Market Participants in queue, the NNMS will first 
attempt to match off the order against the Nasdaq Quoting Market 
Participant's own Quote/Order if the participant is at the best bid/
best offer in Nasdaq. Second, if Displayed Quotes/Orders at a price 
level are simultaneously exhausted and there is Reserve Size available 
at that price, when Displayed Quotes/Orders are refreshed from Reserve 
Size the system will establish order-receipt priority for these 
refreshed Quotes/Orders based on the size of a participant's Displayed 
Quote/Order and then based on the original order-entry time for same-
sized refreshed Displayed Quotes/Orders.
    (C) Decrementation Procedures--The size of a [displayed quotation] 
Quote/Order displayed in the Nasdaq Order Display Facility and/or the 
Nasdaq Quotation Montage will be decremented upon the delivery of a 
Liability Order or the delivery of an execution of a[n NNMS] Non-
Directed order in an amount equal to [or greater than one normal unit 
of trading] the system-delivered order or execution; provided, however, 
that [the execution of] if an NNMS order that is a mixed lot (i.e., an 
order that is for more than a normal unit of trading but not a multiple 
thereof), the system will only deliver a Liability Order or an 
execution for the number of round lots contained in the mixed lot 
order, and will only decrement [a displayed quotation's] the size of a 
Displayed Quote/Order by the number of shares represented by the number 
of round lots contained in the mixed lot order. The odd-lot portion of 
the mixed lot will be executed at the same price against the next NNMS 
Market Maker in the odd-lot rotation, as described in subparagraph (e) 
of this rule.
    (i) If an NNMS Auto-Ex ECN has its bid or offer Attributable Quote/
Order and Reserve Size decremented to zero without transmission of 
another Attributable Quote/Order to Nasdaq, the system will zero out 
the side of the quote that is exhausted. If both the bid and offer are 
decremented to zero without transmission of a revised Attributable 
Quote/Order, the ECN will be placed into an excused withdrawal state 
until the ECN transmits to Nasdaq a revised Attributable Quote/Order.
    (ii) If an NNMS Order-Delivery ECN declines or partially fills a 
Non-Directed Order without immediately transmitting to Nasdaq a revised 
Attributable Quote/Order that is at a price inferior to the previous 
price, or if an NNMS Order-Delivery ECN fails to respond in any manner 
within 5 seconds of order delivery, the system will cancel the 
delivered order and send the order (or remaining portion thereof) back 
into the system for immediate delivery to the next Quoting Market 
Participant in queue. The system then will zero out the ECN's Quote/
Orders at that price level on that side of the market, and the ECN's 
quote on that side of the market will remain at zero until the ECN 
transmits to Nasdaq a revised Attributable Quote/Order. If both the bid 
and offer are zeroed out, the ECN will be placed into an excused 
withdrawal state until the ECN transmits to Nasdaq a revised 
Attributable Quote/Order.
    (iii) If an NNMS ECN's Quote/Order has been zeroed out or if the 
ECN has been placed into excused withdrawal as described in 
subparagraphs (b)(1)(C)(i) and (ii) of this rule, the system will 
continue to access the ECN's Non-Attributable Quotes/Orders that are in 
the NNMS, as described in Rule 4707 and subparagraph (b) of this rule.
    (D) Interval Delay--After the NNMS system has executed all 
Displayed Quotes/Orders and Reserve Size interest at a price level [an 
order against a market maker's displayed quote and reserve size (if 
applicable), that market maker shall not be required to execute another 
order at its bid or offer in the same security until a predetermined 
time period has elapsed from the time the order was executed, as 
measured by the time of execution in the Nasdaq system. This period of 
time shall initially be established as 5 seconds, but may be modified 
upon Commission approval and appropriate notification to NNMS 
participants.], the following will occur:
    (i) If the NNMS system cannot execute in full all shares of a Non-
Directed Order against the Displayed Quotes/Orders and Reserve Size 
interest at the initial price level and a price two price levels (i.e., 
two minimum trading increments) away, the system will pause for 5 
seconds before accessing the interest at the next price level in the 
system; provided, however, that once the Non-Directed order can be 
filled in full within two price levels, there will be no interval delay 
between price levels and the system will execute the remainder of order 
in full; or 
    (ii) If the Non-Directed Orders is specially designated by the 
entering market participant as a ``sweep order,'' the system will 
execute against all Displayed Quotes/Orders and Reserve Size at the 
initial price level and the two price levels being displayed in the 
NODF without pausing between the displayed price levels. Thereafter, 
the system will pause 5 seconds before moving to the next price level, 
until the Non-Directed Order is executed in full.
    The interval delay described in this subparagraph may be modified 
upon Commission approval and appropriate notification to NNMS 
Participants.
    (E) All entries in NNMS shall be made in accordance with the 
requirements set forth in the NNMS User Guide, as published from time 
to time by Nasdaq.
(2) Refresh Functionality
    (A) Reserve Size Refresh--Once a Nasdaq Quoting Market 
Participant's [an NNMS Market Maker's displayed quotation] Displayed 
Quote/Order size on either side of the market in the security has been 
decremented to zero due to NNMS [executions] processing Nasdaq will 
refresh the [market maker's] displayed size out of Reserve Size to a 
size-level designated by the Nasdaq Quoting Market Participant [NNMS 
Market Maker], or in the absence of such size-level designation, to the 
automatic refresh size. [If the market maker is using the reserve size 
function for its proprietary quote or Agency Quote the NNMS Market 
Maker must refresh to a minimum of 1,000 shares, consistent with 
subparagraph (b)(1)(A) of this rule]. To utilize the Reserve Size 
functionality, a minimum of 1,000 shares must initially be displayed in 
the Nasdaq Quoting Market Participant's Displayed Quote/Order, and the 
Displayed Quote/Order must be refreshed to at least 1,000 shares. This 
functionality will not be available for use by UTP Exchanges.
    (B) [Auto]Quote Refresh (``QR'')--Once an NNMS Market Maker's 
Displayed Quote/Order [quotation] size and Reserve Size on either side 
of the market in the security has been decremented to zero due to NNMS 
executions, the NNMS Market Maker may elect to have The Nasdaq Stock 
Market refresh the market maker's quotation as follows:
    (i) Nasdaq will refresh the market maker's quotation price on the 
bid or offer side of the market, whichever is decremented to zero, by 
an price interval designated by the NNMS Market Maker; and
    (ii) Nasdaq will refresh the market maker's displayed size to a 
level

[[Page 16987]]

designated by the NNMS Market Maker, or in the absence of such size 
level designation, to the automatic refresh size.
    (iii) This functionality shall produce an Attributable Quote/Order. 
In addition, if an NNMS Market Maker is utilizing the QR functionality 
but has an Attributable Quote/Order in the system that is priced at or 
better than the quote that would be created by the QR, the NNMS will 
display the Attributable Quote/Order, not the QR-produced quote.
    (iv) An NNMS Market Maker's Agency Quote shall not be subject to 
the functionality described in this subparagraph, nor shall this 
functionality be available to Quoting Market Participants other than 
NNMS Market Makers.
    (3) Entry of Locking/Crossing Quotes/Orders [Except as otherwise 
provided in subparagraph (b)(10) of this rule, at any time a locked or 
crossed market, as defined in Rule 4613(e), exists for an NNMS 
security, a market maker with a quotation for that security (including 
an Agency Quote) that is causing the locked or crossed market may have 
orders representing shares equal to the size of the bid or offer that 
is locked or crossed executed by the NNMS system against the market 
maker's quote (including an Agency Quote) at the quoted price if that 
price is the best price. During locked or crossed markets, the NNMS 
system will execute orders against those market makers that are locked 
or crossed in predetermined time intervals. This period of time 
initially shall be established as five (5) seconds, but may be modified 
upon approval by the Commission and appropriate notification to NNMS 
participants.] The system shall process locking/crossing Quotes/Orders 
as follows:
    (A) Locked/Crossed Quotes/Orders During Market Hours--If during 
market hours, a Quoting Market Participant enters into the NNMS a 
Quote/Order that will lock/cross the market (as defined in NASD Rule 
4613(e)), the system will not display the Quote/Order as a quote in 
Nasdaq; instead the system will treat the Quote/Order as a marketable 
limit order and enter it into the system as a Non-Directed Order for 
processing as follows:
    (i) For locked-market situations, the order will be routed to the 
Quoting Market Participant next in queue whom would be locked, and the 
order will be executed at the lock price;
    (ii) For crossed-market situations, the order will be entered into 
the system and routed to the next Quoting Market Participants in queue 
who would be crossed, and the order will be executed at the price of 
the Displayed Quote/Order that would have been crossed.
    Once the lock/cross is cleared, if the participant's order is not 
completely filled, the system will reformat the order and display it in 
Nasdaq (consistent with the parameters of the Quote/Order) as a Quote/
Order on behalf of the entering Quoting Market Participant.
    (B) Locked/Crossed Quotes/Orders at the Open--If the market is 
locked or crossed at 9:30 a.m., Eastern Time, the NNMS will clear the 
locked and/or crossed Quotes/Order by executing the oldest bid(offer) 
against the oldest offer(bid) against which it is marketable at the 
price of the oldest Quote/Order. Nasdaq then will begin processing Non-
Directed Orders as described in subparagraph (b) of this rule.
    [(4) For each NNM security in which a market maker is registered, 
the market maker may enter orders into the NNMS for its proprietary 
account as well as on an agency or riskless principal basis.]
    [(5)] (4) An NNMS Market Maker may terminate its obligation by 
keyboard withdrawal (or its equivalent) from NNMS at any time. However, 
the market maker has the specific obligation to monitor its status in 
NNMS to assure that a withdrawal has in fact occurred. Any transaction 
occurring prior to the effectiveness of the withdrawal shall remain the 
responsibility of the market maker.
    [(6)] (5) [An NNMS Market Maker will be suspended from NNMS if its 
bid or offer has been decremented to zero due to NNMS executions and 
will be permitted a standard grace period, the duration of which will 
be established and published by the Association, within which to take 
action to restore a two-sided quotation in the security for at least 
one normal unit of trading. An NNMS Market Maker that fails to reenter 
a two-sided quotation within the allotted time will be deemed to have 
withdrawn as a market maker (``Timed Out of the Box''). Except as 
provided below in this subparagraph and in subparagraph (b)(7) of this 
rule, an NNMS Market Maker that withdraws in an NNM security may not 
re-register as a market maker in that security for twenty (20) business 
days.] If an NNMS Market Maker's Attributable Quote/Order is reduced to 
zero on one side of the market due to NNMS executions, the NNMS will 
close the Market Maker's quote in the NNMS with respect to both sides 
of its market, and the NNMS Market Maker will be permitted a standard 
grace period of three minutes within which to take action to restore 
its Attributable Quote/Order, if the market maker has not authorized 
use of the QR functionality or does not otherwise have an Attributable 
Quote/Order on both sides of the market in the system. An NNMS Market 
Maker that fails to transmit an Attributable Quote/Order in a security 
within the allotted time will have its quotation restored by the system 
at the lowest bid price and the highest offer price in that security. 
Except as provided in subparagraph (b)(6) of this rule, an NNMS Market 
Maker that withdraws from a security may not re-register in the system 
as a market maker in that security for twenty (20) business days. The 
requirements of this subparagraph shall not apply to a market maker's 
Agency Quote.
    [(A) Notwithstanding the above, a market maker can be reinstated 
if:
    (i) the market maker makes a request for reinstatement to Nasdaq 
Market Operations as soon as practicable under the circumstances, but 
within at least one hour of having been Timed Out of the Box, and 
immediately thereafter provides written notification of the 
reinstatement request;
    (ii) it was a Primary Market Maker at the time it was Timed Out of 
the Box;
    (iii) the market maker's firm would not exceed the following 
reinstatement limitations:
    a. for firms that simultaneously made markets in less than 250 
stocks during the previous calendar year, the firm can receive no more 
than four (4) reinstatements per year;
    b. for firms that simultaneously made markets in 250 or more but 
less than 500 stocks during the previous calendar year, the firm can 
receive no more than six (6) reinstatements per year;
    c. for firms that simultaneously made markets in 500 or more stocks 
during the previous calendar year, the firm can receive no more than 
twelve (12) reinstatements per year; and
    (iv) the designated Nasdaq officer makes a determination that the 
withdrawal was not an attempt by the market maker to avoid its 
obligation to make a continuous two-sided market. In making this 
determination, the designated Nasdaq officer will consider, among other 
things:
    a. whether the market conditions in the issue included unusual 
volatility or other unusual activity, and/or the market conditions in 
other issues in which the market maker made a market at the time the 
firm was Timed Out of the Box;
    b. the frequency with which the firm has been Timed Out of the Box 
in the past;
    c. procedures the firm has adopted to avoid being inadvertently 
Timed Out of the Box; and
    d. the length of time before the market maker sought reinstatement.

[[Page 16988]]

    (B) If a market maker has exhausted the reinstatement limitations 
in subparagraph[s] (b)(6)(A)(iii) above, the designated Nasdaq officer 
may grant a reinstatement request if he or she finds that such 
reinstatement is necessary for the protection of investors or the 
maintenance of fair and orderly markets and determines that the 
withdrawal was not an attempt by the market maker to avoid its 
obligation to make a continuous two-sided market in instances where:
    (i) a member firm experiences a documented problem or failure 
impacting the operation or utilization of any automated system operated 
by or on behalf of the firm (chronic system failures within the control 
of the member will not constitute a problem or failure impacting a 
firm's automated system) or involving an automated system operated by 
Nasdaq;
    (ii) the market maker is a manager or co-manager of a secondary 
offering from the time the secondary offering is announced until ten 
days after the offering is complete; or
    (iii) absent the reinstatement, the number of market makers in a 
particular issue is equal to two (2) or less or has otherwise declined 
by 50% or more from the number that existed at the end of the prior 
calendar quarter, except that if a market maker has a regular pattern 
of being frequently Timed Out of the Box, it may not be reinstated 
notwithstanding the number of market makers in the issue.
    [(7)] (6) Notwithstanding the provisions of subparagraph [(6)] (5) 
above:
    (A) an NNMS Market Maker that obtains an excused withdrawal 
pursuant to Rule 4619 prior to withdrawing from NNMS may reenter NNMS 
according to the conditions of its withdrawal; and
    (B) a NNMS Market Maker that fails to maintain a clearing 
arrangement with a registered clearing agency or with a member of such 
an agency, and is thereby withdrawn from participation in ACT and NNMS 
for NNM securities, may reenter NNMS after a clearing arrangement has 
been reestablished and the market maker has compiled with ACT 
participant requirements. Provided however, that if the Association 
finds that the ACT market maker's failure to maintain a clearing 
arrangement is voluntary, the withdrawal of quotations will be 
considered voluntary and unexcused.
    [(8)] (7) The Market Operations Review Committee shall have 
jurisdiction over proceedings brought by market makers seeking review 
of their removal from NNMS pursuant to subparagraphs (b)(5)[(6) or 
(b)(7)] of this rule.
    [(9)] (8) In the event that a malfunction in the [NNMS Market 
Maker's] Quoting Market Participant's equipment occurs, rendering [on-
line] communications with NNMS inoperable, the [NNMS Market Maker] 
Quoting Market Participant is obligated to immediately contact Nasdaq 
Market Operations by telephone to request withdrawal from NNMS and a 
closed-quote status, and if the Quoting Market Participants is an NNMS 
Market Maker an excused withdrawal from Nasdaq[. Such request must be 
made] pursuant to Rule 4619. If withdrawal is granted, Nasdaq Market 
Operations personnel will enter the withdrawal notification into NNMS 
from a supervisory terminal and shall close the quote. Such manual 
intervention, however, will take a certain period of time for 
completion and, unless otherwise permitted by the Association pursuant 
to its authority under Rule 11890, the [NNMS Market Maker] Quoting 
Market Participants will continue to be obligated for any transaction 
executed prior to the effectiveness of [his] the withdrawal and closed-
quote status.
    [(10) In the event that there are no NNMS Market Makers at the best 
bid (offer) disseminated by Nasdaq, market orders to sell (buy) entered 
into NNMS will be held in queue until executable, or until 90 seconds 
has elapsed, after which such orders will be rejected and returned to 
their respective order entry firms.]
    (c) Directed Order Processing--A participant may enter a directed 
order into the NNMS to access a specific Quote/Order in the Nasdaq 
Quotation Montage and to begin the negotiation process with a 
particular Quoting Market Participant. The system will deliver an order 
to the Quoting Market Participant designated as the recipient of the 
order. Upon delivery, the Quoting Market Participants shall owe no 
liability under the Firm Quote Rule to that order and the system will 
not decrement the receiving Quoting Market Participant's Quote/Order.
    [(c)] (d) NNMS Order Entry Firms
    All entries in NNMS shall be made in accordance with the procedures 
and requirements set forth in the NNMS User Guide. Orders may be 
entered in NNMS by the NNMS Order Entry Firm through either its Nasdaq 
terminal or computer interface. The system will transmit to the firm on 
the terminal screen and printer, if requested, or through the computer 
interface, as applicable, an execution report generated immediately 
following the execution.
[(d) Order Entry Parameters
    (1) NNMS will only accept market and marketable limit orders for 
execution and will not accept market or marketable limit orders 
designated as All-or-None (``AON'') orders; provided, however, that 
NNMS will not accept any limit orders, marketable or unmarketable, 
prior to 9:30 a.m., Eastern Time. For purposes of this subparagraph, an 
AON order is an order for an amount of securities equal to the size of 
the order and no less.
    (2) Additionally, the NNMS will only accept orders that are 
unpreferenced, thereby resulting in execution in rotation against NNMS 
Market Makers, and will not accept preferenced orders.
    (3) NNMS will not accept orders that exceed 9,900 shares, and no 
participant in the NNMS system shall enter an order into the system 
that exceeds 9,900.]
[(e) Electronic Communication Networks
    An Electronic Communications Networks, as defined in SEC Rule 
11Ac1-1(a)(8), may participate in the NNMS System if it complies with 
NASD Rule 4623 and executes with the Association a Nasdaq Workstation 
Subscriber Agreement, as amended, for ECNs.]
(e) Odd-Lot Processing
    (1) Participation in Odd-Lot Process--All NNMS Market Makers may 
participate in the Odd-Lot Process for each security in which the 
market maker is registered.

(2) Execution Process

    (a) Odd-lot orders will be executed against an NNMS Market Maker 
only if it has an odd-lot exposure limit in an amount that would fill 
the odd-lot order. A NNMS Market Maker may, on a security-by-security 
basis, set an odd-lot exposure limit from 0 to 999,999 shares.
    (b) An odd-lot order shall be executed automatically against the 
next available NNMS Market Maker when the odd-lot order becomes 
executable (i.e., when the best price in Nasdaq moves to the price of 
the odd-lot limit order). Such odd-lot orders will execute at the best 
price available in the market, in rotation against NNMS Market Makers 
who have an exposure limit that would fill the odd-lot order.
    (c) For odd-lots that are part of a mixed lot, once the round-lot 
portion is executed, the odd-lot portion will be executed at the round-
lot price against the next NNMS Market Maker in rotation (as described 
in subparagraph (e)(2)(b) of this rule) even if the round-

[[Page 16989]]

lot price is no longer the best price in Nasdaq.
    (d) Odd-lot executions will decrement the odd-lot exposure limit of 
an NNMS Market Maker but will not decrement the size of NNMS Market 
Maker's Displayed Quote/Order.
    (e) After the NNMS system has executed an odd-lot against an NNMS 
Market Maker, the system will not deliver another odd-lot order against 
the same market maker until a predetermined time period has elapsed 
from the time the last execution was delivered, as measured by the time 
of execution in the Nasdaq system. This period of time shall initially 
be established as 5 seconds, but may be increased upon Commission 
approval and appropriate notification to NNMS Participants or may be 
decreased to an amount less than five seconds by the NNMS Market Maker.

(f) UTP Exchanges

    Unless specified otherwise in these rules or in the Nasdaq UTP 
Plan, UTP Exchanges shall participate in the NNMS as follows:
    (1) Order Entry--UTP Exchanges shall be permitted to enter Directed 
and Non-Directed orders into the system subject to the conditions and 
requirements of Rules 4706. Directed and Non-Directed Orders entered by 
UTP Exchanges shall be processed (unless otherwise specified) as 
described subparagraphs (b) and (c) of this rule.

(2) Display of UTP Exchange Quotes/Orders in Nasdaq

    (a) UTP Exchange Principal Orders/Quotes--UTP Exchanges shall be 
permitted to transmit to the NNMS a single bid Quote/Order and a single 
offer Quote/Order. Upon transmission of the Quote/Order to Nasdaq, the 
system shall time stamp the Quote/Order, which time stamp shall 
determine the ranking of the Quote/Order for purposes of processing 
Non-Directed Orders. The NNMS shall display the best bid and best offer 
Quote/Order transmitted to Nasdaq by a UTP Exchange in the Nasdaq 
Quotation Montage under the MMID for the UTP Exchange, and shall also 
display such Quote/Order in the Nasdaq Order Display Facility as part 
of the aggregate trading interest when the UTP Exchange's best bid/best 
offer Quote/Order falls within the best three price levels in Nasdaq on 
either side of the market. 
    (b) UTP Exchange Agency Quotes/Orders--A UTP Exchange may transmit 
to the NNMS orders that meet the following requirements: are for the 
benefit of the account of a natural person executing securities 
transactions with or through or receiving investment banking services 
from a broker/dealer; are not for the benefit of a broker and/or 
dealer; and are designated as Non-Attributable Quotes/Orders (``UTP 
Agency Order/Quote''). Upon transmission of a UTP Agency Quote/Order to 
Nasdaq, the system shall time stamp the order, which time stamp shall 
determine the ranking of these Quote/Order for purposes of processing 
Non-Directed Orders, as described in subparagraph (b) of this rule. A 
UTP Agency Quote/Order shall not be displayed in the Nasdaq Quotation 
Montage under the MMID for the UTP Exchange. Rather, UTP Agency Quotes/
Orders shall be reflected in the Nasdaq Order Display Facility and 
Nasdaq Quotation Montage in the same manner in which Non-Attributable 
Quotes/Orders from Nasdaq Quoting Market Participants are reflected in 
Nasdaq, as described in Rule 4707(b)(2).
    (3) Non-Directed Order Processing--UTP Exchanges shall participate 
in the automatic-execution functionality of the system, shall accept an 
execution of an order up to the size of the UTP Exchange's displayed 
Quote/Order, and shall otherwise participate in the Non-Directed Order 
processing described in subparagraph (b) of this rule. UTP Exchanges 
shall be subject to the decrementation procedures described in 
subparagraph (b)(1)(C) of this rule. 
    (4) Directed Order Processing--UTP Exchanges shall participate in 
the Directed Order processing as described in subparagraph (c) of this 
rule.

4711-4714--No Change

4718. Termination of System Service

    The Association or its subsidiaries may, upon notice, terminate 
System service to a participant in the event that a participant fails 
to abide by any of the rules or operating procedures of the System or 
any other relevant rule or requirement, or fails to pay promptly for 
services rendered.
* * * * *
4750. SMALLCAP SMALL ORDER EXECUTION SYSTEM (SOES)
4751-4757--Deleted

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

    In its filing with the Commission, the NASD and Nasdaq included 
statements concerning the purpose of, and basis for, the proposed rule 
change and discussed any comments it received on the proposed rule 
change. The text of these statements may be examined at the places 
specified in Item IV below. The NASD and Nasdaq have 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
    In the original filing, the NASD and Nasdaq proposed enhancing the 
Nasdaq quotation montage and Nasdaq's main trading platform--the Nasdaq 
National Market System (``NNMS'').\7\ In particular, Nasdaq proposed 
to: (1) Add a new display to the Nasdaq Workstation II (``NWII'') 
called the Nasdaq Order Display Facility (``NODF''), 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 UTP Exchanges; (2) make 
substantial enhancements to the NNMS, which would improve the 
efficiency of the current trading platform; (3) allow market makers and 
ECNs to designate orders for ``display'' in Nasdaq on either an 
attributable (i.e., not anonymous) or non-attributable (i.e., 
anonymous) basis; (4) establish the Order Collector Facility (``OCF'') 
as part of the NNMS, which would allow Nasdaq market makers and ECNs to 
give the Nasdaq system multiple quotes/orders at a single as well as 
multiple price levels, which would be displayed in the Nasdaq Quotation 
Montage and the NODF, consistent with an order's parameters; (5) 
establish the OCF as a single point of order entry and single point of 
delivery of liability orders and executions; and (6) create an odd-lot 
processing facility in Nasdaq.
---------------------------------------------------------------------------

    \7\ See note 3, above.
---------------------------------------------------------------------------

    The Commission received approximately 21 comment letters.\8\ In

[[Page 16990]]

the NASD's and Nasdaq's view, the overwhelming majority of these 
comments were extremely positive. However, some commenters stated that 
notwithstanding their overall support, there were aspects of the 
proposal that raised concerns. A few commenters opposed the proposal in 
its entirety. In response to the commenters, the NASD and Nasdaq 
propose to amend the following aspects of the proposal: (1) Odd-lot 
processing; (2) five-second interval delay between price levels; (3) 
the order execution algorithm as it relates to ECNs and UTP Exchanges, 
and displayed size refreshed from reserve; and (4) UTP Exchange 
participation in the system. The NASD and Nasdaq are working to address 
concerns regarding Nasdaq technology, competition, system roll-out, and 
any other relevant comments.
---------------------------------------------------------------------------

    \8\ See letters from: Investment Company Institute, dated 
January 11, 2000 (``ICI Letter''); Chicago Stock Exchange, dated 
January 11, 2000 (``CHX Letter''); Bloomberg, dated January 11, 2000 
(``Bloomberg Letter''); Merrill Lynch, dated January 20, 2000 
(``Merrill Letter''); Morgan Stanley Dean Witter, dated February 3, 
2000 (``Morgan Stanley Letter''); Salomon Smith Barney, dated 
February 3, 2000 (``Salomon Letter''); Goldman, Sachs & Co., dated 
February 15, 2000 (``Goldman Letter''); ITG, dated January 10, 2000 
(``ITG Letter''); BNY ESI & Co., dated January 11, 2000 (``BNY 
Letter''); Heartland Securities, Corp. dated December 17, 1999 
(``Heartland Letter''); Automated Trading Desk, dated December 26, 
1999 (``Automated Trading Desk Letter''); The Security Traders 
Association of New York, dated December 22, 1999 (``STANY Letter''); 
NexTrade Holdings, Inc., undated (``NexTrade Letter); Thelen Reid & 
Priest, LLP on behalf of the Electronic Traders Association, dated 
January 11, 2000 (ETA Letter); USbancorp, Piper Jaffray, dated 
December 30, 1999 (``USbancorp Letter''); Island, dated January 11, 
2000 (``Island Letter''); Securities Traders Association, dated 
December 22, 1999 (``STA Letter''); American Century Investment 
Management, dated January 10, 2000 (``American Century Letter''): 
Instinet, dated February 16, 2000 (``Instinet Letter''); Franklin 
Portfolio on behalf of the Nasdaq Institutional Trader's Advisory 
Council (``ITAC Letter''); and Mount Pleasant Brokerage date 
December 27, 1999 (``Mount Pleasant Letter'').
---------------------------------------------------------------------------

A. Odd-Lot Processing

    A number of the commenters raised concerns regarding the odd-lot 
process. As originally proposed, all market makers in a stock would 
execute odd-lots entered into the system at the inside bid/offer, in a 
``round-robin'' rotation, regardless of whether the market maker is at 
the inside bid/offer. Odd-lot executions would not decrement or be 
driven off a market maker's quoted size in the NODF or the Nasdaq Quote 
Montage. One commenter stated that it would be unfair to execute odd-
lots against dealers without current trading interest in a particular 
security.\9\ Various commenters stated that the odd-lot process could 
be ``gamed'' by splitting up large round lot orders into multiple odd-
lot orders in order to jump the processing queue for round lots (e.g., 
a 1,000 share order would be split up into 10 orders for 99 shares) or 
to access size greater than the depth at the inside market. Commenters 
also thought that the originally proposed odd-lot process could create 
certain arbitrage opportunities.\10\
---------------------------------------------------------------------------

    \9\ See e.g., STANY Letter; STA Letter; Morgan Stanley Letter; 
Salomon Smith Barney Letter; Merrill Lynch Letter; and USbancorp.
    \10\ In the NNMS (which Nasdaq expects will be implemented on 
May 15, 2000), odd-lots are processed against only those market 
makers who are at the inside bid or offer, in round-robin fashion. 
An odd-lot execution does not decrement a market maker's quote. 
However, if a market maker has reserve size in the system, an odd-
lot execution will decrement the reserve size held in Nasdaq. The 
system cannot decrement displayed quotes in Nasdaq, because Nasdaq 
only can display round lots (i.e., 100 shares or multiples thereof). 
Since reserve size is not displayed in the Nasdaq Quotation Montage, 
but rather is held within the system, it is possible to decrement 
reserve size by the amount of an odd-lot execution.
---------------------------------------------------------------------------

    In light of the concerns raised in comment letters, the NASD and 
Nasdaq propose to amend the odd-lot process to: (1) Add an ``odd-lot 
exposure limit'' for market makers; (2) provide a market maker interval 
delay between odd-lot executions against the same market maker; and (3) 
establish an odd-lot order entry parameter of one order per second, per 
firm. While odd-lots would still be processed in a round-robin fashion 
against a market maker even if it is not at the inside, odd-lots would 
be processed only against those market makers who have an available 
exposure limit.
    A market maker could set its exposure limit, on a security-by-
security basis, from 0 to 999,999 shares. The system would not execute 
an odd-lot order against a market maker unless the market maker had a 
sufficient exposure limit to fill the odd-lot order. If no market maker 
had an odd-lot exposure, the system would suspend the processing of 
odd-lots until the exposure limit was refreshed. Odd-lot executions 
would decrement the exposure limit (but not the quote/order sizes 
displayed in the Nasdaq Quotation Montage and/or NODF) by the size of 
the odd-lot order. When a market maker's odd-lot exposure limit was 
reduced to zero, the participant would be taken out of the odd-lot 
rotation unless, and until, the market maker set a new exposure limit.
    Next, there also would be a maximum five-second interval delay 
between executions against the same market maker in the same security. 
Once an odd-lot is executed against a market maker, if the market maker 
had an available exposure limit there would be a five-second interval 
delay before the market maker was subject to another odd-lot execution. 
During the five-second interval delay, the market maker could adjust 
its odd-lot exposure limit up or down. A market maker would also be 
able to adjust the interval-delay time down (i.e., down to 0-4 
seconds), so that it receives executions more frequently than five 
seconds apart. Lastly, the system would be programmed to accept odd-lot 
orders at a rate of, no faster than, one order per second from any 
single NNMS participant. This would prevent a single firm from flooding 
the system with odd-lots.\11\
---------------------------------------------------------------------------

    \11\ Some commenters suggested that the system decrement a 
market maker's quote (as displayed in the Nasdaq Quotation Montage 
and the NODF) as a method of addressing the concerns with the odd-
lot processing. Nasdaq considered this approach but determined that 
it would be extremely complex and difficult to approach from a 
systems perspective. For example, because Nasdaq only displays 
quotations in round lots, the system could not decrement a quote to 
reflect an odd-lot execution until there were enough odd-lot 
executions against the same quote to equal one round lot. 
Accordingly, Nasdaq has proposed the alternative outlined above, as 
it addresses the concerns raised by commenters and also is 
technologically more feasible.
---------------------------------------------------------------------------

B. Five-Second Interval Delay Between Price Levels

    As originally proposed, if all trading interest is exhausted at a 
particular price level, there would be a five-second interval delay 
before the system would attempt to execute an order at a new price 
level (e.g., the next tick down). Commenters believed the proposed 
five-second interval delay between price levels was too long and/or 
unnecessary for liquid stocks and could cause queuing of orders within 
the system.\12\ The rationale underlying the five-second interval delay 
was the concern that in the present high-speed trading environment it 
is beneficial to allow sufficient time for market makers to 
automatically update their quotes to ensure that a series of orders do 
not exhaust the interest at or near the inside, resulting in a partial 
execution at a significantly inferior price. Nevertheless, the NASD and 
Nasdaq recognize that the concerns raised by commenters have merit. In 
response, the NASD and Nasdaq propose that the system have a more 
limited interval delay parameter, as follows.
---------------------------------------------------------------------------

    \12\ See e.g., STA Letter; STANY Letter; American Century 
Letter; ICI Letter; ETA Letter; USbancorp Letter; Salomon Smith 
Barney Letter; and Merrill Lynch Letter.
---------------------------------------------------------------------------

    First, the system would limit the five-second interval delay to 
situations where an order is partially filled at one price level, and 
the remaining shares of the order would not be filled in full at the 
next two trading increments (``ticks'') away (i.e., within \1/8\ of a 
point for stocks currently priced above $10, or within 10 cents in a 
decimals environment with a five-cent minimum trading increment). In 
these situations, there would be a five-second interval delay or pause 
before the order moved to the next increment away from the original 
increment. At any point after a delay, if the remainder of the order 
could be filled in full within two ticks, there would be no further 
delays and the order would be filled completely. In other words, if a 
large market order

[[Page 16991]]

moves through many prices, it would delay before every price move 
except for the last two. Additionally, orders would be processed in 
time sequence. Thus, if an order was in interval delay because it met 
the above parameters, the orders behind the ``interval-delay order'' 
would not jump the queue.
    For example, assume that at 10:00:01 a.m., the inside market in 
Stock G is $104.50 to $104.55. At 10:00:02 a.m., Order 1, which is a 
market sell order for 2,000 shares, is entered into the system. At 
10:00:03 a.m., Order 2, which is a market sell order for 5,000 shares 
is entered into the system, and one second later Order 3, also a 5,000 
share market sell order, is entered into the system. Thus, the 
following quotes/orders are being displayed in the system.

MMA $104.50-100 (total, including reserve)
ECN1 $104.45-1,900 (total, including reserve)
MMC $104.40-1,000 (total, including reserve)
MMD $104.35-1,000 (total, including reserve)
MME $104.30-1,000 (total, including reserve)
MMF $104.25-2,000 (total, including reserve)

    As amended, the first 100 shares for Order 1 executes against MMA 
at $104.50, and since there would be sufficient size at $104.45 to 
satisfy the remaining shares 1,900 shares of the order, the remaining 
shares executes against ECN1 at $104.45, with no delay.\13\ As to Order 
2, since it could not be filled in full at the $104.40 price level or 
within two ticks away, 1,000 shares would execute at $104.40 and there 
would be a five-second interval delay between each price level until 
the order can be filled within two ticks. Note that during the interim, 
Order 3 would remain in queue behind Order 2, until Order 2 is executed 
in full.
---------------------------------------------------------------------------

    \13\ As explained in the original filing, if ECN1 were an ECN 
that participates in automatic execution, it could protect itself 
from incurring dual liability by using the request to cancel feature 
in the system, even though there was no interval delay between price 
levels. That is, if while Nasdaq was executing against ECN1's quote 
an internal subscriber also wished to execute against the 1,900 
shares for $104.45 in the ECN, before filling the subscriber's order 
ECN1 could send a request to cancel the order to Nasdaq. If Nasdaq 
had executed against the 1,900 shares at $104.45, ECN1 would send a 
message to its customer declining the execution because the order 
had been filled.
---------------------------------------------------------------------------

    Second, a market participant would be able to set a parameter on an 
individual order so that the order would trade through all interest 
(i.e., displayed and reserve interest) at the three price levels being 
displayed in the NODF at the time of entry, without pausing five 
seconds in between each displayed price (``Sweep Order''). However, a 
Sweep Order may only execute through a maximum of the two price levels 
displayed in the NODF (and into the third price level). If the Sweep 
Order were not executed in full at the third price level, the order 
would pause for five seconds between each subsequent price level. For 
example, if a 10,000 share market order were entered into the system 
and received the appropriate designation, the order would sweep all the 
shares at the three price levels in the NODF at the time of entry, and 
would pause for five seconds before moving to the fourth (as well as 
subsequent) price level(s) if the order were not fully executed at such 
level.
    The NASD and Nasdaq believe that these two approaches provide a 
balance between the need of institutional investors and market 
professionals for speed, while providing greater price continuity for 
individual investors.

C. Processing of Non-Directed Orders and ECNs and UTP Exchange 
Participation

    As originally proposed, the system would execute non-directed 
orders entered into the system in general price/time priority. However, 
within a price level, the system would execute non-directed orders 
against displayed quotes/orders of market makers and ECNs that 
participate in the automatic-execution functionality of the system 
(``Auto-Ex ECNs''), within time priority of this class of market 
participants. The system then would execute against the displayed 
quotes/orders of ECNs that participate in order-delivery (``Order-
Delivery ECNs''). After displayed size of Nasdaq market makers and ECNs 
was exhausted, the system would execute against reserve size of market 
makers and Auto-Ex ECNs, and then reserve size of Order-Delivery ECNs. 
Lastly, the system would execute against the quotes of UTP Exchanges.
    i. ECNs. Some commenters believe that Order-Delivery ECNs should 
have the same standing to receive non-directed orders against their 
quotes as market makers and Auto-Ex ECNs. These commenters believe that 
executing first against market makers and Auto-Ex ECNs and then against 
Order-Delivery ECNs who are displaying orders at the same price raises 
competitive concerns. In light of these concerns, the NASD and Nasdaq 
propose to alter the order execution algorithm with respect to ECNs. 
The NASD and Nasdaq believe that all ECNs (who are NASD members), 
market makers, and non-attributed UTP Exchange agency interest, at a 
given price level should be executed against in strict time priority, 
unless an ECN charges a fee to non-subscribers for accessing its quote. 
ECNs that charge an access fee should be executed after non-attributed 
UTP Exchange agency interest, market makers, and ECNs who do not charge 
an access fee because such a fee represents an increase in trading 
costs and clearly an inferior price.\14\ This prioritization is 
consistent with common industry practice today, where a market 
participant would route its orders first to market makers and ECNs that 
do not charge a fee and then to ECNs that charge an access fee, to 
ensure the investor incurs the lowest possible trading costs. The NASD 
and Nasdaq believe that any other prioritization would be inconsistent 
with the statutory mandate of providing investors with best execution 
of their orders.
---------------------------------------------------------------------------

    \14\ The NASD and Nasdaq note that Commission staff and at least 
one commentor raised concerns about ECN fees and best execution. See 
ITG Letter.
---------------------------------------------------------------------------

    ii. UTP Exchange Participation. As noted above, as originally 
proposed, UTP Exchanges would receive non-directed orders behind market 
makers and ECNs who are at the same price. The system would deliver 
orders from UTP Exchanges to the next market participant in queue, even 
if the receiving market participant participates in the automatic 
execution functionality of the system. Some Nasdaq market participants 
stated that mandating order delivery for orders from UTP Exchanges was 
cumbersome from a technology prospective. In addition, the Chicago 
Stock Exchange (``CHX'') believed that the system would disadvantage 
customer orders that reside on the floor of its exchange because such 
orders would be executed last even if they had time priority.
    Subsequent to the filing of the original proposal, the NASD and 
Nasdaq have had constructive discussions with the CHX. First, the NASD 
and Nasdaq has offered to provide automatic execution (against market 
participants that accept auto-ex) for non-directed orders emanating 
from the floor of the CHX, if CHX agrees to provide automatic execution 
for orders directed to the CHX by Nasdaq.\15\ This is consistent with 
Nasdaq's previously-articulated position that it is willing to provide 
automatic execution against its market if a UTP Exchange is willing to 
provide

[[Page 16992]]

automatic execution against its specialist's quotes.
---------------------------------------------------------------------------

    \15\ To be clear, the NASD and Nasdaq are proposing to eliminate 
from the proposal the requirement that all non-directed orders 
entered into the system by UTP Exchanges be delivered to the next 
market participant in queue even if that market participant is a 
market maker or Auto-Ex ECN.
---------------------------------------------------------------------------

    Second, the NASD and Nasdaq has offered the CHX, and will offer to 
all other UTP Exchanges, the ability to display agency interest on a 
non-attributable basis in the NODF. That is, a UTP Exchange's agency 
orders would be aggregated into the NODF. These orders would not be 
displayed next to the UTP Exchange's MMID in the Nasdaq Quotation 
Montage, but instead would be aggregated into the SIZE MMID (which 
represents all non-attributable/anonymous interest at the best price in 
the system). The system would execute against the UTP-Exchange's non-
attributable agency interest in strict price/time priority with other 
orders/quotes from Nasdaq market makers and ECNs that do not charge a 
quote-access fee. This approach should assure that a customer's order 
in a Nasdaq security, regardless of where it is entered in the National 
Market System, would be executed on a price/time priority basis. A UTP 
Exchange's principal (i.e., non-agency) interest would continue to be 
displayed next to its MMID in the Nasdaq Quotation Montage and accessed 
after Nasdaq market maker and ECN interest (as well as UTP Exchange 
agency interest). The NASD and Nasdaq believe that the CHX has 
preliminarily agreed to this approach. The NASD and Nasdaq intend to 
work with all relevant UTP Plan participants to resolve the linkage 
issue.
    iii. Reserve Size. One commenter suggested that when displayed size 
is completely exhausted, quotes/orders refreshed out of reserve size 
should be accessed in a slightly different manner than as described in 
the original proposal. Specifically, the commenter suggested that after 
the displayed size of market participants quoting at the same price 
level is exhausted simultaneously and then displayed size is refreshed 
from reserve, the system should establish a quoting market 
participant's priority to receive non-directed orders based on the new 
size of the displayed quotes (instead of the market participant's time 
of original quote/order entry) with time priority governing as to any 
two (or more) market participants at the same size.\16\ In this narrow 
instance, there would be parity among the market participants with 
none, arguably, having time priority because their displayed interest 
was taken out simultaneously. The NASD and Nasdaq proposes to amend the 
filing to incorporate this approach into the order execution algorithm 
since it appears logical, in this instance, to reward Nasdaq Quoting 
Market Participants displaying greater size.
---------------------------------------------------------------------------

    \16\ See Goldman Sachs Letter.
---------------------------------------------------------------------------

    For example, assume that MMA and MMB are each at the inside bid 
quoting 1,000 shares. MMA, who is first in time to receive an order, 
has a reserve refresh size of 1,000 shares, and MMB who is second in 
time has a reserve refresh size of 3,000. A sell market order for 2,000 
shares is entered into the system, and the system executes against MMA 
for 1,000 shares and MMB for 1,000 shares. As originally proposed, MMA 
and MMB would now be refreshed out of reserve to 1,000 and 3,000 shares 
respectively, but MMA would have priority to receive the next non-
directed order in the system because MMA had original time priority. As 
amended, because MMB would be displaying 3,000 shares and MMA only 
1,000 shares, MMB would receive the next order, as it is displaying a 
larger size refreshed out of reserve. The NASD and Nasdaq believe that 
this could encourage market participants to display greater size to the 
market, which could enhance liquidity and transparency.
    iv. Order Execution Algorithm. Based on the above, the NASD and 
Nasdaq propose to amend the order execution algorithm to execute non-
directed orders entered into the system as follows: (1) displayed 
quotes of market makers, ECNs that do not charge a quote-access fee to 
non-subscribers, non-attributable agency quotes of UTP Exchanges, in 
time priority between such participants; (2) displayed quotes of ECNs 
that charge a quote-access fee to non-subscribers, in time priority 
between such participants; (3) reserve size of market makers and ECNs 
that do not charge a quote-access fee to non-subscribers in time 
priority between such participants; (4) reserve size of ECNs that 
charge a quote-access fee to non-subscribers in time priority between 
such participants; and (5) principal quotes of UTP Exchanges, in time 
priority between such participants. The exception to the above would be 
if a non-directed order was from a market maker or ECN at the inside, 
the system would match off a non-directed order against that market 
maker or ECN (in lieu of sending it to the next market participant in 
queue). Second, if displayed size is exhausted and there is still 
reserve size available at that price, for the purpose of delivering the 
next order, the system would determine priority first based on the 
displayed size of the refreshed quotes and then based on time.
2. Statutory Basis
    The NASD and Nasdaq believe that the proposed amendments are 
consistent with the provisions of Sections 15A(b)(6) and (b)(11) of the 
Act,\17\ as well as Sections 11A(a)(1)(C) and 11A(a)(1)(D) of the 
Act.\18\ Section 15A(b)(6) \19\ 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 not be designed to 
permit unfair discrimination between customers, issuers, brokers, or 
dealers. Section 15A(b)(11) of the Act \20\ requires that the rules of 
a registered national securities association be designed to produce 
fair and informative quotations, prevent fictitious or misleading 
quotations and to promote orderly procedures for collecting, 
distributing, and publishing quotations. Section 11A(a)(1)(C) of the 
Act \21\ states that 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. Section 11A(a)(1)(D) \22\ states 
that Congress finds that the linking of all markets for qualified 
securities through communication and data processing facilities will 
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.
---------------------------------------------------------------------------

    \17\ 15 U.S.C. 78o-3(b)(6) and (b)(11).
    \18\ 15 U.S.C. 78k-1(a)(1)(C) and (a)(1)(D).
    \19\ 15 U.S.C. 78o-3(b)(6).
    \20\ 15 U.S.C. 78o-3(b)(11).
    \21\ 15 U.S.C. 78k-1(a)(1)(C).
    \22\ 15 U.S.C. 78k-1(a)(1)(D).
---------------------------------------------------------------------------

    The NASD and Nasdaq believe that the amendments to the odd-lot 
process balance the concerns raised by commenters regarding potential 
gaming

[[Page 16993]]

and the need for a fair and orderly method of executing odd-lot orders. 
The NASD and Nasdaq believe this proposed change would prevent 
fraudulent and manipulative acts, since it would reduce the opportunity 
for gaming. Additionally, the proposed changes to the five-second 
interval delay, provide a balance between the need of institutional 
investors and market professionals for speed, while providing greater 
price continuity for individual investors. Thus, the NASD and Nasdaq 
believe the proposal is consistent with Sections 15A(b)(6) and 
(b)(11),\23\ as well as Section 11A(a)(1)(C) of the Act.\24\
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78o-3(b)(6) and (b)(11).
    \24\ 15 U.S.C. 78k-1(a)(1)(C).
---------------------------------------------------------------------------

    The NASD and Nasdaq believe the proposed changes to the order 
execution algorithm addresses competitive concerns raised by some ECNs, 
in that all ECNs that do not charge a quote-access fee (whether they 
accept automatic execution or order delivery) would be treated in time 
priority. Additionally, the change as it relates to ECNs that charge a 
fee addresses concerns about best execution. Specifically, this change 
ensures that an investor's order would be routed to the market 
participant in Nasdaq that is displaying the best price, when 
considering quote access fees. Accordingly, the NASD and Nasdaq believe 
that these changes are consistent with Sections 15A(b)(6) and (b)(11) 
of the Act,\25\ and Sections 11A(a)(1)(C) and 11A(a)(1)(D).\26\
---------------------------------------------------------------------------

    \25\ 15 U.S.C. 78o-3(b)(6) and (b)(11).
    \26\ 15 U.S.C. 78k-1(a)(1)(C) and (a)(1)(D).
---------------------------------------------------------------------------

    The NASD and Nasdaq believe that the changes regarding the handling 
of agency orders from UTP Exchanges is consistent with Congress view of 
a national market system. That is, this approach assures that a 
customer's order in a Nasdaq security, no matter where it is entered in 
the National Market System, would be executed on a price/time priority 
basis. Accordingly, the NASD and Nasdaq believe the proposal is 
consistent with Sections 11A(a)(1)(C) and 11A(a)(1)(D) of the Act.\27\
---------------------------------------------------------------------------

    \27\ 15 U.S.C. 78k-1(a)(1)(C) and (a)(1)(D).
---------------------------------------------------------------------------

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The NASD and Nasdaq do not believe that the proposed rule change 
will result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 4, including whether Amendment No. 4 
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 Amendment No. 4 to file number 
NASD-99-53 and should be submitted by April 20, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\28\
---------------------------------------------------------------------------

    \28\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-7840 Filed 3-29-00; 8:45 am]
BILLING CODE 8010-01-P