[Federal Register Volume 65, Number 158 (Tuesday, August 15, 2000)]
[Notices]
[Pages 49842-49860]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-20686]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43133; File No. SR-NASD-99-53]


Self-Regulatory Organizations; Notice of Filing of Amendment Nos. 
5, 6, and 7 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

August 10, 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 
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 Nos. 5, 6, and 7 to the proposed rule change 
as described in Items I, II, and III below, which Items have been 
prepared by Nasdaq. On May 16, 2000, Nasdaq filed Amendment No. 5 to 
the proposal.\3\ On July 6, 2000, Nasdaq filed Amendment No. 6 to the 
proposal.\4\ On August 7, 2000, Nasdaq filed Amendment No. 7 to the 
proposal.\5\ The proposed rule change and Amendment Nos. 1 and 2 were 
published for comment in the Federal Register on December 6, 1999.\6\ 
On March 16, 2000, Nasdaq filed Amendment No. 3 to the proposal.\7\ On 
March 30, 2000 Amendment No. 4 was published for comment in the Federal 
Register.\8\ The Commission is publishing this notice to solicit 
comments on Amendment Nos. 5, 6, and 7 to the proposed rule change from 
interested persons.\9\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Richard G. Ketchum, President, NASD, to 
Belinda Blaine, Associate Director, Division of Market Regulation 
(``Division''), Commission (May 16, 2000) (``Amendment No. 5'').
    \4\ See letter from Richard G. Ketchum, President, NASD, to 
Belinda Blaine, Associate Director, Division of Market Regulation 
(``Division''), Commission (July 6, 2000) (``Amendment No. 6'').
    \5\ See letter from Richard G. Ketchum, President, NASD, to 
Belinda Blaine, Associate Director, Division of Market Regulation 
(``Division''), Commission (August 7, 2000) (``Amendment No. 7'').
    \6\ See Securities Exchange Act Release No. 42166 (Nov. 22, 
1999), 64 FR 69125.
    \7\ 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.
    \8\ See Securities Exchange Act Release No. 42573 (March 23, 
2000), 65 FR 16981.
    \9\ This 19b-4 filing, representing Amendment Nos. 5, 6, and 7 
to SR-NASD-99-53, reflect the substantive amendments to the filing, 
and contains some technical changes and clarifying information to 
the proposal.
---------------------------------------------------------------------------

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: \10\
---------------------------------------------------------------------------

    \10\ The amended rule language contained in this notice reflects 
the Commission's 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, 3 and 4.
---------------------------------------------------------------------------

    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]

[[Page 49843]]

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 
in The Nasdaq Stock Market] must display a 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.
    (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['s] 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 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:
    (1) 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.
    (2) 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, which must be at least one normal unit of 
trading. The [maximum order] automatic refresh size default [size] 
amount 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

[[Page 49844]]

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.
    (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 Participants.
    (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 (NNMS)] 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 
participants in the NNMS with respect to one or more NNMS eligible 
securities.
    (1) 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.
    (2) 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 that are Liability 
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.
    [(e)] (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.
    [(b)] (u) The term ``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. Unless specifically referring to a UTP Exchange's 
Agency Quote/Order (as set out in Rule 4710(f)(2)(b)), when this term 
is used in connection with a UTP Exchange, it shall mean the best bid 
and/or 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

[[Page 49845]]

    (5) acceptable 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 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.
    (d) Participation in NNMS as an NNMS 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 4710(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/Order displayed in the 
Nasdaq Quotation Montage, subject to the following conditions and 
requirements:
    (1) Unless the Quoting Market Participant to which a Directed Order 
is being sent has indicated that it wishes to receive Directed Orders 
that are Liability Orders, a Directed Order must be a Non-Liability 
Order, and as such, at the time of order entry must be designated as:
    (A) 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
    (B) 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. Nasdaq will append an indicator to the quote of a Quoting 
Market Participants that has indicated to Nasdaq that it wishes to 
receive directed orders that are Liability Orders.
    (2) 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 4710(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

[[Page 49846]]

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 at a single 
as well as multiple price levels. Such Quote/Order shall indicate 
whether it 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 a least one normal unit of trading.
    (4) Nasdaq Quoting Market Participants may continue to transmit to 
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 Non-Attributable Quote/Order in the Nasdaq 
Order Display Facility (consistent with the parameters described above) 
if it falls 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 an NNMS 
Market Maker, NNMS ECN, or 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 NNMS 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 an 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 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; provided however, that the 
system always shall deliver an order (in lieu of an execution) to the 
Quoting Market Participant next in queue when the participant that 
entered the Non-Directed Order into the system is a UTP Exchange that 
does not provide automatic execution against its Quotes/Orders for 
Nasdaq Quoting Market Participants and NNMS Order Entry Firms. Non-
Directed Orders entered into

[[Page 49847]]

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 separate quote-access fee to non-subscribers, and Non-
Attributable agency Quotes/Orders of UTP Exchanges (as permitted by 
subparagraph (f) of this rule), as well as Quotes/Orders from NNMS ECNs 
that charges a separate quote-access fee to non-subscribers where the 
ECN entering such Quote/Order indicates that the price improvement 
offered by the specific Quote/Order exceeds the separate quote-access 
fee the ECN charges, in time priority between such participants' Quote/
Orders;
    (ii) Displayed Quote/Order of NNMS ECNs that charge a separate 
quote-access fee to non-subscribers, in time priority between such 
participant's Quote/Orders;
    (iii) Reserve Size of NNMS Market Makers and NNMS ECNs that do not 
charge a separate quote-access fee to non-subscribers, as well as 
Reserve Size of Quote/Orders from NNMS ECNs that charges a separate 
quote-access fee to non-subscribers where the ECN entering such Quote/
Order has indicated that the price improvement offered by the specific 
Quote/Order exceeds the separate quote-access fee the ECN charges, in 
time priority between such participants' Quote/Orders;
    (iv) Reserve Size of NNMS ECNs that charge a separate quote-access 
fee to non-subscriber, in time priority between such participants' 
Quote/Orders; and
    (v) Principal Quote/Orders of UTP Exchanges, in time priority 
between such participants' Quote/Orders [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 Quote/Orders at a price 
level are simultaneously exhausted and there is Reserve Size available 
at that price, when Displayed Quote/Orders are refreshed from Reserve 
Size the system will establish order-receipt priority for these 
refreshed Quote/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 Quote/Orders.
    (C) Decrementation Procedures--The size of [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 [o]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 transmition 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 Quote/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 Quote/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 Quote/Orders and Reserve Size 
interest at the initial price level and at price 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 executed the remaindere of order in full; or
    (ii) If the Non-Directed Orders is specially designated by the 
entering market participants as a ``sweep order,'' the system will 
execute against all Displayed Quote/Orders and Reserve Size at the 
initial price level and the two price levels being displayed in the 
Nasdaq Order Display Facility 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.
    (iii) The interval delay described in this subparagraph may be 
modified upon Commission approval and appropriate notification to NNMS 
Participants.

[[Page 49848]]

    (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 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 q] 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 marker'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 
a[n] price interval designated by the NNMS Market Maker; and
    (ii) Nasdaq will refresh the market maker's displayed size to a 
level designated by the NNMS Market Maker, or in the absence of such 
size level designation, to the automatic refresh size. [A Market 
Maker's Agency Quotation shall not be subject to the functionality 
described in the subparagraph.]
    (iii) This functionality shall produce an Attributable Quote/Order. 
In addition, if an NNMS Market Maker is utilizing the QR functionality 
but has an Atributable 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 (consistent with subparagraph (b) of this rule) as follows:
    (i) For locked-market situations, the order will be routed to the 
Quoting Market Participant next in queue who 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, and NNMS Market 
Maker that withdraws from a security may not re-register in the system 
as a market maker in that security for twenty

[[Page 49849]]

(20) business days. The requirements of this subparagraph shall not 
apply to a market maker's Agency Quote.
    [(A) Nothwithstanding 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.
    (B) If a market maker has exhausted the reinstatement limitations 
in subparagraph (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 NNMS 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 subparagraph[s] (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, 
unless the Quoting Market Participant to which a Directed Order is 
being sent has indicated that it wishes to receive Directed Orders that 
are Liability Orders (as described in Rule 4706(b)).
[(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

[[Page 49850]]

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 makers 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-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

    As a general matter, Nasdaq shall endeavor to provide fair and 
equivalent access to the Nasdaq market for UTP Exchanges, as a UTP 
Exchange provides to its market for Nasdaq Quoting Market Participants 
and NNMS Order Entry Firms. Unless specified otherwise in these rules 
or in the Nasdaq UTP Plan, UTP Exchanges may 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

    (i) A UTP Exchange may transmit to the NNMS Quotes/Orders at a 
single as well as multiple price levels 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'').
    (ii) 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

    (a) UTP Exchanges that agree to provide automatic execution against 
their Quotes/Orders for Nasdaq Quoting Market Participants and NNMS 
Order Entry Firms, shall accept an execution of an order up to the size 
of the UTP Exchange's displayed Quote/Order, and shall have Non-
Directed Orders they enter into the system processed as described in 
subparagraph (b) of this rule.
    (b) UTP Exchanges that do not provide automatic execution against 
their Quotes/Orders for Nasdaq Quoting Market Participants and NNMS 
Order Entry firms, shall accept the delivery of an order up to the size 
of the UTP Exchange's Displayed Quote/Order, and shall have Non-
Directed Orders they enter into the system processed as described in 
subparagraph (b) of this rule. If such a UTP Exchange declines or 
partially fills a Non-Directed Order without immediately transmitting 
to Nasdaq a revised Quote/Order that is at a price inferior to the 
previous price, or if such a UTP Exchange fails to respond in any 
manner within 5 seconds of order delivery, the NNMS will send the order 
(or remaining portion thereof) back into the system for delivery to the 
next Quoting Market Participant in queue. The system will then move the 
side of such UTP Exchange's Quote/Order to which the declined or 
partially-filled order was delivered, to the lowest bid or highest 
offer price in Nasdaq, at a size of 100 shares.
    (4) Directed order Processing--UTP Exchanges shall participate in 
the

[[Page 49851]]

Directed Order processing as described in subparagraph (c) of this 
rule.
    (5) Decrementation--UTP Exchanges shall be subject to the 
decrementation procedures described in subparagraph (b)(1)(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 its 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''). 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 communications 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 order 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. In 
response to comment letters Nasdaq submitted Amendment Nos. 5, 6, and 
7, which are described in greater detail below.
    a. Amendment No. 5. i. Nasdaq Technology Resources: The NASD and 
Nasdaq wish to give all assurances that construction of the Nasdaq 
order Display Facility (also known as the ``SuperMontage'') will not 
divert resources from our ongoing decimalization efforts. Nasdaq's 
SuperMontage development team consists of personnel that are 
exclusively dedicated to SuperMontage and are completely separate from 
other Nasdaq software teams. Nasdaq has used outside consultants to 
augment internal staff where needed for SuperMontage. Nasdaq has not 
and will not, in any way, divert technology resources from those needed 
to ready Nasdaq systems for decimal pricing or to meet other critical 
initiatives.
    Nasdaq's trading operations is run in our state-of-the-art Nasdaq 
Technology Center in Trumbull, Connecticut. Since the core operations 
of Nasdaq system are unique, Trumbull staff have to write and implement 
much of the software to ensure Nasdaq's reliable operation. The 
facility in Trumbull includes the most advanced infrastructure 
available in computer operations today, including connection to two 
separate electrical power feeds, it's own power generations, and 
sophisticated systems that oversee and proactively protect against 
failure situations.
    The quotation facilities and execution and post-trade facilities of 
Nasdaq currently are operated on two separate computer systems--the 
Tandem System and the Unisys System. The Tandem System functions as the 
processor of executions that occur through Nasdaq's trading platforms. 
The Tandem execution and post-trade systems include the Automated 
Confirmation and Transaction Service (``ACT''), SelectNet, and the 
Small Order Execution System (``SOES''). The capacity of the Tandem, 
which Nasdaq represents is a highly reliable and scalable system, is a 
function of the number of work paths that can be created in parallel--
by adding a module of machine Nasdaq can continue to scale to 
capacities many times larger than our current capabilities.
    The Unisys System functions as the processor of quotations, which 
are displayed on the Nasdaq WorkStation and are disseminated to vendors 
and the Public. The Unisys operates in an entirely separate environment 
from the Tandem system. Unlike the execution and post-trade functions 
which can be scaled across parallel processors, the Unisys processes 
all quote updates through a single machine. \11\ \12\
---------------------------------------------------------------------------

    \11\ [Reserved]
    \12\ The Unisys System uses only about 62% of its processing 
capacity, and can transact 700 quotations per second, about twice 
what our current average peak demand is at the market's opening.
---------------------------------------------------------------------------

    As has been the case for many years, the technology staff that 
programs and maintains the Unisys System and its applications is 
separate and distinct from the technology staff that programs and 
maintains the Tandem System. This is because these systems demand a 
high level of understanding and expertise in how they function, which 
is a knowledge and skill-set base that is often difficult to develop in 
a short period of time. The system architecture of the Unisys is vastly 
different from the system architecture of the Tandem. Similarly, the 
language that Nasdaq staff uses to code Tandem applications is 
completely different than the Unisys coding language. Both languages 
are highly specialized and complex in nature. Thus, it would not be an 
easy or quick undertaking for a Tandem programmer to learn the 
architecture and programming language for the Unisys system, and vice 
versa.
    Because Nasdaq systems must be highly reliable and because the 
systems are highly sophisticated and complex, the technology staff must 
have a deep understanding of their respective systems so that they may 
react to a system problem in the most expeditious manner. This is 
necessary to ensure the integrity of the market. Thus, the Nasdaq staff 
that maintains the Tandem and Unisys systems are by necessity highly 
skilled and highly specialized ``experts'' in their subject system. 
This expertise extends not only to programming skill but to system 
architecture knowledge and agility to ``trouble shoot.'' Conversely, in 
our opinion it would be extremely difficult and inefficient (if not ill 
advised) for the Tandem and Unisys staff to attempt to become experts 
in the other's system, particularly over the short term.
    As to SuperMontage, that system is being built using the multi-
parallel

[[Page 49852]]

architecture (``MPA'') that runs on a high-performance and highly 
reliable parallel computing platform on the Tandem System. Nasdaq is 
modifying its existing Unisys-based quotation platform to accommodate 
decimal pricing, and that project is staffed with a dedicated Unisys-
based development team. Thus, the development team on the Unisys-based 
decimalization project cannot be drawn onto the Tandem-based 
SuperMontage project, and vice versa. In fact, there are 30 programmers 
who are dedicated to Nasdaq's efforts to achieve decimals. These 
resources will not be utilized or otherwise distracted from their 
efforts to achieve trading in a decimal environment. Nor will any other 
resources related to achieving decimalization--such as quality 
assurance and testing personnel--be utilized at the expense of 
completing decimalization efforts. Personnel resources for decimals 
will take complete priority over other Nasdaq projects, such as 
SuperMontage.
    With respect to non-personnel resources, the SuperMontage project 
utilizes dedicated Tandem computing resources for development and 
integration testing while sharing the actual production testing 
facilities with other Tandem-based applications. The decimalization of 
other Tandem legacy applications, such as SOES, SelecNet, and ACT, use 
other non-conflicting resources.
    All of the NASD's international development efforts have been out-
sourced to separate and distinct teams, with only two individuals 
coming from existing NASD staff--neither of whom were involved in any 
related Nasdaq market systems. All systems development for the 
international markets is being performed by a joint venture company and 
has no impact on domestic Nasdaq development or resources. All NASD and 
NASD Regulation activities have been out-sourced in Electronic Data 
Systems, which relieves the Nasdaq team of any billing or 
administrative technology burdens. Systems development for the American 
Stock Exchange is managed by a fully independent team that is not out-
sourced to SIAC.
    ii. Automatic Execution and Order Delivery: In response to the 
request of Commission staff, Nasdaq is also responding to a suggestion 
by one commentor that Nasdaq develop a hybrid order-routing and 
execution assignment system instead of SuperMontage.\13\ Under this 
alternative proposal, Nasdaq would send orders (not executions) to 
liquidity providers, and would default to an execution if the liquidity 
provider did not respond within a specified time frame. The commentor 
asserts this would be a better approach for reducing dual liability for 
ECNs, instead of what Nasdaq has proposed vis a vie the request to 
cancel feature.
---------------------------------------------------------------------------

    \13\ See Bloomberg Letter.
---------------------------------------------------------------------------

    First, many of the commenters arguments are grounded in the 
assumption that ECNs will be forced to accept automatic execution. 
According to the commentor, this is because (as originally proposed) 
market makers and ECNs that accept automatic execution against their 
quotes (``auto-ex ECNs'') will have priority to receive non-directed 
orders over ECNs that accept order deliver (``Order-Deliver ECNs''), 
regardless of time priority. In Amendment 4 to this filing, we have 
proposed to alter the order-execution algorithm so that the system no 
longer determines execution priority based on the manner in which an 
ECN participates in Nasdaq. Rather, the system will now route non-
directed orders to market makers, ECNs that do not charge a quote 
access fee, and to a UTP-Exchange's non-attributable agency interest, 
in strict price/time priority as between these market participants. (As 
re-proposed, non-directed orders will be routed to ECNs that charge an 
access fee after the interest of market makers, ECNs that do not charge 
an access fee, and UTP-Exchange's non-attributable agency interest.) 
Thus, the underlying basis of this commentor's argument is no longer 
true.
    Next, the commentor's counter-proposal that Nasdaq essentially act 
as an order switch and eliminate automatic execution, is problematic at 
best. The Commission has long recognized the many benefits that 
automatic execution provides. Automatic execution ensures a level of 
certainty that orders from large and small investors alike will be 
filled almost instantaneously. Certainty of execution is important to 
all investors, particularly in fast moving markers.
    The NASD and Nasdaq developed the Small Order Execution System to 
address concerns that individual investors have a facility for 
processing their orders quickly and efficiently. In our view, the 
commentator's approach could harm investors, particularly small 
investors, as there no longer would be a method of providing automatic 
execution to small orders. This would be a step backwards in light of 
the fact that Nasdaq will soon implement the Nasdaq National Market 
Execution System (``NNMS''), which will move most trading in Nasdaq 
(save for ECNs that choose to take order delivery only) to an automatic 
execution environment.
    Additionally, if all market participants only receive orders (as 
opposed to executions) which they may reject in full or fill partially, 
the likelihood of investors' orders being ``bounced'' from one market 
participant/market center to another would substantially increase. 
This, in turn, would increase the likelihood that orders would be 
partially executed or not executed at all, and ultimately ``traded 
through.'' This approach also could result in orders that are entered 
later in time being filled before orders that are entered earlier in 
time, depending on how and when the market participant receiving the 
order responds to the order.
    As an illustration of these problems, assume the market is $20-
$20\1/16\ at 10:00:01 a.m., and the following quotes are being 
displayed on the bid side of the market:

ECNI $20--1,000 (total, including reserve)
MMA $20--1,000 (total, including reserve)
MMC $19\15/16\--100 (total, including reserve)
MMD $19\7/8\--2000 (total, including reserve)

    Orders are entered and processed as follows:
     At 10:00:02 Customer A enters a marketable limit order to 
sell 1,000 shares at $19\15/16\, which is routed to ECN1. The order 
resides at ECN1 while ECN1 determines whether to accept, decline, or 
partially fill the order.
     At 10:00:06 a.m., Customer 2 enters a marketable limit 
order to sell 500 shares at 20 and Customer 3 enters a market order to 
sell 500 shares. Both of these orders are executed immediately upon 
receipt by MMA.
     At 10:00:07 a.m., ECNI determines to decline Customer 1's 
order, which is routed back in to the system and re-delivered to MMC. 
MMC then fills 100 shares of Customer 1's order at a price of $19 \15/
16\. Customer 1's order is filled only partially; the remaining 900 
shares of Customer 1's order go unfilled because the market has moved 
to $19 \7/8\ and the order is no longer marketable.
    Note that in the above situation, Customers 2 and 3 had their 
orders filled in full even though they entered their orders into the 
system later in time. Additionally, the ``bouncing'' of Customer 1's 
order results in a partial fill at a price ($19 \15/16\) that is 
inferior to the prices that Customers 2 and 3 received. As this 
illustration shows, surety and efficiency of execution is substantially 
decreased by the commentor's counter-proposal.
    Separately, Nasdaq believes that automatic execution reduces the

[[Page 49853]]

potential that a market participant may back away from (i.e., refuse to 
honor) its quote. Under the commentor's counter-proposal, instances of 
backing away complaints would surely increase. In light of the fact 
that we believe that backing away will decrease significantly when the 
NNMS is implemented, it would appear to us that moving to a pure order-
delivery environment would be a step backward in terms of streamlining 
surveillance and reducing regulatory costs for members.
    The commentor's suggestion that the system deliver an execution 
after a specified time period, in our view, could exacerbate the ``dual 
liability'' that commentor complains of in the first instance. In 
contrast, Nasdaq believes that Nasdaq's proposal to retrieve an order 
if there is no response after five seconds is more reasonable and 
protects against double executions. For example, under the commentor's 
proposal if an ECN or market maker is having equipment problems and 
cannot timely decline an order or move its quote out of the way, the 
system would deliver an execution against a quote that no longer is 
valid. If the equipment problems of the market maker or ECN prevent it 
from changing its quote, multiple orders and executions could 
thereafter be delivered to the same stale quote. Conversely, under our 
proposal, the order would not execute against a stale quote; rather the 
system would simply retrieve and route the order to the next available 
market participant, blank out that market stale participant's quote, 
and not deliver more orders and executions to that stale quote until 
the system problems were resolved. Our proposed approach appears to be 
a more reasonable and measured approach, and eliminated (instead of 
potentially exacerbating) concerns of dual liability.
    In addition, automatic execution significantly reduces the 
potential for locked and crossed markets. Locked/crossed markets have a 
negative impact on market quality and can result in disorderly markets. 
Nasdaq believes that the NNMS will reduce instances of locked/crossed 
markets because a substantial number of market participant quotes will 
be subject to automatic execution. In SuperMontage, locked/crossed 
markets will be eliminated altogether. However, Nasdaq believes that 
the commentor's proposal would lessen the system's efficacy in reducing 
and eliminating locked/crossed markets. The system presumably would not 
move stale quotes out of the way and hence resolve a locked/crossed 
market; instead, the system would keep delivering orders and defaulting 
to executions against a stale quote. The quote would have to be 
manually removed before the lock/cross could be resolved.
    Lastly, Nasdaq recognizes that no approach will eliminate all of 
the potential problems associated with a system that relies strictly on 
automatic execution or order deliver. Nasdaq has proposed the 
alternative approach in this filing to accommodate the needs of diverse 
market participants, while assuring that a minimum level of the 
protections and benefits offered by automatic execution is built into 
the system. Recognizing that ECNs act as agent only, we have given 
ECN's a choice of how to participate in Nasdaq, as well as the tools 
for eliminating dual liability. In this way, Nasdaq believes that our 
proposal strikes a reasonable balance between protecting investors and 
ensuring fair and orderly markets by providing automated executions, 
while also meeting this specific needs of market participants.
    ii. Sweep Orders and Request to Cancel: On a similar matter, 
Commission staff has asked us to specifically address how the sweep 
order and the request to cancel function will interact for market 
makers and ECNs that accept automatic execution. As noted in Amendments 
3 and 4 to this filing, a market participant would be able to set a 
parameter on an individual order so that the order would execute 
against 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, assume that at 10:00:01 a.m., the inside market in 
Stock G is $104.55 to $104.60, and the following quotes/orders are 
being displayed in the system on the bid side of the market:

MMA $104.55--1,000 (total, including reserve)
MMB $104.50--2,000 (total, including reserve)
ECN1 $104.45--9,000 (total, including reserve)
MMC $104.45--1,000 (total, including reserve)

    At 10:00:02 a.m., Institution Q enters a 10,000 share market sell 
order (through a market maker), which is designated as a Sweep Order. 
since the order will be filled in full by the interest that is at the 3 
price levels being displayed in Nasdaq, Institution Q's order is filled 
in full with no time delay between prices. If at 10:00:02 a.m., while 
the Sweep Order were executing against the quotes/orders in Nasdaq, an 
internal subscriber of ENC1 also wished to execute against the $104.45 
for 9,000 shares being displayed in Nasdaq, before filling the 
subscriber's order, ENC1 could send a request to cancel the order to 
Nasdaq. If Nasdaq had already executed against the 9,000 shares, ENC1 
would send a message to its customer declining the execution because 
the quote/order had filled viz a vie the Sweep Order. If the Nasdaq had 
not executed against the 9,000 shares, ENC1's request to cancel would 
be granted, the internal execution could occur, and the remainder of 
Institution Q's order would be executed against MMC.
    iv. System Roll Out: As Nasdaq explained in Amendment No. 3 to this 
filing, they understand concerns that the system should be rolled out 
in phases, and they will attempt to roll out the system on a measured 
basis. In response to Commission staff request, Nasdaq is providing 
further detail on the planned roll-out schedule.
    v. Notification of Changes, Coding and Testing: If the Commission 
approves this filing, it would be Nasdaq's plan (consistent with 
previous practice) to give market participants and vendors at least 90 
days notification of a change in system specifications. At the time 
that Nasdaq gives notification, they plan to give market participants 
the new specification so that they can begin to analyze the system 
changes and take appropriate measures to implement the changes. During 
this period, most market participants will begin to code their systems. 
Throughout this period, Nasdaq staff will work with market participants 
to answer any system and specification-related questions and issues.
    At least 60 days prior to system implementation, Nasdaq plans to 
give participants notice of testing capabilities-i.e., specific testing 
dates and notification of the availability of a testing environment. 
Lastly, at least 30 days prior to system implementation, Nasdaq plans 
to make available a testing environment for firms to begin testing 
their software and hardware (if applicable). Additionally, Nasdaq plans 
to hold at least two full day, mock trading sessions on weekend days. 
This will allow market participant to train their personnel on the new 
system and to participate in a real-time trading environment.

[[Page 49854]]

    vi. Stock Phase-In: Nasdaq plans to roll out the systems similar to 
the manner in which we implemented the SEC's Order Handling Rules in 
the Nasdaq environment. Specifically, it is their intention to 
implement the system on ``day one'' for a limited number of securities 
(e.g., 100) which represent a cross-section of Nasdaq-listed stocks. On 
a regular basis thereafter, Nasdaq will include 100 new stocks in the 
system until the system is implemented for all Nasdaq-listed 
securities. Nasdaq will select a cross section of stocks to be included 
in each group of 100 securities to be rolled out during a particular 
week.
    The purpose of the roll out is to give Nasdaq and its members the 
opportunity to observe and gain experience with the new system and to 
give Nasdaq the opportunity to make any adjustments and changes to the 
system (in consultation with and approval by the Commission), if and 
when necessary. Accordingly, while Nasdaq has proposed to included 100 
additional securities on a rolling basis, they seek to retain a 
reasonable degree of latitude to adjust the schedule if experience and 
events so dictate. Nasdaq believes this approach reasonably responds to 
the comments, in that it should give market participants time to 
adequately identify and address issues (technical or otherwise) that 
may arise when the system is implemented. Additionally, Nasdaq will 
work closely with the Commission during the roll-out phase to ensure a 
smooth transition to the new system.
    vii. SuperMontage is Voluntary: Nasdaq is reiterating that the NODP 
is completely voluntary. They understand that market participants may 
not wish to relinquish their order book to Nasdaq and that they may 
provide valuable services away from the central Nasdaq market. As 
Nasdaq has stated in the past, market makers and ECNs will retain 
ownership of their orders displayed in the Nasdaq system and it is our 
intention to file a rule change in the near future that would allow 
ENCs and market makers to share in revenues gained from their 
execution. Nasdaq also reiterates that nothing requires or compels 
market participants to give their order book to Nasdaq. ECNs and market 
makers are free to give Nasdaq only their top of file (consistent with 
the SEC's Order Handling Rules), or they can choose to give Nasdaq all 
or some of their orders. Nor does anything require that executions in 
Nasdaq securities occur through the SuperMontage or other Nasdaq 
facility. To be sure, any of these options for handling and executing 
orders would be consistent with NASD rules.
    While the proposal provides a central means for accessing liquidity 
in Nasdaq and other market centers, it in no way establishes the 
SuperMontage as the sole means for providing or accessing liquidity. 
NASD members, individual investors, and members of other exchanges are 
free to leave their orders with any market center they chose. Moreover, 
subscribers of ECNs are free to use the execution services offered by 
the ECNs to access liquidity within that market center. Nasdaq notes 
that a number of ECNs have recently publicly announced plans to link 
with one another, independent of the Nasdaq network and execution 
systems. Nothing in the NODF proposal prohibits ECNs and other market 
participants from establishing links or order-routing arrangements. The 
SuperMontage will provide a central, but not exclusive, means of 
accessing liquidity and of exposing trading interest to the market.
    viii. Best Execution: As re-proposed in Amendment No. 4 to this 
filing, ECNs that charge an access fee, would be executed after 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\ Thus, orders of market makers, ECNs 
that do not charge an access fee, and agency orders of UTP Exchanges, 
would be executed in strict price/time priority, but orders of ECNs 
that charge an access fee would be executed after the aforementioned 
interest at a price level were exhausted. We stated that this 
prioritization is consistent with common industry practice today, where 
a market participant will 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 
and best execution. One commentor stated, however, that such a 
prioritization was contrary to best execution because ECNs offer a 
price better than a market maker at the NBBO even after access fees 
have been fully deducted from the execution price. This sometimes 
occurs because ENCs permit subscribers to trade in finer increments 
than recognized by Nasdaq's quotation system and such finer-priced 
orders are rounded to the nearest quotation increment when they are 
displayed in Nasdaq.
---------------------------------------------------------------------------

    \14\ We note that Commission staff and at least one commentor 
raised concerns about ECN fees and best execution. See e.g., ITG 
Letter.
---------------------------------------------------------------------------

    Nasdaq disagrees with these assertions. They believe that when 
Nasdaq implements decimals--which will occur prior to SuperMontage--
such rounding will not occur to the extent that it does today. That is, 
in a decimals environment the quotation increments will most likely be 
fine enough to match the trading increment. Accordingly, if an ECN 
charges a fee over and above its quote, that ECN's quote will represent 
an inferior price in comparison to an ECH that charges a fee should be 
accessed behind the ECN that does not charge.
    b. Amendment No. 6. i. Odd lot Processing: In Amendment No. 4, we 
proposed to change the odd lot process to of the Nasdaq Order Display 
Facility (``NODF'' or ``SuperMontage'' as follows: (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.\14\ Under the re-proposal, while odd-lots would 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. In Amendment No. 4, Nasdaq noted 
that under the re-proposal, 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. They also noted that if no 
market maker had an odd-lot exposure, the system would suspend 
processing of odd-lots until exposure interest was refreshed. Odd-lot 
executions would decrement the exposure limit (not the quote or 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 was 
reduced to 0, the participant would be taken out of the odd-lot 
rotation unless and until the market maker sets a new exposure limit.
---------------------------------------------------------------------------

    \15\ In SOES today, 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.
---------------------------------------------------------------------------

    Despite the potential for odd-lot processing in a security to 
suspend if no market maker establishes an exposure limit, Nasdaq 
believes that competitive forces to capture and service this segment of 
the market will yield a swift and robust processing of odd-lot 
transactions. Additionally, we will closely monitor odd-lot processing 
during the roll-out of SuperMontage and we will be prepared to consider 
modifications to the system should the quality of odd-lot processing 
deteriorate.

[[Page 49855]]

    ii. Implementation Date: Nasdaq intends to implement SuperMontage 
as soon as practicable after decimal pricing is fully implemented in 
Nasdaq. As stated in previous amendments, Nasdaq will provide 
sufficient lead time for all market participants to have the 
opportunity to adequately prepare and test their internal systems for 
SuperMontage functionality before implementing its new system.
    iii. Order Execution Algorithm: As re-proposed in Amendment No. 4 
to this filing, ECNs that charge a separate access fee, would be 
executed after UTP Exchange agency interest, market makers, and ECNs 
who do not charge a separate access fee because such a fee represents 
an increase in trading costs and clearly an inferior price.\16\ Thus, 
orders of market makers, ECNs that do not charge a separate access fee, 
and agency orders of UTP Exchanges, would be executed in strict price/
time priority, but orders of ECNs that charge a separate access fee 
would be executed after the aforementioned interest at a price level 
were exhausted. Nasdaq stated that this prioritization is consistent 
with common industry practice today, where a market participant will 
route its orders first to market makers and ECNs that do not charge an 
access fee and then to ECNs that charge an access fee, to ensure the 
investor incurs the lowest possible trading costs and best execution.
---------------------------------------------------------------------------

    \16\ We note that Commission staff and at least one commentor 
raised concerns about ECN fees and best execution. See e.g., ITG 
Letter.
---------------------------------------------------------------------------

    The prioritization described above is based on the current 
environment in which ECNs charge a separate fee when a market 
participant accesses its quote. We understand that in a decimals 
environment, ECNs may change the manner in which they charge fees and 
may develop the capability to reflect access fees in their published 
quotes. Nasdaq is strongly committed to working with ECNs to address 
the related trade-reporting and clearing issues, as well as the 
significant technology changes that would need to be addressed in order 
for ECNs to reflect their fees in their quotes. Once these issues and 
technology changes are resolved, these ECN quotes would be given the 
same priority for non-directed orders as market maker quotes/orders and 
non-attributable agency orders of UTP Exchanges.
    Additionally, when decimal pricing is implemented in Nasdaq, we 
understand that ECNs and market makers may wish to reflect orders in 
Nasdaq that are at an increment finer than one penny. This could occur, 
for example, if an ECN charges a separate access fee that is less than 
one penny and that separate access fee is included in the quoted price. 
In the event that priced quotations shrink to this level, Nasdaq is 
committed to re-examining the order execution algorithm (and the 
related technology, legal, and policy issues) to determine whether it 
is prudent and feasible to rank orders based on quotation increments of 
less than one penny.
    iv. UTP Exchange Participation: As noted in Amendment No. 4, Nasdaq 
has offered to provide automatic execution against Nasdaq market 
participants that take auto-ex for non-directed orders emanating from 
the floor of the Chicago Stock Exchange, so long as Chicago agrees to 
provide automatic execution for orders sent to the Chicago by Nasdaq 
market participants. This is consistent with Nasdaq's standing position 
that it is willing to provide automatic execution against its market if 
a UTP Exchange is willing to provide automatic execution against its 
specialist's quotes.
    Commission staff has noted that the proposed rules do not address 
the situation where a UTP Exchange may not wish to participate in 
automatic execution, but rather may wish to take order delivery against 
its quotes.\17\ In response to comments by Commission staff, Nasdaq has 
amended the proposed rules to address the situation where a UTP 
Exchange declines to participate in automatic execution, but rather 
wishes to take order delivery against its quotes (``Order-Delivery UTP 
Exchange''). Nasdaq had not previously included such rule language 
because that situation had not presented itself. In fact, no other UTP 
exchange has approached Nasdaq to discuss a reciprocal arrangement for 
market access. In the absence of a specific request by a UTP Exchange 
to participate in the SuperMontage on an order-delivery basis, Nasdaq 
is able to offer only generic rule language, similar to the proposed 
treatment of ECNs receiving order delivery in the Nasdaq system, to 
govern that hypothetical situation.
---------------------------------------------------------------------------

    \17\ This is because the Chicago Stock Exchange is currently the 
only Nasdaq UTP Plan Participant that has established the requisite 
interface for transmitting to the processor quotation and last sale 
information.
---------------------------------------------------------------------------

    Under the proposed generic rules, if an Order-Delivery UTP Exchange 
is next in queue to receive a non-directed Liability Order, Nasdaq will 
deliver the order to the UTP Exchange up to the size of the UTP 
Exchange's quote. The system will decrement the Order-Delivery UTP 
Exchange's quote by an amount equal to the size of the delivered order. 
If an Order-Delivery UTP Exchange declines or partially fills the 
order, Nasdaq will send the order (or remaining portion thereof) back 
into the system for immediate delivery to the next available quoting 
market participant (i.e., market maker, ECN, UTP Exchange). If the 
Order-Delivery UTP Exchange declines or partially fills the order 
without immediately transmitting a revised quote at an inferior price, 
or fails to respond in any manner within 5 seconds of order delivery, 
Nasdaq will presume equipment failure and immediately enroute the order 
to the next market participant in queue. After doing so, the system 
will automatically re-set the UTP Exchange's un-accessed bid or offer 
to the lowest bid or highest offer then being displayed in the system, 
at a size of 100 shares. Order-Delivery UTP Exchanges wishing to access 
the best price in the Nasdaq market may enter non-directed Liability 
Orders into the order collector facility, which will, in turn, deliver 
that order (rather than an automatic execution) to next quoting market 
participant. This delivery shall take place regardless of whether the 
recipient participates in automatic execution.
    In the event an UTP Exchange determines to participate in the NODF 
on an order-delivery basis, Nasdaq will revisit applicable rule 
language and, if necessary, make appropriate changes to its rules. As 
always, Nasdaq will continue to work with the Commission with any UTP 
Exchange wishing to participate in the NODF on an order-delivery basis, 
in a manner consistent with Nasdaq's long-standing policy of supporting 
fair and equivalent access among competing market centers.
    c. Amendment No. 7. i. Proposed Amendments: (A) Order Execution 
Algorithm. As proposed in Amendment No.6 to this filing, orders of ECNs 
that charge a separate quote-access fee would be executed after UTP 
Exchange non-attributable agency interest, market makers, and ECNs that 
do not charge a separate quote-access fee because such a fee represents 
an increase in trading costs and clearly an inferior price. Some ECNs 
claim that they should not be prioritized behind market makers, non-
attributable agency orders of UTP Exchanges, and ECNs that do not 
charge a separate quote-access fees because they (ECNs) often provide 
price improvement over their displayed quote price. Never the less, 
such treatment is consistent with previously articulated Commission 
policy.
    The Commission has suggested that ECNs could address the quote-
access fee issue by reflecting the fee in their public

[[Page 49856]]

quote.\18\ As stated in Amendment No. 6 Nasdaq is committed to working 
with the Commission and ECNs to implement this solution to the ECNs' 
concern.\19\ We also stated that ECN quotes would be given the same 
priority for non-directed orders as market maker quotes/ orders and 
non-attributable agency orders of UTP Exchanges, if ECNs develop the 
capability to reflect quote-access fees in their published quotes and 
the related legal, technology, and policy issues were resolved.\20\ As 
a result, in Amendment No. 6 Nasdaq proposed technical rule language 
that clarifies that we would give ECNs that include the quote-access 
fee in their quote the same priority as same-priced orders from UTP 
agency interest, market makers, and ECNs that do not charge a fee. The 
ECNs claim that including the fee in the quote will not completely 
resolve their concerns because: (1) ECN orders may be priced in 
increments less than a penny; and (2) ECNs do not charge the same fee 
to all subscribers, but rather charge a sliding fee based on a 
subscriber's volume. Nasdaq has addressed both of these arguments in 
our previous letter to you dated July 18, 2000, and for the reasons set 
forth in that letter, we continue to find their arguments unpersuasive.
---------------------------------------------------------------------------

    \18\ As proposed by the SEC, the maximum fee that the ECN 
charges to non-subscribers accessing the ECN's quote would be 
deducted from a bid or added to the offer price.
    \19\ See Amendment No. 6.
    \20\ As we stated previously, SuperMontage will not be 
implemented until decimal pricing is introduced in Nasdaq, where the 
minimum quotation increment is one penny. See July 18, 2000 Letter. 
In a penny environment, a quote that includes a fee will clearly 
represent an inferior price when compared to same-priced quotes of 
market participants that do not charge an access fee. Id. It would 
be unfair to the investing public and countrary to principals of 
best execution if Nasdaq's system routed an order to an ECN that 
charges a fee when that same order could be executed at a better 
price by a market participant that does not charge a fee. Id. We 
believe that including ECN access fees in the quotes will go a long 
way to improving price transparency in Nasdaq.
---------------------------------------------------------------------------

    Regardless, in an attempt to address and resolve this issue and be 
fully responsive to the Commission, we are amending the filing to offer 
a second alternative to ECNs. Specifically, ECNs that charge a separate 
access fee will have the ability to indicate on an order-by-order basis 
whether the price improvement offered by the order exceeds the access 
fee charged. If the price improvement exceeds the access fee, Nasdaq 
will rank that order for execution purposes with same-priced orders of 
market makers, ECNs that do not charge an access fee, and non-
attributable agency interest of UTP Exchanges. For example, if an ECN 
charges an access fee of a half a cent (.05 cents) on an order to buy 
at $20.005, that order would be ranked with orders to buy a $20.00 from 
market makers, ECNs, and non-attributable agency interest of UTP 
Exchanges. (Note that the $20.005 buy order would normally be rounded 
down to $20.00 and would be ranked behind market makers, ECNs that do 
not charge a separate access fee, and non-attributable agency interest 
of UTP Exchanges if it were entered by an ECN that charged a separate 
access fee.) We believe this addresses the ECN's concerns in a fair and 
even-handed manner.
    (B) Order Routing of SuperMontage. Instinet and Bloomberg also 
raise concerns with the order-routing capabilities of the system. 
First, they claim that the order-routing capabilities of the non-
directed order process prevent their customers from using a Nasdaq 
system to preference them (i.e., the ECN) or other market participant 
with which they have a relationship. They also claim that the directed 
order processing is an ineffective way of preferencing orders because 
all directed orders must be designated as non-liability under system 
rules.\21\
---------------------------------------------------------------------------

    \21\ Under system rules, a directed order must be designated as: 
(1) All-or-None and be at least 100 shares greater than the size of 
the displayed quote/order of the market participant to which the 
order is directed; or (2) a Minimum Acceptable Quantity order 
(``MAQ'') with an MAQ value of at least 100 shares greater than the 
displayed amount of the quote/order of the participant to which the 
order is directed. Because of these conditions, when presented to a 
market participant's quote a directed order will impose no 
obligation under the SEC's and NASD's firm quote rules. This is to 
limit the potential for dual liability that market participants 
currently face as the result of being required to accept liability 
orders against the same quote from two separate points of access--
the SelectNet and Small Order Execution systems.
---------------------------------------------------------------------------

    Nasdaq proposes to change the directed order processing rules, so 
that ECNs and market makers can elect to receive ``liability orders'' 
through the directed order process of the system. Under the proposed 
change, a market participant (market maker or ECN) could choose to 
receive against its quote a directed order that is also a liability 
order (i.e., an order that when delivered to the market participant's 
quote imposes an obligation to respond in a manner consistent with the 
SEC's firm quote rule). A market participant could also choose to 
accept against its quote, only non-liability directed orders, as is 
currently contemplated by SuperMontage rules. If a market participant 
chooses to accept directed liability orders, Nasdaq will append an 
indicator to the quoting market participant's MMID, showing that the 
market participant is available to receive directed liability orders. 
ECNs opting to receive directed liability orders would avoid dual 
liability because, like today, they would have the ability to fill, 
partially execute, or decline a directed or non-directed liability 
order that is presented to the ECN, consistent with the Commission's 
firm quote rule.
    Nasdaq believes this addresses the ECNs' concerns, as it will allow 
market participants to continue to preference liability orders to those 
market participants that wish to receive them and to transact business 
in that manner. This will also preserve an important feature currently 
available in Nasdaq, where a market participant can sweep the quotes in 
order to access liquidity for size, at prices at and near the inside 
market.
    ii. Response to Comments: Other than the proposed amendments 
outlined above, Nasdaq believes that neither Instinet nor Bloomberg 
raise any new or significant arguments that we have not already 
addressed. We would, however, like to briefly address their claim that 
Nasdaq is unfairly competing with the ECNs by enhancing its trading and 
execution services. They suggest that Nasdaq should merely provide a 
means for displaying quotations, and that Nasdaq should not provide 
execution services.
    Nasdaq believes that this idea is preposterous. Providing a means 
for accessing liquidity and trading interest in an essential and core 
function of a market. Nasdaq--like every other equities market in the 
United States, if not the world--provides both quotation and execution 
services. As the Commission is aware, Nasdaq has operated the Small 
Order Execution System (``SOES'') since 1984, and the SelectNet service 
since 1988. Both of these execution services are integrated with 
Nasdaq's quotation system, and provide great value to public investors 
as well as market professionals. Eliminating this capability would be a 
step backward for the market and investors alike. In essence, certain 
ECNs are trying to design an inefficient market structure to the 
detriment of investors and Nasdaq, in order to preserve and enhance 
their commercial interests. That is, Instinet's and Bloomberg's 
approach would create an inefficient and fragmented market structure, 
as market participants would be able to view trading interest, but be 
unable to quickly and efficiently access such interest. This would be 
contrary to section 11A and 15A of the Exchange Act as it would foster 
inefficiencies in the execution of securities, minimize opportunities 
to obtain best execution, limit market linkages, and result in

[[Page 49857]]

disorderly markets, and ultimately harm investors.
    Instinet and Bloomberg ignore the fact that SuperMontage provides 
investors with greater information about trading interest in the market 
and a more efficient means for accessing that interest. Nasdaq, like 
any other national securities exchange or national securities 
association, has the right and responsibility to improve upon 
inefficiencies in our market. As Nasdaq has stated in the past, the 
goal of SuperMontage is to better the Nasdaq market structure vis a vis 
increased transparency, reduced fragmentation, enhanced liquidity, and 
improved access to trading interest in the market.
    iii. ECN Micharacterizations of SuperMontage: Nasdaq wishes to 
address a few of the continuing, seemingly intentional, 
mischaracterizations about the SuperMontage proposal that are contained 
in Instinet's and Bloomberg's submissions. Specifically, Instinet and 
Bloomberg mischaracterize at least three aspects of SuperMontage. These 
ECNs claim that: (1) the five-second maximum time for ECNs to respond 
to delivered orders would increase their risk of loss from canceled 
trades; (2) the system response to a locking or crossing quote or order 
would expose ECNs to automatic executions; and (3) the system forces 
the unexecuted portion of a non-directed, previously-marketable limit 
order, to be displayed in the SuperMontage.
    As to the first argument, Nasdaq notes that the SuperMontage will 
be programmed to retrieve from an order-delivery participant, such as 
an ECN, any order to which the ECN fails to respond within five 
seconds. (As noted in previous correspondence,\22\ the five-second 
maximum response time in practice is seven seconds, because two seconds 
are added to this time period for internal Nasdaq system processing. As 
designed, the five-second maximum response time is a system parameter 
that can be quickly changed and adjusted, with the Commission's 
approval of course). The ECNs claim that the five-second maximum 
response time would exacerbate losses they currently incur when they 
accept an order from Nasdaq that is canceled before the ECN can execute 
against and fill the order.
---------------------------------------------------------------------------

    \22\ See Letter from Richard G. Ketchum, President, NASD, to 
Annette Nazareth, Director, Division, Commission, dated July 18, 
2000.
---------------------------------------------------------------------------

    The Nasdaq believes that this is incorrect. SuperMontage will 
protect ECNs against cancellations better than SelectNet does today. 
Today, orders that are entered into SelectNet are time-stamped only 
with the time of order entry, and not with the time the order is 
delivered to an ECN. When the ECN receives the order, the ECN has no 
knowledge of the time that the order was actually delivered or how much 
time remains for the ECN to respond to the order before it may be 
canceled. In SuperMontage, an order will be stamped when Nasdaq 
delivers the order to a market participant. Thus, when the ECN (or 
other order-delivery participant) receives the order, it can compare 
the order's delivery time stamp to the current system time. If the 
order's delivery time is less than 7 seconds, the ECN will know that 
the order is valid and that it can execute against that order. 
Additionally, changes to the order messaging/confirmation process will 
provide greater information and improvements for ECNs. Specifically, in 
SelectNet when an ECN attempts to execute an order, it receives an 
acknowledgement that Nasdaq has received the ECN's attempt to execute--
it does not receive a confirmation that the Nasdaq system has accepted 
the ECN's execution. An ECN knows it has actually executed the 
SelectNet order only when it receives an execution report from 
SelectNet, confirming that the transaction has occurred. In contrast, 
when the ECN attempts to execute against a delivered order in the 
SuperMontage environment, the system will immediately send a message 
back to the ECN confirming the execution has occurred. The ECN will not 
have to wait for the execution report to confirm that the transaction 
has actually occurred. These two pieces of information greatly enhance 
the ECNs' ability to protect against losses arising from cancellations.
    Additionally, SuperMontage improves the current SelectNet order-
cancellation process. In SuperMontage an order cannot be canceled if it 
has exited Nasdaq's system and is in delivery to an ECN (or other 
order-delivery participant). Only orders that have not been delivered 
to an ECN and are in the Nasdaq system can be canceled if the entering 
market participant so requests. Today, a firm entering an order into 
SelectNet can cancel the order after 10 seconds regardless of the 
order's status (i.e., in delivery or in Nasdaq's system) while the 
market participant that received the order is attempting to execute. It 
then becomes a race back to the Nasdaq Tandem, with the winner 
completing the transaction request. In SuperMontage, an order that has 
exited the Nasdaq system and is in delivery to an ECN cannot be 
canceled. Thus, if a market participant requests to cancel an order, 
the system will hold the cancel request until the ECN completes 
interacting with the delivered order (i.e., the ECN executes, partially 
executes, or declines the order). For example, if an order is delivered 
to an ECN and the entering market participant request to cancel, the 
system will ``pend'' (or hold) the cancel request. If the ECN declines 
or partially executes the order, the order will re-enter the system and 
the cancel request will be honored, thus canceling the original order 
(or the unexecuted balance or the original order for partially executed 
orders). The solution we have proposed achieves the same end and is a 
far less drain on capacity, than a ``hear beat'' approach that 
Bloomberg has suggested.
    As to the second argument, Instinet claims that when a market 
participant enters into the system a quote or order that would lock or 
cross the prevailing market, the system will automatically convert that 
into an order and execute it. Since, according to Instinet, they are 
unable to avoid inadvertently entering locking or crossing quotations, 
they will be exposed to automatic executions that would force them to 
take proprietary positions, which they cannot do.
    The Nasdaq believes that this is also inaccurate. When a market 
participant, including an ECN, enters a locking or crossing quote into 
the system, they will receive a system warning the same as they do 
today. In order to complete the quote entry, the participant is 
required to override the system warning. After over-riding the warning, 
the quote update results in an order being generated that accesses the 
quote(s) which would be locked or crossed. Thus, ECNs can avoid 
``automatic executions'' for its own quote updates by not overriding 
the system warning.
    Nor are ECNs at risk if another participant enters a quote or order 
that locks or crosses an existing ECN quote. If that occurs, the system 
will again issue a warning to the party attempting to lock/cross the 
market. If that party overrides the system warning, the system will 
then convert the locking or crossing quote, but it will only deliver an 
automatic execution to market participants that accept them (i.e, 
market maker, ECN that accepts automatic execution, etc.). If an order-
delivery ECN's quote is locked or crossed, the system will convert the 
locking or crossing quote into an order and deliver it to the ECN; it 
will not deliver an automatic execution to an ECN that chooses to 
accept only order delivery against its quote. In either case, there is 
little risk to the order delivery participant of an unwanted automatic 
execution.

[[Page 49858]]

    The third argument--that the system forces certain orders from 
market makers and ECNs to be displayed in the SuperMontage--is also 
incorrect. According to Bloomberg, if a marketable limit order is 
entered into the system on a non-directed basis and only a portion of 
the order is executed because all interest against which it is 
marketable has been taken out, the remaining portion of the order will 
be displayed as quote (or trading interest) in the Nasdaq montage and/
or SuperMontage. Bloomberg fails to recognize that the system will give 
the entering firm and its customer a choice of how the unexecuted 
portion of a marketable limit order should be handled. That is, a firm 
can designate an order as ``immediate or cancel,'' which will result in 
the unexecuted portion of a limit order being canceled and not being 
displayed in the SueprMontage. Rather, the unexecuted portion of the 
previously marketable limit order will be returned to the entering 
participant. If a market maker or ECN does not designate an order as 
immediate or cancel, the unexecuted portion of a previously marketable 
limit order, will be displayed as a quote in the system if it is 
entered by a quoting market participant. Thus, the system offers great 
flexibility in order handling, and in no way force orders to be 
displayed in the SuperMontage.
    iv. Treatment of Order-Delivery Participants: At the request of the 
Commission, Nasdaq is providing this explanation of how the system will 
deliver non-directed orders when an order-delivery ECN is at the inside 
market. In the non-directed order process, when Nasdaq is accessing the 
quote of a delivery participant that is first in line to receive an 
execution, the system will deliver orders up to that participant's 
available size before accessing displayed interest of the next market 
participant in queue who is at the same price. For example, there are 
three market participants alone at the inside bid of $20. ECNI, which 
is ranked first for execution purposes, is displaying 1,000 shares at 
$20 on the bid side of the market, with 5,000 in reserve. Five market 
sell orders are then entered into the system for the following amounts: 
(1) 100 shares; (2) 100 shares; (3) 100 shares; (4) 100 shares; (5) 700 
shares. These market sell orders would be processed as follows. The 
first 100 share order would be delivered to ECN1, reducing its 
displayed size to 900. The second, third, and fourth orders would also 
be delivered to ECN1, further reducing its displayed size to 600. When 
the fifth order is delivered to ECN1, its displayed size would be is 
reduced to 0 and the remaining 100 would access the displayed size of 
the next market participant in queue which is at $20.
    v. Request for Accelerated Approval: Nasdaq requests that the 
Commission use its broad authority under section 19 of the Exchange Act 
to approve the filing and Amendments 5, 6, and 7 Immediately, without 
further delay in the process. Nasdaq does not believe, as Bloomberg 
suggests, that Amendments 5, 6, and 7 to this filing are required to be 
republished for comment before the Commission may act on the filing. 
Rather, Nasdaq believes that it is wholly consistent with the 
Commission's broad authority under sections 19(b)(2)(B) and 19(b)(3)(B) 
of the Exchange Act, to approve the filing and the amendments 
expeditiously. Specifically, we request that the Commission exercise 
its discretion and approve this filing and all related amendments 
(including Amendments 5, 6, and 7) under Exchange Act section 
19(b)(2)(B), or in the alternative under Exchange Act section 
19(b)(3)(B). As set forth below in greater detail, we believe that 
there is good cause for approving the rule filing and all related 
amendments (including Amendments 5, 6, and 7) on an expedited basis, 
pursuant to Exchange Act section 19(b)(2)(B).\23\ Alternative, Nasdaq 
also believes the rule filing and Amendments 5, 6, and 7 should be 
approved summarily pursuant to section 19(b)(3)(B), as it is necessary 
in order to protect investors and maintain fair and orderly 
markets.\24\
---------------------------------------------------------------------------

    \23\ Section 19(b)(2)(B) of the Exchange Act provides, in 
relevant part, that the Commission may approve a proposed rule 
change prior to the 30th day after its publication in the Federal 
Register for good cause shown.
    \24\ Section 19(b)(3)(B) of the Exchange Act provides, in 
relevant part, that a proposed rule change may be put into effect 
summarily if it appears to the Commission that such action is 
necessary for the protection of investors or the maintenance of fair 
and orderly markets.
---------------------------------------------------------------------------

    Nasdaq believes that we have met the standards for the Commission 
to approve the rule filing under either section 19(b)(2)(B) or section 
19(b)(3)(B). As the filing and subsequent amendments explain, 
SuperMontage will provide significant benefits and protections for 
investors, such as increased transparency, reduced fragmentation, 
enhanced liquidity, and improved access to trading interest in the 
market. SuperMontage will also reduce instances of locked/crossed 
markets, and provide for a smoother opening process. Accordingly, 
notions of investor protection dictate that the filing should be 
approved on an expedited basis. In addition Amendments 5, 6, and 7, 
respond directly to comments and SEC questions, and do not alter the 
fundamental nature of the proposal, as re-published for comment in 
Amendment 4. Rather, Amendments 6 and 7 further specify how orders from 
ECNs' that charge a separate access fee will be treated. Additionally, 
Amendment 7 amends the SuperMontage's directed order process, by 
providing greater options as to how a directed order may be handled.
    Conversely, republication would further delay the Commission's 
review of this proposal, would give ECNs another opportunity to submit 
re-packaged arguments, but contribute no new information to the review 
process. As Instinet admits in its August 2, 2000 submission, it is not 
raising new issues, but rather restating issues identified in previous 
comment letters and meetings with SEC staff. From Instinet's own 
admission, is clear that republication would add nothing to the public 
review process, which we note has been extensive. SuperMontage has 
withstood intense scrutiny by the public and the Commission. The 
original proposal and Amendments 1, 2, 3, and 4 were published in the 
Federal Register and were the subject of voluminous public comments. 
The Commission diligently pored through the comments and requested 
clarification of numerous issues raised by commentors. Nasdaq then 
thoroughly responded to the public's and the Commission's concerns by 
further explaining the operation and rationable of the system, 
clarifying the filings, and making numerous changes to the system as 
originally proposed. Finally, the Commission has afforded ECNs the 
extraordinary opportunity for face-to-face meetings with high-ranking 
Commission and Nasdaq staff. Congress, in enacting section 19(b), could 
not have envisioned a more thorough review of a self-regulatory 
organization's rule filing or greater access to the process, at least 
for ECNs.
    Nasdaq notes that there is substantial precedent for approving 
SuperMontage on an accelerated basis. For example, in approving the 
National Market Execution System (``NNMS)'',\25\ the Commission noted 
that Amendments 1, 2, and 3 merely ``respond to concerns raised by the 
commentors, provide additional representations concerning operation of 
the proposal, and clarify the proposed changes.'' \26\ Likewise, 
SuperMontage Amendment Nos. 5, 6, and 7 simply respond to public 
comments and clarify limited aspects of

[[Page 49859]]

the previously noticed proposal. Considered on their own merits, these 
Amendments would qualify for expedited effectiveness under section 
19(b)(2)(B) and 19(b)(3)(B). In light of the rigorous review described 
above and the fact that republication would add nothing to the 
Commission's review process, the filing and Amendments 5, 6, and 7 
should not be subject to additional scrutiny.\27\
---------------------------------------------------------------------------

    \25\ See Exchange Act Release No. 34-42344 (January 14, 2000).
    \26\ Id., at 51.
    \27\ The Commission has decided not to grant accelerated 
approval to Amendment Nos. 5, 6, and 7 at this time, and instead is 
soliciting comments on the Amendments to the proposal to be 
submitted within 15 days of the date of this notice in the Federal 
Register.
---------------------------------------------------------------------------

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,\28\ as well as sections 11A(a)(1)(C) and 11A(a)(1)(D) of the 
Act.\29\ Section 15A(b)(6) \30\ 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 \33\ 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. Section11A(a)(1)(C) of the Act 
\32\ 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) \33\ 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.
---------------------------------------------------------------------------

    \28\ 15 U.S.C. 78o-3(b)(6) and (b)(11).
    \29\ 15 U.S.C. 78k-1(a)(1)(C) and (a)(1)(D).
    \30\ 15 U.S.C. 78o-3(b)(6).
    \31\ 15 U.S.C. 78o-3(b)(11).
    \32\ 15 U.S.C. 78k-1(a)(1)(C).
    \33\ 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 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),\34\ as well as section 11A(a)(1)(C) of the Act.\35\
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78o-3(b)(6) and (b)(11).
    \35\ 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 related 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 the changes are consistent with sections 15A(b)(6) and (b)(11) of 
the Act,\36\ and sections 11A(a)(1)(C) and 11A(a)(1)(D).\37\
---------------------------------------------------------------------------

    \36\ 15 U.S.C. 78o-3(b)(6) and (b)(11).
    \37\ 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.\38\
---------------------------------------------------------------------------

    \38\ 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 Nos. 5, 6, and 7, including whether 
Amendment Nos. 5, 6, and 7 are consistent with the Act. Persons making 
written submissions should file six copies thereof with the Secretary. 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NASD. All submissions should refer to Amendment 
Nos. 5, 6, and 7 to file number NASD-

[[Page 49860]]

99-53 and should be submitted by August 30, 2000.
---------------------------------------------------------------------------

    \39\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\39\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-20686 Filed 8-10-00; 4:51 pm]
BILLING CODE 8010-01-M