[Federal Register Volume 67, Number 46 (Friday, March 8, 2002)]
[Notices]
[Pages 10785-10787]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-5550]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45496; File No. SR-NASD-2002-31]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing and Immediate Effectiveness of a 
Proposed Rule Change to Extend a Pilot That Permits SuperSOES To Trade 
Through the Quotations of UTP Exchanges That Do Not Participate in the 
Nasdaq National Market Execution Service

March 1, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on March 1, 
2002, the National Association of Securities Dealers, Inc. (``NASD''), 
acting through its subsidiary, The Nasdaq Stock Market, Inc. 
(``Nasdaq''), filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the NASD. 
The NASD filed the proposal pursuant to section 19(b)(3)(A) \1\ of the 
Act, and Rule 19b-4(f)(6) thereunder,\2\ which renders the proposal 
effective on filing with the Commission.\3\ The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(3)(A).
    \2\ 17 CFR 240.19b-4(f)(6).
    \3\ Nasdaq asked the Commission to waive the 30-day operative 
delay. See Rule 19b-4(f)(6)(iii). 17 CFR 240.19b-4(f)(6)(iii).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    There is no new language. The pilot rule language is as follows:

4710. Participant Obligations in NNMS

    (a)-(e) No Change.
    (f) UTP Exchanges.

    (i) A UTP Exchange may voluntarily participate in the NNMS 
System according to the approved rules for the NNMS System if it 
executes a Nasdaq Workstation Subscriber Agreement, as amended, for 
UTP Exchanges.
    (ii) If a UTP Exchange does not participate in the NNMS System, 
the UTP Exchange's quote will not be accessed through the NNMS, and 
the NNMS will not include the UTP Exchange's quotation for order 
processing and execution purposes.
    (iii) For purposes of this rule the term ``UTP Exchange'' shall 
mean any registered national securities exchange that has unlisted 
trading privileges in Nasdaq-listed 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'').

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 included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. Nasdaq has prepared summaries, set forth in Sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Nasdaq is filing to extend until May 31, 2002, a pilot pertaining 
to a change to NASD Rule 4710 which specifies that if a UTP Exchange 
elects not to participate in SuperSOES, SuperSOES will not include the 
UTP Exchange's quotation for order processing and execution 
purposes.\4\
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    \4\ The temporary approval of the pilot expired February 28, 
2002. See Exchange Act Release No. 45047 (November 8, 2001), 66 FR 
57496 (November 15, 2001).
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    The pilot is consistent with Nasdaq's long-standing goal to improve 
the quality of its market. Establishing SuperSOES as the primary 
platform for trading Nasdaq-listed securities is a critical step in 
that respect. Nasdaq's successful implementation of SuperSOES has 
significantly improved The Nasdaq Stock Market. In particular, our 
initial assessment based on preliminary data shows that SuperSOES 
orders are processed quickly, enjoy high fill rates, and execute at the 
current market price. Moreover, neither SuperSOES nor the pilot has had 
a significant negative impact on spreads, depth or volatility. The ease 
with which the market reopened on September 17, 2001, appears to be 
directly connected to the efficiency of SuperSOES. In addition, the 
Chicago Stock Exchange (``CHX'') and the Boston Stock Exchange, which 
currently represent the vast majority of the trading volume in Nasdaq-
listed stocks by UTP Exchanges, have adopted SuperSOES.\5\
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    \5\ In July 2001, the Commission approved a rule change to 
permit UTP Exchanges to participate on a voluntary basis in 
SuperSOES. See Exchange Act Release No. 44526 (July 6, 2001), 66 FR 
36814 (July 13, 2001).
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    While SuperSOES is improving the operation of The Nasdaq Stock 
Market, we have identified an area of concern that we believe must be 
addressed immediately to ensure the smooth functioning of the Nasdaq 
system.\6\ Specifically, if a UTP Exchange chooses to access Nasdaq but 
does not accept automatic executions through SuperSOES, there is a 
potential for queuing in the system that could disrupt and slow the 
market, when that exchange is alone at the best quote in The Nasdaq 
Stock Market. To improve the trading environment for all of Nasdaq's 
valued market participants, and to avoid potential significant market 
disruptions, we are proposing to modify SuperSOES to remove non-
automatic execution UTP Exchanges from the SuperSOES execution and 
order processing function.
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    \6\ In SR-NASD-2001-69, filed October 4, 2001, Nasdaq identified 
and attempted to address the above concern, as well as a second 
concern. Specifically, permitting UTP Exchanges to participate in 
Nasdaq without automatic execution functionality perpetuates the 
potential for ``dual liability'' that Nasdaq designed SuperSOES to 
eliminate. The potential for dual liability exists when market 
participants, such as UTP Exchanges, send SelectNet liability 
messages to Nasdaq market makers that simultaneously receive 
executions through SuperSOES. Simultaneous with this filing, Nasdaq 
will amend SR-NASD-2001-69 to remove the material contained in this 
filing.
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Background

    On January 14, 2000, the Commission approved a rule change to 
establish the NNMS and to modify Nasdaq's SelectNet Service with 
respect to Nasdaq National Market Securities (``NMS'').\7\ On July 30, 
2001, NNMS and the changes to SelectNet were implemented for all NMS 
issues. As approved and implemented, Nasdaq market participants can use 
two systems to trade NMS issues: A reconfigured Small Order Execution 
System (``SOES'')--the NNMS--and a reconfigured SelectNet system. 
SuperSOES is an automated execution system that allows the entry of 
orders for up to 999,999 shares.\8\ By removing the size and capacity 
restrictions from

[[Page 10786]]

its principal automatic execution system, Nasdaq intended for most of 
the orders executed through Nasdaq's systems to migrate to SuperSOES. 
Consistent with that approach, access to SelectNet was limited to 
certain types of non-liability orders that require negotiation with the 
receiving market participant.\9\
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    \7\ See Exchange Act Release No. 42344 (January 14, 2000), 65 FR 
3987 (January 25, 2000).
    \8\ SOES was limited to small agency orders for customers.
    \9\ As originally proposed, market participants were permitted 
to enter into the modified SelectNet only: (1) Those orders that 
specify a minimum acceptable quantity for a size that is at least 
100 shares greater than the posted quote of the receiving market 
participant; or (2) All-or-None orders that are at least 100 shares 
in excess of the displayed bid bid/offer size. Since the original 
proposal, the SEC has also approved the entry of non-liability, 
inferior-priced orders through SelectNet.
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    As was the case with SOES, Nasdaq market makers are required to 
participate in SuperSOES and, therefore, to accept automatic execution 
against their displayed quotations. However, UTP Exchanges continue to 
have their quotes in Nasdaq accessed through SelectNet and, as such, 
are not required to accept automatic executions. Whereas Nasdaq can 
require, by rule, that its member ECNs provide immediate response to an 
inbound SelectNet order, it has no authority to extend that requirement 
to a UTP Exchange. As a result, when a UTP Exchange is alone at the 
best bid/best offer for a particular security, and that UTP Exchange is 
only accessible through SelectNet, SuperSOES will stop processing 
orders in that security and will hold those orders in queue for up to 
90 seconds.
    This pause serves two purposes. First, it provides a Nasdaq market 
participant the opportunity to send a SelectNet liability message to 
the UTP Exchange (if that exchange has chosen to participate in 
SelectNet\10\), but at the risk of substantial queuing of market and 
marketable limit orders for that security as the Nasdaq market 
participant awaits a response to its order. Second, it enables a 
SuperSOES market participant (i.e., market maker, Full Participant ECN, 
or participating UTP Exchange) to join the current best bid/best offer 
or create a new best bid/best offer.\11\
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    \10\ The Cincinnati Stock Exchange does not participate in any 
Nasdaq market systems. Instead, it relies on the language in 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 (the ``Nasdaq UTP Plan''), and provides only telephone access 
to its quotes.
    \11\ This pause occurs because the quotes of UTP Exchanges and 
Order Entry ECNs are not accessible through SuperSOES, but only 
through the order-delivery portion of the system.
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    If, after 90 seconds, a SuperSOES market participant does not join 
the current best bid/best offer, and the UTP Exchange does not respond 
to its inbound SelectNet order, SuperSOES returns the orders that are 
in queue and the system shuts down for that security. The system will 
only resume once the UTP Exchange responds to orders delivered to its 
quote, or moves its quote away from the inside.\12\ Such delays will 
adversely impact Nasdaq's ability to ensure the proper functioning of 
our market through a major Nasdaq market system, and to enable market 
participants to obtain executions for their customers.
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    \12\ To illustrate, assume CHX does not participate in SuperSOES 
and is alone at the current best bid of $20 for 1000 shares of ABCD. 
MMA enters an order into SuperSOES, and MMB directs (or preferences) 
1,000 shares via SelectNet to CHX. If no other market maker or Full 
Participant ECN joins the current best bid of $20, SuperSOES stops 
processing orders in ABCD for 90 seconds. CHX waits 2 minutes before 
responding to MMB's preferenced SelectNet liability order either by 
filling or declining the order. (This delay could occur if there are 
equipment problems at CHX, in Nasdaq, or both.) The result is that 
the market in ABCD effectively is held up for 2 minutes and 
SuperSOES is shut off for ABCD (after 90 seconds.)
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    SuperSOES increases the speed of executions and improves the access 
of all market participants to the full depth of a security's trading 
interest. The volume and speed at which trading occurs in Nasdaq have 
increased dramatically from when SuperSOES was first proposed nearly 
two and a half years ago. While SelectNet was adequate as the primary 
means of UTP Exchange access in the past, this no longer is true. 
Market participants demand and require the ability to access liquidity 
at the best prices instantaneously. Because Nasdaq cannot compel UTP 
Exchanges to provide an automated, immediate response to outbound 
Nasdaq orders, Nasdaq must be able to trade through the quotations of 
UTP Exchange participants that do not participate in Nasdaq via 
automatic execution.

Proposed Amendment

    To address these problems, Nasdaq proposed, and the Commission 
approved, a pilot to amend NASD Rule 4710 to require that UTP Exchanges 
that voluntarily choose to trade Nasdaq securities through Nasdaq 
market systems either participate fully in the automatic executions 
through SuperSOES, or participate in SelectNet pursuant to existing 
NASD Rules and have their quotations removed from the SuperSOES 
execution and order processing functionality. Specifically, if a UTP 
Exchange elects not to participate in SuperSOES (in favor of SelectNet 
or the telephone), the UTP Exchange's quote will not be accessed 
through SuperSOES. In this case, SuperSOES will not include that UTP 
Exchange's quotation for order processing and execution purposes. This 
will prevent a UTP Exchange that is not otherwise accessible via 
SuperSOES from effectively shutting down the market in that 
security.\13\
    UTP Exchanges that choose this option would be accessible by 
telephone as contemplated in the Nasdaq UTP Plan,\14\ via SelectNet 
(pending approval of Nasdaq's proposal to eliminate UTP Exchange access 
to SelectNet), or via a mutually agreed-upon alternative bilateral link 
created by the UTP Exchange.\15\ Nasdaq welcomes the opportunity to 
explore the possibility of bilateral linkages, which Nasdaq anticipates 
could be formed via separate agreement between Nasdaq and the 
exchange(s).
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    \13\ The Nasdaq UTP Plan governs the trading of Nasdaq-listed 
securities pursuant to unlisted trading privileges. Subsection (b) 
of Section IX of the Nasdaq UTP Plan states, in pertinent part, that 
Plan participants ``shall have direct telephone access to the 
trading desk of each Nasdaq market participant in each [e]ligible 
[s]ecurity in which the [p]articipant displays quotations.'' See 
Section IX, Market Access, of the Nasdaq UTP Plan.
    \14\ We note that this currently is the method that the 
Cincinnati Stock Exchange has elected to use for trading Nasdaq 
securities under the Nasdaq UTP Plan.
    \15\ This proposal would not preclude a UTP Exchange from 
forming a link with Nasdaq outside Nasdaq's market system or the 
parameters of an NMS plan.
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    Nasdaq is proposing the pilot for a number of reasons. First, 
significant changes in market conditions have resulted in the need for 
Nasdaq, via SuperSOES, to increase the speed of executions and improve 
the access of all market participants to the full depth of a security's 
trading interest. The volume and speed at which trading occurs in 
Nasdaq have increased dramatically since SuperSOES was first proposed 
nearly two and a half years ago. Market participants demand and require 
the ability to access liquidity at the best prices instantaneously. 
SuperSOES is a significant improvement over prior Nasdaq execution 
systems, and has become the backbone of our marketplace by providing 
market participants with a more efficient trading platform as evidenced 
by faster executions, higher fill rates, larger orders, and prices at 
the best bid or best offer.
    Nasdaq wants to ensure that the market in a particular security 
does not shut down--thereby harming investors and the market--if there 
is an unresponsive UTP Exchange setting the current best bid/best offer 
for that security. The system recognizes the

[[Page 10787]]

importance of maintaining price priority and ensuring that market 
participants receive the best possible price in the market. As such, 
SuperSOES was originally designed not to trade through the best quote 
that appears in the Nasdaq montage. However, that premise assumed all 
quotes would be immediately accessible.\16\ SuperSOES must be able to 
continue operating when a particular quote is not accessible by market 
participants. To that end, if a UTP Exchange chooses not to participate 
in SuperSOES, and that UTP Exchange sets the inside bid or ask, Nasdaq 
will enable SuperSOES not to include that UTP Exchange's quotation for 
order processing and execution.
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    \16\ Order Entry ECNs are not subject to inbound automatic 
executions in SuperSOES. However, as NASD members, Order Entry ECNs 
are subject to NASD Rules and the enforcement and disciplinary 
powers granted therein. As non-members, UTP Exchanges are not 
subject to the same regulatory infrastructure.
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    Participation in SuperSOES by a UTP Exchange is a voluntary action 
by each exchange. Nasdaq is not obligated to provide UTP Exchanges with 
access to any of Nasdaq's proprietary systems. Nasdaq's voluntary 
action, designed to improve efficiency and maintain an orderly market, 
should not become an opportunity for a Nasdaq competitor to harm the 
ability of Nasdaq to improve its markets.
    Overall, Nasdaq believes it was appropriate to alter the terms 
under which a UTP Exchange participates in The Nasdaq Stock Market to 
address all of the concerns described in this proposal. For the same 
reasons, it is important to continue the pilot program to preserve the 
status quo as additional UTP Exchanges prepare to commence trading 
Nasdaq securities.
2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of section 15A(b)(6) of the Act, in that the proposal is 
designed to facilitate 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. In particular, Nasdaq believes that modifying 
SuperSOES to trade through quotations of non-automatic execution UTP 
Exchanges is necessary for the fair and orderly operation of The Nasdaq 
Stock Market by helping to reduce the potential for order queuing or 
for system stoppages, when a UTP Exchange's quote is inaccessible and 
is alone at the best bid or best offer.

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

    The Nasdaq does not believe that the proposed rule change will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

(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

    Because the foregoing proposed rule change does not:
    (i) Significantly affect the protection of investors or the public 
interest;
    (ii) Impose any significant burden on competition; and
    (iii) Become operative for 30 days from the date on which it was 
filed, or such shorter time as the Commission may designate, it has 
become effective pursuant to section 19(b)(3)(A) of the Act \17\ and 
Rule 19b-4(f)(6), thereunder.\18\ At any time within 60 days of the 
filing of the proposed rule change, the Commission may summarily 
abrogate the rule change if it appears to the Commission that such 
action is necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the Act.
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    \17\ 15 U.S.C. 78s(b)(3)(A).
    \18\ 17 CFR 240.19b-4(f)(6).
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    Nasdaq has requested that the Commission waive the 30-day operative 
delay. The Commission finds good cause to waive both the 5-day pre-
filing notice requirement and the 30-day operative delay, because the 
waivers are consistent with the protection of investors and the public 
interest. Acceleration of the operative date will permit the NASD pilot 
to continue in operation without interruption. Nasdaq states that the 
pilot reduces the potential for a shut down in Nasdaq's automatic 
execution systems. For these reasons, the Commission finds good cause 
to waive both the 5-day pre-filing requirement and the 30-day operative 
date.\19\
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    \19\ For purposes only of accelerating the operative date of 
this proposal, the Commission has considered the proposed rule's 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposal is 
consistent with the Act. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Copies of 
the submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the Commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying in the Commission's 
Public Reference Room. Copies of the filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to File No. SR-NASD-2002-31 and should be 
submitted by March 29, 2002.
    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).

Jill M. Peterson,
Assistant Secretary.
[FR Doc. 02-5550 Filed 3-7-02; 8:45 am]
BILLING CODE 8010-01-P