[Federal Register Volume 67, Number 47 (Monday, March 11, 2002)]
[Notices]
[Pages 10956-10962]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-5816]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45508; File No. SR-NASD-00-76]


Self-Regulatory Organizations; Notice of Filing of Amendment Nos. 
2 and 3 to a Proposed Rule Change by the National Association of 
Securities Dealers, Inc. Relating to Locked and Crossed Markets That 
Occur at or Prior to the Market Open

March 5,2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby 
given that the National Association of Securities Dealers, Inc. 
(``NASD''), through its subsidiary, the Nasdaq Stock Market, Inc. 
(``Nasdaq''), filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') Amendment Nos. 2 and 3 to the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by Nasdaq. The proposed rule change and Amendment No. 1 
were published for comment in the Federal Register on February 7, 
2001.\3\ The Commission received seven comment letters regarding the 
proposal.\4\ Nasdaq

[[Page 10957]]

has responded to the commenters in Amendment Nos. 2 and 3 to the 
proposal, which Nasdaq filed with the Commission on August 13, 2001,\5\ 
and February 21, 2002, respectively.\6\ The Commission is publishing 
this notice to solicit comments on Amendment Nos. 2 and 3 to the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 43913 (January 31, 
2001), 66 FR 9394 (``February 2001 Release'').
    \4\ See letter from Mark R. Grewe, Managing Director, NDB 
Capital Markets, L.P., to Jonathan G. Katz, Secretary, Commission, 
dated February 27, 2001 (``NDB Letter''); letter from Martin 
Cunningham, Senior Vice President Trading, Schwab Capital Markets 
L.P. (``Schwab''), to Jonathan G. Katz, Secretary, Commission, dated 
February 28, 2001 (``Schwab Letter''); letter from Richard B. Levin, 
Assistant General Counsel and Regulatory Affairs Officer, Knight 
Securities, L.P. (``Knight''), to the Commission, dated March 1, 
2001 (``Knight Letter''); letter from Kim Bang, President, Bloomberg 
Tradebook LLC (``Bloomberg''), to the Commission, dated March 
15,2001 (``Bloomberg Letter''); letter from Timothy G. Grazioso, 
Subcommittee Chairman, Trading Issues Committee, Security Traders 
Association (``STA''), Michael T. Bird, Chairman, Trading Issues 
Committee, STA, and Geoffrey W. Cloud, Counsel, Trading Issues 
Committee, STA, to Jonathan G. Katz, Secretary, Commission, dated 
March 13, 2001 (``STA Letter''); letter from Kevin J.P. O'Hara, 
General Counsel, Archipelago, L.L.C. (``Archipelago'') to Jonathan 
G. Katz, Secretary, Commission, dated April 3, 2001 (``Archipelago 
Letter''); and letter from William O'Brien, Senior Vice President & 
General Counsel, The BRUT ECN, L.L.C., (``BRUT'') to the Commission, 
dated April 17, 2001 (``BRUT Letter'').
    \5\ See letter (with attachment) from Eugene A. Lopez, Senior 
Vice President, Nasdaq, to Belinda Blaine, Associate Director, 
Division of Market Regulation (``Division''), Commission, dated 
August 10, 2001 (``Amendment No. 2''). In Amendment No. 2, Nasdaq 
responds to the commenters and proposes to revise its original 
proposal to: (1) Require electronic communications networks 
(``ECNs'') to send Trade-or-Move Messages prior to entering locking/
crossing quotes and require market makers to send Trade-or-Move 
Messages after entering locking/crossing quotes; (2) reduce the time 
to respond to a Trade-or-Move Message to 10 seconds; (3) provide a 
10,000-share minimum share requirement for Trade-or-Move Messages 
for Nasdaq 100 and S&P 400 issues; (4) prohibit all market 
participants from entering locking/crossing quotes between 9:29:30 
a.m. and 9:29:59 a.m.; and (5) delete provisions imposing Trade-or-
Move requirements between 3:50 p.m. and 4 p.m.
    \6\ See letter from Jeffrey S. Davis, Nasdaq, to John Polise, 
Senior Special Counsel, Division, Commission, dated February 21, 
2002 (``Amendment No. 3''). In Amendment No. 3, Nasdaq responds to 
comments from BRUT and clarifies a misstatement in Amendment No. 2. 
Specifically, Amendment No. 3 states that the requirement that ECNs 
send Trade-or-Move Messages prior to entering locking or crossing 
quotes applies to all orders that ECNs receive and is not limited to 
agency orders, as stated incorrectly in Amendment No. 2.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    In its original proposal, Nasdaq proposed to amend NASD Rule 
4613(e)(1)(C), ``Locked and Crossed Markets,'' to revise the use of 
Trade-or-Move Messages during locked and crossed market conditions that 
occur prior to the market's opening and to add provisions relating to 
the use of Trade-or-Move Messages prior to the market's close. In 
response to comment letters filed with the Commission and based upon 
input from a special subcommittee of Nasdaq's Quality of Markets 
Committee, Nasdaq proposes to amend its original proposal to: (1) 
Require ECNs to send Trade-or-Move Messages prior to entering locking/
crossing quotes and require market makers to send Trade-or-Move 
Messages after entering locking/crossing quotes; (2) reduce the time to 
respond to a Trade-or-Move Message to 10 seconds; (3) provide a 10,000-
share minimum share requirement for Trade-or-Move Messages for Nasdaq 
100 and S&P 400 issues; (4) prohibit all market participants from 
entering locking/crossing quotes between 9:29:30 a.m. and 9:29:59 a.m.; 
and (5) delete provisions imposing Trade-or-Move requirements between 
3:50 p.m. and 4:00 p.m.
    Proposed changes to the original proposal, as published in the 
February 2001 Release, appear below. Proposed additions are in italics; 
proposed deletions are in [brackets].

Rule 4613--Character of Quotations

    (a)-(d) No change.
    (e) Locked and Crossed Markets:
    (1) A market maker shall not, except under extraordinary 
circumstances, enter or maintain quotations in Nasdaq during normal 
business hours if:
    (A) No change.
    (B) No change.
    (C) Obligations Regarding Locked/Crossed Market Conditions Prior to 
Market Opening [And Prior to Market Closing]--
    (i) No change.
    (i) Locked/Crossed Market Between 9:20 and 9:29:59 a.m.--
    (a) Before an ECN [market maker] enters a quote that would lock or 
cross the market between 9:20 and 9:29:29 a.m. Eastern Time, the ECN 
[market maker] must first send through SelectNet to the market maker or 
ECN whose quote it would lock or cross a Trade-or-Move Message that is 
at or superior to the receiving market maker's or ECN's quoted price 
[and that is for at least 10,000 shares (if multiple market makers 
would be locked/crossed, each one must receive a Trade-or-Move Message 
and the aggregate size of all such messages must be at least 10,000 
shares); provided, however, that if a market participant is 
representing an agency order (as defined in subparagraph (vi) of this 
rule), the market participant shall be required to send a Trade-or-Move 
Message in an amount equal to the agency order, even if that order is 
less than 10,000 shares. A [market maker]. An ECN that sends a Trade-
or-Move Message during these periods must then wait at least [15]10 
seconds before entering a quote that would lock or cross the market.
    (b) If a market maker enters a quote that would lock or cross the 
market between 9:20 and 9:29:29 a.m. Eastern Time, the market maker 
must then immediately send through SelectNet to the market maker or ECN 
whose quote it would lock or cross a Trade-or-Move Message that is at 
or superior to the receiving market maker's or ECN's quoted price.
    (c) Market participants shall be prohibited from entering a quote 
that would lock or cross the market between 9:29:30 and 9:29:59.
    (ii)(a) In the case of securities included in the Nasdaq 100 Index 
or the S&P 400 Index, a Trade-or-Move Message must be [and that is] for 
at least 10,000 shares (if multiple market makers would be locked/
crossed, each one must receive a Trade-or-Move Message and the 
aggregate size of all such messages must be at least 10,000 shares); 
provided, however, that if a market participant is representing an 
agency order (as defined in subparagraph (vi) of this rule), the market 
participant shall be required to send a Trade-or-Move Message(s) in an 
amount equal to the agency order, even if that order is less than 
10,000 shares.
    (b) In the case of all other securities, a Trade-or-Move Message 
must be for at least 5,000 shares (if multiple market makers would be 
locked/crossed, each one must receive a Trade-or-Move Message and the 
aggregate size of all such messages must be at least 5,000 shares); 
provided, however, that if a market participant is representing an 
agency order (as defined in subparagraph (vi) of this rule), the market 
participant shall be required to send a Trade-or-Move Message(s) in an 
amount equal to the agency order, even if that order is less than 5,000 
shares.
    [Locked/Crossed Market Between 3:50 and 3:59:59 p.m.--Before a 
market maker enters a quote that would lock or cross the market between 
3:50 and 3:59:59 p.m. Eastern Time, the market maker must first send 
through SelectNet to the market maker whose quote it would lock or 
cross, a Trade-or-Move Message that is at the receiving market maker's 
quoted price and that is for at least 10,000 shares (if multiple market 
makers would be locked/crossed, each one must receive a Trade-or-Move 
Message and the aggregate size of all such messages must be at least 
10,000 shares); provided, however, that if a market participant is 
representing an agency order (as defined in subparagraph (vi) of this 
rule), the market participant shall be required to send a Trade-or-Move 
Message(s) in an amount equal to the agency order, even if that order 
is less than 10,000 shares. A market maker that sends a Trade-or-Move 
Message during this period must then wait at least 15 seconds before 
entering a quote that would lock or cross the market.]
    (iv) A market maker that receives a Trade-or-Move Message must, 
within [15] 10 seconds of receiving such message, either fill the 
incoming Trade-or-Move Message for the full size of the message, or [, 
consistent with its Firm Quote obligations,] move its bid down

[[Page 10958]]

(offer up) by a quotation increment that restores or maintains an 
unlocked/uncrossed market.
    (v) A market maker that sends a Trade-or-Move Message pursuant to 
subparagraphs (e)(1)(C)(i)[,] or (ii)[, or (iii)] of this rule must 
append to the message a Nasdaq-provided symbol indicating that it is a 
Trade-or-Move Message.
    (vi) No Change.
    (2) No Change.
    (3) Except as indicated in subsection (1)(C)(ii), [F]for purposes 
of this rule, the term ``market maker'' shall include:
    (A)-(D) No Change.

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

    In its filing with the Commission, Nasdaq included statements 
concerning the purpose of, and basis for, the proposed rule change, and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item 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
    (a) Amendment No. 2.

Background

    In its original rule proposal, Nasdaq proposed amendments to NASD 
Rule 4613(e)(1)(C) that would alter the obligations of market makers 
and ECNs during locked and crossed markets that occur prior to the 
market's open and also prior to the close. Specifically, Nasdaq 
originally proposed to: (1) Extend the application of NASD Rule 
4613(e)(1)(C)(ii) regarding locked/crossed markets before the open to 
the period prior to the close; (2) require market makers and ECNs that 
send a Trade-or-Move Message to do so at least 15 seconds before 
entering a locking/crossing quote rather than after entering a locking/
crossing quote, as the rule currently requires; (3) increase from 5,000 
to 10,000 the minimum number of shares that must accompany a non-agency 
Trade-or-Move Message; and (4) reduce from 30 seconds to 15 seconds the 
amount of time within which the recipient of a Trade-or-Move Message 
must properly respond.
    The Commission received seven comment letters regarding the 
original proposal.\7\ Nasdaq notes that the commenters, who are among 
the most active participants in the Nasdaq market, expressed materially 
different views regarding Nasdaq's proposal. In response to the comment 
letters, Nasdaq's Quality of Markets Committee formed a subcommittee 
(``Subcommittee'') to address the concerns raised by the commenters. 
The Subcommittee was comprised of all of the commenters, as well as 
members representing other constituencies within the Nasdaq market 
making community.
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    \7\ See note 4, supra.
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    At its first meeting, the Subcommittee spent two hours discussing 
the operation of the Trade-or-Move rule during the pre-opening period. 
This meeting, like the comment letters, generated significant 
disagreement regarding the best approach to improving the operation of 
the rule. Following that meeting, a straw poll of the Subcommittee on 
four aspects of Trade-or-Move during the pre-opening period revealed no 
clear majority supporting any proposal on any aspect of NASD Rule 
4613(e)(1)(C).
    After the first Subcommittee meeting, members of the staff of 
Nasdaq Transaction Services, Economic Research, Regulation and 
Controls, Technology Services, and the Nasdaq Office of General Counsel 
met several times in different groupings to develop a recommendation 
based upon the Subcommittee deliberations. Nasdaq staff presented its 
recommendations at the second Subcommittee meeting, where the 
Subcommittee members spent nearly two hours discussing the pre-opening 
period and another half-hour discussing the pre-closing period.

Response to Comments

    Nasdaq is aware that there remain meaningful, legitimate 
disagreements within the market making community regarding the best 
solution to locked and crossed markets that occur on Nasdaq. Nasdaq's 
goal is to incrementally improve and simplify the operation of and 
compliance with the Trade-or-Move rule, rather than to pursue an 
impossible ideal of solving every Trade-or-Move problem experienced by 
every market participant. The recommendations described in greater 
detail below are designed to accomplish that goal, as well as to 
promote price discovery and the maintenance of an orderly market.

Pre-Opening

    An orderly opening is critical to Nasdaq and to investors.\8\ 
Nasdaq notes that a sizable portion of the volume in Nasdaq occurs at 
or around the market's opening. According to Nasdaq, many marker makers 
guarantee their customers an execution at the opening inside bid or 
offer price, or in some cases the midpoint of (or other range between) 
the opening inside bid/inside offer. Thus, the inside market at the 
opening affects the price at which a sizable number of orders from 
individual investors in Nasdaq stocks are filled. Moreover, the prices 
of certain options contracts, indexes, and derivative instruments often 
are set based on the opening prints in Nasdaq. Accordingly, it is of 
utmost importance that the market open in an orderly fashion.
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    \8\ See Arthur Levitt, Chairman, Commission, Remarks before the 
Securities Industry Association, Boca Raton, Florida (November 4, 
1999).
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    As discussed more fully below, Amendment No. 2 revises the proposal 
to eliminate the use of Trade-or-Move Messages prior to the market's 
close. In addition, Amendment No. 2 modifies the following aspects of 
the original proposal with regard to the way that Trade-or-Move 
operates prior to the opening: (1) The sequence of Trade-or-Move 
Messages; (2) the time within which to respond to a Trade-or-Move 
Message; (3) the number of shares accompanying a Trade-or-Move Message; 
and (4) the period between 9:29:30 a.m. and 9:29:59 a.m.
    Sequence of Messages: Under current NASD Rule 4613(e)(1)(C), a 
market participant that enters a locking or crossing quote between 9:20 
and 9:29:59 a.m. is then required to send a message with an appended 
Trade-or-Move designator to the party or parties it is locking/
crossing. Nasdaq adopted the Trade-or-Move requirements because it 
believed that requiring market participants to lock/cross the market 
prior to sending a Trade-or-Move Message would reduce the frequency and 
severity of pre-opening locked and crossed markets by providing more 
informative quotation information and facilitating price discovery.
    In its original proposal, Nasdaq proposed to revise NASD Rule 
4613(e)(1)(C) to require all market participants to send Trade-or-Move 
Messages before rather than after entering a locking or crossing 
quotation during the applicable periods. Nasdaq believed that switching 
the sequence of messages in this way would further reduce the instances 
of locked and crossed markets in Nasdaq by

[[Page 10959]]

preventing them from occurring in the first instance. Nasdaq believed 
that the benefits of preventing the occurrence of locked/crossed 
markets would outweigh the concomitant loss of price discovery provided 
by the entry of locking or crossing quotes.
    Two commenters opposed the proposed change of sequence, claiming 
that the current sequence results in a one-step process that can be 
readily programmed into firms' automated trading systems,\9\ while the 
opposite sequence would result in a two-step process that would be 
difficult to program. According to these commenters, the programming of 
automated systems improves firms' compliance with the Trade-or-Move 
requirements and their ability to surveil for compliance internally. 
These commenters also claimed that the change of sequence would result 
in more locked or crossed markets, not fewer, as Nasdaq believed.
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    \9\ See Schwab Letter and NDB Letter, supra note 4.
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    Two commenters argued that reversing the sequence of messaging 
would unduly hinder price discovery because the recipient of a Trade-
or-Move Message would not know the price to which it would be required 
to move its quote to maintain an unlocked/uncrossed market.\10\ They 
further argued that decimalization would exacerbate this problem by 
permitting the recipients of Trade-or-Move Messages to move their 
quotes in penny increments rather than in sixteenths. Nasdaq maintains 
that these arguments are based upon the incorrect assumption that 
market participants can send Trade-or-Move Messages only to the 
recipient's quoted price (i.e., to lock the market). In fact, a party 
sending a Trade-or-Move Message may send the Trade-or-Move Message at 
the recipient's quoted price or at a superior price.\11\ In that case, 
the recipient would be required to trade in full or to move its quote 
beyond the superior price to maintain an unlocked and uncrossed market.
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    \10\ See Schwab Letter and NDB Letter, supra note 4.
    \11\ Although Nasdaq announced this interpretation of NASD Rule 
4613(e) in NASD Notice to Members 2000-29, Nasdaq notes that there 
appears to be some confusion concerning this point among market 
makers. Accordingly, Nasdaq is adding language to the current 
proposal to further clarify this point.
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    Two other commenters, both operators of ECNs, supported the 
proposed change of sequence.\12\ One commenter argued that the current 
rule has a disproportionately negative effect on ECNs because it 
requires them to stand willing to trade twice for every Trade-or-Move 
Message they send: once with the participant to which it routes the 
message, and again with any participant that attempts to access its 
quote.
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    \12\ See Archipelago Letter and Bloomberg Letter, supra note 4.
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    Nasdaq notes that because ECNs choose not to accumulate proprietary 
positions, they are unwilling to accept the risk of double execution. 
Nasdaq states that while a neutral application of the Trade-or-Move 
requirements may affect market participants differently, that result 
stems from the ECNs' voluntary selection of a particular business model 
and access methodology rather than from any action of Nasdaq. Nasdaq 
also notes that market makers risk similar double liability from 
internalization and orders from non-Nasdaq means of access. Nasdaq 
maintains that its decision to switch the message sequence, like its 
decision to adopt the existing Trade-or-Move requirements, was based 
upon Nasdaq's assessment of the benefit of the Trade-or-Move 
requirements to the entire market rather than their impact on 
particular market participants or business models.
    Nonetheless, based upon the comments received, Nasdaq has decided 
to amend its proposal to permit the sequence of messaging to differ by 
market participant business model. Amendment No. 2 will revise the 
proposal to require ECNs to send Trade-or-Move Messages before entering 
locking or crossing quotes. Market makers will enter a locking or 
crossing quote and then immediately send a Trade-or-Move Message.\13\ 
Nasdaq believes that the proposed change has the dual benefit of 
permitting ECNs to participate more effectively in the pre-opening 
period and also permitting market makers to retain their current 
automated systems. It also preserves the benefits that Nasdaq sought to 
achieve when it first implemented the Trade-or-Move requirements, 
namely increased price discovery and decreased gamesmanship surrounding 
the occurrence and resolution of locked and crossed markets. Nasdaq 
believes that this approach will incrementally improve the operation of 
NASD Rule 4613(e)(1)(C).\14\
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    \13\ ``Immediate'' issuance of a Trade-or-Move Message will be 
understood to mean instantaneous in the case of automated systems 
and not exceeding a different, specified period where manual 
processes are utilized.
    \14\ The STA also supported changing the sequence of messages, 
contending that doing so would reduce the instances of locked and 
crossed markets in Nasdaq. Based upon the STA's comments and upon 
Nasdaq's own desire to reduce the instances of locked/crossed 
markets, Nasdaq also considered permitting each market participant 
to choose the sequence of messages that it preferred. After careful 
analysis, Nasdaq concluded that this approach would create confusion 
in the marketplace and hinder Nasdaq's ability to surveil for 
compliance with the Trade-or-Move requirements.
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    Response Time: Under current NASD Rule 4613(e)(1)(C), the recipient 
of a Trade-or-Move Message must respond properly to the message within 
30 seconds. In the original proposal, Nasdaq reduced the response time 
to 15 seconds to reduce the duration of locked/crossed markets that 
occur. Nasdaq believes that markets have become materially faster and 
that a 30-second delay in price discovery is impractical under the 
current, rapid conditions. The commenters unanimously agreed that a 30-
second response time is too long and that 15 seconds is more 
appropriate.\15\ In fact, two commenters suggested reducing the 
response time to five seconds.\16\
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    \15\ See Bloomberg Letter; Archipelago Letter; Schwab Letter; 
and NDB Letter, supra note 4.
    \16\ See STA Letter and Knight Letter, supra note 4.
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    Nasdaq is reluctant to reduce the response time to five seconds 
because that would impose a great burden on firms that lack automated 
systems. Nasdaq is also concerned that the operation and surveillance 
of a five-second rule could be compromised by potential delays in 
network communications between Nasdaq's systems and firms' systems.
    To balance Nasdaq's desire to respond to the increased speed of 
markets as well as the potential burden imposed on non-automated firms, 
Nasdaq proposes to reduce to 10 seconds the time permitted to respond 
to a Trade-or-Move Message. Although this is a relatively brief period 
for non-automated participants, Nasdaq believes that firms that choose 
to participate in the pre-open must vigilantly monitor their quotes. As 
explained in greater detail below, the 10-second period corresponds to 
the minimum life of a SelectNet order, thereby allowing ECNs to avoid 
dual liability by canceling a Trade-or-Move Message when entering a 
locking or crossing quote.
    Number of Shares: Under current NASD Rule 4613(e)(1)(C), the 
aggregate size of the Trade-or-Move Message must be at least 5,000 
shares (i.e., the market participant must send a total of 5,000 shares 
to all parties it is locking/crossing) in the case of a proprietary 
quote, or the actual size of an agency order if that is the basis for 
the locking/crossing quote. Under the original proposal, Nasdaq sought 
to raise the minimum Trade-or-Move Message share requirement to 10,000 
shares or the

[[Page 10960]]

actual size of an agency order. Nasdaq believes that a market 
participant or its customer should not be able to lock or cross the 
market in the 10 minutes prior to the opening with a de minimus number 
of shares. Rather, Nasdaq believes that a market participant must be 
willing to risk significant capital and to trade a significant amount 
if it wishes to lock or cross the market during one of the most 
critical points in the trading day.
    Several commenters supported the proposed increase and agreed with 
the rationale behind it.\17\ In fact, the STA suggested that, in 
certain circumstances, the minimum Trade-or-Move Message share size 
should be 25,000 shares rather than 10,000 shares. One commenter stated 
that the requirement should remain at 5,000 shares due, in part, to 
what the commenter believes is non-compliance with the Trade-or-Move 
requirements by certain regional markets and NASD members.\18\
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    \17\ See NDB Letter and Schwab Letter, supra note 4.
    \18\ See Knight Letter, supra note 4.
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    On the other hand, one commenter claimed that the 10,000-share 
requirement discriminates unfairly against ECNs and effectively 
prevents them from participating in the pre-opening.\19\ The commenter 
suggested that Nasdaq address this issue by permitting ECNs to withhold 
from a Trade-or-Move Message a portion of an agency order rather than 
requiring the ECN to append the entire amount of the order to the 
Trade-or-Move Message it wishes to send. The ECN would then use the 
shares withheld to enter a locking or crossing quote.
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    \19\ See Bloomberg Letter, supra note 4.
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    Nasdaq disagrees with this argument. Contrary to the commenter's 
assertions, the minimum share requirement and agency exception each 
apply evenly to all market makers and ECNs, and also to their 
respective customers. The proposal simply prohibits any market 
participant from locking or crossing the market on a proprietary 
basis--regardless of the conduit through which it enters an order into 
the market--for less than the minimum number of shares. In fact, to do 
as the commenter suggests and permit ECNs to withhold a portion of 
their agency orders would itself create disparity between market makers 
and ECNs. Such an approach would be inconsistent with Nasdaq's view 
that, to the greatest extent possible, the lock/crossed rule should 
apply equally to all market participants.
    Nasdaq also disagrees that the current rule operates to exclude 
ECNs from the pre-opening period, as evidenced by several ECNs' current 
participation. Moreover, Nasdaq believes that the modifications 
described above will ameliorate the ECNs' concerns. Specifically, 
Nasdaq believes that allowing ECNs to send a Trade-or-Move Message 
before locking/crossing the market and reducing the response time to 10 
seconds should virtually eliminate the risk to an ECN of assuming a 
proprietary position. For example, Nasdaq notes that an ECN could send 
Trade-or-Move Message for the actual size of an agency order and wait 
10 seconds, the minimum life of a SelectNet order. Assuming that the 
ECN receives no reply, it could then cancel the SelectNet order and 
enter the full size of its agency order as a locking/crossing quote.
    Nonetheless, in light of the comments received, Nasdaq has 
determined to modify the proposal as follows: proprietary orders with 
Trade-or-Move Messages must be accompanied by a minimum of 10,000 
shares in the case of Nasdaq 100 and S&P 400 issues, and 5,000 shares 
for all other issues. The ``agency exception'' contained in current 
NASD Rule 4613(e)(1)(C) will continue to operate as it does today. 
Nasdaq believes that Nasdaq 100 and S&P 400 issues are marked by higher 
liquidity and faster trading and, therefore, merit a more stringent 
requirement to create a locked or crossed market. Nasdaq believes that 
this proposal proportionately increases the economic significance of 
entering a locking/crossing quotation for stocks that are widely 
followed and for which a locked/crossed market would have the greatest 
impact.
    Limited Prohibition On Entry Of Locking/Crossing Quotes: Based upon 
the recommendation of the Subcommittee, which was comprised of the 
commenters and additional members of the Quality of Markets Committee, 
Nasdaq proposes that market participants be prohibited by rule from 
entering a locking or crossing quote between 9:29:30 and 9:29:59. 
During that period, all market participants will be permitted to send 
Trade-or-Move Messages for the required number of shares to parties 
that they would lock or cross if permitted to enter such locking/
crossing quotes. Market participants that receive Trade-or-Move 
Messages during that time period will be obligated to respond properly 
by trading in full or moving their quote within the appropriate 
response time.
    Nasdaq believes that a prohibition on the entry of locking/crossing 
quotes immediately prior to the market opening, in conjunction with the 
continued obligation to respond properly to Trade-or-Move Messages, 
will facilitate the resolution of locks and crosses that exist at 
9:29:30. Further, Nasdaq believes that the potential benefits to all 
market participants of a more orderly opening outweigh the limited loss 
of price discovery that will result from suppressing locking and 
crossing quotes during this brief but critical period.

Pre-Closing

    NASD Rule 4613(e)(1)(C) does not currently apply during normal 
business hours. Based upon the positive effect that the Trade-or-Move 
requirements have had on resolving potential locked and crossed markets 
at and immediately before the market opening, Nasdaq originally 
proposed to expand the application of NASD Rule 4613(e)(1)(C) to 
include the 10-minute period preceding the market close (3:50 p.m. to 
3:59:59 p.m.). Like the opening, the closing is a critical period 
characterized by volatile, rapid, and heavy trading. The closing price 
is a benchmark for numerous transactions and could be affected 
dramatically by the existence of locks and crosses.
    In its original proposal, Nasdaq proposed that the Trade-or-Move 
Messages used prior to the close would operate in the same manner as 
currently proposed for Trade-or-Move Messages used prior to the 
opening, with one exception. Prior to the market's opening, the market 
participant receiving a Trade-or-Move Message has no liability under 
the NASD's firm quote rule (NASD Rule 4613(b)) or under the 
Commission's firm quote rule (Exchange Act Rule 11aAc-1). Thus, a 
market maker is permitted to move its quote without trading upon the 
receipt of what, during market hours, would be a SelectNet 
``liability'' order. Prior to the close, however, a Trade-or-Move 
Message would be considered a liability order. Therefore, unlike during 
the earlier period, a market participant that received a Trade-or-Move 
Message prior to the close could move its quote or trade with just a 
portion of the Trade-or-Move Message only if doing so would be 
consistent with its firm quote obligations under the NASD and SEC 
rules.
    The commenters argued overwhelmingly that applying the Trade-or-
Move requirements before the close would be unnecessary or would cause 
more problems than they would solve. Several commenters argued that the 
implementation of Nasdaq's National Market Execution System 
(``SuperSOES'') would obviate the need for supplemental locked and 
crossed

[[Page 10961]]

markets restrictions or, at the very least, that Nasdaq should monitor 
the implementation of SuperSOES to determine whether or not this claim 
is accurate.\20\ Another commenter noted that the proposal fails to 
account for economic inefficiencies that exist prior to the close.\21\ 
No commenter expressed support for the proposal to implement Trade-or-
Move requirements prior to the market close.
---------------------------------------------------------------------------

    \20\ See NDB Letter; Schwab Letter; Archipelago Letter, supra 
note 4.
    \21\ See Knight Letter, supra note 4.
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    In light of the comments received and the implementation of 
SuperSOES, Nasdaq has decided to withdraw its proposal to expand the 
application of NASD Rule 4613(e)(1)(C) to the period prior to the 
closing. Nasdaq will monitor the effect of SuperSOES at the close and 
will, at a later date, reevaluate whether applying the Trade-or-Move 
requirements at the close would materially reduce the instances and 
duration of locked and crossed markets in Nasdaq.
    (b) Amendment No. 3.
    One commenter suggested that Nasdaq revise the Trade-or-Move 
requirements to provide that, for purposes of the Trade-or-Move rule, 
all ECN orders be treated as agency orders.\22\ The commenter asserted 
that the change was necessary because an ECN could incur principal 
liability when routing a Trade-or-Move Message where the underlying 
subscriber order was for a size smaller than the required minimum 
message size. The commenter maintained that the proposal would 
materially increase the principal liability risk to ECNs by doubling 
the minimum Trade-or-Move Message size requirement from 5,000 shares to 
10,000 shares.
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    \22\ See BRUT Letter, supra note 4. NASD Rule 4613(e)(1)(C)(iv) 
states that, for purposes of that rule, an `agency order' means an 
order(s) that is 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, or for the benefit 
of an `institutional account' as defined in NASD Rule 3110. An 
agency order shall not include an order(s) that is for the benefit 
of a market maker in the security at issue, but shall include an 
order(s) that is for the benefit of a broker/dealer that is not a 
market maker in the security at issue.''
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    In response, Nasdaq asserts that permitting market makers to 
transform their orders into agency orders by sending them to an ECN 
would undermine the progress that the Trade-or-Move requirements have 
made towards eliminating locked and crossed markets in Nasdaq.\23\ In 
addition, Nasdaq maintains that the benefit to the overall market of 
raising the minimum Trade-or-Move Message size requirement for certain 
stocks outweighs the risk the commenter perceives. Nasdaq notes that 
under the proposal, as amended, the 10,000-share Trade-or-Move Message 
requirement applies only to the most active, liquid stocks in the 
market, and that a smooth opening for these stocks is critical to 
investors.\24\ Nasdaq also states that some ECNs have implemented 
systems to differentiate between agency and principal order flow from 
market makers.\25\
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    \23\ See Amendment No. 3, supra note 6.
    \24\ See Amendment No. 3, supra note 6.
    \25\ See Amendment No. 3, supra note 6.
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2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of section 15A(b)(6) and section 11A of the Exchange 
Act. Section 15A(b)(6) requires that the rules of a registered national 
securities association are designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principals of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest; and are not designed to 
permit unfair discrimination between customers, issuers, brokers, or 
dealers. Section 11A(a)(1)(C) provides that is in the public interest 
and appropriate for the protection of investors and the maintenance of 
fair and orderly 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.
    Nasdaq believes that the proposed amendments to NASD Rule 4613(e) 
are consistent with sections 15A(b)(6) and 11A(a)(1)(C) of the Exchange 
Act. By attempting to resolve locks and crosses at the market opening, 
the proposed amendments foster cooperation and coordination with 
members. The proposal also ensures the fair and orderly operation of 
Nasdaq and the protection of investors, as its purpose is to limit the 
disruptions to the Nasdaq market and the potential for harm to 
investors.

B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

    See response to written comments above.

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 Exchange consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether Amendment Nos. 2 
and 3 are consistent with the Exchange Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NASD. All submissions should refer to file 
number SR-NASD-00-76 and should be submitted by April 1, 2002.


[[Page 10962]]


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
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    \26\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 02-5816 Filed 3-8-02; 8:45 am]
BILLING CODE 8010-01-P