[Federal Register Volume 67, Number 102 (Tuesday, May 28, 2002)]
[Notices]
[Pages 36946-36952]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-13191]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45968; File No. SR-NASD-2002-42]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment Nos. 1, 2 and 3 thereto by the National 
Association of Securities Dealers, Inc. Relating to the Integrated 
Processing of Odd-Lot Share Amounts in Nasdaq's SuperMontage System

May 20, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934

[[Page 36947]]

(``Act''), \1\ and Rule 19b-4 thereunder, \2\ notice is hereby given 
that on March 25, 2002, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association'') through its subsidiary, the Nasdaq 
Stock Market, Inc. (``Nasdaq''), filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by Nasdaq. 
Nasdaq filed Amendment No. 1 to the proposed rule change on April 23, 
2002.\3\ Nasdaq filed Amendment No. 2 to the proposed rule change on 
May 17, 2002.\4\ Nasdaq filed Amendment No. 3 to the proposed rule 
change on May 17, 2002.\5\ The Commission is publishing this notice to 
solicit comments on the proposed rule change, as amended, from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On April 23, 2002, the Exchange filed a Form 19b-4, which 
replaced the original filing in its entirety (``Amendment No. 1'').
    \4\ On May 17, 2002, the Exchange filed a form 19b-4, which 
replaced the original filing in its entirety (``Amendment No. 2'').
    \5\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated May 17, 2002 
(``Amendment No. 3''). In Amendment No. 3, Nasdaq replaced the text 
of NASD Rule 4707 in its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq proposes changes to several NASD Rules governing the 
operation of Nasdaq's future Order Display and Collector Facility 
(``NNMS'' or ``SuperMontage'') to allow the system to accept, 
integrate, process, and otherwise facilitate the interaction of orders 
of less than one round-lot (100 shares) with all other SuperMontage 
quotes and orders.
    The text of the proposed rule change appears below. New text is in 
italics; deletions are in brackets.\6\
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    \6\ The Commission notes that it has made technical, non-
substantive change to the proposed rule text. Nasdaq has committed 
to submit an amendment conforming to these changes. Telephone 
conversation between Thomas P. Moran, Associate General Counsel, 
Nasdaq, and Kelly Riley, Senior Special Counsel, Division, 
Commission, on May 17, 2002.
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4701. Definitions
    Unless stated otherwise, the terms described below shall have the 
following meaning:
    (a) through (cc) No Change.
    (dd) 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] reduced by executions to less than a 
normal unit of trading.
    (ee) through (ff) No Change.
    (gg) The term ``Legacy Quote'' shall mean the quotation mechanism 
that existed in Nasdaq on or before July 1, 2002, and that does not 
permit the entry of Quotes/Orders at multiple price levels in the NNMS.
* * * * *
4706. Order Entry Parameters
    (a) Non-Directed Orders --
    (1) General. The following requirements shall apply to Non-Directed 
Orders Entered by NNMS Market Participants:
    (A) No Change.
    (B) A Non-Directed Order must be a market or marketable limit 
order, [must be a round-lot or a mixed-lot,] must indicate whether it 
is a buy, short sale, short-sale exempt, or long sale, and if entered 
by a Quoting Market Participant may be designated as Immediate or 
Cancel.
    (C) through (E) No Change.
    (2) No Change.
    (b) Directed Orders A participant may enter a Directed Order into 
the NNMS to access a specific Attributable Quote/Order displayed in the 
Nasdaq Quotation Montage, subject to the following conditions and 
requirements:
    (1) through (3) No Change.
    (c) No Change.
    (d) Order Size--Any [round or mixed-lot] order in whole shares 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) No Change.
    [(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) No Change.
    (b) Display of Quotes/Orders in Nasdaq--The NNMS will display a 
Nasdaq Quoting Market Participant's Quotes/Orders as follows:
    (1) No Change.
    (2) No Change.
    (3) Exceptions--The following exceptions shall apply to the display 
parameters set forth in paragraphs (1) and (2) above:
    (A) Odd-lots, Mixed-lots, and Rounding--The Nasdaq system (and all 
accompanying data feeds) shall be capable of displaying trading 
interest in round-lot amounts. For quote display purposes, Nasdaq will 
aggregate all shares, including odd-lot share amounts, entered by a 
Quoting Market Participant at a single price level and then round that 
total share amount down to the nearest round-lot amount for display and 
dissemination consistent with subparagraphs (b)(1) and (b)(2) of this 
rule. Though rounded, any odd-lot portion of a Quoting Market 
Participant's trading interest that is not displayed as a result of 
this rounding process will remain in the system, with the time-priority 
of their original entry, and be continuously available for execution. 
Round-lots that are subsequently reduced by executions to a mixed-lot 
amount will likewise be rounded for display purposes by the system to 
the nearest round-lot amount at that same price level. Any odd-lot 
number of shares that do not get displayed as a result of this rounding 
will remain in the system with the time-priority of their original 
entry and thus be continuously available for execution. If executions 
against an Attributable Quote/Order result in there being an 
insufficient (odd-lot) amount of shares at a price level to display an 
Attributable Quote/Order for one round-lot, the system will display the 
Quoting Market Participant's next best priced Attributable Quote/Order 
consistent with Rule 4710(b)(2). If all Attributable Quotes/Orders on 
the bid and/or offer side of the market are exhausted so that there are 
no longer any Attributable Quotes/Orders, the system will refresh a 
market maker's exhausted bid or offer quote using the process set forth 
in Rule 4710(b)(5). With the exception of Legacy Quotes, odd-lot 
remainders that are not displayed will remain in the system at their 
original price levels and continue to be available for execution.
    (c) through (e) No Change.
* * * * *
4710. Participant Obligations in NNMS
    (a) No Change.
    (b) Non-Directed Orders
    (1) General Provisions--A Quoting Market Participant in an NNMS 
Security shall be subject to the following requirements for Non-
Directed Orders:
    (A) No Change.
    (i) No Change.

[[Page 36948]]

    (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 the full size of such order (even if the delivered order is 
a mixed-lot or odd-lot) unless that interest is no longer available in 
the ECN, in which case the ECN is required to execute in a size equal 
to the remaining amount of trading interest available in the ECN [such 
order in a manner consistent with the Firm Quote Rule].
    (iii) No Change.
    (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 (based on the 
algorithm selected by the entering participant, as described in 
subparagraph (b)(B)(i)--(iii) of this rule), 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 the NNMS system shall be delivered to or 
automatically executed against Quoting Market Participants' Displayed 
Quotes/Orders and Reserve Size, including Agency Quotes (if 
applicable), in strict price/time priority, as described in the 
algorithm contained in subparagraph (b)(B)(i) of this rule. 
Alternatively, an NNMS Market Participant can designate that its Non-
Directed Orders be executed based on a price/time priority that 
considers ECN quote-access fees, as described in subparagraphs 
(b)(B)(ii) of this rule, or executed based on price/size/time priority, 
as described in subparagraph (b)(B)(iii) of this rule. For purposes of 
the execution algorithms described in paragraphs (i), (ii) and (iii) 
below, ``Displayed Quotes/Orders'' shall also include any odd-lot, odd-
lot portion of a mixed-lot, or any odd-lot remainder of a round-lot(s) 
reduced by execution, share amounts that while not displayed in the 
Nasdaq Quotation Montage, remain in system and available for execution.
    (i) through (iv) No Change.
    (C) Decrementation Procedures--The size of a 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 Non-Directed Order or Preferenced 
Order in an amount equal to the system-delivered order or execution. [; 
provided, however, that if an NNMS order that is a mixed-lot, 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 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 NNMS Market Maker next in the odd-lot rotation, 
as described in subparagraph (e) of this rule.]
    (i) through (iv) No Change.
    (D) through (E) No Change.
    (2) Refresh Functionality
    (A) Reserve Size Refresh--Once a Nasdaq Quoting Market 
Participant's Displayed Quote/Order size on either side of the market 
in the security has been decremented to [zero] an amount less than one 
normal unit of trading due to NNMS processing Nasdaq will refresh the 
displayed size out of Reserve Size to a size-level designated by the 
Nasdaq Quoting Market Participant, or in the absence of such size-level 
designation, to the automatic refresh size. The amount of shares taken 
out of reserve to refresh display size shall be added to any shares 
remaining in the Displayed Quote/Order. To utilize the Reserve Size 
functionality, a minimum of a normal unit of trading 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 a 
normal unit of trading. This functionality will not be available for 
use by UTP Exchanges.
    (B) Auto Quote Refresh (``AQR'')--Once an NNMS Market Maker's 
Displayed Quote/Order size and Reserve Size on either side of the 
market in the security has been decremented to [zero] an amount less 
than one normal unit of trading due to NNMS executions, the NNMS Market 
Maker may elect to have The Nasdaq Stock Market refresh the market 
maker's quotation as follows:
    (i) Nasdaq will refresh the market maker's quotation price on the 
bid or offer side of the market, whichever is decremented to [zero] an 
amount less than a normal unit of trading, by a price interval 
designated by the NNMS Market Maker; and
    (ii) No Change.
    (iii) This functionality shall produce an Attributable Quote/Order. 
[In addition, if an NNMS Market Maker is utilizing the QR functionality 
but has an Attributable Quote/Order in the system that is priced at or 
better than the quote that would be created by the QR, the NNMS will 
display the Attributable Quote/Order, not the QR-produced quote.]
    (iv) The AQR functionality described in this subparagraph shall 
only be available for use in connection with a NNMS Market Maker's 
``Legacy Quote.'' [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) through (8) No Change.
    (c) No Change.
    (d) No Change.
    [(e) Odd-Lot Processing
    (1) Participation in Odd-Lot Process--All NNMS Market Makers may 
participate in the Odd-Lot Process for each security in which the 
market maker is registered.
    (2) Execution Process
    (A) Odd-lot orders will be executed against an NNMS Market Maker 
only if it has an odd-lot exposure limit in an amount that would fill 
the odd-lot order. A NNMS Market Maker may, on a security-by-security 
basis, set an odd-lot exposure limit from 0 to 999,999 shares.
    (B) An odd-lot order shall be executed automatically against the 
next available NNMS Market Maker when the odd-lot order becomes 
executable (i.e., when the best price in Nasdaq moves to the price of 
the odd-lot limit order). Such odd-lot orders will execute at the best 
price available in the market, in rotation against NNMS Market Makers 
who have an exposure limit that would fill the odd-lot order.
    (C) For odd-lots that are part of a mixed-lot, once the round-lot 
portion is executed, the odd-lot portion will be executed at the round-
lot price against the next NNMS Market Maker in rotation (as described 
in subparagraph (e)(2)(b) of this rule) even if the round-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

[[Page 36949]]

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)] (e) UTP Exchanges
    (1) through (6) No Change.
* * * * *
4715. Adjustment of Open Quotes and/or Orders
    NNMS will automatically adjust the price and/or size of open quotes 
and/or orders resident in the system in response to issuer corporate 
actions related to a dividend, payment or distribution, on the ex-date 
of such actions, except where a cash dividend or distribution is less 
than one cent ($0.01), as follows:
    (a) No Change.
    (b) No Change.
    (c) Buy Orders--Buy side orders shall be adjusted by the system 
based on the particular corporate action impacting the security (i.e. 
Cash dividend, stock dividend, both, stock split, reverse split) as set 
forth below:
    (1) No Change.
    (2) Stock Dividends and Stock Splits: Buy side order prices shall 
be determined by first rounding up the dollar value of the stock 
dividend or split to the nearest penny. The resulting amount shall then 
be subtracted from the price of the buy order. Unless marked ``Do Not 
Increase'', the size of the order shall be increased by first, (A) 
multiplying the size of the original order by the numerator of the 
ratio of the dividend or split, then (B) dividing that result by the 
denominator of the ratio of the dividend or split, then (C) rounding 
that result to the next lowest [round-lot] share.
    (3) No Change.
    (4) No Change.
    (5) No Change.
    (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
    Currently, the rules of SuperMontage provide for the voluntary 
participation of market makers in the execution of odd-lot orders. Only 
those market makers that voluntarily set individual odd-lot exposure 
limits on specific securities would have odd-lot orders sent to them on 
a rotating basis for execution. Resulting executions would reduce the 
market maker's odd-lot exposure limit, but not its displayed quote, and 
the system would not deliver an additional execution against the same 
odd-lot market maker until at least 5 seconds have elapsed since the 
market maker's last previous odd-lot execution in the security. For 
mixed-lot orders, SuperMontage would execute the round-lot portion(s) 
of such orders through the main non-directed order process and 
thereafter execute any odd-lot remainder against the next market maker 
in rotation with an odd-lot exposure amount sufficient to fully execute 
the odd-lot. The resulting odd-lot execution would be done at the same 
price as the round-lot portion(s) of the mixed-lot order.
    Upon further review, Nasdaq has determined to alter this approach 
to the processing of odd-lots and mixed-lot orders in SuperMontage. 
Instead, Nasdaq proposes to implement in SuperMontage a fully 
integrated process to execute and process orders in share amounts of 
less than one round-lot (100 shares). As such, Nasdaq will not provide 
a separate process for odd-lot orders and instead allow the entry of 
orders in any whole share amount from 1 to 999,999 shares. The outline 
of this ``actual shares'' approach follows.
I. Display of Quotations and Dissemination of Transaction Reports
    Nasdaq will continue to display and disseminate quote and trade 
information solely in round-lot amounts. The Nasdaq inside market will 
consist of the best-priced bid display quote and the best-priced offer 
display quote that are at least one round-lot (100 shares) in size. 
Nasdaq will continue to disseminate transactions to the public tape, 
whether it is a round or mixed-lot execution, in round-lot increments. 
\7\ For quote display purposes, Nasdaq will aggregate all shares 
(orders and quotes) entered by a market participant, including UTP 
Exchanges, at a single price level and then round that total share 
amount down to the nearest round-lot amount for display and 
dissemination. For example, a quoting market participant with three 
separate orders to buy of 50 shares, 225 shares and 590 shares at the 
same price level would have displayed next to its market identifier on 
the bid side of the market an aggregate quote size of 800 shares (50 + 
225 + 590 = 865 which is then rounded down to 800 shares for display 
purposes). Likewise, a party entering a mixed-lot quote/order will have 
that mixed-lot amount automatically rounded down to nearest round-lot 
amount for display. Though rounded, any odd-lot portion that is not 
displayed as a result of this rounding process (in the previous 
example, 65 shares) will remain in the system, with the time-priority 
of their original entry. SuperMontage's aggregated share price 
information features will disseminate price and size information based 
solely on aggregated round-lot share amounts (including aggregated 
mixed-lots rounded down to round-lots) and will not include any price 
level where there is less than a round-lot share amount of trading 
interest.
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    \7\ For the purpose of publicly reporting transactions to the 
tape, Nasdaq would round a mixed-lot execution down, and report it 
as the next lowest round-lot increment. Telephone conversation 
between Thomas P. Moran, Associate Counsel, Nasdaq, and Marc 
McKayle, Special Counsel, Division, Commission, on May 17, 2002.
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A. Display of Mixed-Lot and Odd-lot Remainders
    SuperMontage will not display odd-lots.\8\ Aggregated or initial 
round-lot amounts that are subsequently reduced by executions to a 
mixed-lot amount will be rounded down for display purposes to the 
nearest round-lot amount at that same price level. If executions result 
in there being an insufficient (odd-lot remainder) amount of shares at 
a price level to display a round-lot share amount for a market 
participant using SuperMontage's new quote/order interface (``Quote/
Order''), the system will instead display that market participant's 
next best priced round-lot share amount on that same

[[Page 36950]]

side of the market where the market participant using quotes/orders has 
displayable trading interest of at least a single round-lot share 
amount. If there is no remaining displayable trading interest on a 
particular side of the market a new quote/order will be generated using 
the ``penalty process,'' as set forth in Section I.B. below.
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    \8\ Under the proposal, the maximum number of shares of an 
individual order, or an aggregated total of multiple orders, that 
potentially may not be displayed is 99 shares. Nasdaq believes that 
this approach is consistent with the Commission's Limit Order 
Display Rule that exempts customer limit orders of odd-lot size from 
the display requirement. See Exchange Act Rule 11Ac1-4(c)(3); 17 CFR 
240.11Ac-4(c)(3).
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    If a market participant in SuperMontage continues to use current 
quote technology--``Legacy Quote''--instead of SuperMontage's new quote 
and order entry messages and features,\9\ the system will likewise not 
display any odd-lot remainder of the Legacy Quote and will instead 
either: (1) refresh the Legacy Quote using the Auto Quote Refresh 
(``AQR'') function to a price and size selected by the entering party, 
or (2) generate a entirely new Legacy Quote using the penalty process, 
as set forth below.
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    \9\ An integral part of Nasdaq's implementation strategy for 
SuperMontage is to provide users with the ability to initially 
select their level of interaction with the system and the timing of 
internal firm programming changes necessary to take advantage of 
some or all of SuperMontage's new features and functionality. 
Through a programming approach known as ``backward compatibility,'' 
SuperMontage will allow firms to continue to use the quote and order 
templates they use today in the SuperSoes environment to format 
messages to interact with the SuperMontage (i.e., Legacy Quote). 
Likewise, firms that continue to use current SelectNet formats, will 
be able to use SuperMontage's Directed Order Process to communicate 
with other market participants.
    Firms would need to make at least some programming changes to 
participate in the new SuperMontage environment using existing 
SuperSOES formats, interfaces and functions. However, backward 
compatibility allows a firm to internally prioritize which 
SuperMontage features and functions it would like to take advantage 
of, and program for those changes first. In one limited 
circumstance, however, the decision to program to use a SuperMontage 
feature providing greater flexibility than that available in today's 
environment, can result in losing a complimentary capability. This 
occurs when a firm programs to use SuperMontage's new Quote/Order 
interface and thus is able to place multiple quotes at multiple 
price levels in the system. When this occurs, the firm may no longer 
use Nasdaq's AQR feature which is associated exclusively with Legacy 
Quotes. See Section I.C. of this filing.
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B. Penalty Quote Refresh
    If a market maker is using either a Quote/Order, or a Legacy Quote 
without AQR functionality, and has no attributable round-lot share 
amounts on a particular bid or ask side of a market to round to, 
SuperMontage will automatically generate, consistent with NASD Rule 
4710(b)(5), a quote of a normal size unit of trading (i.e., a round-
lot).\10\ When a market participant's Legacy Quote is refreshed using 
the penalty process, any odd-lot remainder of the market participant's 
present in the system will be purged and will not be retained for 
potential execution.\11\ However, the odd-lot remainder of a market 
maker using a Quote/Order will remain in the system, will not be 
purged, and will be retained for potential execution.
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    \10\ The currently approved SuperMontage rule provides that if a 
market maker's quote or order is decremented to zero and the market 
maker does not update its principal quote via AQR, transmit a 
revised attributable quote/order to Nasdaq, or have another 
attributable quote or order in the system, Nasdaq will place the 
market maker's quote (both sides) in a closed state for three 
minutes. At the end of that time, if the market maker did not 
voluntarily update or withdraw its quote from the market, Nasdaq 
will refresh the market maker's quote/order to its normal unit of 
trading at the lowest bid and highest offer currently being 
displayed in that security and reopen the market maker's quote.
    Nasdaq recently filed with the Commission a proposed rule change 
to modify this process. Under the proposal, if all bids and/or 
offers are exhausted so that there are no longer any Quote/Orders 
displayed on the bid or offer side of the market, and the market 
maker does not update its principal quote via AQR, transmit a 
revised attributable quote/order to Nasdaq, or have another 
attributable quote or order in the system, the system, after 30 
seconds, would refresh only the market maker's exhausted bid or 
offer quote to a normal unit of trading priced $0.01 inferior to the 
lesser of either: a) the last valid displayed inside bid/offer in 
the security before all such bids/offers were exhausted; or b) the 
market maker's last displayed bid/offer before exhaustion. If the 
resulting bid/offer quote would create a locked or crossed market, 
SuperMontage will instead re-open the exhausted market maker's bid/
offer quote at a price $0.01 inferior to the unexhausted inside bid/
offer in that security. If at any time this penalty quote refresh 
process would result in the creation of a bid/offer of less than 
$0.01, the system will refresh that bid/offer to a price of $0.01. 
See Securities Exchange Act Release No. 45671 (March 28, 2002), 67 
FR 16784 (April 8, 2002) (Notice for File No. SR-NASD-2002-01).
    Changes were made to this footnote pursuant to a telephone 
conversation between Thomas P. Moran, Associate General Counsel, 
Nasdaq, and Marc McKayle, Special Counsel, Division, Commission, on 
May 20, 2002.
    \11\ Note, however, between the time a market maker's Legacy 
Quote is decremented to less than a round-lot share amount and the 
time the market maker's Legacy Quote is refreshed pursuant to the 
penalty process or the transmission of a revised attributable quote 
prior to the system refreshing the quote via the penalty process, 
any odd-lot remainders will be retained by the system and shall be 
accessible for execution. In essence, odd-lot remainders of a Legacy 
Quote are purged from the system contemporaneous with the actually 
refreshing of a Legacy Quote. Telephone conversation between Thomas 
P. Moran, Associate General Counsel, Nasdaq, and Marc McKayle, 
Special Counsel, Division, Commission, on May 20, 2002.
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C. Automatic Quote Refresh
    As stated previously, a market participant using a Legacy Quote, 
but not Quote/Order, may use Nasdaq's AQR functionality to have their 
displayed quote refreshed to a price and size (round-lot share amount) 
selected by the firm immediately after its displayed and reserve size 
at a price level is reduced to less than 100 shares. Any odd-lot share 
amount present at the time a Legacy Quote is refreshed by AQR shall not 
be retained in the SuperMontage system for execution and the system 
will only recognize and potentially process the round-lot refreshed 
amount.
    AQR was introduced in a SOES environment (and carried over into 
SuperSOES), where market participants can only enter one price level, 
and can have their quotes decremented to zero due to automatic 
executions. In SOES and SuperSOES, if a firm does not refresh its quote 
after being decremented to zero, the firm is subject to a mandatory 
withdrawal from market making in the security at issue, as it has 
failed to maintain a two-sided market (``SOESed-out-of-the-Box''). 
Thus, the purpose of AQR is to allow market participants to meet their 
two-sided quote obligations in an environment where market participant 
are subject to automatic execution and withdrawal and have only one 
means of meeting with two-sided market requirement (i.e., via a two-
sided quote).
    In this filing, Nasdaq proposes that SuperMontage will only allow 
AQR to function with Legacy Quotes.\12\ AQR will not function with new 
SuperMontage Quotes/Orders as AQR was tied to an environment where an 
market participant can only enter a single quote to manage their 
position. In addition, Nasdaq believes that AQR is redundant if a firm 
is using multiple quote/orders to manage their positions--that is, if a 
firm is using multiple quotes or orders to manage their position and 
meet their two-sided market obligation, AQR is duplicative.
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    \12\ The SuperMontage, as originally approved, contemplated the 
use of the AQR function with a market participant's use of multiple 
attributable quotes. See Securities Exchange Act Release No. 43863 
(January 19, 2001), 66 FR 8020 (January 26, 2001).
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    Lastly, Nasdaq believes it is important to note that the need for 
AQR in a SuperMontage environment is less, in part, because market 
makers can no longer be SOESed-out-of-the-Box pursuant to the penalty 
quote process (as described in Section B of this filing).
D. Retention of Odd-Lot Remainders for Potential Execution
    SuperMontage will always retain for potential execution all odd-lot 
remainders of Quotes/Orders unless canceled by the entering party. For 
Legacy Quotes, odd-lot remainders will be retained by the system only 
to the extent that Legacy Quote has not been refreshed by either the 
AQR function or the penalty process. Legacy Quotes using Nasdaq's AQR 
functionality shall have their displayed quote refreshed to

[[Page 36951]]

the price and round-lot share amount selected by the firm immediately 
after its display and reserve at a price level is reduced to less than 
100 shares. Any odd-lot share amount present at the time a Legacy Quote 
is refreshed using the AQR function shall not be retained in the 
SuperMontage system for execution. In addition, when a Legacy Quote 
without AQR functionality is refreshed using the penalty process, any 
odd-lot remainder shall not be retained by the system after the market 
maker has had its quote refreshed by the penalty process.\13\ ECNs that 
have only odd-lot share amounts remaining at a price level will remain 
in the montage with no displayed quote on the side(s) of the market 
where they have the odd-lot amount. Though un-displayed, such odd-lots 
remainders will reside in the system, retain their price and time 
priority, and will be available for execution.
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    \13\ See supra note 11.
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E. Reserve Refresh
    SuperMontage also allows market participants to use reserve size 
and select a round-lot refresh amount that the market participant 
wishes its quote to be refreshed to once its displayed size is reduced 
to less than a round-lot. Thus, once a quote or an order is decremented 
to a size less than 100 shares, the system will refresh the quote from 
reserve size by an amount designated by the market participant. If 
there was an odd-lot amount available prior to the quote being 
refreshed, the odd-lot remainder of quotes and orders being refreshed 
from reserve would be retained by the system and combined with the 
refresh size. For example, a market maker (``MMA'') is displaying a 
1000 share bid quote. MMA has 5000 shares in reserve and a 500 share 
refresh size. SuperMontage executes 925 shares against MMA's. Upon 
execution, since MMA's displayable interest is less than 100 shares, 
the system will refresh MMA's' quote by the refresh amount--500 shares, 
but will also retain the 75 share odd-lot remainder in the system. The 
resulting 575 share total will remain in the system and available for 
execution but will be rounded down to 500 shares for display purposes.
II. Entry of Orders
    Under the new approach to odd-lot orders, market participants will 
be able to enter orders into SuperMontage in any whole-share amount 
from 1 to 999,999 shares. Though eligible for entry and execution along 
with all other quotes and orders, orders originally entered in odd-lot 
amounts may not use SuperMontage's Reserve Size feature.\14\ Like 
round-lot orders, odd-lot and mixed-lot orders will be allowed to be 
entered as ``market'' orders or priced ``limit'' orders, and may have a 
designated time-in force of ``Day,'' ``Immediate or Cancel,'' or 
``Good-till-canceled.''\15\ They can also be replaced, increased or 
decreased under the same terms and conditions as round-lot orders. Odd-
lot orders may also be preferenced (via the Non-Directed Order Process 
set forth in NASD Rule 4710(b)(1)(B)(iv)) to other market participants 
in the same manner as round and mixed-lots.
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    \14\ Quotes and orders originally entered into the system as 
mixed-lots may use the SuperMontage reserve size feature. Telephone 
conversation between Thomas P. Moran, Associate General Counsel, 
Nasdaq, and Marc McKayle, Special Counsel, Division, Commission, on 
May 17, 2002.
    \15\ Nasdaq has filed a rule proposed rule change with the 
Commission to allow orders in SuperMontage to be designated as 
``Day.'' The Commissions expects that Nasdaq will amend the proposed 
rule change shortly to include the ``Good-till-cancelled'' 
designation. See File No. SR-NASD-2001-98.
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    Finally, to the extent that any order residing in SuperMontage 
becomes subject to an issuer corporate action related to a stock split 
or dividend that would require adjustment of the size of that order, 
Nasdaq will adjust the order's size to an appropriate individual share 
amount.\16\ Currently, the rules governing these adjustments call for, 
in certain cases, the rounding of share amounts to the nearest round-
lot. If this proposal is approved, such rounding, when required, will 
be done to the single share. Nasdaq believes that this will result in 
more accurate representation of buying and selling interest.
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    \16\ Nasdaq filed a proposed rule change with the Commission 
that became effective pursuant to section 19(b)(3)(A) of the Act, 
which sets forth this adjustment process that currently contains 
rule language rounding share amounts to round-lots. See Securities 
Exchange Act Release No. 4577 (April 18, 2002), 67 FR 20566 (April 
25, 2002).
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III. Execution Process
    Odd-lots and mixed-lots shall be processed through SuperMontage's 
Non-Directed Order process. All market and marketable limit orders for 
odd-lots and mixed-lots will execute against trading interest on the 
other side of the market (against which it is marketable) on a share-
by-share basis (in actual share amounts). Odd-lots and mixed-lots will 
receive a time stamp upon entry into SuperMontage, which they will 
retain while in the system. Odd-lots and mixed-lots will be executed 
pursuant to the execution algorithm selected (price/time (default), 
price/time with fee consideration, and price/size/time) by the entering 
market participant. Priced mixed-lot orders (limit orders) that are 
entered by a quoting market participant and that are or become non-
marketable, will be displayed in SuperMontage on a rounded basis. That 
is, the system will round down the size of mixed-lot to the nearest 
round-lot amount.\17\ An odd-lot, mixed-lot, or round-lot that 
subsequently is reduced to an odd-lot or mixed-lot size will retain the 
time-stamp of original entry for purposes of determining priority in 
the Non-Directed Order processing queue.
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    \17\ ``Immediate or Cancel'' (``IOC'') Orders are not eligible 
for display in SuperMontage. Orders entered by order-entry firms are 
designated as IOC. Quoting market participants (i.e., market makers, 
ECNs, and UTP Exchanges) may designate orders as IOC.
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    As described above, odd-lots will be retained by the system, but 
will not be displayed. Odd-lots and mixed-lots will interact with other 
quotes and orders against which they are marketable in the same manner 
as round-lots. As also described above, SuperMontage will not execute 
at an inferior price level until all better-priced share amounts that 
are in the system, both round-lots and undisplayed odd-lots, are 
executed.
    Nasdaq believes that the full integration of odd-lot share amounts 
into SuperMontage is a great step forward in ensuring that the small 
orders of public customers are treated fairly, consistently, and on the 
same terms as the larger orders of professional market participants. In 
addition, by placing such orders on an equal execution footing with 
round-lot trading interest, Nasdaq believes that odd-lot share amounts 
can be a significant source of liquidity in the Nasdaq market.
(2) Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of section 15A of the Act,\18\ in general and with 
section 15A(b)(6) of the Act,\19\ in particular, in that the proposal 
is 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 and 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.
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    \18\ 15 U.S.C. 78o-3.
    \19\ 15 U.S.C. 78o-3(b)(6).

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[[Page 36952]]

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 Act.

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

    Nasdaq neither solicited nor received written comments.

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 NASD 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.\20\
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    \20\ Nasdaq has requested the Commission to find good cause 
pursuant to Section 19(b)(2) of the Act to approve the proposed rule 
change prior to the 30th day after its publication in the Federal 
Register. See Amendment No. 2, supra note 4.
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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 proposed rule 
change, as amended, 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 such 
filings will also be available for inspection and copying at the 
principal office of the Association. All submissions should refer to 
File No. SR-NASD-2002-42 and should be submitted by June 18, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-13191 Filed 5-24-02; 8:45 am]
BILLING CODE 8010-01-P