[Federal Register Volume 67, Number 105 (Friday, May 31, 2002)]
[Notices]
[Pages 38152-38163]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-13623]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45983; File No. SR-NASD-2002-60]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by National Association of Securities Dealers, Inc. Relating to 
Permanent Approval of the Primex Auction System \

May 23, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on May 1, 2002, the National Association of Securities Dealers, Inc. 
(``NASD''), 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 Nasdaq. 
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)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Nasdaq is seeking permanent approval of its application of the 
Primex

[[Page 38153]]

Auction System\ (``Primex'' or ``System''). The System began operating 
as a Pilot Trading System on December 17, 2001, pursuant to Rule 19b-5 
of the Act.\3\ Pursuant to paragraph (f) of Rule 19b-5 of the Act,\4\ 
Nasdaq has filed a companion proposed rule change to continue operating 
the System while the Commission considers granting permanent 
approval.\5\ The companion proposed rule change is effective upon 
filing. The Exchange represents that the proposed rule language 
contained in the companion filing and set forth below is identical and 
is the same language that governs use of the System today.
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    \3\ 17 CFR 240.19b-5.
    \4\ 17 CFR 240.19b-5(f).
    \5\ See Securities Exchange Act Release No. 45982 (May 23, 2002) 
(publishing SR-NASD-2002-58 for notice and comment).
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5010. NASDAQ Application of the PRIMEX AUCTION SYSTEM \
5011. Definitions
    For purposes of this Rule Series, unless the context requires 
otherwise:
    (a) ``Application'' or ``Nasdaq Application'' as used in this Rule 
Series, and ``Nasdaq Application of the Primex Auction System'' as used 
throughout the NASD Rules means the voluntary Nasdaq trading service 
facility that permits NASD member firms, among other things, to submit 
orders in Primex Eligible Securities to be exposed to a Crowd of 
Participants in an anonymous, electronic auction format for the purpose 
of obtaining an execution for their own account or the account of a 
customer; to have required reports of any resulting trades 
automatically disseminated to the public and the industry; and to 
``lock in'' these trades as necessary by sending both sides to the 
applicable clearing agency designated by the Participants involved for 
clearance and settlement, all in accordance with this Rule Series and 
other applicable rules and policies of Nasdaq.
    (b) ``Primex Auction System Participant,'' ``Participant,'' or 
``Participant Firm'' means a broker-dealer registered with the NASD 
that, when authorized, can access and participate in the Application 
for its customers or its own account, consistent with this Rule Series. 
Participants access the Application through one or more Subscribers 
associated with that Participant within the Application.
    (c) ``Subscriber'' means a user associated with a Participant who, 
when authorized, can access and participate in the Application on 
behalf of that Participant, consistent with this Rule Series. A user 
also can access and participate directly in the Application on its own 
behalf, but in the name of a Participant, subject to a sponsored 
arrangement with that Participant, and consistent with these Rules.
    (d) ``Firm Administrator'' means a Subscriber who, for a particular 
Participant, is authorized among other things to: (1) Monitor and 
control access to and participation in the Application by all of that 
Participant's Subscribers, including establishing Credit Limits for 
each of the Participant's Subscribers who access and participate in the 
Application on behalf or in the name of that Participant; and (2) view 
the status of the Clearing Limits applicable to the Participant 
overall.
    (e) ``Nasdaq Supervisor'' means the Nasdaq staff responsible for 
establishing and supervising certain operational functions with respect 
to the operation of the Application.
    (f) ``Credit Limits'' means the dollar amount of aggregated 
purchases or sales established within the Application by a 
Participant's Firm Administrator for each of the Participant's 
Subscribers which, when reached, causes the Application to: (1) Inhibit 
any future executions or the entry of future interest for that 
Subscriber; (2) cancel any orders and withdraw any Indications resident 
within the Application for that Subscriber; and (3) send a notice to 
that Subscriber, its Firm Administrator, and the Nasdaq Supervisor. 
Credit Limits may be established, monitored, and modified by the Firm 
Administrator on a real-time basis directly through the Application.
    (g) ``Clearing Limits'' means the dollar amount of aggregated 
purchases and sales (calculated separately and not netted) of all 
Subscribers, collectively for a Participant, effected through or in the 
name of that Participant, that is established within the Application 
for that Participant, which, when reached, causes the Application to: 
(1) Inhibit any future executions for all Subscribers associated with 
that Participant; (2) cancel any orders and withdraw any Indications 
resident within the Application for all Subscribers associated with 
that Participant; and (3) send a notice to that Participant's Firm 
Administrator, the Nasdaq Supervisor, and to the clearing broker for 
that Participant provided that the clearing broker also is a 
Participant. If the clearing broker is not a Participant in the 
Application, then the Nasdaq Supervisor will notify the clearing broker 
that the Clearing Limits have been reached as soon as practicable. 
Clearing Limits for a Participant may be monitored on a real-time basis 
by the Participant's Firm Administrator and can be established, 
monitored, and modified by the Firm Administrator of the Participant's 
clearing broker, provided the clearing broker also is a Participant. 
Clearing Limits also can be established and modified by the Nasdaq 
Supervisor on behalf of the clearing broker.
    (h) ``Crowd,'' ``Primex Crowd'' or ``Crowd Participant'' means 
Primex Auction System Participants that, when authorized, can access 
and participate in the Application consistent with this Rule Series by: 
(1) Submitting orders to be exposed to other Participants; (2) viewing 
orders submitted by other Participants; and (3) submitting Responses 
and Indications for the purpose of interacting with the orders of other 
Participants.
    (i) ``Watch List'' means the list of Primex Eligible Securities 
identified by a Crowd Participant for which the Crowd Participant will 
be notified by Nasdaq electronically when one or more orders in such 
securities is exposed in an Auction and made available for response by 
the Crowd.
    (j) ``Primex Auction Market Maker'' means a Participant that, when 
authorized, may participate in the Application: (1) As a Primex Auction 
Market Maker consistent with Rule 5020 with respect to those Primex 
Eligible Securities for which the Participant is registered as a Primex 
Auction Market Maker; and (2) as a Crowd Participant consistent with 
Rule 5019 with respect to any Primex Eligible Security.
    (k) ``Primex Eligible Security'' means any security listed on the 
Nasdaq Stock Market and any exchange-listed security eligible for 
participation in the Intermarket Trading System.
    (l) ``Mandatory Eligible Order'' means a public customer order, as 
more fully defined in Rule 5020, that a Primex Auction Market Maker 
must submit to the System for exposure in order for the Primex Auction 
Market Maker to maintain its status as such, subject to any exclusions 
or minimum permissible amount provided therein.
    (m) ``Market Order'' means an order submitted to the Application to 
purchase or sell a security at the most advantageous price(s) 
obtainable, without a specified, fixed price.
    (n) ``Fixed Price Order'' means an order submitted to the 
Application to purchase or sell a security at a specified, fixed price 
or better.
    (o) ``Minimum Relative Price Improvement'' means a condition that a 
Participant may attach to a market order consistent with Rule 5014(a), 
expressed in terms of the minimum relative price improvement required 
to execute the order. This condition is expressed in

[[Page 38154]]

terms relative to the best bid (for orders to sell) or best offer (for 
orders to buy) displayed in the NBBO at the time the order is eligible 
to be executed against within the Application. Neither the existence 
nor amount of any Minimum Relative Price Improvement condition is 
displayed, exposed or communicated to any Participant when attached to 
an order.
    (p) ``Response'' means an instruction submitted to the Application 
by a Participant, for the purpose of responding to an order or orders 
being exposed to the Crowd, consistent with Rule 5018.
    (q) ``Predefined Relative Indication'' or ``PRI'' means an 
instruction that a Participant can submit to the Application for the 
purpose of responding to an order(s) in an Auction, and which does not 
contain a specific, fixed price, but is expressed in terms relative to 
the best bid (for PRIs to buy) or offer (for PRIs to sell) publicly 
displayed for the security, consistent with Rule 5018. While resident 
within the Application, PRIs are ranked to respond to incoming orders 
in relative price/time priority, but are not displayed, exposed or 
communicated to any other Participant.
    (r) ``Go-Along Indication'' means an instruction that a Participant 
can submit to the Application for the purpose of responding to an 
order(s) in an Auction, and which does not contain a specific, fixed 
price, consistent with Rule 5018. A Go-Along Indication will be 
triggered to respond to an Auction at a price equal to the best bid 
(for Go-Along Indications to buy) or best offer (for Go-Along 
Indications to sell) publicly displayed whenever there has been at 
least one contemporaneous Crowd execution at such bid or offer, 
provided there are no PRIs or other orders available to execute against 
the order(s) in the Auction. While resident within the Application, Go-
Along Indications are not displayed, exposed or communicated to any 
other Participant.
    (s) ``Auction'' means the automated process through which orders in 
Primex Eligible Securities are exposed to Crowd Participants. Orders 
for the same security being exposed simultaneously (i.e. those which 
have overlapping exposure periods) are available on an aggregate basis, 
in whole or in part, for interaction with other Crowd participants, but 
only during the period of overlapping exposure. An Auction begins when 
an order is accepted by the Application and exposed to the Primex 
Crowd, and ends whenever such order(s) (including any orders that 
subsequently join the Auction in progress) are completely executed or 
their exposure ceases.
    (t) ``Public Order'' or ``Public Customer Order'' means an order 
for the account of a customer, and not for the account of a broker-
dealer, regardless of whether the customer is that of the Participant 
entering the order or another firm that has routed the customer order 
to the Participant.
    (u) ``Professional Order'' means an order for the proprietary 
account of a broker-dealer, regardless of whether the broker-dealer is 
a market maker or specialist, and regardless of whether it is the 
Participant's own order or the proprietary order of another broker-
dealer routed to the Participant.
    (v) ``Market Maker Guarantee'' means the feature within the 
Application that allows a Participant registered as a Primex Auction 
Market Maker to provide an automatic execution against public customer 
orders it submits to the Application for exposure in an Auction where 
such orders are not otherwise subject to an execution. The Application 
will automatically execute any unexecuted balance of the order against 
that Primex Auction Market Maker, after the Auction exposure period for 
the order has expired, consistent with Rule 5020. The Market Maker 
Guarantee shall be provided at a price equal to the best publicly 
quoted offer price (for orders to buy) or best publicly quoted bid 
price (for orders to sell) existing for the security at the time when 
such exposure period for the order has expired, for any amount of 
shares established by the Primex Auction Market Maker for the order.
5012. Access
    (a) The Application shall be available on a voluntary basis to any 
NASD member in good standing that chooses to register as a Participant 
in the Primex Auction System. Such registration shall be conditioned 
upon the Participant's initial and continuing compliance with the 
following requirements:
    (1) Execution of the necessary agreements with Nasdaq or its 
affiliate;
    (2) Membership in, or access arrangement with, a clearing agency 
registered with the Commission which maintains facilities through which 
Primex Auction System compared trades may be settled;
    (3) Compliance with all applicable rules and operating procedures 
of Nasdaq (including these rules) and the Commission;
    (4) Maintenance of the physical security of the equipment located 
on the premises of the Participant to prevent the improper use or 
access to Nasdaq systems, including unauthorized entry of information 
into the Primex Auction System; and
    (5) Acceptance and settlement of each trade that is executed 
through the facilities of the Primex Auction System, or if settlement 
is to be made through another clearing member, guarantee of the 
acceptance and settlement of such execution by the clearing member on 
the regularly scheduled clearing date.
    (b) Non-NASD members may access the Application in the name of a 
Participant by becoming a sponsored Subscriber of the Participant, 
provided the Participant and sponsored Subscriber have executed the 
necessary agreements with Nasdaq or its affiliate, and the NASD member 
Participant assumes the responsibilities set forth in paragraph (a) of 
this Rule 5012 with respect to any activity conducted by the sponsored 
Subscriber.
    (c) The Application may be made available through Nasdaq-provided 
network(s) via:
    (1) Primex Auction System Workstation Service;
    (2) An Application Programming Interface (``API''); or
    (3) A FIX protocol interface. Certain functionality of the 
Application also may be made available via Computer to Computer 
Interface (CTCI).
5013. Order Acceptance and Exposure
(a) Order Types
    The Application shall accept the following types of orders in 
Primex Eligible Securities, subject to any conditions or match 
parameters attached thereto to the extent permitted by the Application 
and Rule 5014, and other rules applicable to Participants with respect 
to the entry of orders. Conditions and match parameters, to the extent 
attached to an order, are never communicated to any Participant:
    (1) Market Orders;
    (2) Fixed Price Orders, when the specified price is equal to or 
between the best bid or offer publicly displayed, or is a buy (sell) 
order priced higher (lower) than the best offer (bid) publicly 
displayed. Fixed Price Orders to buy (sell) priced below (above) the 
best bid (offer) publicly displayed will be rejected.

    For example: If the best bid and offer publicly displayed in 
Nasdaq is $20--$20.10, then the Application will accept orders to 
buy priced at $20.00 and higher, including orders to buy priced 
higher than the offer of $20.10 (although no execution can take 
place outside of the NBBO prevailing at the time of execution). An 
order submitted to buy at $19.95, however, would not be accepted by 
the Application in this situation and will be returned to the 
Participant that entered it.

[[Page 38155]]

(b) Order Size
    The Application will accept orders that are either round lots, or 
mixed lots. Odd lot orders will not be accepted.
(c) Exposure Times Available
    (1) The Application allows Participants to expose orders to the 
Primex Crowd. Only the size associated with an order is communicated to 
the Crowd, and only for the time during which the order is available 
for execution. Crowd Participants may monitor the availability of 
orders exposed in an auction through the use of their Watch List.
    (2) For each Market Order submitted to the Application, a 
Participant can specify a maximum exposure time of either 0 (i.e., 
immediate), 15, or 30 seconds. Participants that are Primex Auction 
Market Makers for a security may submit Market Orders in that security 
for an immediate (i.e. ``zero second'') Auction, provided the 
Participant attaches certain match parameters as set forth in Rule 
5014(b). Market Orders for at least 10,000 shares or $200,000 in market 
value are also eligible for a zero second Auction, regardless of 
whether or not match parameters are attached.
    (3) Fixed Price Orders that are accepted by the Application can 
only be exposed for an immediate execution, in whole or in part.
5014. Conditions and Match Parameters
(a) For All Participants
    Subject to any other rules applicable to Crowd Participants and 
Primex Auction Market Makers with respect to the entry of orders, any 
Participant may enter an order with the following condition attached:
Minimum Relative Price Improvement
    Market Orders may be submitted with a condition for Minimum 
Relative Price Improvement. The Minimum Relative Price Improvement 
established for an order is the minimum amount of price improvement 
superior to the best bid or offer publicly displayed (as applicable) 
that the order must receive before it may be executed against in whole 
or in part by any interest from the Crowd. This condition must be 
attached before the order is entered into the Application. Such 
condition may be expressed only in terms relative to the best bid or 
offer on the opposite side of the market existing at such time when any 
Indication, Response, or other order is or becomes available to 
interact with the order in an Auction, as permitted by the Application 
and this Rule Series. Neither the existence nor amount of any Minimum 
Relative Price Improvement condition is displayed, exposed or 
communicated to any Participant when attached to an order. This 
condition shall not be available for orders submitted solely for the 
proprietary account of a Nasdaq market maker or CQS market maker 
(including Primex Auction Market Makers) and not involving a customer 
order.

    For example:  an order to buy 500 shares entered into the 
Application may contain a condition for Minimum Relative Price 
Improvement requiring that any Indication or Response (or sell order 
exposed in an Auction and which is available for a match) provide to 
that order at least a certain amount (e.g., 3 cents) of price 
improvement superior to the best offer publicly displayed at such 
time the Indication, Response or sell order is available to be 
matched with the order to buy.
(b) For Primex Auction Market Makers Only
    A Participant registered as a Primex Auction Market Maker for a 
particular security is entitled, but not required, to enter customer 
orders with any of the following match parameters as discussed below. 
These allow the Primex Auction Market Maker to provide liquidity in 
addition to that which may be provided by the Crowd. The match 
parameters contained in this paragraph are only available to 
Participants who are Primex Auction Market Makers, and only for those 
securities for which they are so registered. Neither the existence nor 
type of any match parameter associated with an order is displayed, 
exposed or communicated to any other Participant:
(1) Two Cent Match
    A Participant registered as a Primex Auction Market Maker for a 
particular security may enter an order with the Two Cent Match 
parameter.
    (A) If there is interest from the Crowd that can satisfy the order, 
the order entered with the Two Cent Match will be executed against such 
interest by the Crowd during its exposure, provided that such Crowd 
interest offers to provide price improvement greater than two cents 
superior to the best quote publicly displayed in the NBBO at the time 
such Crowd interest is available.

    Note: Because the system will never execute an order at a price 
outside of the NBBO, any Crowd interest offering an amount of price 
improvement that would potentially be outside of the NBBO will be 
executed, if matched with an order, at a price bounded by the NBBO, 
in effect adjusting the execution price to allow for the maximum 
amount of price improvement within that NBBO without trading through 
the NBBO at that time. As a result, it is possible that an order 
subject to the Two Cent Match parameter may be matched with interest 
from the Crowd, and not the Primex Auction Market Maker that entered 
it, notwithstanding the fact that the actual execution price results 
in price improvement of two cents or less. This can happen, for 
example, where there is Crowd interest available that is offering 
three cents of relative price improvement, but the Application 
causes the actual execution price to be equal to two cents of price 
improvement, due to a prevailing NBBO spread of two cents at the 
time of execution.

    (B) If there is interest from the Crowd that can satisfy the order 
but such Crowd interest would only offer price improvement of two cents 
or less in relation to the best quote publicly available, then this 
will immediately cause the Application to execute the entire order 
against the Primex Auction Market Maker that entered it, and not 
against such Crowd interest, thereby allowing the execution of that 
order to be retained by the Primex Auction Market Maker. In this 
situation, the entire order will be executed with that Primex Auction 
Market Maker at the best price the Crowd interest would have otherwise 
provided, regardless of the size associated with such Crowd interest.
    (C) Any unexecuted balance of the order remaining at the end of its 
exposure will be executed against the Primex Auction Market Maker. With 
respect to Market Orders, this execution price will be at the best 
quote then publicly displayed. With respect to Fixed Price Orders, the 
execution price will be the price specified in the Fixed Price Order, 
unless such price is outside the best quote publicly displayed, in 
which case the execution price will be at the best quote publicly 
displayed in the NBBO.
    (D) A Primex Auction Market Maker may enter customer orders of any 
size with the Two Cent Match parameter.
    (E) A Primex Auction Market Maker that enters a Market Order with 
the Two Cent Match parameter may elect immediate (``zero seconds''), 15 
or 30 second maximum exposure duration for that order. A Fixed Price 
Order can be exposed only for an immediate ``zero second'' auction.
(2) 50% Match
    A Participant registered as a Primex Auction Market Maker for a 
particular security may enter an order with a 50% Match parameter.
    (A) Orders entered with the 50% Match parameter will be executed 
against any interest by the Crowd that satisfies the order during its 
exposure at the price(s) and size of such Crowd interest, for no more 
than 50% of the

[[Page 38156]]

order. Any execution with the Crowd will immediately cause the 
Application to provide the order with an additional execution of like 
size and price against the Primex Auction Market Maker that entered the 
order.
    (B) Any unexecuted balance of the order remaining at the end of its 
exposure will be automatically executed against the Primex Auction 
Market Maker. With respect to Market Orders, this execution price will 
be at the best quote then publicly displayed. With respect to Fixed 
Price Orders, the execution price will be at the price specified in the 
Fixed Price Order, unless such price is outside the best quote publicly 
displayed, in which case the execution price will be at the best quote 
publicly displayed.
    (C) A Primex Auction Market Maker may enter customer orders of any 
size with the 50% Match parameter.
    (D) A Primex Auction Market Maker that enters a Market Order with 
the 50% Match parameter may elect immediate (``zero seconds''), 15 or 
30 second maximum exposure duration for that order. A Fixed Price Order 
can be exposed only for an immediate ``zero second'' auction.

    For example: The best bid and offer publicly displayed for a 
security is $20-20.10. A Primex Auction Market Maker for that 
security enters into the Application a Market Order to buy 2,000 
shares for a customer and selects the 50% Match Parameter. The 
Participant selects an exposure time of 30 seconds. During its 
exposure, the order elicits the following executions by other Crowd 
Participants (which could be in the form of Indications, Responses, 
or contra-side orders to sell): 500 at $20.04, and 200 at $20.05. 
The Application will execute these transactions, and immediately 
match each one as they occur by executing an additional 500 and 200 
shares, at $20.04 and $20.05, respectively, against the Primex 
Auction Market Maker entering the order. If there is no other 
interest from the Crowd at the end of the 30 second exposure period, 
the Application will cause the remaining balance of 600 shares to be 
automatically executed against the Primex Auction Market Maker 
entering the order at the best offer publicly displayed at that 
time. Assuming the best offer publicly displayed is still $20.10 at 
this time, this would result in the Primex Auction Market Maker 
selling the balance of 600 shares to the customer at $20.10.
(3) Block Facilitation Match
    A Participant registered as a Primex Auction Market Maker for a 
particular security may enter an order with a Block Facilitation match 
parameter, provided the order is for at least 10,000 shares. The Primex 
Auction Market Maker may elect to expose the order in an Auction for a 
maximum of 0, 15, or 30 seconds. Any Crowd interest that executes 
against the order during the selected exposure period, up to a maximum 
of 50% of the order size, will be immediately matched with an execution 
of like size and price against the entering Participant until the order 
is fully executed. If any unexecuted portion remains at the end of the 
exposure period, it will be automatically executed against the entering 
Participant. With respect to Market Orders, the execution price will be 
the then existing best offer (for orders to buy) or best bid (for 
orders to sell) publicly displayed. With respect to a Fixed Price 
Order, the execution price will be the price specified in the Fixed 
Price Order, unless such price is outside of the best quote publicly 
displayed, in which case the execution price will be at the best quote 
publicly displayed.

    For example: The best bid and offer publicly displayed is $20-
20.10. A Participant enters into the Application an order to buy a 
block of 10,000 shares for a customer and selects the Block 
Facilitation Match Parameter. The Participant selects an exposure 
time of 15 seconds. During its exposure, the order elicits the 
following executions by other Crowd Participants (in the form of 
Indications, Responses, or contra-side orders to sell): 1000 at 
$20.05, and 2000 at $20.07. The Application will execute these 
transactions, and immediately match each one as they occur by 
executing an additional 1000 and 2000 shares, at $20.05 and $20.07, 
respectively, against the Participant entering the block order. If 
there is no other interest from the Crowd at the end of the 15 
second exposure period, the Application will cause the remaining 
balance of 4000 shares to be automatically executed against the 
Participant entering the block order at the best offer publicly 
displayed at that time. Assuming the best offer publicly displayed 
is still $20.10 at this time, this would result in the Participant 
selling the balance of 4000 shares to the customer at $20.10.
(4) Clean Cross
    A Participant registered as a Primex Auction Market Maker for a 
particular security may enter a Clean Cross order for the accounts of 
two separate customers where the order represents both sides of a cross 
for at least 10,000 shares to be exposed to the Crowd in an immediate, 
zero second Auction. The two sides will be executed against each other 
at the midpoint of the best bid and offer publicly displayed unless 
superior-priced interest within the Application breaks up one or both 
sides of the cross. In order to break up a side of the cross, there 
must be Crowd contra-side interest resident within the Application 
(e.g., resident PRIs) that totals at least 10,000 shares in the 
aggregate at a price or prices that are all superior to the bid-ask 
midpoint by at least the nearest whole cent. Any portion of a side that 
is not executed against either the opposite side of the Clean Cross 
order or contra-side interest resident within the Application will be 
returned unexecuted.
5015. Public and Professional Orders
    All orders submitted to the Application shall be identified as 
either a Public Order or a Professional Order, as those terms are 
defined in Rule 5011. This Public or Professional status is not 
displayed, exposed or communicated to any other Participant in the 
Application, but is used to determine whether an order is available to 
interact with the Response or Indication of a Crowd Participant. As 
indicated in Rule 5018(e), a Participant that responds to orders in an 
Auction can choose whether its Responses and Indications interact with 
all orders (both Public and Professional Orders) or just Public Orders. 
When entering an order, however, a Participant entering an order does 
not have the ability to select or control whether Public or 
Professional interest may interact with the order.
5016. Option To Route Orders Outside of the System After Exposure in 
the Application
    (a) All Market Orders submitted to the Application shall include an 
identifier as to whether any unexecuted balance, after the order is 
exposed to the Crowd, should be forwarded to SuperSoes\SM\, in the case 
of a Nasdaq security, or to ITS/CAES, in the case of an exchange-listed 
security, or whether the order should be returned to the entering 
Participant. This option to route orders outside of the Application is 
available for Market Orders only. Orders submitted to the Application 
with a specified, fixed price cannot be automatically forwarded to 
Nasdaq's other execution systems. Routing identifiers are not 
displayed, exposed or communicated to any other Participant in the 
Application.
    (b) With respect to exchange-listed securities, only Primex Auction 
Market Makers (which also must be ITS/CAES market makers with respect 
to these securities, as required by these rules) may elect to have 
Market Orders in exchange-listed securities routed out to ITS when 
there is a balance remaining following exposure in the System, 
provided, however, that customer orders so routed must first be exposed 
in the Application for at least 15 seconds. In addition, to the extent 
the best price publicly quoted at that time is available within 
Nasdaq's CAES system, regardless of whether the same price also is 
being publicly quoted by another ITS market center, such orders 
designated for routing to ITS/CAES will

[[Page 38157]]

be delivered to CAES for execution up to the size publicly quoted by 
CAES participants and will not be routed out to another market center 
through ITS.
5017. Short Sales
    Participants are responsible for complying with applicable short 
sale rules when using the Application. No Participant shall submit to 
the Application an order for a security that, if executed, would result 
in a ``short sale'' as that term is defined in Exchange Act Rule 3b-3, 
unless the transaction would be exempt from, or otherwise permissible 
under, the requirements of NASD Rule 3350 or Exchange Act Rule 10a-1, 
as applicable.
5018. Responses and Indications
    (a) General--Participants may submit Responses and Indications to 
the Application, consistent with this Rule Series, for the purpose of 
interacting with orders in an Auction, as described herein. Responses 
and Indications are not displayed, exposed or communicated to any 
Participant, except to the extent they result in an execution with an 
order. Responses and Indications cannot execute against other Responses 
or Indications.
    (b) Responses--Responses are instructions submitted to the 
Application by Participants to interact with available orders exposed 
in an Auction. Responses may be either a Fixed Price Response (e.g. buy 
1000 at $20) or a Relative Priced Response (e.g., buy 1000 at the bid 
plus 3 cents). All Responses must be entered in an amount of at least 
one round lot, but also may be for a mixed lot.
    (c) Indications--Indications are instructions, with the 
characteristics set forth below, submitted to the Application by 
Participants to interact with orders exposed in an Auction. An 
Indication may be a Predefined Relative Indication (``PRI'') or a Go-
Along Indication.
(1) Predefined Relative Indications
    (A) PRIs can be submitted to the Application for the purpose of 
automatically responding to an Auction at a point in time when one or 
more orders becomes available. PRIs have no specific, fixed price, but 
are expressed at time of entry in terms relative to the best bid or 
offer publicly displayed at such time when the Application activates 
the PRI against orders in an Auction. While resident within the 
Application, PRIs are ranked in relative price/time priority among all 
other PRIs resident within the Application and any same-side orders 
currently being exposed in an Auction, as indicated in paragraph (e) of 
this Rule. Neither the existence nor terms of a PRI are displayed, 
exposed or communicated to any other Participant while resident in the 
Application. When activated by the Application, a PRI will match 
against orders in an Auction at a price equal to the best bid (for PRIs 
to buy) or offer (for PRIs to sell) publicly displayed at that time in 
the NBBO, plus or minus (respectively) the relative price term 
associated with that PRI; provided that such price also satisfies any 
applicable condition associated with the order(s) in the Auction to 
which it is responding.
    (B) At the time of its original entry, each PRI submitted to the 
Application must be for the following share amounts:
    (i) NBBO PRIs must be for at least 3000 shares upon entry;
    (ii) NBBO .01or .02 must be for at least 2000 shares 
upon entry;
    (iii) NBBO .03 or greater must be for at least 1000 
shares upon entry.
    (C) The Application will accept a PRI with the following amounts of 
relative price improvement:
    (i) If the NBBO, at the time the PRI is submitted, has a spread 
equal to three cents or more, the PRI will be accepted if it offers any 
amount of price improvement between zero and the actual NBBO spread 
prevailing at that time;
    (ii) If the NBBO, at the time the PRI is submitted, has a spread 
that is less than three cents, the PRI may offer any amount of price 
improvement between zero and three cents.
    (D) Participants may elect to limit their exposure when using PRIs 
by entering a Per Auction Maximum size for each PRI submitted. The Per 
Auction Maximum represents the maximum share amount of a PRI available 
for a single Auction. It cannot be greater than the size of the PRI, 
but is subject to the same minimum values applicable to the original 
entry of a PRI with that relative price term. Once the Per Auction 
Maximum, if any, for a PRI is exhausted, the Participant will have 15 
seconds to withdraw the PRI, during which time no further executions 
against that PRI will occur. In the absence of a withdrawal during this 
period, the Application will restore the PRI up to the Per Auction 
Maximum and the PRI will become available again for any subsequent 
Auctions to the extent there is an eligible balance remaining for that 
PRI. For purposes of relative price/time priority, the restored PRI 
will receive a new timestamp within the Application.
    (E) Participants may select a maximum residency period of one (1) 
or five (5) days, during which time the PRI remains resident within the 
Application unless fully executed or withdrawn. The Application will 
automatically withdraw any PRIs that remain at the end of the 
applicable residency period.
(2) Go-Along Indications
    (A) A Go-Along Indication can be submitted to the Application for 
the purpose of automatically responding in an Auction at a point in 
time when one or more orders becomes available in an Auction and there 
has been at least one other contemporaneous Crowd execution within the 
Application at the NBBO; provided there are no PRIs available or orders 
being exposed in an Auction (executions resulting from a Primex Auction 
Market Maker Guarantee do not trigger Go-Along Indications). Go-Along 
Indications have no specific, fixed price when entered, but will match 
against orders at a price equal to the best bid (for Go-Along 
Indications to buy) or best offer (for Go-Along Indications to sell) 
that exists at such time the Go-Along Indication is activated. While 
resident within the Application, Go-Along Indications are not 
displayed, exposed or communicated to any other Participant.
    (B) At the time of its original entry, each Go-Along Indication 
submitted to the Application must be for at least 10,000 shares.
    (C) Participants may select a maximum residency period of one (1) 
or five (5) days, during which time the Go-Along Indication remains 
resident within the Application unless fully executed or withdrawn. The 
Application will automatically withdraw any Go-Along Indications that 
remain at the end of the applicable residency period.
    (d) Executions Bounded by the NBBO--Application will never execute 
an order outside of the NBBO prevailing at the time of execution. 
Indications such as PRIs that potentially would offer an amount of 
price improvement that could result in an execution outside of the NBBO 
will be priced at the NBBO if matched with an order, in effect 
providing the maximum amount of price improvement permissible within 
the NBBO at that time.
    (e) Relative Priority Of Predefined Relative Indications and 
Orders--(1) While resident within the Application, Predefined Relative 
Indications are ranked in relative price/time priority while they await 
activation against incoming orders notwithstanding that PRIs have no 
specified, fixed price associated with them. For example, among 
resident PRIs for the same security on the same side of the market, 
PRIs offering greater relative price improvement are ranked ahead of 
PRIs

[[Page 38158]]

offering less relative price improvement. PRIs offering the same 
relative amount of price improvement are ranked by time of entry (or 
the time the Indication was restored after exhausting its Per Auction 
Maximum).
    (2) Market Orders being exposed within the Application also are 
ranked in relative price/time priority during the life of their 
exposure, notwithstanding that Market Orders have no specified, fixed 
price associated with them. For example, among Market Orders in the 
same security being exposed on the same side of the market, those 
orders not seeking any relative price improvement are ranked ahead of 
orders seeking some relative amount of Minimum Relative Price 
Improvement. Orders seeking a greater relative amount of Minimum 
Relative Price Improvement are ranked behind orders seeking a lesser 
relative amount of Minimum Relative Price Improvement. Orders seeking 
the same relative amount of price improvement are ranked by time of 
entry.
    (3) Among and between Indications and orders on the same side of 
the market, the relative price/time priorities for each are integrated, 
based on their respective ranking relative to the best bid and offer 
publicly displayed. The Application recalculates and maintains these 
relative priorities whenever there is a change in the best bid or offer 
prices publicly displayed in the NBBO. Market Orders that are matched 
with other Market Orders being auctioned are executed at the midpoint 
of the best bid and offer publicly displayed, provided that such price 
satisfies any condition for Minimum Relative Price Improvement 
associated with each order.
    (f) Responding to All Orders or Public Orders Only--All Responses 
and Indications shall include an identifier as to whether it may 
interact with either: (1) All available orders (both Public Orders and 
Professional Orders); or (2) Public Orders only. Such identifier is not 
displayed, exposed or communicated to any Participant at any time, but 
is used by the Application for determining the universe of orders with 
which the Response or Indication may interact.
5019. Crowd Participation
    (a) There are two levels of participation in the Application: Crowd 
Participant and Primex Auction Market Maker. Becoming a Participant in 
the Application automatically entitles the Participant to be a Crowd 
Participant for any security, allowing participation consistent with 
this Rule 5019. A Crowd Participant may also choose to register as a 
Primex Auction Market Maker, but only on a security-by-security basis, 
as set forth in Rule 5020, and only consistent with the requirements 
for participation under that Rule.
    (b) Unless otherwise specified, a Crowd Participant may enter 
orders, Indications, and Responses in any Primex Eligible Security at 
any time, for its own account or for the account of a customer. Crowd 
Participants have no mandatory obligation to submit to the Application 
any order at any time.
5020. Market Maker Participation
    (a) A Participant may register as a Primex Auction Market Maker in 
one or more Primex Eligible Securities, and may maintain such 
registration while in compliance with the requirements of this Rule. 
Unless otherwise specified, a Primex Auction Market Maker is 
automatically subject to the same rights and obligations of Crowd 
Participants pursuant to Rule 5019 with respect to customer orders in 
any and all Primex Eligible Securities. In addition, a Primex Auction 
Market Maker is entitled, but not obligated, to use either of the 
following features of the Application when submitting customer orders, 
but only with respect to those securities in which it is currently 
registered as a Primex Auction Market Maker:
    (1) A Primex Auction Market Maker, for securities in which it is 
registered as such, may submit customer orders to the Application with 
any of the available match parameters that enable the Primex Auction 
Market Maker to exercise certain matching rights facilitated by the 
Application, as set forth in Rule 5014(b). When associated with an 
order, these match parameters are not displayed, exposed or 
communicated to any other Participant; or
    (2) A Primex Auction Market Maker, for securities in which it is 
registered as such, may submit customer orders to the Application with 
a Market Maker Guarantee enabling the Primex Auction Market Maker to 
guarantee an execution within the Application where such orders are not 
otherwise subject to an execution as a result of either satisfactory 
Crowd interest or matching rights processing elected by the Primex 
Auction Market Maker pursuant to Rule 5014(b) for the order.
    (i) Public customer orders of any size are eligible for the Market 
Maker Guarantee. The Application will facilitate the Market Maker 
Guarantee by automatically executing any unexecuted balance of the 
order against the Primex Auction Market Maker that submits the order, 
after the Auction exposure period for the order has expired.
    (ii) The Market Maker Guarantee is automatically provided at a 
price equal to the best publicly quoted offer price (for orders to buy) 
or best publicly quoted bid price (for orders to sell) existing for the 
security at the time when such exposure period for the order has 
expired (including ``zero second'' auctions), for any amount of shares 
established by the Primex Auction Market Maker for the order.
    (b) With respect to each security in which a Participant is 
registered as a Primex Auction Market Maker, the Participant shall:
    (1) If the security is a Nasdaq-listed security, be registered as a 
Nasdaq market maker in such security (or become so registered), and at 
all times comply with all applicable NASD rules and interpretations 
relating to Nasdaq market makers, including the requirement to enter 
and maintain two-sided quotations in Nasdaq for such security, subject 
to the excused withdrawal procedures set forth in Rule 4619;
    (2) if the security is an ITS/CAES eligible security, be registered 
as an ITS/CAES Market Maker (or become so registered) in such security, 
and at all times comply with all applicable NASD rules and 
interpretations relating to ITS/CAES Market Makers, including the 
requirement to enter and maintain two-sided quotations in CQS for such 
security, subject to the excused withdrawal procedures set forth in 
Rule 6350;
    (3) Submit to the Application a minimum of 80%\*\ of the number of 
its

[[Page 38159]]

Mandatory Eligible Orders (including customer orders of another broker-
dealer that has directed such orders to the Participant) as soon as 
practicable upon receipt by the Participant, for the purpose of 
exposing such orders to the Primex Crowd. Mandatory Eligible Orders do 
not include:
---------------------------------------------------------------------------

    \\ *The 80% test will be applied on a quarterly basis, and will 
be phased in as follows: For the calendar quarters commencing on 
October 1, 2001; January 1, 2002; April 1, 2002; and July 1; 2002, 
any participant may register in any eligible security as a Primex 
Auction Market Maker and maintain that status during such calendar 
quarters without regard to the percentage of its orders it submits 
to the System for such security during that time, provided it also 
satisfies all other requirements of a Primex Auction Market Maker 
pursuant to these rules. Beginning with the calendar quarter that 
commences on October 1, 2002, a participant previously registered as 
a Primex Auction Market Maker for a particular security may maintain 
its status as such until December 31, 2002 only if it submitted at 
least 50% of its Mandatory Eligible Orders during the calendar 
quarter that commences on July 1, 2002 (or during such portion of 
the calendar quarter that commences on July 1, 2002 in which the 
participant was so registered if the participant registered in mid 
quarter), provided it also satisfies all other requirements of a 
Primex Auction Market Maker pursuant to these rules. A participant 
that is newly registering as a Primex Auction Market Maker for a 
particular security any time after the start of the calendar quarter 
that commences on October 1, 2002 may maintain its status as such 
until the end of the calendar quarter in which it registered without 
regard to the percentage of its orders it submits to the System for 
such security during that time.
    Beginning with the calendar quarter that commences on January 1, 
2003, and each calendar quarter thereafter, a participant previously 
registered as a Primex Auction Market Maker for a particular 
security may maintain its status as such until the end of that 
calendar quarter only if it submitted at least 80% of its Mandatory 
Eligible Orders during the previous calendar quarter (or during the 
portion of such previous calendar quarter in which it was so 
registered if the participant registered in mid quarter), provided 
it also satisfies all other requirements of a Primex Auction Market 
Maker pursuant to these rules.
---------------------------------------------------------------------------

    (A) Any customer order that is greater than 1099 shares at 
origination, except that nothing in these rules prohibits a Participant 
from submitting orders of greater size at any time;
    (B) Any customer order that, when initially received by the 
Participant, is a Fixed Price Order with a specified price that is not 
eligible for acceptance by the Application because it is priced outside 
the NBBO and is not otherwise marketable pursuant to Rule 5013(a)(2), 
regardless of whether or not the order becomes eligible for acceptance 
and exposure at a subsequent point in time;
    (C) Any customer order placed by a customer who authorizes the 
Participant to not expose the order, either at the time the order is 
placed or prior thereto pursuant to an individually negotiated 
agreement with respect to such customer's orders;
    (D) Any customer order that is an odd lot order (e.g., less than 
100 shares);
    (E) Any customer order to be executed outside of the hours of 
operation of the Application; or
    (F) Any other order that would not fall within the definition of 
the term ``covered order'' as defined in Exchange Act Rule 11Ac1-
5(a)(8).
    (4) Not attach a condition for Minimum Relative Price Improvement 
to any order submitted to the Application solely for its own principal 
account and not involving a customer order.
5021. Anonymity, Execution, Reporting, and Clearing
    (a) Anonymity--The Application will process all activity among 
Participants on an anonymous basis until the end of the day. After 
facilitating an execution, the Application will send an execution 
report to all Participants involved as soon as practicable. The 
execution report will indicate the details of the transaction, but will 
not contain the identity of the contra-party. At the end of each 
trading day, the actual contra-party for executions obtained within the 
Application will be made available to the Participants involved through 
Nasdaq's systems. For regulatory and other necessary purposes, the NASD 
and Nasdaq will have the ability to determine the identity of the 
actual contra-parties at any time.
    (b) Tape Reporting and Clearing--Matches within the Application are 
executed and reported through Nasdaq systems for public tape reporting 
and forwarding to NSCC for clearing, where necessary. Participants (or 
their clearing brokers) are the parties responsible for the clearance 
and settlement of all trades executed through the Application. Once a 
transaction is executed, Participants do not have the ability within 
the Application to modify or reallocate any portion of the execution to 
a clearing broker other than the clearing broker that the Application 
associates with the Participant at the time of execution. Neither the 
NASD (and its affiliates) nor any operator or administrator of the 
Primex Auction System shall be directly or indirectly a party to any 
transaction entered into, matched, or otherwise effected through the 
Application, notwithstanding that, for the remainder of the trading day 
after a transaction, the actual contra-parties have not had their 
identities disclosed to each other by the Application.
5022. Credit Limits and Clearing Limits
    (a) Credit Limits--The Application shall allow a Participant's Firm 
Administrator to establish Credit Limits for each of its associated 
Subscribers, including sponsored Subscribers, on an individual 
Subscriber basis. The limits are established as a dollar amount of 
aggregated purchases or sales which, when reached, causes the 
Application to: (1) Inhibit any future executions or the entry of 
future interest for that Subscriber; (2) cancel any orders and withdraw 
any Indications resident within the Application for that Subscriber; 
and (3) send a notice to that Subscriber, its Firm Administrator, and 
the Nasdaq Supervisor. Credit Limits may be monitored and modified by 
the Firm Administrator on a real-time basis directly through the 
Application.
    (b) Clearing Limits--The Application shall allow a Participant's 
clearing broker to establish Clearing Limits within the Application for 
the Participant on a firm-wide basis. The limits are established as a 
dollar amount of both purchases and sales (calculated separately, and 
not netted) of all Subscribers, collectively for a Participant, 
effected within the Application through or in the name of that 
Participant. When the Clearing Limits for a Participant are reached, 
the Application will: (1) Inhibit any future executions for all 
Subscribers associated with that Participant; (2) cancel any orders and 
withdraw any Indications resident within the Application for all 
Subscribers associated with that Participant; and (3) send a notice to 
that Participant's Firm Administrator, the Nasdaq Supervisor, and to 
the clearing broker for that Participant provided that the clearing 
broker also is a Participant. Clearing Limits for a Participant may be 
monitored on a real-time basis by the Participant's Firm Administrator 
and can be established, monitored, and modified by the Firm 
Administrator of the Participant's clearing broker, provided the 
clearing broker also is a Participant. If the clearing broker is not a 
Participant in the Application, then the Nasdaq Supervisor will notify 
the clearing broker that the Clearing Limits have been reached as soon 
as practicable. Clearing Limits also can be established and modified by 
the Nasdaq Supervisor on behalf of the clearing broker.
5023. Hours of Operation
    (a) The Application is available for executing securities 
transactions during regular Nasdaq trading hours whenever there is a 
free and open quote (i.e., not locked or crossed), subject to the 
general authority and regulatory responsibilities of Nasdaq or its 
affiliates in operating the Application as a facility of Nasdaq or its 
affiliate (including but not limited to its authority to implement 
trading halts in one or more securities due to regulatory reasons, 
market-wide emergencies, and system malfunctions).
    (b) Nasdaq may permit certain functionality of the Application to 
be available outside of the time period during which securities 
transactions may be effected through the Application, including but not 
limited to, the monitoring, entering, canceling, withdrawing, or 
modifying resident Indications, Credit Limits, or Clearing Limits.
5024. Limitation of Liability
    (a) Neither Nasdaq, the NASD (including their affiliates), Primex 
Trading N.A., L.L.C. (including its affiliates) nor any other operator, 
licensor, or administrator (including their affiliates) of the Nasdaq 
Application of the Primex Auction System shall have any liability for 
any loss, damages, claim or expense arising from or occasioned by any 
inaccuracy,

[[Page 38160]]

error or delay in, or omission of or from: (1) The Nasdaq Application; 
or (2) the collection, processing, reporting or dissemination of any 
information derived from the Nasdaq Application, resulting either from 
any act or omission by Nasdaq or any affiliate, or any operator, 
licensor, or administrator of the Nasdaq Application or from any act, 
condition or cause beyond the reasonable control of Nasdaq or any 
affiliate, operator, licensor or administrator of the Nasdaq 
Application, including, but not limited to, flood, extraordinary 
weather conditions, earthquake or other act of nature, fire, war, 
insurrection, riot, labor dispute, accident, action of government, 
communications or power failure, or equipment or software malfunction. 
If a Participant that enters, authorizes its Subscribers (including 
sponsored Subscribers) to enter, or is authorized by other Participants 
to enter orders, Responses, or Indications that result in a transaction 
through the Application fails to perform its settlement or other 
obligations under the terms of such transaction, the NASD (and its 
affiliates) and Primex Trading N.A., L.L.C. (and its affiliates) shall 
have no liability for such failure to settle.
    (b) Neither Nasdaq, the NASD (including their affiliates), Primex 
Trading N.A., L.L.C. (including its affiliates) nor any other operator, 
licensor, or administrator (including their affiliates) of the Nasdaq 
Application of the Primex Auction System makes any express or implied 
warranties or conditions to Participants or their associated 
Subscribers (including sponsored Subscribers) as to results that any 
person or party may obtain from the Nasdaq Application for trading or 
for any other purpose, and all warranties of merchantability or fitness 
for a particular purpose or use, title, and non-infringement with 
respect to the Nasdaq Application are hereby disclaimed.

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

Pilot Trading System

    The Primex Auction System is a facility of Nasdaq that has been 
operating as a Pilot Trading System, as defined in paragraph (c)(2) of 
Rule 19b-5 of the Act.\6\ As such, Nasdaq was not required to file a 
proposed rule change pursuant to Rule 19b-4 of the Act \7\ as long as 
the System maintained its status as a Pilot Trading System. Under 
paragraph (c)(2) of Rule 19b-5 of the Act, a system must comply with 
three criteria to maintain its status as a Pilot Trading System.\8\ One 
such criteria is that, for each security traded in the System, the 
System cannot trade more than one percent of the average daily 
consolidated trading volume of any such security, during at least two 
of the last four consecutive calendar months. Nasdaq represents that 
Primex has exceeded this threshold for many securities. Nasdaq also 
represents that while not all eligible securities have been phased in 
as of this date, the Primex Auction System has already executed 
approximately 1.7 million trades representing almost 500 million shares 
since it began operation just over four months ago. Therefore, Nasdaq 
is seeking permanent approval of the System pursuant to Section 19(b) 
of the Act \9\ and Rule 19b-4 under the Act.\10\
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    \6\ 17 CFR 240.19b-5(c)(2).
    \7\ 17 CFR 240.19b-4.
    \8\ Pursuant to Rule 19b-5(c)(2), to qualify as a Pilot Trading 
System, a system must: (1) be in operation for less than two years; 
(2) with respect to each security traded on such Pilot Trading 
System, during at least two of the last four consecutive calendar 
months, has traded no more than one percent of the average daily 
trading volume in the United States; and (3) with respect to all 
securities traded on such Pilot Trading System, during at least two 
of the last four consecutive calendar months, has traded no more 
than 20 percent of the average daily trading volume of all trading 
systems operated by the self-regulatory organization. 17 CFR 
240.19b-5(c)(2).
    \9\ 15 U.S.C. 78s(b).
    \10\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

Background

    Nasdaq represents that as market structure continues to evolve, 
Nasdaq is committed to providing its participants with a variety of 
sophisticated execution services to automate the trading process in the 
most efficient manner possible. The Primex Auction System is a hybrid 
that combines an extended, electronic auction mechanism with the speed 
and liquidity of Nasdaq's competing market maker environment. By 
incorporating an automated auction process into Nasdaq's existing 
multi-dealer environment, the System allows participants to facilitate 
the exposure of their customer orders to the entire market while still 
allowing these participants to commit liquidity and execution 
guarantees to their customers. Nasdaq believes that as a consequence, 
the Primex Auction System can provide increased opportunities for price 
improvement, enhanced liquidity, and order interaction.
    Nasdaq believes that the System can improve upon the traditional 
auction market model, where market participants gather in a ``crowd'' 
at a physical location to bid for incoming orders. The crowd sometimes 
improves the best bid or offer, enhances the liquidity otherwise 
available, or validates the current quoted prices in the absence of any 
improvement to the published quotations. Most auction markets employ a 
single specialist that manages trading in a security and supplies 
liquidity when there is no buying or selling interest in the crowd.
    The Primex Auction System automates many of these elements. By 
facilitating an ``electronic crowd,'' not bound by the physical 
limitations of space or the number of persons that can be at any one 
place at a given time, the System can provide the benefits of an 
auction model on a larger and more efficient scale. By further 
combining this within a competitive, multi-dealer structure that has 
been Nasdaq's hallmark, Nasdaq believes it can make available a greater 
amount of liquidity than would be available in a market with only one 
provider of capital. Nasdaq believes the result of this combination and 
automation is a market-based solution for providing price improvement 
opportunities and enhanced liquidity.

System Overview

    The following is a brief overview of how the System typically will 
operate. Additional details on the System and its tools can be found 
within the rules of the System and the Form PILOT.\11\
---------------------------------------------------------------------------

    \11\ See supra note 3.
---------------------------------------------------------------------------

    A customer sends an order to his or her broker, who, in turn, can 
forward it to the System. The System is voluntary. Once an order is 
submitted, an auction for that order commences. Through a unique 
mechanism, the order is exposed to the System's electronic crowd, which 
can be composed of market makers, proprietary traders, institutions, 
ECNs and even the orders of other customers. The System's electronic 
crowd is open to any NASD member (or their

[[Page 38161]]

customers, through a sponsored arrangement), and thus the universe of 
participants who may have access to these orders is very broad. Using 
the System's auction response tools, crowd participants anonymously bid 
for the order at prices at or within the parameters of the National 
Best Bid and Offer (``NBBO''). The order will be executed if an 
appropriate match is found in the electronic crowd or if the 
participant submitting the order provided an execution guarantee. The 
types of orders that can be submitted and the System's response tools 
are specified in the attached rules and generally are described below.

Participation in the System

    Primex is a voluntary System available to any NASD member and other 
entities that a member chooses to sponsor. To access the System, a 
member must be in good standing and have executed the necessary 
agreements with Nasdaq. Members granted access to the System are 
referred to as Primex Auction System Participants (``Participants''), 
and can access the facility for their customers or for themselves. 
Participants in the System are classified as either Primex Auction 
Market Makers (``PAMMs'') or Crowd Participants.
    Entities that are not members can access the System by becoming a 
Sponsored Subscriber of a Participant (``Sponsored Subscriber''). The 
Participant assumes responsibility for all activity conducted through 
the System by the Sponsored Subscriber and will have the ability to 
monitor and control such activity, including the ability to monitor and 
establish credit limits for each Sponsored Subscriber. Participants and 
their Sponsored Subscribers must have the necessary agreements executed 
with Nasdaq with respect to these sponsored arrangements.
    As mentioned above, there are two categories of Primex 
Participants: PAMMS and Crowd Participants. By becoming a Participant, 
a member automatically receives the right to trade as a Crowd 
Participant for any security eligible for trading in the System. To 
become a PAMM, a member must register as such with Nasdaq for each 
security in which the member wishes to trade in such capacity. Members 
that seek to become PAMMs also must be registered as Nasdaq market 
makers with respect to Nasdaq-listed securities (i.e., Nasdaq National 
Market and The Nasdaq SmallCap MarketSM 
securities) or Consolidated Quotation Services (``CQS'') market makers 
with respect to exchange-listed securities. Because Primex is a 
voluntary service, however, Nasdaq and CQS market makers, or other 
members for that matter, are neither required to become Participants in 
the System, nor are they required to become PAMMs.
    The rights and obligations of each class of Participant are 
specified in the rules. Generally, however, for any security eligible 
for trading in the System, Crowd Participants can do the following: 
view all orders exposed in the System; interact with any order put to 
auction in the System by responding to auctions; submit orders to be 
put to auction; and trade as principal, agent, or riskless principal.
    PAMMS have certain obligations when they participate in the System. 
With respect to any security eligible for trading in the System for 
which a Participant is registered as a PAMM, it must: maintain a two-
sided quote in Nasdaq (or Nasdaq's InterMarket for CQS securities) with 
respect to any security for which it is registered as a PAMM, and 
otherwise be in compliance with all applicable NASD rules; and submit 
to the System a minimum percentage \12\ of its Mandatory Eligible \13\ 
public customer orders (including customer orders of another broker-
dealer that directs such orders to the PAMM) for those securities in 
which it is registered as a PAMM.
---------------------------------------------------------------------------

    \12\ See NASD Rule 5020.
    \13\ See NASD Rule 5011 (definition of ``Mandatory Eligible'') 
and NASD Rule 5020.
---------------------------------------------------------------------------

    PAMMs have the same privileges as Crowd Participants, but because 
they have certain obligations, PAMMs also have additional privileges. 
PAMMs are entitled but not obligated to: exercise certain matching 
rights that allow a PAMM to commit capital to its customer orders in 
conjunction with the auction exposure process; provide execution 
guarantees for its own customer orders submitted to the System; and use 
certain types of orders that permit the PAMM to facilitate block trades 
and ``clean crosses.'' PAMMs also are entitled to share in transaction 
revenue paid by other Participants when those other Participants 
execute against a PAMM's customer orders.

System Features

    The System is designed to be highly flexible in the types of orders 
it accepts, how orders are auctioned, and how PAMMs and Crowd 
Participants can respond to auctions. As such, the System accepts 
unpriced market orders, as well as orders that have specified, fixed 
prices that are marketable or priced between the NBBO. Orders can be 
submitted in any round lot or mixed lot, but odd lot orders are not 
accepted. The System is not an ``ECN Display Alternative'' under the 
Order Handling Rules \14\ because it does not display limit orders. 
Fixed price orders are eligible only for ``immediate or cancel'' 
treatment.
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    \14\ Commission Rules 11Ac1-1 (Quote Rule), and 11Ac1-4 (Limit 
Order Display Rule), together are commonly referred to as the Order 
Handling Rules. Specifically, the System is not an ECN Display 
Alternative under paragraph (c)(5)(ii) of Rule 11Ac1-1 and paragraph 
(c)(5) of Rule 11Ac1-5.
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    The System also provides a variety of features that allow 
participants to control the manner in which their orders are exposed 
for auction. For example, Participants can choose the maximum duration 
of the exposure for their orders. PAMMs can submit orders with match 
parameters, or execution guarantees. An order also can be submitted 
with a condition attached requiring a minimum amount of price 
improvement relative to the current NBBO at the time of execution. A 
participant utilizing this feature for an order to buy would specify, 
when entering the order into the System, that the order be executed 
only if the auction yields an execution with price improvement of 3 
cents below the ``Best Offer'' as publicly displayed in the NBBO at the 
time of execution.
    PAMMs are entitled to attach certain match parameters to customer 
orders they submit to the System. This feature provides PAMMs the 
ability to provide additional liquidity to their customer orders, in 
conjunction with the exposure process. For example, a PAMM may submit a 
customer order with a 50% match parameter. Any interest provided by the 
crowd is matched in both size and price by a corresponding execution 
with the PAMM. This function effectively can double the amount of 
liquidity otherwise available from the crowd, at prices established by 
the crowd, for a customer order. It also ensures that the PAMM will 
participate in no less than 50% of the order. The PAMM must be willing 
to execute the entire order when using this match parameter, in the 
absence of sufficient response from the crowd.
    PAMMs also can submit customer orders with a Two Cent Match 
parameter. This function allows the PAMM entering the order to execute 
the customer order, provided it is willing to match the price 
established by the crowd for the entire order to the extent the price 
offered by the crowd is within two cents of the NBBO. If there is crowd 
interest willing to provide more than two cents of price improvement, 
the

[[Page 38162]]

PAMM loses that portion of the order to the crowd.
    PAMMs also are entitled to provide execution guarantees within the 
System. This feature ensures that any balance of an order remaining 
after exposing it to the crowd will receive a liquidity guarantee, 
established by the PAMM for each order submitted, at a price at least 
as good as the NBBO at that time.
    Nasdaq believes the match parameter and execution guarantee 
features will encourage market maker participation by providing PAMMs 
the opportunity to continue to commit capital to their own customer 
orders, in conjunction with a broad exposure process. The process 
ensures that the PAMM submitting a customer order and the Participants 
in the electronic crowd both have opportunities to interact with orders 
in the System in a fair and balanced manner. In all cases, customers 
receive the benefit of any improved prices generated by the auction 
process.
    Any condition, match parameter, or guarantee must be attached to an 
order at the time it is submitted to the System. The existence of any 
condition, match parameter, or guarantee that may be attached to an 
order is never communicated or displayed to the crowd.
    The System also provides participants the option of having the 
balance of an unexecuted order returned to them or forwarded to other 
Nasdaq systems for execution. Participants must indicate their 
preference upon submission of an order to the System. For example, a 
Participant can submit an order with an indication that it should be 
forwarded to another Nasdaq system if the order is not completely 
executed in Primex. To the extent the auction concludes and there is a 
portion of the order remaining, that balance will be converted by the 
System to an order that is forwarded to SuperSoes (for Nasdaq National 
Market securities), SuperMontage (when implemented), or ITS/CAES (for 
exchange-listed securities, provided the participant also is an ITS/
CAES market maker). A Participant's preference is not displayed, 
exposed or communicated to any other Participant.
    The entire auction process is designed to give participants maximum 
flexibility and choice in how their orders are exposed while allowing 
for the fastest execution possible. For example, although unpriced 
market orders generally have a default maximum broadcast period of 15 
seconds, executions can take place sooner if there are satisfactory 
responses from the crowd at any time during the exposure of the order. 
In addition, executions can occur instantaneously when there is crowd 
trading interest residing in the System. Trading interest can reside in 
the System when Participants define their interest in advance of an 
order being auctioned, or when other, contra side orders are already in 
the process of being exposed in an auction. In addition, participants 
also may elect to have the order exposed for an immediate or ``zero 
second'' auction, depending on the size of the order or, as described 
above, guarantee an execution by committing liquidity in the absence of 
satisfactory interest from the crowd. Transactions always are executed 
at or within the NBBO.
    Another feature of the System is that it processes all activity 
among Participants on an anonymous basis until the end of the trading 
day. After facilitating an execution, the System sends an execution 
report to all Participants involved. The execution report indicates the 
details of the transaction, but the identity of the counterparty is 
withheld. At the end of each trading day, the counterparties' 
identities are revealed to each other. Nasdaq, however, has the ability 
to determine the identity of the parties at any time.
    Trades executed within the System are reported and settled through 
the same process as trades executed using other Nasdaq systems. Through 
ACT, trades are reported to the public tape and forwarded to DTCC for 
clearing, if necessary. Participants (or their clearing brokers) are 
the parties responsible for clearing and settling all trades executed 
through the System. Once a transaction is executed, Participants do not 
have the ability within the System to modify or reallocate any portion 
of the execution to a clearing broker other than the clearing broker 
that the System associates with the participant at the time of 
execution. Neither the NASD (and its affiliates), Primex Trading, N.A., 
LLC (and its affiliates) nor any operator or administrator of the 
System will be directly or indirectly a party to any transaction 
entered into, matched, or otherwise effected through the System, 
notwithstanding that, for the remainder of the trading day after a 
transaction is executed, the identities of the counterparties will not 
be disclosed to each other by the System.
    Trades executed within the System are subject to several levels of 
risk management. All trades are included in the existing risk 
management feature of ACT, which allows firms to rely on ACT to monitor 
all trading activity of executing brokers that clear through them, even 
when those firms use the System to effect trades.
    The System itself provides additional risk management controls. 
Participants and their clearing firms can closely monitor and control 
their exposure specifically with respect to System activity, both at an 
individual subscriber/user level, as well as across an entire firm. 
Specifically, through the System, supervisory personnel at a 
Participant firm have the ability to establish credit limits applicable 
to each individual subscriber/user authorized by that firm to access 
the System (including any Sponsored Subscriber). The limits are 
established as a dollar amount of aggregated purchases or sales within 
the System, which, when reached, cause the System to: (1) Inhibit any 
future executions or the entry of future interest for that subscriber; 
(2) cancel any orders and withdraw any indications resident within the 
System for that subscriber; and (3) send a notice to that subscriber, 
its firm administrator, and the Nasdaq supervisor. Credit limits can be 
monitored and modified by the Participant on a real-time basis directly 
through the System. As a backup, clearing limits also can be 
established and modified by the Nasdaq supervisor on behalf of the 
Participant firm.
    The System also allows a Participant (or its clearing firm) to 
establish clearing limits within the System for that Participant on a 
firm-wide basis. The limits are established as a dollar amount of both 
purchases and sales (calculated separately, and not netted) of all 
subscribers of the Participant. When the clearing limits for a 
Participant are reached, the System will: (1) Inhibit any future 
executions for all subscribers associated with that Participant; (2) 
cancel any orders and withdraw any indications resident within the 
System for all subscribers associated with that Participant; and (3) 
send a notice to that Participant's firm administrator, the Nasdaq 
supervisor, and to the clearing firm for that Participant provided that 
the clearing firm also is a Participant. Clearing limits for a 
Participant can be monitored on a real-time basis by the Participant's 
firm administrator, and can be established, monitored, and modified by 
the firm administrator of the Participant's clearing firm, provided the 
clearing firm also is a Participant. If the clearing firm is not a 
Participant, the Nasdaq supervisor, as soon as practicable, will notify 
the clearing firm that the clearing limits have been reached. Clearing 
limits also can be established and modified by the Nasdaq supervisor on 
behalf of the clearing firm.

[[Page 38163]]

2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of Section 15A(b) of the Act,\15\ in general, and 
furthers the objectives of Section 15A(b)(6),\16\ in particular, 
because it is designed to prevent fraudulent and manipulative acts and 
practices, promote just and equitable principals of trade, foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, protect investors and the public interest; and is not designed 
to permit unfair discrimination between customers, issuers, brokers, or 
dealers.
---------------------------------------------------------------------------

    \15\ 15 U.S.C. 78o-3(b).
    \16\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    Nasdaq also believes that the proposed rule change is consistent 
with Section 11A(a)(1) of the Act,\17\ which sets forth findings of 
Congress that new data processing and communications techniques create 
opportunity for more efficient and effective market operations. Nasdaq 
believes its application of Primex is consistent with the NASD's 
obligations under the Act, as well as the finding of Congress, because 
the System provides members with an additional electronic, execution 
system, which is designed to provide members with flexibility in 
executing orders and the opportunity to obtain price improvement. 
Nasdaq believes the System is a hybrid that combines an extended, 
electronic auction mechanism with the speed and liquidity of Nasdaq's 
competing market maker environment. Nasdaq believes the System can 
improve on the traditional auction market model by automating many of 
its elements, including the trading crowd, but will not be bound by 
physical limitations of space or the number of persons that can be in 
one physical location at any given time. Nasdaq believes this 
attribute, combined with a multiple market maker structure provides an 
opportunity for enhanced liquidity.
---------------------------------------------------------------------------

    \17\ 15 U.S.C. 78k-1(a)(1).
---------------------------------------------------------------------------

    Another attribute of the System is that all orders may be exposed 
to a wider audience and thus have the opportunity to obtain price 
improvement. Nasdaq believes this provides for order interaction and 
can facilitate best execution. At the same time, however, the System 
continues to provide PAMMs with incentives to expose orders and provide 
liquidity to those orders. To ensure the protection of investors, 
orders will not be executed at prices inferior to the NBBO.
    Nasdaq believes the System also is designed to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to, and facilitating 
transactions in securities. Trades executed using the System will be 
processed through ACT in the same manner as trades executed using other 
Nasdaq systems. As such, information on these trades will be 
incorporated in Nasdaq's audit trail, ACT's risk management function, 
and forwarded to DTCC for clearance and settlement, if necessary. 
Trades executed in the System also will be disseminated on the public 
tape.

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, as amended.

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

    Prior to filing the Form PILOT, Nasdaq published a Notice to 
Members describing the operation of the System.\18\ One letter was 
received in response thereto.\19\ A copy of the Notice to Members is 
attached as Exhibit 2 to Nasdaq's proposal. A copy of the comment 
letter is attached as Exhibit 3 to Nasdaq's proposal.
---------------------------------------------------------------------------

    \18\ NASD Notice to Members 00-65 (September 2000).
    \19\ See letter from Antonio Cecin, Managing Director, Director 
of Equity Trading, U.S. Bancorp Piper Jaffray Inc., to Eugene Lopez, 
Senior Vice President, Nasdaq, dated January 2, 2001.
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III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the proposed rule change, including whether the 
proposed rule change 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 
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-2002-60 and should be submitted by June 21, 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).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-13623 Filed 5-30-02; 8:45 am]
BILLING CODE 8010-01-P