[Federal Register Volume 67, Number 163 (Thursday, August 22, 2002)]
[Notices]
[Pages 54515-54519]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-21378]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46369; File No. SR-NASD-2002-42]


Self-Regulatory Organizations; Order Granting Approval to a 
Proposed Rule Change and Amendments Nos. 1, 2, 3, 4, 5 and 6 Thereto by 
the National Association of Securities Dealers, Inc. Relating to the 
Integrated Processing of Odd-Lot Share Amounts in Nasdaq's SuperMontage 
System

August 16, 2002.

I. Introduction

    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''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend several NASD Rules 
governing the operation of Nasdaq's future Order Display and Collector 
Facility (``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. 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 proposed rule change, as amended by 
Amendments Nos. 1, 2, and 3, was published for comment in the Federal 
Register on May 28, 2002.\6\ The Commission received thirteen comment 
letters on the proposed rule change, as amended.\7\ Nasdaq filed 
Amendment

[[Page 54516]]

No. 4 to the proposed rule change on June 6, 2002.\8\ Nasdaq filed 
Amendment No. 5 to the proposed rule change on August 9, 2002.\9\ 
Nasdaq filed Amendment No. 6 to the proposed rule change on August 13, 
2002.\10\ This order approves the proposed rule change, as amended.
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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 and Amendment No. 1 in their 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'').
    \6\ See Securities Exchange Act Release No. 45968 (May 20, 
2002), 67 FR 36946 (``Proposing Release'').
    \7\ See email to [email protected], Commission, from Joshua 
Levine, dated May 30, 2002 (``Levine Letter''). See also letters to 
Jonathan G. Katz, Secretary, Commission, from Keith A. Gertsen, 
Managing Director, Head, Nasdaq Trading, and Ken P. Dengler, 
Managing Director, Head, Nasdaq Sales Trading, Deutsche Bank 
Securities, Inc., dated June 14, 2002 (``Deutsche Bank Letter''); C. 
Thomas Richardson, Head, Nasdaq Trading, Salomon Smith Barney, dated 
June 14, 2002 (``Salomon Letter''); Michael A. Bird, Chairman, and 
John C. Giesea, President and Chief Operating Officer, Securities 
Traders Association, dated June 17, 2002 (``STA Letter''); Bruce 
Turner, CIBC World Markets Corp. (``CIBC''), dated June 6, 2002 
(``CIBC Turner Letter''); Scott W. Anderson, Associate Director, 
Region Americas Legal, USB Warburg LLC, dated June 17, 2002 (``USB 
Warburg Letter''); Howard Berstein, Vice President, Compliance 
Department, Robertson Stephens, Inc., dated June 17, 2002, 
(``Robertson Stephens Letter''); Robert Arancio on behalf of Mathew 
Johnson, Managing Director, Lehman Brothers Inc., dated June 18, 
2002 (``Lehman Letter''); Elliot Levine, Assistant General Counsel 
and Executive Director, CIBC, dated June 18, 2002 (``CIBC Levine 
Letter''); John P. Hughes SR. V.P., Director, Nasdaq & Listed 
Trading, Janney Montgomery Scott LLC, dated June 12, 2002 (``Janney 
Letter''); Heidi H. Reynolds, Managing Director, Nasdaq Trading, 
Morgan Keegan & Company, Inc., dated June 14, 2002 (``Morgan 
Letter''); C.E. Wasson, SVP Director, Nasdaq Trading, Legg Mason, 
Inc., dated June 20, 2002 (``Legg Mason Letter''); and Gerald D. 
Putnam, Chairman and CEO, Archipelago Holdings, LLC, dated July 9, 
2002 (``Arca Letter'').
    \8\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division, 
Commission, dated June 6, 2002 (``Amendment No. 4''). In Amendment 
No. 4, Nasdaq made technical, non-substantive changes to the 
proposed rule text, which were reflected in the Proposing Release.
    \9\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division, 
Commission, dated August 9, 2002 (``Amendment No. 5''). In Amendment 
No. 5, Nasdaq made technical, non-substantive changes to the 
proposed rule text that are not subject to notice and comment.
    \10\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division, 
Commission, dated August 13, 2002 (``Amendment No. 6''). In 
Amendment No. 6, Nasdaq amended the text of NASD Rule 4710(b)(2)(A) 
to reflect recent amendments to the rule. See Securities Exchange 
Act Release No. 46320 (August 8, 2002) (File No. SR-NASD-2002-84). 
The Commission notes that this is a technical, non-substantive 
amendment and not subject to notice and comment.
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II. Description of the Proposed Rule Change

    As originally approved, SuperMontage included a separate mechanism 
for processing and executing odd-lot orders at the inside price.\11\ 
Nasdaq now proposes to fully integrate the processing of odd, mixed, 
and round-lot orders in the SuperMontage Non-Directed Order 
Process.\12\ As such, Nasdaq would not provide a separate process for 
odd-lot orders in SuperMontage, as originally approved, but instead 
would allow the entry and execution of orders in any whole share amount 
from 1 to 999,999 shares.
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    \11\ See Securities Exchange Act Release No. 43863 (January 19, 
2001), 66 FR 8020 (January 26, 2001) (``SuperMontage Order'').
    \12\ The term ``odd-lot'' refers to an order that is less than 
100 shares. The term ``round-lot'' refers to an order in 100 share 
increments. The term ``mixed-lot'' refers to an order that is 
comprised of round and odd lots.
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A. Entry and Display of Quotes/Orders

    Under the proposal, all Nasdaq market participants including market 
makers, Electronic Communication Networks (``ECNs''), order entry 
firms, and Unlisted Trading Privilege (``UTP'') Exchanges will be able 
to enter orders into SuperMontage in any whole-share amount from 1 to 
999,999 shares. Odd-lot and mixed-lot orders would generally be treated 
the same as round-lot orders. For instance, odd-lot and mixed-lot 
orders, like round-lot orders, will receive a time stamp upon entry in 
the SuperMontage. Market makers and ECNs (``Nasdaq Quoting Market 
Participants'') and UTP Exchanges will be able to enter odd-lot and 
mixed-lot orders as market orders or limit orders with any non-directed 
order designation type permitted by the NASD rules.\13\ Odd-lot and 
mixed-lot orders will be aggregated, decremented, and cancelled under 
the same terms and conditions as round-lot orders.\14\ Odd-lot and 
mixed-lot orders could be preferenced to other market participants in 
the same manner as round-lots.\15\ While orders originally entered into 
the SuperMontage as odd-lots would not be able to use reserve size, 
orders originally entered into the system as mixed-lots could use 
reserve size.\16\
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    \13\ See NASD Rule 4706(a)(1)(B).
    \14\ See NASD Rule 4710(b).
    \15\ See NASD Rule 4710(b)(1)(B)(iv).
    \16\ See Securities Exchange Act Release No. 46320 (August 8, 
2002), 67 FR 53033 (August 14, 2002) (File No. SR-NASD-2002-84).
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    Under the proposal, all displayed interest in the Nasdaq Order 
Display Facility (``NODF'') would continue to be in round-lot 
increments. The NODF, which aggregates all quotes and orders 
(attributable and non-attributable) at each price level, and displays 
the five best prices with associated aggregate size on each side of the 
market, will reflect odd and mixed-lots in the manner described below. 
For display purposes, Nasdaq would aggregate the shares of the multiple 
quotes \17\ and orders entered by a Nasdaq Quoting Market Participant 
or UTP Exchange at a single price level and round that total share 
amount down to the nearest round-lot amount for display and 
dissemination.\18\ Likewise, if a party enters a mixed-lot order, the 
system would round down the mixed-lot order to the nearest round-lot 
increment for display in the NODF. Any odd-lot portion of a mixed-lot 
that is not displayed as a result of this rounding process would remain 
in the system eligible for execution, with the time-priority of its 
original entry. Orders originally entered as odd-lots that are not 
aggregated to any other quotes and orders, and quotes or orders that 
have been decremented to an odd-lot remainder would not be displayed.
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    \17\ The Commission notes that the Nasdaq system will continue 
to display and require the entry of quotes in round-lot increments. 
Telephone conversation between Thomas P. Moran, Associate General 
Counsel, Nasdaq, and Kelly Riley, Senior Special Counsel, Division, 
Commission, on July 31, 2002.
    \18\ For example, if a Nasdaq Quoting Market Participant enters 
three separate orders to buy 50 shares, 225 shares and 590 shares at 
the same price level, it 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, rounded down to 800 shares for 
display purposes).
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    Although the SuperMontage is similar in many respects to Nasdaq's 
current trading platform, because it is a new system, market 
participants will have to program their interfaces to enable them to 
utilize SuperMontage features. For market participants that update 
their technology to permit them to enter multiple quotes or orders, any 
insufficient amount of shares at a price level to display a round-lot 
share amount (i.e., odd-lot remainder) after an execution against its 
quote/order would remain in the system eligible for execution, unless 
cancelled by the market participant. Because odd-lots will not be 
displayed in SuperMontage, the system would display that market 
participant's next best priced quote/order in a round-lot share amount 
on that same side of the market if the market participant has 
attributable and displayable trading interest of at least a single 
round-lot share amount in the system. If the market participant does 
not have another quote/order in SuperMontage on a particular side of 
the market, and the market participant fails to update its quote/order, 
a new quote/order would be generated using the ``penalty quote 
refresh'' process.\19\

[[Page 54517]]

The odd-lot remainders of market participants using updated technology 
would remain in the system, undisplayed, until executed or cancelled, 
with its original time-stamp of entry.\20\
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    \19\ Pursuant to NASD Rule 4710(b)(5) if all market maker bids 
and/or offers are exhausted so that there are no longer any quote or 
orders displayed on the bid or offer side of the market, and the 
market maker does not update its principal quote via Auto Quote 
Refresh (``AQR''), transmit a revised attributable quote/order to 
Nasdaq, or have another attributable quote or order in the system, 
the system, after 30 seconds, will 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 will 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 will 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. 46141 
(June 28, 2002), 67 FR 44906 (July 5, 2002) (approving File No. SR-
NASD-2002-01).
    \20\ Market-makers cannot fulfill their quote display 
obligations through the presence of odd-lot remainders in the 
system. See NASD Rule 4613.
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    In the Proposing Release, Nasdaq explained that during the initial 
SuperMontage roll-out it will also permit participants to access 
SuperMontage using their current technology (``Legacy Quotes''), but 
that the use of current technology limits a market participant's 
ability to use certain SuperMontage features. Most notably, if a 
participant uses its current technology, it will be unable to enter 
multiple quotes/orders in SuperMontage. According to Nasdaq, because of 
the inability of Legacy Quote users to enter multiple quotes/orders, it 
would also be technologically infeasible for these market participants 
to simultaneously support a quote/order and an odd-lot remainder in the 
system. Thus, the odd-lot remainders of Legacy Quote users would be 
purged from SuperMontage contemporaneous with a market participant's 
quote or order being refreshed to at least a round-lot amount. The 
quote of a market participant that uses Legacy Quote technology may be 
refreshed: (1) By the market participant, (2) using the AQR function to 
a price and size selected by the entering party,\21\ or (3) using the 
penalty quote refresh process.\22\
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    \21\ Nasdaq's AQR function will allow Legacy Quote market 
participants to have their displayed quote refreshed to a pre-
determined price and size (round-lot share amount) 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 market participant's quote is refreshed by AQR shall 
not be retained in SuperMontage for execution and the system would 
only recognize and potentially process the round-lot refreshed 
amount. Market participants using updated technology who have the 
ability to enter multiple quotes/orders cannot use the AQR function.
    \22\ Between the time a Legacy Quote user's quote/order is 
decremented to less than a round-lot share amount and the Legacy 
Quote user's quote is refreshed pursuant to the penalty quote 
refresh process (or updated by the transmission of a revised 
attributable quote) an odd-lot remainder would be eligible for 
execution in SuperMontage.
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     Nasdaq Quoting Market Participants and UTP Exchanges entering 
orders that are at least 100 shares would be able to use the 
SuperMontage reserve size function.\23\ If a quote/order with a reserve 
size is decremented to an odd-lot remainder, the system would refresh 
the quote/order from reserve size by an amount designated by the market 
participant. Any odd-lot remainder available prior to the reserve size 
refresh would be retained by the system. Thus, the reserve size refresh 
amount and the odd-lot remainder would be aggregated and displayed.\24\
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    \23\ Orders originally entered as odd-lots would not be able to 
use reserve size refresh. See supra note and accompanying text.
    \24\ 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 quote. 
Upon execution, since MMA's displayable interest is less than 100 
shares, the system would refresh MMA's quote by the refresh amount--
500 shares, but would also retain the 75 share odd-lot remainder in 
the system. The resulting 575 share total would remain in the system 
and available for execution but would be rounded down to 500 shares 
for display purposes.
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B. Execution Process

    Under the proposal, odd-lots and mixed-lots shall be executed on a 
share-by-share basis consistent with the SuperMontage order execution 
algorithms. Like round-lots, odd-lots and mixed-lots would 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.\25\ Accordingly, SuperMontage would not execute an 
odd or a mixed-lot at an inferior price level until all better-priced 
share amounts that are in the system, including undisplayed odd-lots, 
are executed.
    Under the proposal, undisplayed odd-lots with a better price than 
the Nasdaq best bid or offer (``BBO'') would be executed pursuant to 
the SuperMontage rule for clearing locked and crossed markets.\26\ A 
locked market occurs when a market participant's bid equals the lowest 
offer of another market participant. A crossed market occurs when a 
market participant's bid exceeds the lowest offer of another market 
participant. If a market participant submitted a quote that would lock 
or cross an undisplayed odd-lot, that market participant would receive 
a system warning. To complete the quote entry, the participant would 
have to override the system warning.\27\ If a Nasdaq Quoting Market 
Participant or UTP Exchange used the system override for a quote that 
would lock or cross an undisplayed odd-lot, the SuperMontage would not 
display the quote, but instead would reformat the quote as a marketable 
limit order and enter it into the SuperMontage as a non-directed order 
for execution. The reformatted order would be routed to the undisplayed 
odd-lot order next in the queue that would be locked or crossed, and 
the order would be executed at the price of the undisplayed odd-lot. 
Once the odd-lot execution takes place, if the Nasdaq Quoting Market 
Participant or UTP Exchange's quote that would have locked or crossed 
the odd-lot has not been completely filled, the SuperMontage would 
reformat the order again and display it (consistent with the parameters 
of the quote) as a quote on behalf of the entering Nasdaq Quoting 
Market Participant or UTP Exchange. If the market participant did not 
override the system warning for a quote/order that would lock or cross 
an undisplayed odd-lot, the SuperMontage would reject the market 
participant's quote and return it to the entering party.
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    \25\ The three SuperMontage order execution algorithms will make 
an exception for non-directed, non-preferenced orders entered by a 
market maker or ECN when that market maker or ECN's quote/order is 
at the inside market. See NASD Rule 4710(b)(1)(B)(iv).
    \26\ See NASD Rule 4710(b)(3)(A).
    \27\ Prior to entry, a market participant could append an 
override instruction to the locking/crossing quote. The system would 
deliver an execution or a rejection based on the market 
participant's instructions.
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C. Trade Reporting

    Under the proposal, Nasdaq would continue to disseminate 
transactions to the public tape, whether it is a round or mixed-lot 
execution, in round-lot increments. Thus, mixed-lot executions would be 
rounded down to the next lowest round-lot increment for the purpose of 
reporting transactions to the public tape. Odd-lot transactions would 
not be reported to the tape. However, odd-lots and mixed-lots would be 
included in Nasdaq's daily volume report.

III. Summary of Comments

    The Commission received thirteen comment letters on the proposed 
rule change, all of which supported the proposal.\28\ A majority of 
commenters noted that the proposal should enhance

[[Page 54518]]

both liquidity and transparency.\29\ Several commenters believed that 
the proposal could benefit individual investors by providing small 
orders with standing along with large orders on the book.\30\ Several 
commenters also believed that the proposed changes would continue to 
address the gaming issues that the originally approved odd-lot process 
intended to minimize.\31\ Some commenters noted that the proposal would 
remove the possibility that existed in the previously approved odd-lot 
process that a market maker might have to execute more shares than it 
was willing to trade.\32\ Finally, a few commenters believed that the 
proposal would prevent market participants from hiding significant 
numbers of shares from their quote and the tape by entering multiple 
odd-lots.\33\
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    \28\ See supra note 7. One commenter, however, noted that it 
would only support approval of the proposed rule change on a pilot 
basis. This commenter believed that only after SuperMontage becomes 
operational can a better solution to the odd-lot process become 
apparent. In addition, the commenter suggested that Nasdaq study the 
proposed odd-lot process in the SuperMontage environment. See UBS 
Warburg Letter.
    \29\ See Deutsche Bank Letter, Salomon Letter, STA Letter, CIBC 
Turner Letter, Lehman Letter, CIBC Levine Letter, Janney Letter, and 
Morgan Letter.
    \30\ See Deutsche Bank Letter, STA Letter, CIBC Turner Letter, 
Lehman Letter, CIBC Levine Letter, Janney Letter, and Morgan Letter.
    \31\ See CIBC Turner Letter, CIBC Levine Letter, Janney Letter, 
and Legg Mason Letter.
    \32\ See Deutsche Bank Letter, Salomon Letter, STA Letter, 
Robertson Stephens Letter, and Lehman Letter.
    \33\ See Deutsche Bank Letter, CIBC Turner Letter, CIBC Levine 
Letter, and Morgan Letter.
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    One commenter, while supporting approval of the proposal, suggested 
modifications.\34\ First, the commenter suggested that SuperMontage 
permit participants to enter multiple quotes/orders with odd-lot and 
mixed-lot sizes. Second, the commenter suggested that Nasdaq extend its 
trade reporting rules to cover odd-lot transactions. Finally, the 
commenter suggested that Nasdaq introduce the actual shares concept to 
their data feeds (i.e., disseminate the actual size of quotes and 
orders).
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    \34\ See Levine Letter.
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    In response to these suggestions, Nasdaq submitted a letter to the 
Commission.\35\ Nasdaq stated that the requirement that initial entry 
of quotes be in round-lot amounts is based on the concept that a party 
should not be allowed to initially enter a quotation that is not 
displayable. With regard to trade reporting and Nasdaq data feeds, 
Nasdaq stated that expanding the actual shares concept to the 
dissemination of quotes and orders would raise issues that impact 
numerous market participants, including data vendors, other markets, 
the internal systems of broker-dealers, regulators, and public 
investors.
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    \35\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine England, Assistant Director, Division, 
Commission, dated July 2, 2002.
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    Finally, one commenter, while supporting Nasdaq's goal of 
integrating odd-lot orders in the execution process, raised concerns 
about the technical design of the proposal.\36\ Specifically, the 
commenter expressed concern regarding undisplayed odd-lots orders that 
have a better price than the displayed BBO. The commenter explained 
that order-delivery ECNs would have three options when an undisplayed 
odd-lot order was locked or crossed: (1) Override the lock/cross 
warning message and receive an automatic execution, (2) accept the 
lock/cross warning message, have the system reject and return the 
quotation, and not display it in SuperMontage, or (3) convert the 
quotation to an order and re-submit it to SuperMontage. The commenter 
believed that these three options were respectively problematic 
because: (1) ECNs would be exposed to dual liability, (2) compliance 
with the Quote Rule \37\ would be frustrated, and (3) delays in the 
entry of trading interest in the system would result.
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    \36\ See Arca Letter.
    \37\ Exchange Act Rule 11Ac1-1, 17 CFR 240.11Ac1-1.
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    In response, Nasdaq submitted a letter to the Commission.\38\ 
Specifically, Nasdaq disagrees with the commenter's suggestion that 
Nasdaq's refusal to display a quotation of an ECN that locks or crosses 
the market is contrary to its requirements under the Quote Rule. 
According to Nasdaq, this issue was previously resolved by the 
Commission both in the context of the Order Handling Rules and the 
SuperMontage Order. Further, Nasdaq believes that SuperMontage ensures 
that ECNs are able to make reasonable efforts to trade before entering 
quotes that would lock or cross the market. Accordingly, Nasdaq 
believes that ECNs do have the ability to display their trading 
interest in SuperMontage by converting any locking or crossing 
quotation into an order or overriding the warning message, which 
enables ECNs to meet their obligations to display customer orders and 
also satisfies Nasdaq requirements under the Quote Rule.
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    \38\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine England, Assistant Director, Division, 
Commission, dated July 26, 2002.
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IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
association.\39\ The Commission finds that the proposed rule change, as 
amended, is consistent with Section 15A of the Act.\40\ Specifically, 
the Commission finds that the proposed rule change is consistent with 
Section 15A(b)(6) of the Act because it 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 in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest.\41\
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    \39\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \40\ 15 U.S.C. 78o-3.
    \41\ 15 U.S.C. 78o-3(b)(6).
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    With this filing Nasdaq proposes to fully integrate the entry, 
execution, and processing of odd and mixed-lot orders into 
SuperMontage. Integrating odd-lot orders into SuperMontage should 
provide investors with small-sized orders with many system protections 
that they do not currently enjoy. For example, odd-lot orders and odd-
lot portions of mixed-lot orders will participate in the Non-Directed 
Order Process in virtually the same manner as larger sized round-lot 
quotes and orders. Under the proposal, odd-lot and mixed-lot orders 
will achieve price and time priority on the same basis as round-lot 
orders. Whether the order is an odd, mixed, or round-lot, SuperMontage 
gives execution priority to the best price in the system (as determined 
by the order execution algorithm selected by the entering party).\42\ 
Specifically, odd and mixed-lot orders will receive a time stamp upon 
entry into SuperMontage, which will be effective until the order is 
fully executed or cancelled. The Commission believes that integrating 
odd, mixed, and round-lot orders into SuperMontage should provide 
investors of such orders with better executions and should enhance the 
integrity of the market.
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    \42\ See NASD Rule 4710.
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    The Commission believes that the proposal may increase liquidity 
and transparency in SuperMontage.\43\ The integration of odd and mixed-
lot orders could increase liquidity since odd-lots and the odd-lot 
portion of mixed-lot orders will be able to fully interact with the 
round-lot market. The accessibility and eligibility for execution of 
odd-lots and the odd-lot portion of mixed-lots should add depth to the 
market, which also could increase liquidity. Although

[[Page 54519]]

SuperMontage will continue to only display quotes and orders in round-
lot increments, the system will aggregate all shares (orders and 
quotes) entered by a Nasdaq Quoting Market Participant or UTP Exchange, 
at a single price level and then round that total share amount down to 
the nearest round-lot amount for display and dissemination. While the 
actual size of a Nasdaq Quoting Market Participant's trading interest 
may not be fully displayed, adding odd-lot amounts to the disseminated 
size of Nasdaq Quoting Market Participants should portray a more 
accurate representation of trading interest. Thus, the proposal should 
enhance transparency.
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    \43\ The Commission notes that a majority of commenters believed 
that the proposal would enhance liquidity and transparency. See 
supra note 29 and accompanying text.
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    The Commission believes that small retail investors who may find it 
difficult to participate in the market in full round-lot increments, 
will be able to have their smaller-sized orders interact with the 
orders of institutional investors and highly-capitalized individuals. 
As noted by a commenter, odd-lot orders are employed typically by small 
investors who cannot afford to transact in full round-lot 
quantities.\44\ Further, the Commission believes that the proposed rule 
change should give market participants greater flexibility in handling 
small retail customer orders as market participants will be able to 
enter odd-lots and mixed-lots in SuperMontage with system protections 
similar to round-lots.
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    \44\ See Levine Letter. See also CIBC Levine Letter.
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    As previously noted, Nasdaq will continue to only display quotes 
and orders in round-lot increments.\45\ One commenter did express a 
concern about the presence of undisplayed odd-lot orders that have a 
better price than the displayed BBO.\46\ The commenter explained that 
order delivery ECNs would have three options when their quote locked or 
crossed an undisplayed odd-lot order: (1) Override the lock/cross 
warning message and receive an automatic execution, (2) accept the 
lock/cross warning message, have the system reject and return the 
quotation, and not display the order in SuperMontage, or (3) convert 
the quotation to an order and re-submit it to SuperMontage. The 
commenter believed that these three options were respectively 
problematic because: (1) ECNs would be exposed to dual liability, (2) 
compliance with the Quote Rule \47\ would be frustrated, and (3) delays 
in the entry of trading interest in the system would result. While the 
Commission appreciates the commenter's concerns, the Commission 
believes that Nasdaq and traditional exchanges must have the 
flexibility to rethink their structures to permit appropriate responses 
to the rapidly changing marketplace. Congress instructed the Commission 
to seek to ``enhance competition and to allow economic forces, 
interacting with a fair regulatory field, to arrive at appropriate 
variation in practices and services.''\48\ The Commission finds that 
the proposal to fully integrate the entry, execution, and processing of 
odd and mixed-lot orders in SuperMontage is consistent with these goals 
in that it is reasonably designed to promote price discovery, best 
execution, liquidity, and market innovation, while continuing to 
preserve competition among market centers. The Commission emphasizes 
that participation in SuperMontage as originally designed, and as 
subsequently amended, is voluntary.
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    \45\ The Commission notes that the Customer Limit Order Display 
Rule exempts odd-lot orders from the display requirement. See 
Exchange Act Rule 11Ac1-4(c)(3), 17 CFR 240.11Ac1-4(c)(3).
    \46\ See Arca Letter.
    \47\ Exchange Act Rule 11Ac1-1, 17 CFR 240.11Ac1-1.
    \48\ See S. Rep. No. 94-75, 94th Cong., 1st Sess. 7 (1975) at p. 
8 (``Senate Report'').
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    As the commenter noted, ECNs that do not wish to be exposed to dual 
liability could accept the lock/cross warning message and then re-route 
the order to SuperMontage. While this solution may be less than 
optimal, the commenter indicated that it is a viable option. Further, 
the Commission notes that the original approval of the SuperMontage was 
conditioned on the NASD offering a quote and trade reporting 
alternative that satisfies the Order Handling Rules, Regulation ATS, 
and other regulatory requirements for ATSs, ECNs, and market makers 
prior to or at the same time as the implementation of SuperMontage.\49\ 
Thus, prior to the implementation of the SuperMontage, market 
participants will be able to fulfill their obligations under the Order 
Handling Rules if they choose not to participate in the SuperMontage 
for any reason.
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    \49\ On July 24, 2002, the Commission approved an NASD proposal 
to establish an alternate display facility on a pilot basis. See 
Securities Exchange Act Release No. 46249, 67 FR 49822 (July 31, 
2002) (File No. SR-NASD-2002-97). However, the Order expressly notes 
that the Commission has not determined that the preconditions of 
SuperMontage have been met.
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    Notwithstanding the flexibility warranted in a market center's 
determination of its market structure, the Commission expects that 
Nasdaq will carefully monitor quote and execution quality under the 
proposal. In addition, the Commission expects Nasdaq to monitor the 
impact and surveil the entry and execution of odd-lot orders in 
SuperMontage. If the integration of odd-lot orders has a deleterious 
effect on quoting and execution in the Nasdaq market, the Commission 
expects that Nasdaq will submit an appropriate response, in the form of 
a proposed rule change, to restore and enhance quote and execution 
quality.
    Finally, the Commission finds that with regard to trade reporting 
this proposal raises no new regulatory issues and that Nasdaq will 
continue to meet its trade reporting obligations under the Act.

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposal, 
as amended, is consistent with the requirements of the Act and rules 
and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\50\ that the proposed rule change (SR-NASD-2002-42), as amended, 
is approved.
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    \50\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\51\
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    \51\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-21378 Filed 8-21-02; 8:45 am]
BILLING CODE 8010-01-P