[Federal Register Volume 67, Number 169 (Friday, August 30, 2002)]
[Notices]
[Pages 55897-55901]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-22216]



[[Page 55897]]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46410; File No. SR-NASD-2002-56]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving a Proposed Rule Change and Amendment No. 
1 Thereto and Notice of Filing and Order Granting Accelerated Approval 
to Amendment Nos. 2 and 3 to the Proposed Rule Change Establishing a 
Uniform Process for Opening Daily Trading for the Nasdaq SuperMontage

August 23, 2002.

I. Introduction

    On April 22, 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 (``SEC'' or ``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 establish a uniform process 
for opening daily trading in Nasdaq's future Order Display and 
Collector Facility (``SuperMontage''). On May 17, 2002, the NASD, 
through Nasdaq, filed Amendment No. 1 to the proposed rule change.\3\ 
The proposed rule change and Amendment No. 1 were published for comment 
in the Federal Register on May 24, 2002.\4\ The Commission received 
thirteen comment letters from twelve commenters regarding the 
proposal.\5\ Nasdaq responded to the issues raised in the comment 
letter on July 12, 2002.\6\ On July 12, 2002, the NASD, through Nasdaq, 
filed Amendment No. 2 to the proposed rule change.\7\ On August 22, 
2002, the NASD, through Nasdaq, filed Amendment No. 3 to the proposed 
rule change.\8\ This order approves the proposed rule change and 
Amendment No. 1, and notices and grants accelerated approval to 
Amendment Nos. 2 and 3.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaced the original Rule 19b-4 filing in 
its entirety.
    \4\ See Securities Exchange Act Release No. 45965 (May 20, 
2002), 67 FR 36659.
    \5\ See letters to Jonathan G. Katz, Secretary, Commission, from 
Howard Bernstein, Vice President, Compliance Department, Robertson 
Stephens, Inc. (``RSSF''), dated June 13, 2002 (``RSSF Letter); Seth 
Weber, on behalf of Matthew Johnson, Managing Director, Lehman 
Brothers, Inc., dated June 14, 2002 (``Lehman Brothers Letter''); 
Keith A. Gertsen, Managing Director, Head, Nasdaq Trading, Deutsche 
Banc Alex. Brown, Inc. on behalf of Deutsche Bank Securities, Inc., 
dated June 14, 2002 (``Deutsche Bank Letter''); C. Thomas 
Richardson, Head, Nasdaq Trading, Salomon Smith Barney, Inc. 
(``SSB''), dated June 14, 2002 (``SSB Letter''); Michael T. Dorsey, 
Senior Vice President, General Counsel and Secretary, Knight Trading 
Group, Inc. (``Knight''), dated June 14, 2002 (``Knight Letter''); 
Michael A. Bird, Chairman, and John C. Giesea, President and CEO, 
Security Traders Association (``STA''), dated June 17, 2002 (``STA 
Letter''); Bruce Turner, CIBC World Markets, dated June 6, 2002 
(``CIBC Letter''); Scott W. Anderson, Associate Director, Region 
Americas Legal, UBS Warburg LLC (``UBSW''), dated June 17, 2002 
(``UBSW Letter''); Hedi H. Reynolds, Managing Director, Nasdaq 
Trading, Morgan Keegan & Company, Inc., dated June 14, 2002 
(``Morgan Keegan Letter''); C.E. Wasson, SVP Director Nasdaq 
Trading, Legg Mason Wood Walker, Inc. (``Legg Mason''), dated June 
20, 2002 (``Legg Mason Letter''); Howard Bernstein, Vice President, 
Compliance Department, RSSF, dated June 17, 2002 (``RSSF Addendum 
Letter''); Elliot Levine, Assistant General Counsel, Executive 
Director, CIBC, dated June 18, 2002 (``CIBC II Letter''); and John 
P. Hughes, Senior Vice President, Director of Nasdaq & Listed 
Trading, Janney Montgomery Scott LLC, dated June 12, 2002 (``Janney 
Montgomery Scott Letter'').
    \6\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated July 1, 2002 
(``Response to Comments'').
    \7\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Sapna C. Patel, Attorney, Division, Commission, dated 
July 12, 2002 (``Amendment No. 2''). In Amendment No. 2, Nasdaq made 
a technical correction to its proposed rule text by replacing 
``MPID'' with ``MMID'' in proposed NASD Rule 4613.
    \8\ See letter from Jeffrey S. Davis, Office of General Counsel, 
Nasdaq, to Sapna C. Patel, Attorney, Division, Commission, dated 
August 22, 2002 (``Amendment No. 3''). In Amendment No. 3, Nasdaq 
provided the following: (1) an updated version of its proposed rule 
language reflecting changes to its rules that have occurred since 
the initial filing of this proposal; (2) a representation that it 
will evaluate whether the thirty-second pre-opening unlocking/
uncrossing process time period should be shortened in the 60 days 
following the complete roll-out of SuperMontage, and will report its 
findings to the Commission within 30 days thereafter; (3) a 
representation that it will monitor market participants' inability 
to send Trade-or-Move Directed Orders to SIZE during the Trade-or-
Move process, and will file a proposed rule change with the 
Commission within 90 days of the complete roll-out of SuperMontage 
to resolve problems to Size accessability; and (4) clarification 
that all quotes residing in SuperMontage at the end of the trading 
day will be carried over to the next trading day, and that the 
quoting market participant could update that quote prior to the 9:20 
a.m. Trade-or-Move process.
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

    Nasdaq proposes to amend the operation of SuperMontage during pre-
market hours. Specifically, Nasdaq proposes to: (1) Permit the entry of 
market orders prior to 9:30 a.m. Eastern Time, (2) amend the timeframe 
for the Trade-or-Move Rule to conform to the changes in the opening 
process, and (3) modify the opening process by providing for the 
automatic clearing of locked/crossed quotes between 9:29:30 a.m. and 
9:29:59 a.m. Eastern Time.

A. Expansion of Order Entry During Pre-Market Hours

    Nasdaq proposes to permit the entry of market orders prior to the 
9:30 a.m. market open in SuperMontage. Under current SuperMontage 
rules, market participants may enter limit orders prior to the market 
open at 9:30 a.m. Eastern Time, but not market orders.\9\ Under the 
proposal, market participants would be permitted to enter market orders 
prior to the market open. Market orders and limit orders designated as 
IOC would not be eligible for execution prior to the market open, and 
instead would be held in a separate queue until 9:30 a.m., at which 
time such orders, if marketable, would be executed (in whole or in 
part) through the SuperMontage Non-Directed Order Process, or, if non-
marketable, cancelled and returned (in whole or in part) to the 
entering firm.\10\
---------------------------------------------------------------------------

    \9\ Order-entry firms may enter limit (priced) orders before 
9:30 a.m. Eastern Time, but these orders must be designated as 
Immediate or Cancel (``IOC''). Market Makers, ECNs, and UTP 
Exchanges may enter limit orders, but are not required to designate 
them as IOC orders.
    \10\ Prior to 9:29:30 a.m., the Directed Order Process would be 
the exclusive execution process in SuperMontage. Between 9:29:30 
a.m. and 9:29:59 a.m. execution could occur in the Non-Directed 
Order Process solely to eliminate existing locked or cross markets 
prior to the 9:30 a.m Nasdaq opening.
---------------------------------------------------------------------------

B. Modifications to ``Trade-or-Move'' Rule Timeframes

    Nasdaq proposes to amend its Trade-or-Move Rule to require market 
makers and Electronic Communication Networks (``ECNs'') (collectively 
``Nasdaq Quoting Market Participants'') to send Trade-or-Move Directed 
Orders \11\ between 9:20 a.m. and 9:29:29 a.m. (as opposed to 9:29:59 
a.m.), in order to permit the pre-market unlocking/uncrossing process 
to occur from 9:29:30 a.m. to 9:29:59 a.m. Thus, Nasdaq Quoting Market 
Participants will continue to have an obligation to send Trade-or-Move 
Directed Orders from 9:20:00 a.m. and 9:29:29 a.m. to all attributable 
quotes/orders that it may actively lock or cross, even if the Nasdaq 
Quoting Market Participant is sending its actively locking/crossing 
quote as a non-attributable quote/order (i.e., SIZE). However, Nasdaq 
Quoting Market Participants entering a quote/order that would actively 
lock or cross a quote/order displayed in SIZE would not be obligated to 
send a Trade-or-Move Directed Order.\12\
---------------------------------------------------------------------------

    \11\ Nasdaq proposes to change the term ``Trade-or-Move 
Message'' to ``Trade-or-Move Directed Order.'' See proposed NASD 
Rule 4613(e)(1)(C).
    \12\ Presently, SuperMontage is not programmed with the 
functionality that would enable a Trade-or-Move Directed Order to 
access SIZE during the Nasdaq pre-market.

---------------------------------------------------------------------------

[[Page 55898]]

C. SuperMontage Pre-Open Clearing of Locking and Crossing Quotes and 
Orders

    Nasdaq also proposes to begin an automated process to clear locked 
and crossed markets in SuperMontage between 9:29:30 a.m. and 9:29:59 
p.m. Eastern Time. Under the proposal, the system will pair off the 
most aggressively priced buy quote/order against the most aggressively 
priced sell quote/orders. Once this ``best-priced pair'' is determined, 
the system will execute the two identified orders at the price of the 
newer order until the older order is fully satisfied. If the displayed 
size becomes exhausted at that price level, SuperMontage will continue 
to execute against available reserve size at that price level. This 
process will be repeated until an unlocked and uncrossed market 
results.
    After the initial locks/crosses are cleared, any additional locking 
or crossing quotes/orders entered between 9:29:30 a.m. and 9:29:59 a.m. 
would be cleared consistent with the SuperMontage process for clearing 
locks and crosses applicable during regular market hours.\13\ Such 
executions would occur at the price of the quote/order to be locked/
crossed consistent with the locking/crossing process. All quotes/orders 
residing in SuperMontage, except market orders and orders designated as 
IOC,\14\ including SIZE, would participate in the pre-market clearing 
of locks and crosses subject to the execution logic described above. 
All trades executed prior to the 9:30 a.m. market open, including 
trades that participate in the pre-market lock/cross clearing process, 
would be designated as ``.T'' to reflect that they were executed 
outside of normal market hours.
---------------------------------------------------------------------------

    \13\ If at any time a market participant enters a quote that 
would lock/cross the market in the SuperMontage, the Nasdaq system 
will send the market participant a warning message. If the market 
participant chooses to override the warning message, the quote will 
participate in the unlocking/uncrossing process pursuant to NASD 
Rule 4710(b)(3).
    \14\ According to Nasdaq, if a market maker or ECN receives an 
order during the pre-market and its customer does not wish the order 
to be executed prior to 9:30 a.m., the market participant can enter 
the order into SuperMontage prior to the open as either a market 
order or a limit order with an IOC designation. These orders would 
not drive a quote, would not participate in the pre-market lock/
cross clearing process, and would be held in a separate queue until 
9:30 a.m., at which time such orders would become eligible for 
execution (or canceled if not marketable).
    Alternatively, if the customer limit order would otherwise be 
eligible for execution during the pre-market unlocking/uncrossing 
process, the market participant could hold the orders until 9:30 
a.m., to abide by the customer instructions not to effectuate an 
execution prior to the market open.
---------------------------------------------------------------------------

III. Summary of Comments

    The Commission received thirteen comment letters from twelve 
commenters regarding the proposed rule change.\15\ Ten of the 
commenters supported the proposed rule change.\16\ These commenters 
generally agreed that the proposal would provide a more uniform and 
orderly opening process for the market and improve the accuracy and 
stability of pricing in the market. One commenter believed that the 
benefits promised through the proposed technological changes, alone, 
were sufficient to warrant an expeditious implementation of 
SuperMontage and that they were remarkable and long overdue 
developments for the Nasdaq market.\17\ One commenter believed that the 
proposal would protect customers from having their orders executed at 
prices substantially away from the subsequent unlocked/uncrossed market 
by enabling them to see an accurate and reasonable opening price.\18\ 
Another commenter noted that currently the unlocking/uncrossing process 
occurs after the 9:30 a.m. market open, which results in highs/lows 
being set at prices unrelated to prices established during the 
remainder of the trading day.\19\ This commenter believed that the 
proposal would address this issue by beginning the unlocking/uncrossing 
process before the market open. Finally, several commenters supported 
the new matching algorithm. Specifically, one commenter believed that 
the matching algorithm that executed paired orders at the price of the 
newer order made sense because it required a firm that aggressively 
locks/crosses the market near the open to be good for its quoted price 
and size.\20\ Another commenter believed that the pairing of quotes/
orders at the most aggressive price and executing these paired orders 
at the price of the newer quote/order was more rational because the 
execution would occur at a price which should be more indicative of 
where the stock would open.\21\
---------------------------------------------------------------------------

    \15\ See supra note 5.
    \16\ See Lehman Brothers Letter, Deutsche Bank Letter, SSB 
Letter, STA Letter, CIBC Letter, USBW Letter, Morgan Keegan Letter, 
Legg Mason Letter, CIBC II Letter, and Janney Montgomery Scott 
Letter.
    \17\ See USBW Letter.
    \18\ See STA Letter. See also Legg Mason Letter.
    \19\ See CIBC Letter. See also Lehman Brothers Letter.
    \20\ See CIBC Letter.
    \21\ See Deutsche Bank Letter. See also SSB Letter, which noted 
that the new opening process would reward the most aggressively 
priced order and that the price improvement would go to the older 
order.
---------------------------------------------------------------------------

    Two commenters, while generally supporting the intent of the 
proposal, raised concerns about the proposal.\22\ Specifically, one 
commenter raised concerns about the use and interaction of SIZE in the 
pre-market.\23\ The commenter stated that because SIZE is ``currently 
unable to relay Trade-or-Move Directed Orders to market participants 
with pre-opening non-attributable orders posted in SIZE, market 
participants entering a quote/order that locks or crosses SIZE will be 
relieved of any obligation to send a Trade-or-Move Directed Order to 
SIZE.''\24\ This commenter believed that this component of the proposal 
could hinder the price discovery process because market participants 
entering non-attributable quotes/orders would be limited in their 
capacity to participate in the Trade-or-Move Directed Order process. In 
addition, the commenter believed that requiring a market participant to 
send a Trade-or-Move Directed Order to parties it would lock/cross by 
posting a quote/order in SIZE was contrary to the stated purpose of the 
SIZE facility, which according to the commenter, was to allow market 
participants to anonymously post trading interest. Finally, the 
commenter opined that the inability to access SIZE with Trade-or-Move 
Directed Orders during the pre-opening might also impede the price 
discovery process. Subsequently, this commenter sent an addendum to its 
original letter to express its full support for Nasdaq's goal to 
eliminate locked or crossed markets at the open, and indicated that it 
was satisfied that Nasdaq was seeking to resolve the SIZE accessibility 
issue within a reasonable time after the implementation of 
SuperMontage.\25\ Accordingly, the commenter believed that the proposal 
should be approved.
---------------------------------------------------------------------------

    \22\ See RSSF Letter and Knight Letter.
    \23\ See RSSF Letter.
    \24\ See RSSF Letter.
    \25\ See RSSF Addendum Letter.
---------------------------------------------------------------------------

    Another commenter raised concerns regarding the use of SIZE during 
the pre-market.\26\ Specifically, this commenter believed that because 
quotes placed in SIZE would not interact with other market 
participant's quotes/order in the pre-market until the unlocking/
uncrossing process began at 9:29:30 a.m. For example, the commenter 
noted that a market participant could enter a large size quote in SIZE 
at 9:20 a.m. and cancel the quote just before 9:29:30 a.m., which would 
leave ``all potential buyers and sellers with an incorrect assumption 
as to the potential price of a stock at 9:29:30 a.m. and the open.'' 
The commenter believed that the proposal would permit market 
participants to enter quotes/orders in SIZE while other market 
participants

[[Page 55899]]

would be able to determine whether the market participant in SIZE was 
truly interested in trading at that price. As a solution, the commenter 
suggested that Nasdaq either: (1) Limit the use of SIZE until after the 
open to ensure that pre-open quotes are ``live,'' or (2) revise the 
rule to allow market participants to interact with quotes in SIZE 
during the 9:20:00 a.m. to 9:30:00 a.m. time frame. This commenter also 
objected to the length of time Nasdaq proposed for the pre-opening 
process. Specifically, the commenter believed that 30 seconds was too 
long and believed that technology was such that ten or five seconds was 
more appropriate.
---------------------------------------------------------------------------

    \26\ See Knight Letter.
---------------------------------------------------------------------------

    In response to these commenters concerns, Nasdaq submitted a letter 
to the Commission.\27\ In the Response to Comments regarding the pre-
market accessibility of SIZE, Nasdaq stated that it believed the 
``scope of harm'' is ``speculative'' but that it would monitor and 
carefully study the Trade-or-Move process in the SuperMontage 
environment.\28\ Specifically, Nasdaq noted that market participants 
that wish to enter a locking/crossing quote/order in SIZE have an 
obligation to resolve the lock/cross by sending a Trade-or-Move 
Directed Order. Further, Nasdaq noted that the ``only time interest in 
SIZE would not be immediately accessible is if a party wanted to lock/
cross an existing SIZE quote that was entered prior to 9:20 a.m.,'' and 
that this would be resolved at 9:29:30 a.m. According to Nasdaq, the 
primary purpose of the Trade-or-Move process is to resolve locked or 
crossed markets created prior to the open and Nasdaq believes that the 
proposal accomplishes this goal. However, Nasdaq committed to study the 
Trade-or-Move process during the phase-in of SuperMontage to determine 
whether it needs to be augmented, modified or eliminated.
---------------------------------------------------------------------------

    \27\ See Response to Comments, supra note 6.
    \28\ See Response to Comments. Nasdaq also stated that it 
currently believes that ``attempts to use SIZE to create a locked/
crossed market will be limited,'' based on its ongoing SuperMontage 
user acceptance testing.
---------------------------------------------------------------------------

    With regard to the gaming concerns, Nasdaq stated that while it was 
unwilling to prohibit the use of SIZE in the pre-market, it would take 
all concerns about potential manipulative activity seriously and that 
it would carefully monitor the use of SIZE in the pre-market. In 
addition, Nasdaq noted that it had posted a document on its website 
stating that it is ``antithetical to NASD rules for a market maker, 
ECN, and the customers of market makers and ECNs to enter orders into 
SIZE and then cancel them prior to the 9:29:30 opening process,'' and 
that it will refer any such violations to NASD for ``investigation and 
disciplinary action.'' \29\ Nasdaq also noted that its MarketWatch 
staff would monitor pre-market locks/crosses, including those created 
by SIZE.
---------------------------------------------------------------------------

    \29\ See Response to Comments.
---------------------------------------------------------------------------

    Nasdaq also represented that it is ``analyzing potential 
technological changes to resolve any concerns regarding the 
accessibility of SIZE in the pre-market.'' \30\ For example, Nasdaq 
stated that in addition to its initial concept of passing Directed 
Orders through SIZE to the ultimate entering party, it is also 
considering ``moving the pre-market Trade-or-Move process to the non-
directed order platform and deeming quotations placed in the system in 
the pre-market immediately executable to inhibiting the display of SIZE 
in the pre-market.''
---------------------------------------------------------------------------

    \30\ See Response to Comments.
---------------------------------------------------------------------------

    With regard to the time period of the pre-opening process, Nasdaq 
responded that it had ``contemplated that the unlocking and uncrossing 
process will take far less than 30 seconds to complete.'' \31\ Nasdaq 
reasoned that, because the system would continue to process and execute 
any incoming quotes/orders that would lock or cross the market during 
the remainder of the 30-second period, the system as proposed would 
``provide powerful disincentives to inappropriate quotation or order-
entry activity'' after the initial pre-market clearing of locks and 
crosses but before the official market opening which should in turn 
promote price discovery.\32\
---------------------------------------------------------------------------

    \31\ See Response to Comments.
    \32\ See Response to Comments.
---------------------------------------------------------------------------

IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities association.\33\ The Commission finds that the proposal, as 
amended, is consistent with provisions of Section 15A of the Act,\34\ 
in general and with Section 15A(b)(6) of the Act,\35\ in particular, in 
that the proposal is designed to promote just and equitable principles 
of trade, foster cooperation and coordination with persons engaged in 
processing information with respect to and facilitating transactions in 
securities, as well as removing impediments to and perfect the 
mechanism of a free and open market, and, in general, to protect 
investors and the public interest. The Commission finds that Nasdaq's 
proposal is designed to eliminate pre-opening locked and crossed 
markets, which should help to provide more informative quotation 
information, facilitate price discovery, and contribute to the 
maintenance of a fair and orderly market. The Commission believes that 
the proposal should establish a more orderly market opening and is 
therefore consistent with the Act.
---------------------------------------------------------------------------

    \33\ 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).
    \34\ 15 U.S.C. 78o-3.
    \35\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    The Commission finds that Nasdaq's proposal to permit the entry of 
market orders prior to the 9:30 a.m. market opening is consistent with 
the Act. As originally approved, market orders could not be entered 
prior to the 9:30 a.m. market open in SuperMontage. Under the proposal, 
market participants could enter market orders, as well as limit orders, 
prior to the market open. The Commission believes that the entry of 
market orders prior to the SuperMontage opening should assist market 
makers, ECN, and order entry firms, in the management of their quotes 
and orders. In particular, this could produce efficiencies for market 
participants as they prepare for the market open. The Commission notes 
the proposal does not change the time that market orders are eligible 
for execution because like today, market orders will only be executed 
during regular market hours (i.e., 9:30 a.m. to 4 p.m.), thus the only 
change with regard to the handling of market orders would be the time 
that they are eligible for entry into the system. Further, because 
market orders entered prior to the open would be held in a separate 
queue, and not eligible for execution until the market opening, market 
orders would not be subject to the volatility and lack of liquidity 
that may prevail during pre-market trading. In addition, since market 
orders entered before the open would only become eligible for 
executions at the open after the pre-market clearing of locks and 
crosses, such orders should receive executions that are based on more 
accurate and stable market conditions.
    The Commission finds that Nasdaq's proposal to amend the timeframe 
for the Trade-or-Move Process is consistent with the Act. Under the 
proposal, Nasdaq Quoting Market Participants that are actively locking 
or crossing an attributable quote/order would be required to send 
Trade-or-Move Directed Orders between 9:20 a.m. and 9:29:29 a.m. (as 
opposed to 9:29:59 a.m.), in order to permit the pre-market unlocking/
uncrossing process to occur from 9:29:30 a.m. to 9:29:59 a.m. This 
aspect of the proposal does not effect the operation of Nasdaq's pre-
market

[[Page 55900]]

Trade-or-Move process in a substantive manner. Thus, the Commission 
finds that reducing the Trade-or-Move timeframe by 30 seconds does not 
raise any new regulatory issues, and that the Nasdaq Trade-or-Move rule 
is still designed to reduce the frequency of pre-opening locked and 
crossed markets, which should help to provide more informative 
quotation information, facilitate price discovery, and contribute to 
the maintenance of a fair and orderly market.
    Under the proposal, however, market participants entering a quote/
order that would actively lock or cross unattributed quotes/orders in 
SIZE would not be obligated to send a Trade-or-Move Directed Order. 
Nasdaq explained that there is an exception to the Trade-or-Move 
Directed Order obligation for quotes/orders in SIZE because there is no 
means in the SuperMontage to identify the market participant (or 
participants) that have their trading interest represented in SIZE via 
a Trade-or-Move Directed Order. As noted above, two commenters 
expressed a concern that the quotes/orders in SIZE would be excepted 
from the Trade-or-Move Directed Order requirement.\36\ In particular, 
the commenters expressed a concern that the potential for gaming the 
system may exist wherein a party could place a large share amount into 
SIZE and thereafter remove it immediately before Nasdaq's proposed 
automated unlocking/uncrossing process commences at 9:29:30 Eastern 
Time. In response, Nasdaq stated that it will make clear to Nasdaq 
Quoting Market Participants that it would be antithetical to the NASD 
Rules to enter orders into SIZE and then cancel those orders 
immediately prior to the 9:29:30 a.m. pre-market opening process. 
Further, Nasdaq committed to monitor pre-market locks/crosses, 
including those created by SIZE, and, where appropriate, to either 
contact the parties that are creating those locks/crosses or refer the 
activity to the NASD for investigation and disciplinary action. Nasdaq 
indicated that it was seeking a technological solution to the SIZE 
accessibility problem, and that such a solution should be ready for the 
Commission's review during the fall of this year. Finally, Nasdaq 
committed to work with the Commission to propose and adopt appropriate 
rule-based restrictions on using SIZE in the pre-market if remediation 
is necessary during the SuperMontage roll-out and prior to the 
implementation of a final technology solution. The Commission believes 
that Nasdaq has adequately addressed the concerns of the commenters and 
that the appropriate regulatory and surveillance mechanisms are in 
place to protect the public interest and investors. The Commission 
expects Nasdaq to surveil the pre-market to ensure that manipulative 
activity does not occur, especially with the use of SIZE. Further, if 
Nasdaq observes abusive use of SIZE, the Commission expects that Nasdaq 
would address such activity expeditiously.
---------------------------------------------------------------------------

    \36\ See notes 22-26 supra and accompanying text.
---------------------------------------------------------------------------

    The Commission finds that Nasdaq's proposal to establish an 
automated procedure for clearing locking and crossing quotes in the 
system prior to the market open is consistent with the Act. Under the 
proposal, any locked or crossed markets in SuperMontage during the pre-
market opening would be cleared between 9:29:30 a.m. and 9:29:59 a.m. 
Eastern Time by pairing off the most aggressively priced buy quote/
order against the most aggressively priced sell quote/orders. Once the 
``best-priced pair'' is identified and executed at the price of the 
newer, better priced quote/order, the process would be repeated until 
an unlocked and uncrossed market results. The Commission finds that 
Nasdaq's provision to address locked and crossed markets is consistent 
with the Act because it is designed to eliminate locked and crossed 
markets prior to the market opening, which should in turn help to 
facilitate more efficient openings. Further, the Commission believes 
that the Nasdaq's proposal to eliminate locked and crossed markets 
between 9:29:30 a.m. and 9:29:59 a.m. should help to provide reliable 
quotation information, facilitate price discovery, and contribute to 
the maintenance of a fair and orderly market. As the Commission has 
concluded previously, continued locking and crossing of the market can 
negatively impact market quality.\37\ By clearing locked and crossed 
markets prior to the market opening, the Commission believes that the 
proposal should improve market quality and enhance the production of 
fair and orderly quotations at the market opening.
---------------------------------------------------------------------------

    \37\ See Securities Exchange Act Release No. 40455 (September 
22, 1998), 63 FR 51978 (September 29, 1998) (order approving File 
No. SR-NASD-98-01).
---------------------------------------------------------------------------

    One commenter, while generally approving of the proposal, opined 
that the 30-second time frame to clear pre-market locks and crosses was 
unnecessarily long, as locks and clears would most likely be resolved 
within the first few seconds of the automated process.\38\ The 
Commission believes that Nasdaq has adequately addressed this concern. 
In particular, the Commission agrees with Nasdaq that the proposal 
clearly contemplates that the initial clearing of locks and crosses 
would be completed in much shorter time than 30 seconds. The Commission 
believes this is evidenced by the continued processing of incoming 
quotes/orders that would lock/cross the market between 9:29:30 a.m. and 
9:29:59 a.m. The Commission believes that the continuous potential for 
execution of locked/crossed markets during the 30-second time frame 
should promote price discovery while reducing locked and crossed 
markets. In addition, the Commission believes that the proposal should 
deter inappropriate quotation or order-entry activity during this pre-
market open timeframe. The Commission finds that these factors, when 
considered in tandem, should help to promote a smoother more efficient 
market opening for Nasdaq.\39\
---------------------------------------------------------------------------

    \38\ See note 26 supra and accompanying text.
    \39\ The Commission notes that Nasdaq has committed to study 
whether the pre-opening process can or should be shortened and will 
submit a report of its findings. See Amendment No. 3.
---------------------------------------------------------------------------

    Finally, the Commission finds good cause for approving Amendment 
Nos. 2 and 3 to the proposed rule change prior to the thirtieth day 
after the date of publication of notice of filing thereof in the 
Federal Register. The Commission finds that Amendment No. 2 provides a 
technical correction to the proposed rule language. In addition, the 
Commission finds that Amendment No. 3 provides: (1) An updated version 
of its proposed rule language reflecting changes to Nasdaq's rules that 
have occurred since the initial filing of this proposal, (2) a set time 
frame in which Nasdaq will evaluate whether the thirty-second pre-
opening unlocking/uncrossing process time period should be shortened 
within 60 days of the complete roll-out of SuperMontage, and a 
commitment to report its findings to the Commission within 30 days 
thereafter; (3) a set time frame in which Nasdaq will monitor market 
participants' inability to send Trade-or-Move Directed Orders to SIZE 
during the Trade-or-Move process, and a commitment to file a proposed 
rule change with the Commission within 90 days of the complete roll-out 
of SuperMontage, to resolve any problems regarding the accessibility to 
SIZE; and (4) clarification that all quotes that reside in SuperMontage 
at the end of the trading day will be carried over to the next trading 
day, and that the quoting market participant could update the

[[Page 55901]]

quote prior to the 9:20 a.m. Trade-or-Move process. The Commission 
finds that Amendment No. 3 does not change the proposal. Amendment No. 
3 merely clarifies the proposal and commits Nasdaq to addressing 
technological issues within specified time frames. Consequently, the 
Commission finds good cause, consistent with section 6(b)(5) and 
section 19(b) of the Act to approve Amendment Nos. 2 and 3 to the 
proposed rule change on an accelerated basis.

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,\40\ that the proposed rule change (SR-NASD-2002-56) and Amendment 
No. 1 are approved, and Amendment Nos. 2 and 3 are approved on an 
accelerated basis.
---------------------------------------------------------------------------

    \40\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\41\
---------------------------------------------------------------------------

    \41\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-22216 Filed 8-29-02; 8:45 am]
BILLING CODE 8010-01-P