[Federal Register Volume 67, Number 203 (Monday, October 21, 2002)]
[Notices]
[Pages 64681-64683]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-26685]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46652; File No. SR-NASD-2002-133]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval to a Proposed Rule Change and Amendment 
Nos. 1 and 2 by the National Association of Securities Dealers, Inc. To 
Establish an Execution Price Governor in SuperMontage

October 11, 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 September 30, 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 
(``Commission'') a proposed rule change, as described in Items I and II 
below, which Items have been prepared by the NASD. The NASD amended its 
proposal on October 9, 2002 \3\ and October 10, 2002.\4\ The Commission 
is publishing this notice to solicit comments on the proposed rule 
change and Amendment Nos. 1 and 2 from interested persons and to 
approve the proposal, as amended, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Mary M. Dunbar, Vice President and Deputy 
General Counsel, Nasdaq, to Katherine A. England, Assistant 
Director, Division of Market Regulation (``Division''), Commission, 
dated September 27, 2002 (``Amendment No. 1''). In Amendment No. 1, 
the NASD submitted the proposal on a pilot basis under Section 
19(b)(2) of the Act, requested accelerated approval, and replaced in 
its entirety the original rule filing submitted to the Commission 
dated on September 27, 2002.
    \4\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division, 
Commission, dated October 10, 2002 (``Amendment No. 2). In Amendment 
No. 2, the NASD made minor technical corrections to the rule text.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq is proposing to establish, for a 60-day pilot period, a 
SuperMontage execution price governor to prevent inadvertent executions 
significantly away from the inside market. The text of the proposed 
rule change is below. Proposed new language is italicized.
* * * * *

4710. Participant Obligations in NNMS

    (a) No Change.
(b) Non-Directed Orders
    (1) General Provisions--A Quoting Market Participant in an NNMS 
Security shall be subject to the following requirements for Non-
Directed Orders:
    (A) No Change.
    (i) No Change.
    (ii) No Change.
    (iii) No Change.
    (B) Processing of Non-Directed Orders--No Change.
    (i) through (iii) No Change.
    (iv) Exceptions--The following exceptions shall apply to the above 
execution parameters:
    (a) If a Nasdaq Quoting Market Participant enters a Non-Directed 
Order into the system, before sending such Non-Directed Order to the 
next Quoting Market Participants in queue, the NNMS will first attempt 
to match off the order against the Nasdaq Quoting Market Participant's 
own Quote/Order if the participant is at the best bid/best offer in 
Nasdaq.
    (b) If an NNMS Market Participant enters a Preferenced Order, the 
order shall be executed against (or delivered in an amount equal to) 
both the Displayed Quote/Order and Reserve Size of the Quoting Market 
Participant to which the order is being directed, if that Quoting 
Market Participant is at the best bid/best offer when the Preferenced 
Order is next in line to be delivered (or executed). Any unexecuted 
portion of a Preferenced Order shall be returned to the entering NNMS 
Market Participant. If the Quoting Market Participant is not at the 
best bid/best offer when the Preferenced Order is next in line to be 
delivered (or executed), the Preferenced Order shall be returned to the 
entering NNMS Market Participant.
    (c) If an NNMS Market Participant enters a Quote or Non-Directed 
Order that would result in NNMS either: 1) delivering an execution to a 
Quoting Market Participant(s) that participates in the automatic-
execution functionality of the system at a price substantially away 
from the current inside bid/offer in that security; or 2) delivering a 
Liability

[[Page 64682]]

Order to a Quoting Market Participant(s) that participates in the 
order-delivery functionality of the system at a price substantially 
away from the current inside bid/offer in that security, the system 
shall instead process only those portions of the order that will not 
result in either an execution or delivery at a price substantially away 
from the current inside best bid/offer in the security and return the 
remainder to the entering party. For purposes of this subsection only, 
an execution or delivery based on a sell order shall be deemed to be 
substantially away from the current inside bid if it is to be done at a 
price lower than a break-price established by taking the inside bid, 
reducing it by 10% of the bid's value, and then subtracting $0.01. For 
example, in a stock with a current inside bid of $10.00, the maximum 
price at which a single sell order could be executed would be $8.99 
calculated as follows: ($10.00--($10.00 x .10 e.g. $1)--$.01 = $8.99). 
For offers, an execution or delivery based on a buy order shall be 
deemed to be substantially away from the current inside offer if it is 
done a price higher than a break-price established by taking the inside 
offer, adding 10% of the offer's value to it, and then adding $0.01. 
For example, in a stock with a current inside offer of $10.00, the 
highest price at which a single sell order could be executed would be 
$11.01 calculated as follows: ($10.00 + ($10.00 x .10 e.g. $1) + $.01 = 
$11.01.
    (C) Decrementation Procedures--No Change.
    (i) through (iv) No Change.
    (D) through (E) No Change.
(2) Refresh Functionality
    (A) Reserve Size Refresh--No Change.
    (B) Auto Quote Refresh (``AQR'')--No change.
    (i) through (iv) No Change.
    (3) through (8) No Change.
    (c) through (f) No Change.
* * * * *

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

    In its filing with the Commission, Nasdaq included statements 
concerning the purpose of, and basis for, the proposed rule change, as 
amended, and discussed any comments it received on the proposed rule 
change, as amended. The text of these statements may be examined at the 
places specified in Item III 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
    Nasdaq's SuperMontage system allows the entry of individual orders 
of up to 999,999 shares in size and quotes of 99,900 shares. Once 
entered, SuperMontage immediately processes those quotes/orders against 
the quotes and orders of other market participants then residing in the 
system. If warranted by the price of the quote/order, and the trading 
interest on the other side of the market, the system automatically and 
continuously moves to inferior price levels until the entered quote/
order is executed in full or until there is no longer any quotes or 
orders that would satisfy the terms of the quote/order.
    While this processing dramatically increases the speed and 
efficiency of the Nasdaq market, in certain limited circumstances it 
may also have a material negative impact on market quality. This could 
occur when a very large market quote/order, or a marketable limit order 
priced significantly away from the inside, is entered into the system 
and quickly executes through numerous price levels and establishes a 
new inside wholly unrelated to previous trading activity in the 
security.\5\ In turn, the resulting abnormal execution prices and 
quotes can create new historic high and/or low prices for the 
particular security at issue, as well as potentially trigger the 
automatic execution of other customer orders in electronic systems that 
monitor the last sale and inside prices disseminated by Nasdaq.
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    \5\ Nasdaq's experience with similar orders in the SuperSoes 
environment indicates that the overwhelming majority of such quote/
orders are not entered intentionally, but are generally simple 
mistakes in price or size terms made by entering party.
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    In response, Nasdaq has determined to incorporate into 
SuperMontage, for a 60-day pilot period commencing on October 14, 2002, 
an execution price governor to reduce the impact of grossly mis-priced 
or mis-sized quotes/orders.\6\ In short, SuperMontage will, using the 
formula outlined below, establish a maximum execution or break-point 
price a little over 10% away from a security's current inside price 
(for both the bid and offer side) and will execute a single quote/order 
only up to that price level, and reject the remaining unexecuted 
portion of the quote/order (if any) back to entering party for re-
submission if desired. The following specific threshold formula is 
proposed:
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    \6\ Nasdaq has separately filed with the Commission a proposal, 
pursuant to Section 19(b)(2) of the Act, to make the execution price 
governor permanent. See SR-NASD-2002-142.
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    [sbull] For incoming sell quotes/orders, the break price will be 
the current Inside Bid less 10% less $.01.\7\
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    \7\ Values resulting from the application of the formula will 
not be taken into consideration beyond two decimal places. Telephone 
conversation between Thomas P. Moran, Associate General Counsel, 
Nasdaq, and Terri Evans, Assistant Director, Division, Commission, 
October 10, 2002.
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    [sbull] For incoming buy quotes/orders, the break price will be the 
current Inside Offer plus 10% plus $.01.\8\
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    \8\ When approving this formula, the Nasdaq Board of Directors 
also authorized the Chief Executive Officer of Nasdaq and/or the 
President of Nasdaq to alter the base percentages used in the 
threshold formula by 10% in either direction for a particular 
security or securities if its trading activity or share price 
warrants it. If Nasdaq Senior Management determines to alter this 
standard, Nasdaq will submit a proposed rule change to the 
Commission and alert market participants by posting the new 
percentages on NasdaqTrader.com. Telephone conversation between 
Thomas P. Moran, Associate General Counsel, Nasdaq, and Terri Evans, 
Assistant Director, Division, Commission, October 10, 2002.
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    For example, in a stock with a current Inside Bid of $10.00, the 
maximum or break price at which a single sell order could be executed 
would be $8.99 calculated as follows: ($10.00--($10.00 x .10 e.g. $1)--
$.01 = $8.99). In turn, this price determines how many shares of a 
particular quote/order can be executed based on the trading interest on 
the other side of the market residing in SuperMontage. For example, if 
the sell order discussed here was for 10,000 shares and there was only 
a total of 6,000 shares available between the current inside bid price 
of $10.00 and the threshold price of $8.99, SuperMontage would execute 
a total of 6,000 shares and reject the remaining 4,000 back to the 
entering party. Market participants receiving such a reject would be 
able to re-enter the rejected portion of their original order, if 
desired, with a new maximum break-point for that quote/order being 
calculated using the current inside price at the time of re-entry.
    Nasdaq believes that the above approach best balances the goals of 
rapid execution and price discovery while protecting market 
participants, and the public investors they represent, from excessive 
volatility and market confusion that can result from the entry and 
execution of a grossly mis-priced or mis-sized quotes/orders in an 
automated and linked trading environment.
2. Statutory Basis
    Nasdaq believes that the proposed rule change, as amended, is 
consistent with Section 15A of the Act \9\ in general, and furthers the 
objectives of Section

[[Page 64683]]

15A(b)(6)\10\ in particular, in that it is designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, to 
protect investors and the public interest.
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    \9\ 15 U.S.C. 78o-3.
    \10\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

    Written comments were neither solicited nor received.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change and Amendment Nos. 1 and 2 are 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-2002-133 and should be 
submitted by November 12, 2002.

IV. Commission Findings and Order Granting Accelerated Approval of the 
Proposed Rule Change

    Nasdaq has asked the Commission to approve the proposal and 
Amendment Nos. 1 and 2 on an accelerated basis for a 60-day pilot 
period to reduce the impact of grossly mis-priced or mis-sized quotes/
orders.
    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 
and, in particular, with the requirements of section 15A(b)(6) of the 
Act,\11\ in that it is designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
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.\12\ The Commission believes that the 
establishment of a SuperMontage execution price governor pilot may 
prevent inadvertent executions significantly away from the inside 
market. The Commission also agrees with Nasdaq that this approach may 
act to balance the goals of rapid execution and price discovery while 
protecting market participants and the public investors they represent 
from excessive volatility and market confusion that can result from 
grossly mispriced/sized quotes/orders in an automated and linked 
trading environment.
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    \11\ 15 U.S.C. 78o-3(b)(6).
    \12\ In approving the proposed rule, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
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    The Commission finds good cause for approving the proposed rule 
change, as amended, prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. The 
Commission believes that accelerated approval of the pilot will enable 
the Commission and Nasdaq to gain experience with the execution price 
governor before the Commission considers permanent approval of the 
pilot.\13\ Furthermore, the Commission believes that granting 
accelerated approval to the proposed rule change and Amendment Nos. 1 
and 2 would ensure that the execution price governor is in place for 
the start of the SuperMontage system roll-out scheduled for October 14, 
2002.
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    \13\ Approval of the 60-day pilot should not be interpreted as 
suggesting that the Commission is predisposed to approving the 
proposal on a permanent basis.
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    Accordingly, the Commission believes that there is good cause, 
consistent with sections 15A(b)(6) and 19(b)(2) of the Act \14\ to 
approve the proposal and Amendment Nos. 1 and 2 on an accelerated 
basis.
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    \14\ 15 U.S.C. 78o-3(b)(6) and 78s(b)(2).
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V. Conclusion

    It is Therefore Ordered, pursuant to section 19(b)(2) of the Act 
\15\, that the proposed rule change, as amended, (File No. SR-NASD-
2002-133) be, and it hereby is, approved until December 13, 2002.
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    \15\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-26685 Filed 10-18-02; 8:45 am]
BILLING CODE 8010-01-P