[Federal Register Volume 67, Number 203 (Monday, October 21, 2002)]
[Notices]
[Pages 64683-64685]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-26686]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46650; File No. SR-NASD-2002-142]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by 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 October 9, 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'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the NASD. The NASD 
amended its proposal on October 10, 2002.\3\ The Commission is 
publishing this notice to solicit comments on the proposed rule change, 
as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated October 10, 2002 
(``Amendment No. 1''). In Amendment No. 1, the NASD made minor 
technical corrections to the rule text.
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I. Self-Regulatory Organization's Statement of the Terms of the 
Substance of the Proposed Rule Change

    Nasdaq is filing a proposed rule change, as amended, to establish 
in SuperMontage a permanent 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.
* * * * *

[[Page 64684]]

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 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 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
    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.\4\ 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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    \4\ 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 
a permanent execution price governor to reduce the impact of grossly 
mis-priced or mis-sized quotes/orders.\5\ 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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    \5\ Nasdaq separately filed a proposal, pursuant to Section 
19(b)(2) of the Act, to establish the execution price governor on a 
60-day pilot basis. See SR-NASD-2002-133.
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    [sbull] For incoming sell quotes/orders, the break price will be 
the current Inside Bid less 10% less $.01.\6\
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    \6\ 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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[[Page 64685]]

    [sbull] For incoming buy quotes/orders, the break price will be the 
current Inside Offer plus 10% plus $.01.\7\
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    \7\ 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 the provisions of Section 15A of the Act,\8\ in general 
and with Section 15A(b)(6) of the Act,\9\ in particular, in that it is 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, remove impediments to 
and perfect the mechanism of a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest.
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    \8\ 15 U.S.C. 78o-3.
    \9\ 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 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

    Written comments were neither solicited nor received.

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 foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
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-2002-142 should be submitted by November 12, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-26686 Filed 10-18-02; 8:45 am]
BILLING CODE 8010-01-P