[Federal Register Volume 67, Number 221 (Friday, November 15, 2002)]
[Notices]
[Pages 69279-69280]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-28993]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46783; File No. SR-NASD-2002-153]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. To 
Establish as Permanent Two Pilot Programs Currently Contained in NASD 
Rule 6541 Relating to Manning Rule Protection for Customer Limit Orders 
Executed on the Over-the-Counter Bulletin Board

November 7, 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 25, 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 Nasdaq. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq is filing a proposed rule change to establish as permanent 
two pilot programs currently contained in NASD Rule 6541. Rule 6541, 
which generally prohibits member firms from trading ahead of customer 
limit orders in designated Over-the-Counter Bulletin Board (``OTCBB'') 
securities, was established on a pilot basis for approximately 325 
securities quoted on the OTCBB.\3\ No new rule language is proposed.
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    \3\ See Securities Exchange Act Release No. 43944 (February 8, 
2001), 66 FR 10541 (February 15, 2001) (SR-NASD-00-22).
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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
    On February 8, 2001, the Commission approved NASD Rule 6541, which, 
on a pilot basis, applied the basic customer limit order protection 
principles that presently apply to Nasdaq-listed securities to 
designated securities that are traded on the OTCBB.\4\ Rule 6541(a) 
generally prohibited member firms that accepted customer limit orders 
in these securities from ``trading ahead'' of their customers for their 
own account at prices equal or superior to the limit orders, without 
executing them at the limit price. Rule 6541(b) required member firms 
to provide a minimum level of price improvement of the lesser of $0.05 
per share or one-half of the current inside spread to incoming orders 
in OTCBB securities if the member chose to trade as principal with 
those incoming orders while holding customer limit orders. If a member 
failed to provide the minimum level of price improvement to the 
incoming order, the member was required to execute its held customer 
limit orders.
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    \4\ See Securities Exchange Act Release No. 43944 (February 8, 
2001), 66 FR 10541 (February 15, 2001) (SR-NASD-00-22).
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    The limit order protection embodied in Rule 6541 is an investor 
protection tool based on NASD IM-2110-2 (commonly known as the 
``Manning Rule''). In Manning, the NASD found and the Commission 
affirmed that a member firm that accepts a customer limit order has a 
fiduciary duty not to trade for its own account at prices more 
favorable than the customer order.\5\ Rule 6541 expands to securities 
traded on the OTCBB the protections that IM-2110-2 provides to trading 
of Nasdaq National Market and SmallCap securities.
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    \5\ See In re E.F. Hutton & Co., Securities Exchange Act Release 
No. 25887 (July 6, 1988).
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    On March 2, 2001, and April 6, 2001, the Commission approved 
modifications to IM-2110-2 in Nasdaq listed securities.\6\ In general, 
these modifications narrowed the amount of price improvement required 
to avoid the obligation to fill a customer limit order, in recognition 
of the introduction of decimal pricing of Nasdaq-listed securities. On 
July 26, 2001, Nasdaq filed and implemented an amendment to Rule 
6541(b) (SR-NASD-2001-39) that likewise narrowed the amount of required 
price improvement in OTCBB securities.\7\ Under SR-NASD-2001-39, the 
price improvement requirement was narrowed from $0.05 or one-half the 
inside spread to $0.01 or one-half the inside spread (whichever is 
less) for a member wishing to trade in front of held customer limit 
orders that are priced at or inside the current inside spread for an 
OTCBB security. For customer limit orders priced less than $0.01 
outside the inside spread, however, SR-NASD-2001-39 required a member 
seeking to trade in front of such limit orders to execute its trades at 
a price at least equal to the inside bid (with respect to held customer 
limit orders to buy) or inside offer (for held orders to sell). 
Moreover, SR-NASD-2001-39 provided that limit order protection would 
not apply to customer limit orders that are priced more than $0.01 
outside the current inside spread. The amendment to Rule 6541(b) 
adopted by SR-NASD-2001-39 was effective for a three-month pilot period 
that ended on November 1, 2001.
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    \6\ See Securities Exchange Act Release No. 44030 (March 2, 
2001), 66 FR 14235 (March 9, 2001) (SR-NASD-2001-09); Securities 
Exchange Act Release No. 44165 (April 6, 2001), 66 FR 19268 (April 
13, 2001) (SR-NASD-2001-27). See also Securities Exchange Act 
Release No. 44529 (July 9, 2001), 66 FR 37082 (July 16, 2001) (SR-
NASD-2001-43).
    \7\ See Securities Exchange Act Release No. 44593 (July 26, 
2001), 66 FR 40304 (August 2, 2001) (SR-NASD-2001-39).
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    On November 1, 2001, Nasdaq amended Rule 6541(b) to eliminate the 
minimum price improvement requirement for limit orders outside the 
inside spread.\8\ Accordingly, any degree of price improvement would 
relieve a member from the obligation to fill a limit order that is 
outside of the inside spread. The amendment also clarified that the 
basic prohibition on trading

[[Page 69280]]

ahead of held limit orders at prices equal or superior to the limit 
orders applies to limit orders that are priced more than $0.01 away 
from the current inside spread. Thus, the basic prohibition on trading 
ahead of a customer limit order at a price equal or superior to the 
limit order without filling the limit order applies to all limit orders 
in OTCBB securities covered by Rule 6541. The amount of required price 
improvement for limit orders priced at or inside the current inside 
spread remained the lesser of $0.01 or one-half of the current inside 
spread. The pilots are currently scheduled to expire on December 15, 
2002.\9\
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    \8\ See Securities Exchange Act Release No. 34-45011 (November 
1, 2001); 66 FR 56587 (November 8, 2001) (SR-NASD-2001-78).
    \9\ On January 14, 2002, and again on July 16, 2002, Nasdaq 
filed to extend the pilot programs. See Securities Exchange Act 
Release No. 45276 (January 14, 2002), 67 FR 2936 (January 22, 2002) 
(SR-NASD-2002-06); Securities Exchange Act Release 46248 (July 24, 
2002), 67 FR 49727 (July 31, 2002) (SR-NASD-2002-95).
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    Nasdaq has concluded that it is in investors' best interest to 
establish limit order protection requirements on a permanent basis for 
all securities quoted on the OTCBB. Nasdaq believes that limit order 
protection provides substantial protection to small investors by 
ensuring that members consider those orders when executing their own 
orders. In addition, Nasdaq believes that limit order protection 
prevents the isolation of customer limit orders that could otherwise 
occur when a member trades for its own account and a customer order 
fails to receive an execution. Nasdaq believes that the rule bolsters 
investors' confidence in the fairness of the market as a whole.
    Nasdaq's Department of Economic Research (``ER'') closely analyzed 
the impact of the Manning pilot on relevant aspects of the operation of 
the OTCBB. Nasdaq sought to ensure that the potential negative effects 
on the trading of OTCBB securities do not offset the positive effects 
of limit order protection. ER studied the following areas: impact on 
trading, market maker quoting activity, and spread behavior. To 
determine the impact of the pilot on trading activity, the study 
analyzed total volume, number of trades, and number of riskless 
principal trades (as a proxy for customer limit orders executed). ER 
studied changes to the number of market makers, quote updates, and bid/
ask midpoint to determine that the pilot had no statistically 
significant impact on market maker quoting behavior. Finally, ER looked 
at a variety of spread statistics (quoted, effective, relative, 
relative effective). Overall, ER found no material negative 
implications on the measurable market quality of the OTCBB.
    Based upon this study and its experience with the operation of the 
Manning rule in securities listed on Nasdaq, Nasdaq has concluded that 
limit order protection is a necessary and appropriate rule in the OTCBB 
marketplace. Nasdaq believes that it is a highly visible investor 
protection advancement that is consistent with the maintenance of a 
viable, liquid market. Nasdaq believes that the pilot program has 
effectively demonstrated that limit order protection is not detrimental 
to trading of less-liquid, low priced securities on the OTCBB. 
Accordingly, Nasdaq is extending limit order protection to all 
securities on the OTCBB.
2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of Section 15A of the Act \10\ in general, and with 
Section 15A(b)(6) of the Act \11\ in particular, in that it is designed 
to prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, to foster competition and 
coordination with person engaged in regulating, clearing, settling, 
processing information with respect to, and facilitating transactions 
in securities, to remove impediments to a free and open market, and to 
protect investors and the public interest.
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    \10\ 15 U.S.C. 78o-3.
    \11\ 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 would result 
in 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. 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 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 filings will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-2002-153 and 
should be submitted by December 6, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 02-28993 Filed 11-14-02; 8:45 am]
BILLING CODE 8010-01-P