[Federal Register Volume 67, Number 224 (Wednesday, November 20, 2002)]
[Notices]
[Pages 70096-70098]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-29483]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46822; File No. SR-NASD-2002-152]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of a Proposed Rule Change and Amendment Nos. 1 and 2 
Thereto by the National Association of Securities Dealers, Inc. 
Regarding Trade Throughs and Locked Markets in the Nasdaq InterMarket

November 13, 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'' or ``SEC'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by Nasdaq. On 
November 6, 2002, Nasdaq filed an amendment to the proposed rule 
change.\3\ On November 12, 2002, Nasdaq filed another amendment to the 
proposed rule change.\4\ The Commission is publishing this notice to 
solicit comments on the proposed rule change, as amended, from 
interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Jeffrey S. Davis, Associate General Counsel, 
Nasdaq, to Lisa N. Jones, Attorney, Division of Market Regulation 
(``Division''), Commission (``Amendment No. 1''). Amendment No. 1 
makes a technical amendment to the rule text of the proposal.
    \4\ See letter from Jeffrey S. Davis, Associate General Counsel, 
Nasdaq, to Lisa N. Jones, Attorney, Division, Commission 
(``Amendment No. 2''). Amendment No. 2 makes a further technical 
amendment to the rule text of the proposal. For purposes of 
calculating the 60-day abrogation period, the Commission considers 
the period to begin the date of the original proposed rule change, 
October 25, 2002.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of the 
Substance of the Proposed Rule Change

    Nasdaq is proposing to change NASD Rule 5262 (``Trade-Throughs'') 
to conform its rule to the Commission order of August 28, 2002,\5\ 
which establishes a limited exemption from the trade through provisions 
of the ITS Plan. In addition, Nasdaq is proposing to change NASD Rule 
5263 (``Locked or Crossed Markets''), which addresses locked and 
crossed markets in exchange-listed securities, to conform its rule more 
closely with the locked markets rule contained in the ITS Plan. Below 
is the text of the proposed rule change. Proposed new language is in 
italics; proposed deletions are in brackets.
---------------------------------------------------------------------------

    \5\ See Securities Exchange Act Release No. 46428 (August 28, 
2002), 67 FR 56607 (September 4, 2002) (granting a de minimis 
exemption for transactions in certain exchange-traded funds from the 
trade through provisions of the Intermarket Trading System (``ITS'') 
Plan) (``Exemptive Order'').
---------------------------------------------------------------------------

* * * * *

Rule 5262. Trade Throughs

    (a) A member registered as an ITS/CAES Market Maker in an ITS/CAES 
security, shall avoid purchasing or selling such security, whether as 
principal or agent, at a price which is lower than the bid or higher 
than the offer displayed from an ITS Participant Exchange or ITS/CAES 
Market Maker (``trade-through''), unless the following conditions 
apply:
    (1)-(8) No Change.
    (9) The transaction involves QQQs, DIAMONDs, and SPDRs, and the 
execution occurs at a price that is no more than three cents lower than 
the highest bid displayed in CQS and no more than three cents higher 
than the lowest offer displayed in CQS. This

[[Page 70097]]

exemption shall apply for a pilot period ending June 4, 2003, or for 
such other period specified by the SEC.
    (b) No Change.
    (c) No Change.
* * * * *
NASD Rule 5263. Locked or Crossed Markets
    (a) No Change.
    (b) No Change.
    (c)(1)
    (A) Unless excused by operation of paragraphs (c)(1)(B) or (d) 
below [A]an ITS/CAES Market Maker that [who] makes a bid or offer and 
in so doing creates a locked or crossed market with an[other] ITS 
Participant Exchange [or ITS/CAES Market Maker] and that receives a 
complaint through ITS/CAES from the party whose bid (offer) was locked 
or crossed (the ``aggrieved party''), the ITS/CAES Market Maker 
responsible for the locking or crossing offer (bid) shall, as specified 
in the complaint, either promptly ``ship'' (i.e., satisfy through ITS/
CAES the locked or crossed bid (offer) up to the size of his locking or 
crossing offer (bid)) or ``unlock'' (i.e., adjust his locking or 
crossing offer (bid) so as not to cause a locked or crossed market). If 
the complaint specifies ``unlock'', it may nevertheless ship instead. 
[shall promptly send to such other ITS Participant Exchange or ITS/CAES 
Market Maker a commitment to trade seeking either the bid or offer 
which was locked or crossed, unless excused by operation of paragraph 
(d) below. Such commitment shall be for either the number of shares he 
has bid for (offered) or the number of shares offered (bid for) on the 
ITS Participant Exchange or by the ITS/CAES Market Maker, whichever is 
less.]
    (B) If there is an error in a locking or crossing bid or offer that 
relieves the locking or crossing ITS/CAES Market Maker from its 
obligations under paragraph (c)(2) of Rule 11Ac1-1 and if the ITS/CAES 
Market Maker receives a ``ship'' complaint through ITS/CAES from the 
aggrieved party, the locking or crossing ITS/CAES Market Maker shall 
promptly cause the quotation to be corrected and, except as provided in 
paragraph (d) below, it shall notify the aggrieved party through ITS/
CAES of the error within two minutes of receipt of the complaint. If 
the locking or crossing ITS/CAES Market Maker fails to so notify the 
aggrieved party, he shall promptly ship.
    (2) An ITS/CAES Market Maker that makes a bid or offer and in so 
doing creates a locked or crossed market with another ITS/CAES Market 
Maker shall promptly send to such other ITS/CAES Market Maker an order 
seeking either the bid or offer which was locked or crossed, unless 
excused by operation of paragraph (d) below. Such order shall be for 
either the number of shares he has bid for (offered) or the number of 
shares offered (bid for) by the ITS/CAES Market Maker, whichever is 
less.
    (d) The provisions of paragraph (c) above shall not apply when:
    1. No Change.
    2. The issuance of the commitment to trade or order referred to 
above would be prohibited by an NASD rule or by SEC Rule 10a-1 under 
the Act.
    3.-6. No Change.
    7. The locking bid or offer no longer prevails at the time the 
complaint is received by the ITS/CAES Market Maker.
* * * * *

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 statutory 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
    NASD Rule 5262--Trade Throughs. The ITS Plan requires that each of 
the national securities exchanges and the NASD adopt a similar rule 
governing the practice of ``trading through'' the quote of another ITS 
participant that trades ITS-eligible securities. The trade through rule 
prohibits market participants from purchasing or selling such 
securities at prices that are lower than the bid or higher than the 
offer displayed by another ITS Participant. NASD Rule 5262, the NASD's 
trade through rule, governs the conduct of NASD members that have 
registered as market makers in ITS-eligible securities.
    On August 28, 2002, the Commission issued an order granting a de 
minimis exemption (``Exemption'') for transactions in certain exchange-
traded funds (``ETFs'') from the trade through provisions of the ITS 
Plan. \6\ At present, the exemption extends to transactions in three 
designated ETFs--the Nasdaq-100 Index (``QQQ''), the Dow Jones 
Industrial Average (``DIAMONDs''), and the Standard & Poor's 500 Index 
(``SPDRs''). Pursuant to the Exemption, transactions in these ETFs may 
be ``executed at a price that is no more than three cents lower than 
the highest bid displayed in CQS and no more than three cents higher 
than the lowest offer displayed in CQS'' (``Exempted Trade-Through''). 
The Exemption is effective from September 4, 2002 through June 4, 2003.
---------------------------------------------------------------------------

    \6\ See note 4, supra.
---------------------------------------------------------------------------

    According to Nasdaq, the Exemption was proposed by the Commission 
to permit the rapid execution of orders in ETFs at prices that may 
trade through the quotations of other markets, including the NBBO 
price. Because Exempted Trade-Throughs will, by definition, be exempt 
from ITS restrictions, a market participant that reports execution of 
an Exempted Trade-Through will not be required to satisfy an 
administrative request from any ITS participant for satisfaction 
following the Exempted Trade-Through. \7\ The SEC will measure the 
impact of the Exemption on the trading of those securities during the 
pilot period.
---------------------------------------------------------------------------

    \7\ Pursuant to the ITS Plan, if an ITS participant trades 
through the quotation of another ITS participant, thereby violating 
the ITS trade through prohibition, the non-violating participant is 
entitled to send an administrative message noting the trade-through 
and the violating participant is required to respond with a 
commitment to trade at the price and size quoted by the non-
violating participant.
---------------------------------------------------------------------------

    Nasdaq has decided to add the same exemption to its own trade-
through rule, in Nasdaq's case, NASD Rule 5262. This measure will 
ensure that ITS/CAES Market Makers are aware that they must operate 
under equivalent terms of the ITS Plan as other ITS Plan participants.
    NASD Rule 5263--Locked or Crossed Markets. The ITS Plan requires 
each of the national securities exchanges and the NASD to adopt a 
similar lock/cross rule governing trading in ITS-eligible securities. 
The current wording of the NASD rule is more stringent than required by 
the ITS Plan. Nasdaq believes that the more stringent wording of the 
rule is burdensome and places the NASD at a competitive disadvantage 
with other ITS participant exchanges that have adopted the lock/cross 
language prescribed by the ITS Plan.
    NASD Rule 5263 currently requires ITS/CAES Market Makers that 
create locked or crossed markets with another ITS Participant or ITS/
CAES Market Maker promptly to send that other party a commitment to 
trade seeking either the bid or offer which was locked or

[[Page 70098]]

crossed. Nasdaq believes that the requirement to promptly send a 
commitment contrasts with the current procedure expressed in the ITS 
Plan, which requires that a locking participant respond only after a 
locked market complaint has been properly registered. Nasdaq believes 
that the more stringent NASD requirement could cause ITS/CAES Market 
Makers to prematurely send a commitment to trade without having the 
input or an understanding of the locked or crossed party's intentions 
to trade. To eliminate this disparity and competitive disadvantage with 
other markets, Nasdaq will mirror the language of the ITS Plan and 
remove the more restrictive language with respect to locks or crosses 
that occur between ITS/CAES Market Makers and the exchange participants 
of the ITS Plan.
    Nasdaq will, however, maintain its current, stricter standard of 
conduct with respect to locked and crossed markets that occur between 
ITS/CAES Market Makers within the Nasdaq InterMarket, which are not 
addressed by the ITS Plan. Specifically, Nasdaq believes that the 
requirement that ITS/CAES Market Makers promptly send orders whenever 
they lock or cross other ITS/CAES Market Makers, reduces the number and 
duration of locks and crosses that do, inevitably, occur within a 
competing dealer market. Nasdaq also believes that locking and crossing 
behavior can provide valuable price discovery information to market 
participants. Nasdaq believes, however, that economic and regulatory 
incentives help minimize the extent to which such locks and crosses 
interfere with the smooth operation of the InterMarket and with ITS/
CAES Market Makers' internal systems. This is particularly important 
because CAES and ITS/CAES Market Makers operate on an automatic 
execution basis.
2. Statutory Basis
    Nasdaq believes that the proposed rule change 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 the proposal is 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster competition 
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.
---------------------------------------------------------------------------

    \8\ 15 U.S.C. 78o-3.
    \9\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq does not believe that the proposed rule change 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

    Because the foregoing rule change does not: (1) Significantly 
affect the protection of investors or the public interest; (2) impose 
any significant burden on competition; and (3) become operative for 30 
days from the date on which it was filed, provided that Nasdaq has 
given the Commission written notice of its intent to file the proposed 
rule change at least five business days prior to the filing date of the 
proposed rule change or such shorter time as designated by the 
Commission, it has become effective pursuant to Section 19(b)(3)(A) of 
the Act,\10\ and Rule 19b-4(f)(6) thereunder.\11\ At any time within 60 
days of the filing of the proposed rule change, the Commission may 
summarily abrogate the proposed rule change if it appears to the 
Commission that such action is necessary or appropriate in the public 
interest, for the protection of investors, or otherwise in furtherance 
of the purposes of the Act.
---------------------------------------------------------------------------

    \10\ 15 U.S.C. 78s(b)(3)(A).
    \11\ 17 CFR 240.19b-4(f)(6).
---------------------------------------------------------------------------

    Nasdaq has requested that the Commission waive the 5-day pre-filing 
notification requirement and the 30-day operative delay. The Commission 
believes that waiving the 5-day pre-filing notification requirement and 
the 30-day operative delay is consistent with the protection of 
investors and the public interest.\12\ In particular, the proposed rule 
changes bring Nasdaq rules into conformity with the approved ITS Plan 
and the August 28, 2002 Commission's Exemptive Order. For this reason, 
the Commission waives both the 5-day pre-filing notification 
requirement and the 30-day operative waiting period.
---------------------------------------------------------------------------

    \12\ For purposes only of accelerating the operative date of 
this proposal, the Commission has considered its impact on 
efficiency, competition, and capital formation. 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

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 No. SR-NASD-2002-152 should be 
submitted by December 11, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
---------------------------------------------------------------------------

    \13\ 17 CFR 200.30-3(a)(12).

J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 02-29483 Filed 11-19-02; 8:45 am]
BILLING CODE 8010-01-P