[Federal Register Volume 67, Number 247 (Tuesday, December 24, 2002)]
[Notices]
[Pages 78550-78551]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-32320]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47008; File No. SR-NASD-2002-153]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 1 Thereto by the National Association of Securities 
Dealers, Inc. To Extend Manning Protection to Customer Limit Orders in 
All Securities Quoted on the Over-the-Counter Bulletin Board on a 
Permanent Basis

December 16, 2002.

I. Introduction

    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''), 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 make permanent NASD Rule 6541, 
which currently is operating on a pilot basis. NASD Rule 6541 provides 
Manning protection to customer limit orders in approximately 325 
securities quoted on the Over-the-Counter Bulletin Board (``OTCBB''). 
The proposal was published for comment in the Federal Register on 
November 15, 2002.\3\ The Commission received no comments on the 
proposal. On December 16, 2002, the NASD (through Nasdaq) filed 
Amendment No. 1 to the proposal.\4\ This notice and order solicits 
comment on the proposed rule change, as revised by Amendment No. 1, and 
approves the amended proposal on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 46783 (November 7, 
2002), 67 FR 69279.
    \4\ See letter from Jeffrey S. Davis, Nasdaq, to Nancy J. Sanow, 
Division of Market Regulation, Commission, dated December 13, 2002 
(``Amendment No. 1''). Amendment No. 1 would revise paragraph (e) of 
NASD Rule 6541 to remove: (1) A provision specifying the date of the 
rule's expiration; and (2) a provision limiting the rule only to 
OTCBB securities that are expressly identified as being subject to 
the rule. These provisions are no longer necessary in light of the 
NASD's proposal to extend limit order protection to all OTCBB 
securities on a permanent basis.
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II. Description of Proposed Rule Change and Amendment No. 1

    NASD Rule 6541 is an investor protection tool based on NASD 
Interpretive Material (``IM'') 2110-2 (commonly known as the ``Manning 
Rule''). In the original Manning case, the NASD found, and the 
Commission affirmed, that a member firm that accepts a customer limit 
order has a fiduciary duty to refrain from trading for its own account 
at a price more favorable than the customer's order.\5\ NASD Rule 6541 
currently extends customer limit order protection to approximately 325 
securities quoted on the OTCBB on a pilot basis.\6\ NASD Rule 6541(a) 
prohibits an NASD member that accepts a customer limit order in these 
securities from ``trading ahead'' of the limit order for its own 
account at prices equal or superior to the limit order, without first 
executing the limit order. NASD Rule 6541(b) permits a member to avoid 
the obligation in paragraph (a) through the provision of price 
improvement. If a customer limit order is priced at or inside the 
current inside spread, the price improvement must be for a minimum of 
the lesser of $0.01 or one-half of the current inside spread.\7\
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    \5\ See In re E.F. Hutton & Co., Securities Exchange Act Release 
No. 25887 (July 6, 1988) (``Manning'').
    \6\ See Securities Exchange Act Release No. 43944 (February 8, 
2001), 66 FR 10541 (February 15, 2001) (approving SR-NASD-00-22). 
See also Securities Exchange Act Release No. 44593 (July 26, 2001), 
66 FR 40304 (August 2, 2001) (SR-NASD-2001-39) (amending the price 
improvement provisions of NASD Rule 6541); Securities Exchange Act 
Release No. 45011 (November 1, 2001), 66 FR 56587 (November 8, 2001) 
(SR-NASD-2001-78) (further amending the price improvement 
provisions); Securities Exchange Act Release No. 45276 (January 14, 
2002), 67 FR 2936 (January 22, 2002) (SR-NASD-2002-06) (extending 
pilot period for NASD Rule 6541 for an additional six months); 
Securities Exchange Act Release No. 46248 (July 24, 2002), 67 FR 
49727 (July 31, 2002) (SR-NASD-2002-95) (extending pilot period for 
NASD Rule 6541 for an additional six months).
    \7\ For purposes of NASD Rule 6541(b), the inside spread is 
defined as the difference between the best reasonably available bid 
and offer in the subject security.
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    NASD Rule 6541(c) provides that, notwithstanding the obligation in 
paragraph (a), a member may negotiate specific terms and conditions 
applicable to the acceptance of the limit orders of institutional 
accounts and of orders greater than 10,000 shares and $20,000 in value. 
NASD Rule 6541(d) provides that a member that trades through a held 
limit order must execute such limit order contemporaneously, but in no 
case later than five minutes after the member has traded at a price 
more favorable than the customer's price. NASD Rule 6541(e) provides 
that the rule applies from 9:30 a.m. until 4 p.m. Eastern Time, and 
that the rule applies regardless of whether the subject security is 
also quoted in another quotation medium.
    During the pilot period, Nasdaq's Department of Economic Research 
analyzed the impact of the pilot on relevant aspects of the OTCBB's 
operation. Nasdaq reported that the Department's study found no 
material impact on market quality (as measured by trading activity, 
market maker quoting activity, and spread behavior) for the securities 
subject to the pilot.
    Nasdaq now seeks to establish NASD Rule 6541 on a permanent basis 
and to extend Manning protection to customer limit orders in all 
securities quoted on the OTCBB. In addition, consistent with this 
proposal, Nasdaq in Amendment No. 1 proposed to eliminate two existing 
provisions of NASD Rule 6541(e), which provide that the current pilot 
applies only to certain securities for a specified time period. As 
revised by Amendment No. 1, NASD Rule 6541 would appear as follows:

Rule 6541 Limit Order Protection

    (a)-(d) No change.
(e) Application
    [(1) This rule shall apply only to OTCBB securities specifically 
identified as such through the Nasdaq Workstation service.]
    (1[2]) This rule shall apply, regardless of whether the subject 
security is additionally quoted in a separate quotation medium.
    (2[3]) This rule shall apply from 9:30 a.m. to 4 p.m. Eastern Time.
    [(4) This rule shall be in effect until December 15, 2002.]
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[[Page 78551]]

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the Act and the rules and regulations thereunder applicable to a 
national securities association.\8\ Specifically, the Commission finds 
that the proposal is consistent with the requirements of section 
15A(b)(6) of the Act, \9\ which requires that the rules of a registered 
national securities association be 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.
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    \8\ In approving the proposal, the Commission has considered the 
rule's impact on efficiency, competition, and capital formation. See 
15 U.S.C. 78c(f).
    \9\ 15 U.S.C. 78o(b)(6).
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    When the Commission approved the original proposal that instituted 
limit order protection for Nasdaq securities, it stated:

    The Commission believes that the rule change [which instituted 
NASD IM-2110-2] will enhance investor confidence by improving the 
quality of executions for customers. By giving a customer's limit 
order priority over the market maker's proprietary trading, more 
trade volume will be available to be matched with the customer's 
order, resulting in quicker and more frequent executions for 
customers.
    The NASD's proposal will also improve the price discovery 
process in NASDAQ securities. Limit orders aid price discovery by 
adding liquidity to the market and by tightening the spread between 
the bid and ask price of a security. In the past, customers may have 
refrained from placing limit orders because of the uncertainty of 
and difficulty in obtaining an execution at a price between the 
spread. The new rule will encourage dealers to execute customer 
limit orders in a timely fashion so that they may resume their 
proprietary trading activities. The practice of delaying executions 
until the inside price reaches the customer's limit order also 
impedes price discovery by shielding those orders from the rest of 
the investing public. More expeditious handling of customer limit 
orders * * * will provide investors with a more accurate indication 
of the buy and sell interest at a given moment.\10\
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    \10\ See Securities Exchange Act Release No. 34279 (June 29, 
1994), 59 FR 34883 (July 7, 1994).

The Commission cited this provision in approving the OTCBB Manning 
pilot in February 2001.\11\ In the February 2001 approval order, the 
Commission also stated its view that a Manning pilot on the OTCBB was 
an appropriate first step in bringing limit order protection to the 
OTCBB, and that the pilot program would afford Nasdaq the opportunity 
to study the application of the rule and to consider further 
refinements.\12\
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    \11\ See supra note 6, 66 FR at 10543.
    \12\ See id.
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    The Commission believes that it is appropriate at this time to 
approve limit order protection for all OTCBB securities on a permanent 
basis. In making this determination, the Commission notes that Nasdaq 
did not observe any material impact on market quality for the OTCBB 
securities subject to the pilot.\13\ The rationale for approving limit 
order protection for Nasdaq securities and the pilot for OTCBB 
securities applies equally to approving the OTCBB Manning rule on a 
permanent basis: Limit order protection ensures that a market maker 
considers the limit orders of customers when executing its own orders 
and thus prevents the isolation of customer limit orders that might 
otherwise occur if a market maker were freely able to trade ahead of 
them. The Commission believes that the liquidity and transparency of 
the market in OTCBB securities should improve as a result of applying 
Manning protection to them on a permanent basis.
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    \13\ See supra note 6.
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    Under Section 19(b)(2) of the Act,\14\ the Commission may not 
approve a proposed rule change prior to the thirtieth day after the 
date of publication of notice of the filing thereof, unless the 
Commission finds good cause for so doing. The Commission hereby finds 
good cause for approving the proposal, as revised by Amendment No. 1, 
prior to the thirtieth day after the date of publication of notice in 
the Federal Register. The revisions to the proposed rule text made by 
Amendment No. 1 are technical in nature and consistent with Nasdaq's 
proposal to extend Manning protection to all OTCBB securities on a 
permanent basis. Accordingly, the Commission believes it is appropriate 
to approve the amended proposal at this time.
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    \14\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the proposed rule change, including whether the 
proposal, 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-2002-153 and should be submitted by January 14, 2003.

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the Act 
\15\ that the proposed rule change (SR-NASD-2002-153), as amended, is 
approved on an accelerated basis.
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    \15\ Id.

    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. 02-32320 Filed 12-23-02; 8:45 am]
BILLING CODE 8010-01-P