[Federal Register Volume 68, Number 25 (Thursday, February 6, 2003)]
[Notices]
[Pages 6236-6242]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-2950]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47301; File No. SR-NASD-2002-173]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval to a Proposed Rule Change and Amendment 
Nos. 1, 2, and 3 Thereto by the National Association of Securities 
Dealers, Inc. To Establish a 90-Day Pilot Program To Allow NNMS Order 
Entry Firms To Enter Non-Marketable Limit Orders Into SuperMontage 
Using the SIZE MMID

January 31, 2003.
    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 December 2, 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 Nasdaq. The NASD amended its 
proposal on December 23, 2002,\3\ January 29, 2003,\4\ and January 30, 
2003.\5\ The Commission is publishing

[[Page 6237]]

this notice to solicit comments on the proposed rule change and 
Amendment Nos. 1, 2 and 3 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 Edwards S. Knight, Executive Vice President 
and General Counsel, Nasdaq, to Katherine A. England, Assistant 
Director, Division of Market Regulation (``Division''), Commission, 
dated December 20, 2002, replacing the original Form 19b-4 in its 
entirety (``Amendment No. 1''). In Amendment No. 1, Nasdaq clarified 
that NNMS Order Entry Firms would be allowed to enter multiple 
orders (with or without reserve size) at single or multiple price 
levels and be subject to automatic execution functionality of the 
system. Nasdaq also explained that any order entered by a NNMS Order 
Entry Firm that created a locked/crossed market would be processed 
like other locking/crossing quotes/orders as set forth in Rule 
4710(b)(3). Furthermore, Nasdaq made corrections to its rule text 
and requested accelerated approval of the proposed rule change on a 
90-day pilot basis.
    \4\ See letter from Edwards S. Knight, Executive Vice President 
and General Counsel, Nasdaq, to Katherine A. England, Assistant 
Director, Division, Commission, dated January 29, 2003, replacing in 
its entirety the original Form 19b-4 and Amendment No. 1 
(``Amendment No. 2''). In Amendment No. 2, Nasdaq represented that 
additional programming to distinguish NNMS Order Entry Firms from 
Nasdaq Quoting Market Participants for internalization purposes 
would be implemented on or before April 28, 2003. Furthermore, 
Nasdaq provided additional rational for its request for accelerated 
approval by the Commission, and made corrections to its rule text.
    \5\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division, 
Commission, dated January 30, 2003 (``Amendment No. 3''). In 
Amendment No. 3, Nasdaq made conforming changes to its definitions 
in Rule 4701 and made corrections in Rule 4710(b)(1)(B) to 
incorporate the changes made under the proposed rule change, as 
amended.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq proposes to allow NNMS Order Entry Firms (``OE Firms'') to 
enter non-marketable limit orders into SuperMontage using the SIZE 
Market Maker Identifier (``SIZE MMID'' or ``SIZE'') for a 90-day pilot 
period that commences on February 10, 2003.\6\ The proposed rule 
language follows. Proposed new language is italicized; proposed 
deletions are [bracketed].
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    \6\ This filing also makes certain non-substantive corrective 
and conforming changes to the written rules of the NNMS.
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* * * * *
4701. Definitions--Unless stated otherwise, the terms described below 
shall have the following meaning:
* * * * *
    (a) The term ``Displayed Quote/Order'' shall mean both Attributable 
and Non-Attributable (as applicable) Quotes/Orders transmitted to 
Nasdaq by Quoting Market Participants or NNMS Order Entry Firms.
* * * * *
    (o) The term ``Non-Attributable Quote/Order'' shall mean a bid or 
offer Quote/Order that is entered by a Nasdaq Quoting Market 
Participant or NNMS Order Entry Firm and is designated for display 
(price and size) on an anonymous basis in the Nasdaq Order Display 
Facility.
* * * * *
    (w) The term ``NNMS Order Entry Firm'' shall mean a member of the 
Association who is registered as an Order Entry Firm for purposes of 
participation in NNMS [which permits the firm to enter orders for 
execution against NNMS Market Makers].
* * * * *
    (bb) The term ``Quote/Order'' shall mean a single quotation or 
shall mean an order or multiple orders at the same price submitted to 
Nasdaq by a Nasdaq Quoting Market Participant or NNMS Order Entry Firm 
that is displayed in the form of a single quotation. Unless 
specifically referring to a UTP Exchange's agency Quote/Order (as set 
out in Rule 4710(f)(2)(b)), when this term is used in connection with a 
UTP Exchange, it shall mean the best bid and/or the best offer 
quotation transmitted to Nasdaq by the UTP Exchange.
* * * * *
    (dd) The term ``Reserve Size'' shall mean the system-provided 
functionality that permits a Nasdaq Quoting Market Participant or NNMS 
Order Entry Firm to display in its Displayed Quote/Order part of the 
full size of a proprietary or agency order, with the remainder held in 
reserve on an undisplayed basis to be displayed in whole or in part 
after the displayed part is reduced by executions to less than a normal 
unit of trading.
* * * * *

4706. Order Entry Parameters

    (a) Non-Directed Orders--(1) General. The following requirements 
shall apply to Non-Directed Orders Entered by NNMS Market Participants: 
(A) An NNMS Participant may enter into the NNMS a Non-Directed Order in 
order to access the best bid/best offer as displayed in Nasdaq. (B) A 
Non-Directed Order must be a market or limit order, must indicate 
whether it is a buy, short sale, short-sale exempt, or long sale, and 
[if entered by a Quoting Market Participant] may be designated as 
``Immediate or Cancel'', or as a ``Day'' or a ``Good-till-Cancelled'' 
order. If a priced order designated as ``Immediate or Cancel'' 
(``IOC'') is not immediately executable, the unexecuted order (or 
portion thereof) shall be returned to the sender. If a priced order 
designated as a ``Day'' order is not immediately executable, the 
unexecuted order (or portion thereof) shall be retained by NNMS and 
remain available for potential display/execution until it is cancelled 
by the entering party, or until 4:00 p.m. Eastern Time on the day such 
order was submitted, whichever comes first, whereupon it will be 
returned to the sender. If the order is designated as ``Good-till-
Cancelled'' (``GTC''), the order (or unexecuted portion thereof) will 
be retained by NNMS and remain available for potential display/
execution until cancelled by the entering party, or until 1 year after 
entry, whichever comes first. Starting at 7:30 a.m., until the 4:00 
p.m. market close, IOC and Day Non-Directed Orders may be entered into 
NNMS (or previously entered orders cancelled), but such orders entered 
prior to market open will not become available for execution until 9:30 
a.m. Eastern Time. GTC orders may be entered (or previously entered GTC 
orders cancelled) between the hours 7:30 a.m. to 6:30 p.m. Eastern 
Time, but such orders entered prior to market open, or GTC orders 
carried over from previous trading days, will not become available for 
execution until 9:30 a.m. Eastern Time. Exception: Non-Directed Day and 
GTC orders may be executed prior to market open if required under Rule 
4710(b)(3)(B).
    (C) The system will not process a Non-Directed Order to sell short 
if the execution of such order would violate NASD Rule 3350.
    (D) Non-Directed Orders will be processed as described in Rule 
4710.
    (E) The NNMS shall not accept Non-Directed Orders that are All-or-
None, or have a minimum size of execution.
    (F) A NNMS Market Participant may enter a Non-Directed Order that 
is either a market order or a limit order prior to the market's open. 
Market orders and limit orders designated as Immediate or Cancel orders 
shall be held in a time-priority queue that will begin to be processed 
by NNMS at market open. If an Immediate or Cancel limit order is 
unmarketable at the time it reaches the front of time-priority 
processing queue, it will be returned to the entering market 
participant. Limit orders that are not designated as Immediate or 
Cancel orders shall be retained by NNMS for potential display in 
conformity with Rule 4707(b) and/or potential execution in conformity 
with Rule 4710(b)(1)(B).
    (2) Entry of Non-Directed Orders by NNMS Order Entry Firms--In 
addition to the requirements in paragraph (a)(1) of this rule, the 
following conditions shall apply to Non-Directed Orders entered by NNMS 
Order-Entry Firms:
    (A) All Non-Directed orders shall be designated as Immediate or 
Cancel, GTC or Day but shall be required to be entered as Non-
Attributable if not entered as IOC. [As such] For IOC Orders, if after 
entry into the NNMS of a Non-Directed Order that is marketable, the 
order (or the unexecuted portion thereof) becomes non-marketable, the 
system will return the order (or unexecuted portion thereof) to the 
entering participant.
    (B) A Non-Directed Order that is either a market order or a limit 
order may be entered prior to the market's open. Such limit and market 
orders will be held in a time-priority queue that will begin to be 
processed at market open. [If a] A limit order that is designated as 
IOC and is not marketable at the time it reaches the front of the time-
priority processing queue [, it] will be returned to the entering 
participant.
    (b) through (e) No Change.
* * * * *

4707. Entry and Display of Quotes/Orders

    (a) Entry of Quotes/Orders--Nasdaq Quoting Market Participants may 
enter Quotes/Orders into the NNMS, and NNMS Order Entry Firms may enter

[[Page 6238]]

Non-Attributable Orders into the NNMS, subject to the following 
requirements and conditions:
    (1) Nasdaq Quoting Market Participants shall be permitted to 
transmit to the NNMS multiple Quotes/Orders at a single as well as 
multiple price levels. Such Quote/Order shall indicate whether it is an 
``Attributable Quote/Order'' or ``Non-Attributable Quote/Order,'' and 
the amount of Reserve Size (if applicable). NNMS Order Entry Firms 
shall be permitted to transmit to NNMS multiple Non-Attributable 
Quotes/Orders at a single as well as multiple price levels and the 
amount of Reserve Size (if applicable).
    (2) Upon entry of a Quote/Order into the system, the NNMS shall 
time-stamp it, which time-stamp shall determine the ranking of the 
Quote/Order for purposes of processing Non-Directed Orders as described 
in Rule 4710(b). For each subsequent size increase received for an 
existing quote at a given price, the system will maintain the original 
time-stamp for the original quantity of the quote and assign a separate 
time-stamp to that size increase.
    (3) Consistent with Rule 4613, an NNMS Market Maker is obligated to 
maintain a two-sided Attributable Quote/Order at all times, for at 
least one normal unit of trading.
    (4) Nasdaq Quoting Market Participants may continue to transmit to 
the NNMS only their best bid and best offer Attributable Quotes/Orders. 
Notwithstanding NASD Rule 4613 and subparagraph (a)(1) of this rule, 
nothing in these rules shall require a Nasdaq Quoting Market 
Participant to transmit to the NNMS multiple Quotes/Orders.
    (b) Display of Quotes/Orders in Nasdaq--The NNMS will display [a 
Nasdaq Quoting Market Participant's] Quotes/Orders submitted to the 
system as follows:
    (1) Attributable Quotes/Orders--The price and size of a Nasdaq 
Quoting Market Participant's best priced Attributable Quote/Order on 
both the bid and offer side of the market will be displayed in the 
Nasdaq Quotation Montage under the Nasdaq Quoting Market Participant's 
MMID, and also will be displayed in the Nasdaq Order Display Facility 
as part of the aggregate trading interest at a particular price when 
the price of such Attributable Quote/Order falls within the number of 
price levels authorized for aggregation and display pursuant to Rule 
4701(ee) on either side of the market. Upon execution or cancellation 
of the Nasdaq Quoting Market Participant's best-priced Attributable 
Quote/Order on a particular side of the market, the NNMS will 
automatically display the participant's next best Attributable Quote/
Order on that side of the market.
    (2) Non-Attributable Quotes/Orders--The price and size of a Nasdaq 
Quoting Market Participant's and NNMS Order Entry Firm's Non-
Attributable Quote/Order on both the bid and offer side of the market 
will be displayed in the Nasdaq Order Display Facility as part of the 
aggregate trading interest at a particular price when the price of such 
Non-Attributable Quote/Order falls within the number of price levels 
authorized for aggregation and display pursuant to Rule 4701(ee) on 
either side of the market. A Non-Attributable Quote/Order will not be 
displayed in the Nasdaq Quotation Montage under the Nasdaq Quoting 
Market Participant's MMID. Non-Attributable Quotes/Orders that are the 
best priced Non-Attributable bids or offers in the system will be 
displayed in the Nasdaq Quotation Montage under an anonymous MMID, 
which shall represent and reflect the aggregate size of all Non-
Attributable Quotes/Orders in Nasdaq at that price level. Upon 
execution or cancellation of a Nasdaq Quoting Market Participant's or 
NNMS Order Entry Firm's Non-Attributable Quote/Order, the NNMS will 
automatically display a Non-Attributable Quote/Order in the Nasdaq 
Order Display Facility (consistent with the parameters described above) 
if it falls within the number of price levels authorized for 
aggregation and display pursuant to Rule 4701(ee) on either side of the 
market.
    (3) Exceptions--The following exceptions shall apply to the display 
parameters set forth in paragraphs (1) and (2) above:
    (A) Odd-lots, Mixed Lots, and Rounding--The Nasdaq system (and all 
accompanying data feeds) shall be capable of displaying trading 
interest in round lot amounts. For quote display purposes, Nasdaq will 
aggregate all shares, including odd-lot share amounts, entered by a 
Quoting Market Participant and NNMS Order Entry Firm at a single price 
level and then round that total share amount down to the nearest round-
lot amount for display and dissemination, consistent with subparagraphs 
(b)(1) and (b)(2) of this rule. Though rounded, any odd-lot portion of 
a [Quoting Market Participant's trading interest] Quote/Order that is 
not displayed as a result of this rounding process will remain in the 
system, with the time-priority of their original entry, and be 
continuously available for execution. Round-lots that are subsequently 
reduced by executions to a mixed lot amount will likewise be rounded 
for display purposes by the system to the nearest round-lot amount at 
that same price level. Any odd-lot number of shares that do not get 
displayed as a result of this rounding will remain in the system with 
the time-priority of their original entry and thus be continuously 
available for execution. If executions against an Attributable Quote/
Order result in there being an insufficient (odd-lot) amount of shares 
at a price level to display an Attributable Quote/Order for one round-
lot, the system will display the Quoting Market Participant's next best 
priced Attributable Quote/Order consistent with Rule 4710(b)(2). If all 
Attributable Quotes/Orders on the bid and/or offer side of the market 
are exhausted so that there are no longer any Attributable Quotes/
Orders, the system may refresh a market maker's exhausted bid or offer 
quote using the process set forth in Rule 4710(b)(5). With the 
exception of Legacy Quotes, odd-lot remainders that are not displayed 
will remain in the system at their original price levels and continue 
to be available for execution.
    (c) through (e) No Change.
* * * * *

4710. Participant Obligations in NNMS

    (a) No Change.
    (b) Non-Directed Orders.
    (1) General Provisions--A Quoting Market Participant in an NNMS 
Security, as well as NNMS Order Entry Firms, shall be subject to the 
following requirements for Non-Directed Orders:
    (A) Obligations For each NNMS security in which it is registered, a 
Quoting Market Participant must accept and execute individual Non-
Directed Orders against its quotation, in an amount equal to or smaller 
than the combination of the Displayed Quote/Order and Reserve Size (if 
applicable) of such Quote/Order, when the Quoting Market Participant is 
at the best bid/best offer in Nasdaq. This obligation shall also apply 
to the Non-Attributable Quotes/Orders of NNMS Order Entry Firms. 
Quoting Market Participants, and NNMS Order Entry Firms, shall 
participate in the NNMS as follows:
    (i) NNMS Market Makers, [and] NNMS Auto-Ex ECNs, and NNMS Order 
Entry Firms to the extent they enter a Non-Attributable Quote/Order 
shall participate in the automatic-execution functionality of the NNMS, 
and shall accept the delivery of an execution up to the size of the 
participant's Displayed Quote/Order and Reserve Size.
    (ii) NNMS Order-Delivery ECNs shall participate in the order-
delivery functionality of the NNMS, and shall accept the delivery of an 
order up to the size of the NNMS Order-Delivery ECN's Displayed Quote/
Order and Reserve Size. The NNMS Order-Delivery ECN

[[Page 6239]]

shall be required to execute the full size of such order (even if the 
delivered order is a mixed lot or odd lot) unless that interest is no 
longer available in the ECN, in which case the ECN is required to 
execute in a size equal to the remaining amount of trading interest 
available in the ECN.
    (iii) UTP Exchanges that choose to participate in the NNMS shall do 
so as described in subparagraph (f) of this rule and as otherwise 
described in the NNMS rules and the UTP Plan.
    (B) Processing of Non-Directed Orders--Upon entry of a Non-Directed 
Order into the system, the NNMS will ascertain who the next Quoting 
Market Participant or NNMS Order Entry Firm in queue to receive an 
order is (based on the algorithm selected by the entering participant, 
as described in subparagraph (b)(B)(i)-(iii) of this rule), and shall 
deliver an execution to Quoting Market Participants or NNMS Order Entry 
Firms that participate in the automatic-execution functionality of the 
system, or shall deliver a Liability Order to Quoting Market 
Participants that participate in the order-delivery functionality of 
the system; provided however, that the system always shall deliver an 
order (in lieu of an execution) to the Quoting Market Participant next 
in queue when the participant that entered the Non-Directed Order into 
the system is a UTP Exchange that does not provide automatic execution 
against its Quotes/Orders for Nasdaq Quoting Market Participants and 
NNMS Order Entry Firms. Non-Directed Orders entered into the NNMS 
system shall be delivered to or automatically executed against Quoting 
Market Participants' or NNMS Order Entry Firms' Displayed Quotes/Orders 
and Reserve Size in strict price/time priority, as described in the 
algorithm contained in subparagraph (b)(B)(i) of this rule. 
Alternatively, an NNMS Market Participant can designate that its Non-
Directed Orders be executed based on a price/time priority that 
considers ECN quote-access fees, as described in subparagraphs 
(b)(B)(ii) of this rule, or executed based on price/size/time priority, 
as described in subparagraph (b)(B)(iii) of this rule. The individual 
time priority of each Quote/Order submitted to NNMS shall be assigned 
by the system based on the date and time such Quote/Order was received. 
Remainders of Quote/Orders reduced by execution, if retained by the 
system, shall retain the time priority of their original entry. For 
purposes of the execution algorithms described in paragraphs (i), (ii) 
and (iii) below, ``Displayed Quotes/Orders'' shall also include any 
odd-lot, odd-lot portion of a mixed-lot, or any odd-lot remainder of a 
round-lot(s) reduced by execution, share amounts that while not 
displayed in the Nasdaq Quotation Montage, remain in system and 
available for execution.
    (i) Default Execution Algorithm--Price/Time--The system will 
default to a strict price/time priority within Nasdaq, and will attempt 
to access interest in the system in the following priority and order:
    (a) Displayed Quotes/Orders of NNMS Market Makers[,] and NNMS ECNs, 
displayed Non-Attributable Quotes/Orders of NNMS Order Entry Firms, and 
displayed non-attributable agency Quotes/Orders of UTP Exchanges (as 
permitted by subparagraph (f) of this rule), in time priority between 
such participants' Quotes/Orders[:];
    (b) Reserve Size of Nasdaq Quoting Market Participants and NNMS 
Order Entry Firms, in time priority between such participants' Quotes/
Orders; and
    (c) Principal Quotes/Orders of UTP Exchanges, in time priority 
between such participants' Quotes/Orders.
    (ii) Price/Time Priority Considering Quote-Access Fees--If this 
option[s] is chosen, the system will attempt to access interest in the 
system in the following priority and order:
    (a) Displayed Quotes/Orders of NNMS Market Makers, displayed Non-
Attributable Quotes/Orders of NNMS Order Entry Firms, displayed Quotes/
Orders of NNMS ECNs that do not charge a separate quote-access fee to 
non-subscribers, and non-attributable agency Quotes/Orders of UTP 
Exchanges (as permitted by subparagraph (f) of this rule), as well as 
Quotes/Orders from NNMS ECNs that charge[s] a separate quote-access fee 
to non-subscribers where the ECN entering such Quote/Order indicates 
that the price improvement offered by the specific Quote/Order is equal 
to or exceeds the separate quote-access fee the ECN charges, in time 
priority between such participants' Quotes/Orders;
    (b) Displayed Quotes/Orders of NNMS ECNs that charge a separate 
quote-access fee to non-subscribers, in time priority between such 
participants' Quotes/Orders;
    (c) Reserve Size of NNMS Market Makers and NNMS Order Entry Firms, 
and NNMS ECNs that do not charge a separate quote-access fee to non-
subscribers, as well as Reserve Size of Quotes/Orders from NNMS ECNs 
that charge[s] a separate quote-access fee to non-subscribers where the 
ECN entering such Quote/Order has indicated that the price improvement 
offered by the specific Quote/Order is equal to or exceeds the separate 
quote-access fee the ECN charges, in time priority between such 
participants' Quotes/Orders;
    (d) Reserve Size of NNMS ECNs that charge a separate quote-access 
fee to non-subscribers, in time priority between such participants' 
Quotes/Orders; and
    (e) Principal Quotes/Orders of UTP Exchanges, in time priority 
between such participants' Quotes/Orders.
    (iii) Price/Size Priority--If this option is chosen, Non-Directed 
Orders shall be executed in price/size/time priority against:
    (a) Displayed Quotes/Orders of NNMS Market Makers, displayed Non-
Attributable Quotes/Orders of NNMS Order Entry Firms, displayed Quotes/
Orders of NNMS ECNs, and non-attributable agency Quotes/Orders of UTP 
Exchanges (as permitted by subparagraph (f) of this rule), in price/
size/time priority between such participants' Quotes/Orders[:] ;
    (b) the Reserve Size of Nasdaq Quoting Market Participants and NNMS 
Order Entry Firms, in price/size/time priority between such 
participants' Quotes/Orders, which size priority shall be based on the 
size of the Displayed Quote/Order, and not on the amount held in 
Reserve Size; and
    (c) Principal Quotes/Orders of UTP Exchanges, in price/size/time 
priority between such participants' Quotes/Orders.
    (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. Effective February 10, 2003, until April 28, 2003 (or such 
earlier date as determined by Nasdaq with appropriate notice to the 
Securities and Exchange Commission and market participants), this 
processing shall also apply to Non-Directed Orders of NNMS Order Entry 
Firms. Thereafter, this exception shall not apply to Non-Directed 
Orders entered by NNMS Order Entry Firms.
    (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

[[Page 6240]]

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) or an NNMS Order Entry Firm 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) through (D) No Change.
    (2) Refresh Functionality.
    (A) Reserve Size Refresh--Once a Nasdaq Quoting Market 
Participant's or NNMS Order Entry Firm's Displayed Quote/Order size on 
either side of the market in the security has been decremented to an 
amount less than one normal unit of trading due to NNMS processing, 
Nasdaq will refresh the displayed size out of Reserve Size to a size-
level designated by the Nasdaq Quoting Market Participant or NNMS Order 
Entry Firm, or in the absence of such size-level designation, to the 
automatic refresh size. The amount of shares taken out of reserve to 
refresh display size shall be added to any shares remaining in the 
Displayed Quote/Order and shall be of an amount that when combined with 
the number of shares remaining in the Nasdaq Quoting Market 
Participant's Displayed Quote/Order before it is refreshed will equal 
the displayed size-level designated by the Nasdaq Quoting Market 
Participant or, in the absence of such size-level designation, to the 
automatic refresh size. If there are insufficient shares available to 
produce a Displayable Quote/Order, the Nasdaq Quoting Market 
Participant's Quote/Order, and any odd-lot remainders, will be 
refreshed, updated, or retained, in conformity with NNMS Rules 4707 and 
4710 as appropriate. To utilize the Reserve Size functionality, a 
minimum of 100 shares must initially be displayed in the Nasdaq Quoting 
Market Participant's or NNMS Order Entry Firm's Displayed Quote/Order, 
and the Displayed Quote/Order must be refreshed to at least 100 shares. 
This functionality will not be available for use by UTP Exchanges.
    (B) Auto Quote Refresh (``AQR'')--No Change.
    (3) Entry of Locking/Crossing Quotes/Orders The system shall 
process locking/crossing Quotes/Orders as follows:
    (A) Locked/Crossed Quotes/Orders During Market Hours--If during 
market hours, a [Quoting Market] [P]participant enters into the NNMS a 
Quote/Order that will lock/cross the market (as defined in NASD Rule 
4613(e)), the system will not display the Quote/Order as a quote in 
Nasdaq; instead the system will treat the Quote/Order as a marketable 
limit order and enter it into the system as a Non-Directed Order for 
processing (consistent with subparagraph (b) of this rule) as follows:
    (i) For locked-market situations, the order will be routed to the 
Quoting Market Participant or NNMS Order Entry Firm next in queue who 
would be locked, and the order will be executed (or delivered for 
execution) at the lock price;
    (ii) For crossed-market situations, the order will be entered into 
the system and routed to the next Quoting Market Participants or NNMS 
Order Entry Firms in queue who would be crossed, and the order will be 
executed (or delivered for execution) at the price of the Displayed 
Quote/Order that would have been crossed.
    Once the lock/cross is cleared, if the participant's order is not 
completely filled, the system will reformat the order and display it in 
Nasdaq (consistent with the parameters of the Quote/Order) as a Quote/
Order on behalf of the entering Quoting Market Participant or Order 
Entry Firm.
    (B) No Change.
    (4) through (8) No Change.
    (c) No Change.
    (d) NNMS Order Entry Firms.
    All entries in NNMS shall be made in accordance with the procedures 
and requirements set forth in the NNMS User Guide and these rules. 
Orders may be entered in NNMS by the NNMS Order Entry Firm through 
either its Nasdaq terminal or computer interface. The system will 
transmit to the firm on the terminal screen and printer, if requested, 
or through the computer interface, as applicable, an execution report 
generated immediately following the execution.
    (e) 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
    Currently, OE Firms must designate all limit orders they enter into 
SuperMontage as ``Immediate-or-Cancel'' (``IOC''). This designation, 
while allowing such orders to potentially execute if marketable when 
they reach the front of the SuperMontage processing queue, also 
instructs the system to return the order to the OE Firms if the order's 
price precludes an immediate execution. In short, OE Firms can enter 
market orders and marketable limit orders, but cannot enter non-
marketable limit orders. Nasdaq believes that the result is that all 
SuperMontage participants are deprived

[[Page 6241]]

of the additional liquidity these rejected orders represent and the 
supply/demand information they provide the market as a whole.
    In response to both the negative market impacts rejection of these 
orders engender, and requests from order entry market participants for 
enhanced access to the SuperMontage system, Nasdaq proposes that OE 
Firms be permitted to voluntarily enter non-marketable limit orders 
into SuperMontage without the IOC designation and have such order 
retained for potential execution \7\ through display under the SIZE 
MMID \8\ on a pilot basis for 90-days commencing February 10, 2003.
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    \7\ Under the proposal, OE Firms would be able to designate 
orders as IOC, ``Good-till-Cancelled,'' or ``Day.''
    \8\ The SIZE MMID is the anonymous MMID that represents the 
aggregate size of all Non-Attributable Quotes and Orders entered by 
market participants in Nasdaq at a particular price level. Non-
Attributable Quotes/Orders are not displayed in the Nasdaq Quotation 
Montage using the market participant's MMID. Instead, the SIZE MMID 
is displayed and represents the aggregate, Non-Attributable trading 
interest at a particular price level in the Nasdaq Quotation 
Montage. Telephone conversation between Thomas P. Moran, Associate 
General Counsel, Nasdaq, and Marc F. McKayle, Special Counsel, 
Division, Commission, on January 30, 2003 (making corrections to the 
text in the footnote).
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    With one exception, Non-Attributable Orders entered into the system 
by OE Firms would be processed in the same manner as other non-
attributable orders placed into SIZE by NNMS Market Makers. The only 
exception would be that, unlike the quotes/orders of Nasdaq Quoting 
Market Participants, SuperMontage would not first attempt to have Non-
Attributable Orders submitted by OE Firms match off against orders 
entered by the same OE Firm on the other side of the market. Instead, 
OE Firm orders would execute based solely on the algorithm selected by 
the entering party (price/time, price/time with fee consideration, or 
price/size) against the quotes/orders of other SuperMontage users--
including orders from the same OE firm entered on the other side of the 
market. However, the technology to support this functionality will not 
be available at the start of the pilot program on February 10, 2003. 
Instead, for a limited period, OE Firms would have their orders 
processed in a manner similar to Nasdaq Quoting Market Participants in 
that the system would first attempt to match off OE Firm orders against 
orders from the same OE Firm on the other side of the market. Nasdaq is 
working to program its system and formally commits to having the 
technology in place to inhibit this automatic matching, as proposed in 
this filing, on or before April 28, 2003.
    Under the proposal, OE Firms would be allowed to enter multiple 
orders (with or without reserve size) at single or multiple price 
levels, and such orders would be subject to the automatic execution 
functionality of the system. If any order entered by an OE Firm would 
create a locked/crossed market, such orders would be processed like 
other locking/crossing quotes/orders as set forth in NASD Rule 
4710(b)(3).
    Nasdaq believes that the above proposal is an important step in its 
ongoing process to make its systems more accessible to all NASD member 
firms, while ensuring that market participants who undertake the 
burdens of continuous liquidity provision are provided benefits 
commensurate with their activities. Nasdaq believes that most 
important, however, are the improvements to market quality that can be 
expected from the proposed rule change's swift implementation. In 
addition to enhanced liquidity and informational benefits, retention of 
non-marketable limit orders from OE Firms in SuperMontage can be 
expected, in Nasdaq's view, to reduce fragmentation of trading 
interest, thereby improving execution quality and speed and shrinking 
the costs market participants now incur when searching for trading 
partners in multiple venues. Finally, to the extent that any currently 
rejected OE Firm order is retained, Nasdaq believes that it would 
reduce the potential for locked/crossed markets that can occur if such 
rejected trading interest is subsequently displayed in an unlinked 
market center and thus does not benefit from SuperMontage processing 
that eliminated locks or crosses among all quotes and orders residing 
in the system.
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 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, and, in general, 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, 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-2002-173 and should be submitted by February 27, 2003.

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

    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 
allowing OE Firms to enter non-marketable limit orders into 
SuperMontage using the SIZE MMID should provide greater

[[Page 6242]]

access to the system by all NASD members, as well as encourage OE Firms 
to enter orders into SuperMontage and thereby increase liquidity in the 
market to the benefit of all market participants. Further, even though 
the orders of OE Firms will not be matched off against orders entered 
by the same OE Firm on the other side of the market,\13\ Nasdaq has 
represented that in all other respects, Non-Attributable Orders entered 
by OE Firms will be processed in the same manner as other non-
attributable orders placed into SIZE by NNMS Market Makers. As a 
result, the Commission believes that OE Firms will have far greater 
access to the SuperMontage then currently exists.
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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).
    \13\ Nasdaq's proposed rule change would eliminate the ability 
of OE Firms to use this feature no later than April 28, 2003.
---------------------------------------------------------------------------

    The Commission further believes that the proposal is consistent 
with the goals of Section 11A(a)(1)(C), particularly Congress' finding 
that it is in the public interest and appropriate for the protection of 
investors and the maintenance of fair and orderly market to assure the 
economically efficient execution of securities transactions. The 
proposal should provide OE Firms with greater flexibility to reflect 
buying and selling interest at various price levels by entering Non-
Attributable Orders directly into SuperMontage, instead of relying on 
electronic communications networks and NNMS Market Makers to post their 
trading interest.
    Accordingly, the Commission finds good cause, pursuant to Sections 
15A(b)(6) and 19(b)(2) of the Act,\14\ 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 
Nasdaq to allow OE Firms to enter orders into Nasdaq and thereby, 
remove a barrier to access to the SuperMontage, while enabling the 
Commission, NASD, Nasdaq, and market participants to gain actual 
experience with the pilot before the Commission considers permanent 
approval of the pilot.\15\ As a result, market participants will be 
able to better assess the impact of the proposal and offer insightful 
and valuable public comment on the pilot. Further, the Commission notes 
that several commenters suggested that OE Firms be allowed to enter 
orders directly into the order display facility as part of the original 
public comment process on the SuperMontage proposal.\16\ The Commission 
notes that the proposed rule change addresses those comments.
---------------------------------------------------------------------------

    \14\ 15 U.S.C. 78o-3(b)(6) and 78s(b)(2).
    \15\ The Commission notes that approval of the pilot should not 
be interpreted as suggesting that the Commission is predisposed to 
approving the proposal on a permanent basis if requested by the 
NASD.
    \16\ See Securities Exchange Act Release No. 43863 (January 19, 
2001), 66 FR 8020 (January 26, 2001).
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I. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act\17\, that the proposed rule change, as amended, (File No. SR-NASD-
2002-173) be, and it hereby is, approved on an accelerated basis, as a 
90-day pilot beginning on February 10, 2003 and expiring on May 12, 
2003.
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    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
---------------------------------------------------------------------------

    \18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-2950 Filed 2-5-03; 8:45 am]
BILLING CODE 8010-01-P