[Federal Register Volume 68, Number 33 (Wednesday, February 19, 2003)]
[Notices]
[Pages 8055-8061]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-3945]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47351; File No. SR-NASD-2002-60]


Self-Regulatory Organizations; Order Granting Approval of a 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval of Amendment Nos. 1, 2, and 3 to the Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to Permanent Approval of the Primex Auction System[reg]

February 11, 2003.

I. Introduction

    On May 1, 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 
(``SEC'' or ``Commission'') a proposed rule change, pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act'')\1\ and Rule 
19b-4 thereunder,\2\ requesting permanent approval of the Primex 
Auction System[reg] (``Primex'' or ``System''). The proposed rule 
change was published for public comment in the Federal Register on May 
31, 2002.\3\ On May 28, 2002, Nasdaq filed Amendment No. 1 to the 
proposed rule change.\4\ The comment period expired on June 21, 
2002.\5\ On July 25, 2002, the Commission received one comment letter 
on the Original Proposal.\6\ On October 7, 2002, Nasdaq filed a 
response to the NYSE Comment Letter.\7\ On November 1, 2002, Nasdaq 
filed Amendment No. 2 to the proposed rule change.\8\ On February 4, 
2003, Nasdaq filed Amendment No. 3 to the proposed rule change.\9\
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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. 45983 (May 23, 
2002), 67 FR 38152 (``Original Proposal'').
    \4\ See letter from Peter R. Geraghty, Associate Vice President 
and Associate General Counsel, Nasdaq, to Katherine England, 
Assistant Director, Division of Market Regulation (``Division''), 
Commission, dated May 1, 2002 (``Amendment No. 1''). In Amendment 
No. 1, Nasdaq removed the following language inadvertently included 
in proposed NASD Rule 5013(c)(2): ``Participants that are Primex 
Auction Market Makers for a security may submit Market Orders in 
that security for an immediate (i.e., ``zero second'') Auction, 
provided the Participant attaches certain match parameters as set 
forth in proposed NASD Rule 5014(b). Market Orders for at least 
10,000 shares or $200,000 in market value are also eligible for a 
zero second Auction, regardless of whether or not match parameters 
are attached.''
    \5\ Nasdaq has granted the Commission several extensions of time 
to consider Nasdaq's proposal, the most recent extending the time 
period until February 14, 2003.
    \6\ See letter from Darla C. Stuckey, Corporate Secretary, New 
York Stock Exchange, Inc. (``NYSE''), to Jonathan G. Katz, 
Secretary, Commission, dated July 24, 2002 (``NYSE Comment 
Letter'').
    \7\ See letter from Edward S. Knight, Executive Vice President 
and General Counsel, Nasdaq, to Jonathan G. Katz, Secretary, 
Commission, dated October 7, 2002 (``Nasdaq Response Letter'').
    \8\ See letter from Peter R. Geraghty, Associate Vice President 
and Associate General Counsel, Nasdaq, to Katherine England, 
Assistant Director, Division, Commission, dated October 31, 2002 
(``Amendment No. 2''). In Amendment No. 2, Nasdaq seeks permanent 
approval of the following changes to Nasdaq's application of Primex: 
(1) Elimination of the end-of-day anonymity feature; (2) 
implementation of a system change to prohibit appropriately marked 
orders from executing in violation of the NASD short sale rule; (3) 
amendments to proposed NASD Rule 5020 to reflect that Nasdaq delayed 
for an additional calendar quarter the rule requiring Primex Auction 
Market Makers (``PAMMs'') to submit a certain percentage of their 
orders to Primex; (4) amendments to proposed NASD Rule 5016 to 
reflect that orders not fully executed in Primex can be forwarded to 
the SuperMontage version (``SuperMontage'') of the Nasdaq National 
Market Execution System (``NNMS''); and (5) the addition of two new 
conditions that can be attached to orders submitted to Primex: an 
Anti-Internalization Qualifier and an All or None condition.
    \9\ See letter from Mary M. Dunbar, Vice President and Deputy 
General Counsel, Nasdaq, to Katherine England, Assistant Director, 
Division, Commission, dated February 3, 2003 (``Amendment No. 3''). 
In Amendment No. 3, Nasdaq seeks permanent approval to (1) change 
the minimum size requirement for Predetermined Relative Indications 
from a tiered structure depending on the amount of price 
improvement, to a standard minimum size requirement of 100 shares; 
(2) reprogram the System to reject trading interest marked as 
``short'' or ``short exempt'' in any exchange-listed security 
eligible for participation in the InterMarket Trading System; and 
(3) modify proposed NASD Rule 5017 to be consistent with the system 
change relating to short sales set forth in Amendment No. 2. 
Telephone call among Peter R. Geraghty, Associate Vice President and 
Associate General Counsel, Nasdaq; Gordon Fuller, Counsel to the 
Assistant Director, Division, Commission, and Jennifer Lewis, 
Attorney, Division, Commission, on February 7, 2003.
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    This order approves the proposed rule change. In addition, the 
Commission is publishing this notice to solicit comments on Amendment 
Nos. 1, 2, and 3 from interested persons, and approving Amendment Nos. 
1, 2, and 3 on an accelerated basis.

[[Page 8056]]

II. Background

    Nasdaq has operated Primex as a facility of the NASD since December 
17, 2001. Primex operates as a Pilot Trading System pursuant to a 
temporary, two-year exemption from the rule filing requirements of 
Section 19(b) of the Act \10\ under Rule 19b-5 under the Act.\11\ 
Nasdaq represents that Primex has exceeded the volume threshold 
required to maintain its status as a Pilot Trading System pursuant to 
Rule 19b-5 under the Act.\12\ Accordingly, Nasdaq now seeks permanent 
approval of the Primex rules. Pending such approval, the NASD submitted 
a proposed rule change setting forth the rules governing Primex and 
permitting Nasdaq to continue to operate Primex on a temporary 
basis.\13\
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    \10\ 15 U.S.C. 78s(b).
    \11\ 17 CFR 240.19b-5.
    \12\ 17 CFR 240.19b-5. See Securities Exchange Act Release No. 
45983 (May 23, 2002), 67 FR 38152 (``Original Proposal'').
    \13\ Notice of the filing and the immediate effectiveness of the 
proposed rule change was published on May 31, 2002 in the Federal 
Register. See Securities Exchange Act Release No. 45982 (May 23, 
2002), 67 FR 38163.
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III. Brief Description of Primex \14\
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    \14\ See the Original Proposal for a more detailed description 
of Primex and the NASD Rules governing Primex.
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Participants

    Primex is a voluntary system available to any NASD member and other 
entities that a member chooses to sponsor. To access the System, a 
member must be in good standing and have executed the necessary 
agreements with Nasdaq. Members granted access to the System are 
referred to as Primex Auction System Participants (``Participants''), 
and can access Primex for their customers or for themselves. Entities 
that are not members can access the System by becoming a Sponsored 
Subscriber of a Participant (``Sponsored Subscriber''). The Participant 
assumes responsibility for all activity conducted through the System by 
the Sponsored Subscriber.
    There are two categories of Primex Participants: Primex Auction 
Market Makers (``PAMMs'') and Crowd Participants. By becoming a 
Participant, a member automatically receives the right to trade as a 
Crowd Participant for any security eligible for trading in the System. 
In general, Crowd Participants can view all orders exposed in the 
System; interact with any order in the System; submit orders to the 
System; and trade as principal, agent, or riskless principal. In 
addition, PAMMs are entitled to exercise certain matching rights that 
allow a PAMM to commit capital to its customer orders in conjunction 
with the order exposure process; provide execution guarantees for its 
own customer orders submitted to the System; and use certain types of 
orders that permit the PAMM to facilitate block trades and ``clean 
crosses.'' PAMMs are also entitled to share in transaction revenue paid 
by other Participants when those other Participants execute against a 
PAMM's customer orders.
    To become a PAMM, a member must register as such with Nasdaq for 
each security in which the member wishes to trade in such capacity. 
Members that seek to become PAMMs also must be registered as Nasdaq 
market makers with respect to Nasdaq-listed securities (i.e., Nasdaq 
National Market[reg] and The Nasdaq SmallCap Market\SM\ securities) or 
Consolidated Quotation Services (``CQS'') market makers with respect to 
exchange-listed securities. With respect to any security eligible for 
which a Participant is registered as a PAMM, such PAMM must submit to 
the System a minimum percentage \15\ of its Mandatory Eligible \16\ 
public customer orders (including customer orders of another broker-
dealer that directs such orders to the PAMM) for those securities in 
which it is registered as a PAMM.
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    \15\ See proposed NASD Rule 5020.
    \16\ See proposed NASD Rule 5011 (definition of ``Mandatory 
Eligible Order'') and proposed NASD Rule 5020.
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Orders

    Participants may submit unpriced market orders, as well as orders 
that have specified, fixed prices that are marketable or priced between 
the NBBO. Orders can be submitted in any round lot or mixed lot, but 
odd lot orders are not accepted. Fixed price orders are eligible only 
for ``immediate or cancel'' treatment.
    Participants can choose the maximum duration of the exposure for 
their orders. Unpriced market orders generally have a default maximum 
broadcast period of 15 seconds, but executions can take place sooner if 
there are satisfactory responses from the crowd at any time during the 
exposure of the order. Executions can occur instantaneously when there 
is crowd trading interest residing in the System. Trading interest can 
reside in the System when Participants define their interest in advance 
of an order being placed, or when other, contra side orders are already 
in the process of being exposed. In addition, Participants also may 
elect to have the order exposed for an immediate or ``zero second'' 
execution, depending on the size of the order or, as described below, 
guarantee an execution by committing liquidity in the absence of 
satisfactory interest from the crowd. Transactions always are executed 
at or within the NBBO.
    An order also can be submitted with a condition attached requiring 
a minimum amount of price improvement relative to the current NBBO at 
the time of execution. A Participant utilizing this feature for an 
order to buy would specify, when entering the order into the System, 
that the order be executed only if the exposure yields an execution 
with price improvement of 3 cents below the ``Best Offer'' as publicly 
displayed in the NBBO at the time of execution.
    PAMMs are entitled to attach certain match parameters to customer 
orders they submit to the System. For example, a PAMM may submit a 
customer order with a 50% match parameter. Any interest provided by the 
crowd is matched in both size and price by a corresponding execution 
with the PAMM. The PAMM must be willing to execute the entire order 
when using this match parameter, in the absence of sufficient response 
from the crowd.
    PAMMs also can submit customer orders with a Two Cent Match 
parameter. This function allows the PAMM entering the order to execute 
the customer order, provided it is willing to match the price 
established by the crowd for the entire order to the extent the price 
offered by the crowd is within two cents of the NBBO. If there is crowd 
interest willing to provide more than two cents of price improvement, 
the PAMM loses that portion of the order to the crowd.
    PAMMs also are entitled to provide execution guarantees within the 
System. This feature ensures that any balance of an order remaining 
after exposing it to the crowd will receive a liquidity guarantee, 
established by the PAMM for each order submitted, at a price at least 
as good as the NBBO at that time.
    Any condition, match parameter, or guarantee must be attached to an 
order at the time it is submitted to the System. The existence of any 
condition, match parameter, or guarantee that may be attached to an 
order is never communicated or displayed to the crowd.
    The System also provides participants the option of having the 
balance of an unexecuted order returned to them or forwarded to other 
Nasdaq systems for execution. Participants must indicate their 
preference upon submission of an order to the System. For example, a 
Participant can submit an order with an indication that it should be 
forwarded to another Nasdaq system if the order is

[[Page 8057]]

not completely executed in Primex. To the extent the exposure concludes 
and there is a portion of the order remaining, that balance will be 
converted by the System to an order that is forwarded to SuperSoes (for 
Nasdaq National Market securities), SuperMontage, or ITS/CAES (for 
exchange-listed securities, provided the participant also is an ITS/
CAES market maker). A Participant's preference is not displayed, 
exposed or communicated to any other Participant.

Responses and Indications

    Participants may submit Responses and Indications to the System, 
for the purpose of interacting with orders on Primex. Responses and 
Indications are not communicated to any Participant, except to the 
extent they result in an execution with an order. Responses and 
Indications cannot execute against other Responses and Indications. 
Responses are instructions submitted to the System by Participants to 
interact with available orders exposed on Primex. Responses may be 
either a Fixed Price Response (e.g., buy 1,000 at $20) or a Relative 
Priced Response (e.g., buy 1,000 at the bid plus 3 cents).
    Indications are instructions submitted to the System to interact 
with future orders exposed on Primex by either the next day or the next 
five days, as selected by the Participant. An Indication may be a 
Predefined Relative Indication (``PRI'') or a Go-Along Indication. PRIs 
have no specific fixed price, but are expressed at time of entry in 
terms relative to the best bid or offer publicly displayed at such time 
when the System activates the PRI against orders on Primex. PRIs are 
ranked in relative price/time priority among all other PRIs and any 
same-side orders currently being exposed. When activated by the System, 
a PRI will match against orders at a price equal to the best bid (for 
PRIs to buy) or offer (for PRIs to sell) publicly displayed at that 
time in the NBBO, plus or minus (respectively) the relative price term 
associated with that PRI; provided that such price also satisfies any 
applicable condition associated with the order to which it is 
responding. All PRIs must be for at least 100 shares. The System will 
only accept PRIs that meet the required amounts of price improvement 
(set forth in proposed NASD Rule 5018(c)(1)(C)). Participants may 
associate a Per Auction Maximum size with a PRI, which will provide the 
Participant with an opportunity to withdraw the PRI once the Per 
Auction Maximum is exhausted.
    Go-Along Indications also have no specific fixed price, and are 
also expressed at time of entry in terms relative to the best bid or 
offer publicly displayed at such time when the System activates the PRI 
against orders on Primex. Go-Along Indications are only activated when 
there has been at least one other contemporaneous Crowd execution at 
the NBBO, provided there are no PRIs available or orders being exposed. 
Each Go-Along Indication is required to be for at least 10,000 shares.
    All orders submitted to the System are identified as either a 
Public Order (in general, an order for the account of a customer) or a 
Professional Order (in general, an order for the proprietary account of 
a broker-dealer). This status is not communicated to any other 
Participant, but is used to determine whether an order is available to 
interact with the Response or Indication of a Crowd Participant. A 
Participant that responds to orders on Primex can choose whether its 
Responses and Indications interact with both Public and Professional 
Orders, or just Public Orders. However, a Participant entering an order 
does not have the ability to select or control whether public or 
professional interest may interact with the order.

IV. NYSE Comment Letter and Nasdaq Response

    In the NYSE Comment Letter, the NYSE argued against the Commission 
granting permanent approval to Primex. The NYSE argued that the 
Commission must evaluate whether Primex complies with Nasdaq's 
regulatory obligations as an exchange pursuant to Section 6 of the 
Act,\17\ even though Nasdaq's exchange application is pending with the 
Commission. The NYSE argued, among other things, that Primex's true 
character is not that of an auction, but rather, an anti-competitive 
dealer internalization system. For example, the NYSE argued that 
Primex's ``match mechanism'' for dealer guarantees allows dealers to 
jump ahead of pre-existing customer orders.
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    \17\ 15 U.S.C. 78f.
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    In the Nasdaq Response Letter, Nasdaq stated that it would respond 
to all of the comments raised by the NYSE Comment Letter, even though 
it is only required to comply with the requirements of Section 15A of 
the Act \18\ because of its current status as a registered securities 
association. Nasdaq further stated that Primex is fully consistent with 
these statutory obligations.
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    \18\ 15 U.S.C. 78o-3.
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    The NYSE argued that the requirement that PAMMs submit 80% of their 
order flow is anti-competitive and compromises the ability of broker-
dealers to comply with their best execution obligations. The NYSE 
further stated that the 80% requirement is an off-board trading 
restriction which conditions the ability of any member to effect any 
transaction otherwise than on Primex. The NYSE also believes the 
requirement unfairly discriminates against members with high volume of 
order flow.
    Nasdaq responded that the 80% delivery requirement applies only to 
those dealers who wish to take advantage of the benefits of certain 
rebates and features available to PAMMs. Nasdaq stated that the only 
penalty for not meeting the 80% delivery requirement is to be 
ineligible for PAMM status; there are no disciplinary sanctions for 
failing to meet the 80% requirement, and such dealers will still have 
access to the other features of Primex. Nasdaq contended that the 
requirement does not place participant in a position where it must 
choose between violating a NASD rule and its duty of best execution; 
rather, each participant is free to execute its orders in whichever 
manner it believes can obtain best execution. Finally, Nasdaq stated 
that all orders that are exposed in Primex are eligible for the 80% 
test, even if they are executed elsewhere.
    Nasdaq further argued that the 80% requirement is designed to 
encourage dealers with customer order flow to expose customer's orders 
to the public. It asserted that, without the 80% requirement, the 
market would believe that dealers were only posting unwanted orders.
    NYSE argued that Primex allows participating dealers to provide 
customers with trade prices no better than if their orders had been 
internalized, and therefore should not claim to offer an auction-type 
execution. NYSE contended that there are no true market makers on 
Primex because no participant has an affirmative obligation to provide 
the liquidity of continuous two-sided quotations. NYSE further argued 
that Primex does not display quotes or even the existence of any 
trading interest in the ``virtual'' trading crowds that Nasdaq claims 
exists as a source of liquidity, nor does it display most orders 
entered onto the system to interact with the putative trading crowd. 
NYSE stated that customer orders may be entered for immediate auction, 
which it argued would not provide any opportunity for participants to 
respond.
    Nasdaq responded that Primex is designed to expose to a broader 
audience orders that might otherwise be internalized. Moreover, Nasdaq 
stated that even if such orders are internalized, federal securities 
laws do not prohibit

[[Page 8058]]

internalization. In addition, some customers value speed more than 
other factors. Speed has become an indication of execution quality. 
Nasdaq characterized Primex's use of PRIs as designed to ensure that 
notwithstanding the need for speed on the order entry side, there would 
still remain a fair and reasonable opportunity for any and all crowd 
participants to respond to such order flow if they choose to do so, 
regardless of the auction selected. Nasdaq argued that Primex's 
technology allows this immediate interaction.
    The NYSE argued that Primex artificially limits the ability of 
dealers to enter PRIs below established minimum sizes, thereby 
discouraging trading interest and constraining liquidity. As a result 
of consultation with members, Nasdaq has modified the minimum size 
requirements for PRIs to a less burdensome standard requirement of 100 
shares.
    The NYSE argued that Primex participants may selectively trade 
against agency orders alone by using a mechanism to screen out 
professional orders. NYSE contends that this is discriminatory, not an 
auction, and acts as a disincentive to participation.
    Nasdaq responded that this feature ensures that any price 
improvement or enhanced liquidity opportunities be reserved for public 
customers, and not necessarily professional traders who could otherwise 
take advantage of the System's benefits and ``pre-empt'' the ability of 
a public customer to receive such benefits.
    The NYSE argued that Primex's fee structure penalizes liquidity 
providers. Fees are charged to liquidity providers, and rebates are 
given when PRIs result in a trade. The NYSE believes the fee structure 
formalizes a payment for order flow arrangement to compensate PAMMs 
when they are displaced from internalizing their own customer orders.
    Nasdaq stated that even though the fee structure is not included in 
the proposed rule change and thus not before the Commission for review, 
it would respond to the NYSE's arguments. Nasdaq explained that orders 
exposed in Primex are not charged for an execution so as to avoid any 
penalty that would discourage participants, particularly dealers, from 
exposing customer order flow to others. A fee is charged only to those 
who choose to respond to such order flow with Primex's unique bidding 
tools. Nasdaq also responded that it is not required to have a uniform 
pricing principle for all of its systems. The only requirement is an 
equitable allocation of reasonable fees among members, and the fees for 
Primex comply with this standard.
    The NYSE argued that Primex fails to provide a market structure 
that ensures its participants comply with Rule 10a-1 under the Act (the 
``Short Sale Rule'').\19\ As a result of consultation with members, 
Nasdaq has implemented a system modification that will prohibit 
appropriately marked orders from executing in violation of NASD Rule 
3350, the NASD short sale rule.\20\ In addition, Nasdaq has 
reprogrammed the System to reject trading interest marked as ``short'' 
or ``short exempt'' in any exchange-listed security eligible for 
participation in the InterMarket Trading System.\21\
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    \19\ 17 CFR 240.10a-1.
    \20\ Telephone call among Peter R. Geraghty, Associate Vice 
President and Associate General Counsel, Nasdaq, Gordon Fuller, 
Counsel to the Assistant Director, Division, Commission, and 
Jennifer Lewis, Attorney, Division, Commission, on October 24, 2002. 
See Amendment No. 2, supra note 8.
    \21\ See Amendment No. 3, supra note 9.
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    The NYSE argued that Nasdaq has not provided any market data or 
analysis regarding its trading history for public evaluation. In 
addition, individual market makers have opted to include Primex 
executions within their own ``market center'' reports, rather than as 
orders routed to and executed on another market system. Primex includes 
these trades in statistics used in its advertising and press releases.
    The Nasdaq responded that it has been working closely with SEC 
staff to confirm how Rule 11Ac1-5 will be applied to Primex.

V. Amendment No. 2

    In Amendment No. 2, Nasdaq seeks permanent approval of the 
following changes to Nasdaq's application of Primex: (1) Elimination of 
the end-of-day anonymity feature; (2) implementation of a system 
modification that will prohibit appropriately marked orders from 
executing in violation of NASD Rule 3350, the NASD short sale rule; (3) 
amendments to proposed NASD Rule 5016 to reflect that orders not fully 
executed in Primex can be forwarded to SuperMontage once it is 
available for a particular security; (4) the addition of two new 
conditions that can be attached to orders submitted to Primex, the 
Anti-Internalization Qualifier (``AIQ'') and the All or None (``AON'') 
condition; and (5) amendments to proposed NASD Rule 5020 to reflect 
that Nasdaq delayed for an additional calendar quarter the rule 
requiring PAMMs to submit a certain percentage of their orders to the 
System. The amended rule text follows. New language is italicized; 
deleted language is in brackets.

5011. Definitions
    For purposes of this Rule Series, unless the context requires 
otherwise:
    (a) ``Application'' or ``Nasdaq Application'' as used in this Rule 
Series, and ``Nasdaq Application of the Primex Auction System'' as used 
throughout the NASD Rules means the voluntary Nasdaq trading service 
facility that permits NASD member firms, among other things, to submit 
orders in Primex Eligible Securities to be exposed to a Crowd of 
Participants in an [anonymous,] electronic auction format for the 
purpose of obtaining an execution for their own account or the account 
of a customer; to have required reports of any resulting trades 
automatically disseminated to the public and the industry; and to 
``lock in'' these trades as necessary by sending both sides to the 
applicable clearing agency designated by the Participants involved for 
clearance and settlement, all in accordance with this Rule Series and 
other applicable rules and policies of Nasdaq.
* * * * *
5016. Option to Route Orders Outside of the System After Exposure in 
the Application
    (a) (1) All Market Orders submitted to the Application shall 
include an identifier as to whether any unexecuted balance, after the 
order is exposed to the Crowd, should be forwarded to the 
SuperSoesSM version of the Nasdaq National Market Execution 
System, in the case of a Nasdaq security, or to ITS/CAES, in the case 
of an exchange-listed security, or whether the order should be returned 
to the entering Participant. This option to route orders outside of the 
Application to SuperSoes or ITS/CAES is available for Market Orders 
only. Orders submitted to the Application with a specified, fixed price 
cannot be automatically forwarded to SuperSoes or ITS/CAES [Nasdaq's 
other execution systems].
    Routing identifiers are not displayed, exposed or communicated to 
any other Participant in the Application.
    (2) For securities eligible for the SuperMontage version of the 
Nasdaq National Market Executions System, all orders submitted to the 
Application shall include an identifier as to whether any unexecuted 
balance, after the order is exposed to the Crowd, should be forwarded 
to SuperMontage, or whether the order should be returned to the 
entering Participant. Orders forwarded to SuperMontage will be treated 
as

[[Page 8059]]

immediate or cancel orders. Routing identifiers are not displayed, 
exposed or communicated to any other Participant in the Application.
    (b) No changes.
5020. Market Maker Participation
    (a) No Change.
    (b) With respect to each security in which a Participant is 
registered as a Primex Auction Market Maker, the Participant shall:
    (1) No Change.
    (2) No Change.
    (3) submit to the Application a minimum of 80%\*\ of the number of 
its Mandatory Eligible Orders (including customer orders of another 
broker-dealer that has directed such orders to the Participant) as soon 
as practicable upon receipt by the Participant, for the purpose of 
exposing such orders to the Primex Crowd. Mandatory Eligible Orders do 
not include:
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    \*\The 80% test will be applied on a quarterly basis, and will 
be phased in as follows: For the calendar quarters commencing on 
October 1, 2001; January 1, 2002; April 1, 2002; [and] July 1, 2002, 
and October 1, 2002, any participant may register in any eligible 
security as a Primex Auction Market Maker and maintain that status 
during such calendar quarters without regard to the percentage of 
its orders it submits to the System for such security during that 
time, provided it also satisfies all other requirements of a Primex 
Auction Market Maker pursuant to these rules.
    Beginning with the calendar quarter that commences on [October 
1, 2002] January 1, 2003, a participant previously registered as a 
Primex Auction Market Maker for a particular security may maintain 
its status as such until [December 31, 2002] March 30, 2003 only if 
it submitted at least 50% of its Mandatory Eligible Orders during 
the calendar quarter that commences on [July] October 1, 2002 (or 
during such portion of the calendar quarter that commences on [July] 
October 1, 2002 in which the participant was so registered if the 
participant registered in mid quarter), provided it also satisfies 
all other requirements of a Primex Auction Market Maker pursuant to 
these rules. A participant that is newly registering as a Primex 
Auction Market Maker for a particular security any time after the 
start of the calendar quarter that commences on [October 1, 2002] 
January 1, 2003 may maintain its status as such until the end of the 
calendar quarter in which it registered without regard to the 
percentage of its orders it submits to the System for such security 
during that time.
    Beginning with the calendar quarter that commences on [January] 
April 1, 2003, and each calendar quarter thereafter, a participant 
previously registered as a Primex Auction Market Maker for a 
particular security may maintain its status as such until the end of 
that calendar quarter only if it submitted at least 80% of its 
Mandatory Eligible Orders during the previous calendar quarter (or 
during the portion of such previous calendar quarter in which it was 
so registered if the participant registered in mid quarter), 
provided it also satisfies all other requirements of a Primex 
Auction Market Maker pursuant to these rules.
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* * * * *
5021. [Anonymity, Execution,] Reporting[,] and Clearing
    (a) [Anonymity--The Application will process all activity among 
Participants on an anonymous basis until the end of the day.] After 
facilitating an execution, the Application will send an execution 
report to all Participants involved as soon as practicable. The 
execution report will indicate the details of the transaction, and [but 
will not] contain the identity of the contra-party. [At the end of each 
trading day, the actual contra-party for executions obtained within the 
Application will be made available to the Participants involved through 
Nasdaq's systems. For regulatory and other necessary purposes, the NASD 
and Nasdaq will have the ability to determine the identity of the 
actual contra-parties at any time.]
    (b) [Tape Reporting and Clearing--]Matches within the Application 
are executed and reported through Nasdaq systems for public tape 
reporting and forwarding to NSCC for clearing, where necessary. 
Participants (or their clearing brokers) are the parties responsible 
for the clearance and settlement of all trades executed through the 
Application. Once a transaction is executed, Participants do not have 
the ability within the Application to modify or reallocate any portion 
of the execution to a clearing broker other than the clearing broker 
that the Application associates with the [Participant] transaction at 
the time of execution. Neither the NASD (and its affiliates) nor any 
operator or administrator of the Primex Auction System shall be 
directly or indirectly a party to any transaction entered into, 
matched, or otherwise effected through the Application[, 
notwithstanding that, for the remainder of the trading day after a 
transaction, the actual contra-parties have not had their identities 
disclosed to each other by the Application].
* * * * *
    Nasdaq represents that it eliminated the end-of day anonymity 
feature to respond to concerns raised by clearing firms, and to 
harmonize the anonymity features of Primex and SuperMontage. Nasdaq 
represents that Primex continues to offer pre-trade anonymity, which 
also is a feature of SuperMontage.
    Nasdaq states that Primex originally was designed with an anonymity 
feature that masked until the end of the day the identity of parties 
trading in the System. When a match occurred in Primex, the parties 
would be notified that they executed a trade, but they would not know 
the identity of their counterparty until the end of the day.\22\ At the 
end of the day, the System would send messages to the parties revealing 
the identities of their counterparties. A participant would receive a 
message for each trade executed in the System. Nasdaq represents that 
the messages formats were unique to Primex, which required Primex users 
to program their internal systems to recognize the messages. Nasdaq 
believes this additional programming requirement created a disincentive 
for firms to participate in Primex. Nasdaq states that, in particular, 
clearing firms expressed a concern about the additional programming 
requirements, and some chose not to make the changes and thus not 
participate in Primex. Nasdaq states that when a clearing firm chose 
not to participate, its correspondent firms also could not participate.
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    \22\ The anonymity feature only masked the identity from the 
parties to the trade. Nasdaq staff could obtain the identity of the 
parties immediately.
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    Nasdaq represents that it eliminated the anonymity feature to 
remove this disincentive. With the end-of-day anonymity feature 
removed, the parties to a trade will be informed of their 
counterparty's identity immediately upon a match. Therefore, the need 
for the messages at the end of the day is eliminated. Nasdaq expects 
this change will result in greater participation in Primex.
    To further encourage participation in Primex, Nasdaq represents 
that it added a feature to assist members in complying with the NASD 
short sale rule. Specifically, Nasdaq represents that the System has 
been reprogrammed to prevent appropriately marked orders from executing 
in violation of this rule. An order that is marked to indicate that it 
is short sale, for which no exemption from the short sale rule is 
available (e.g., the market maker exemption), will not execute at or 
below the current best bid when the current best bid as displayed by 
Nasdaq is below the preceding best bid in the security.
    Primex also has been modified to account for Nasdaq simultaneously 
operating SuperSoes and SuperMontage. Primex always provided members an 
option to have certain orders routed to other Nasdaq execution systems 
after exposure in Primex.\23\ Nasdaq represents that, when Primex began 
operation, the SuperSoes version of NNMS was the only system to which 
orders in Nasdaq-listed stocks could be forwarded. Recently, however, 
Nasdaq began to phase in the SuperMontage version of NNMS on a 
security-by-security basis. As such, until the phase-in is complete, 
Nasdaq simultaneously will operate SuperSoes and SuperMontage. 
Accordingly, Primex has the functionality to route orders to

[[Page 8060]]

either of these systems, depending on whether the security is eligible 
for SuperSoes or SuperMontage. Nasdaq states that the functionality for 
routing orders to either SuperSoes or SuperMontage generally is the 
same. Only orders that are marked for routing outside Primex will be 
routed to SuperSoes or SuperMontage, and only after the order has been 
exposed in Primex and an unexecuted balance remains. While only Market 
Orders can be routed to SuperSoes, both Fixed Price Orders \24\ and 
Market Orders will be eligible for routing to SuperMontage. Orders 
routed to SuperMontage will be considered as immediate or cancel 
orders.
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    \23\ See proposed NASD Rule 5016.
    \24\ The term Fixed Price Order is defined in proposed NASD Rule 
5011(n) as an order submitted to Primex to purchase or sell a 
security at a specified, fixed price or better.
---------------------------------------------------------------------------

    To permit Primex to operate more efficiently with SuperMontage, 
Nasdaq also modified the System to allow it to accept orders with AIQ 
and AON conditions. These conditions can be attached to orders 
submitted to SuperMontage, but Primex originally was not designed to 
accept these types of orders. The AIQ functionality, when selected, can 
preclude an order from executing against proprietary interest from the 
same firm. The AIQ condition may be applied to orders, responses and 
indications. The function is designed to prevent intra-firm trades that 
may not be permissible for certain types of accounts, such as those 
subject to ERISA or an investment advisory relationship.
    The AON functionality allows Primex subscribers to place a 
condition on certain orders that ensures the order will be executed in 
its entirety or not at all. The AON condition can be used for orders 
that the subscriber exposes for a ``zero-second'' auction.
    Finally, Nasdaq is modifying the language in proposed NASD Rule 
5020 to reflect that it has delayed for an additional calendar quarter 
the rule implementing the requirement that PAMMs submit a certain 
percentage of Mandatory Eligible Orders \25\ to the System to be 
eligible for certain features of the System (the ``percentage test''). 
Some firms, especially those that are now expected to participate in 
Primex because the anonymity feature has been removed, need to 
reprogram their internal systems to make Primex an order routing 
destination. Nasdaq believes delaying the percentage test will allow 
firms to make these changes and gain experience with the System. The 
percentage test will continue to be measured on a quarterly basis. 
However, the phase-in schedule was amended to implement the test 
starting with the calendar quarter that begins on January 1, 2003, 
instead of October 1, 2002. Specifically, beginning on January 1, 2003, 
a participant previously registered as a PAMM can retain this status if 
it submitted to the System 50% of its Mandatory Eligible Orders during 
the calendar quarter that commences on October 1, 2002. Beginning on 
April 1, 2003, and every calendar quarter thereafter, a PAMM can retain 
its status if it submits 80% of its Mandatory Eligible Orders during 
the previous calendar quarter.
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    \25\ The term ``Mandatory Eligible Order'' is defined in 
proposed NASD Rules 5011 and 5020.
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VI. Amendment No. 3

    In Amendment No. 3, Nasdaq seeks permanent approval to (1) change 
the minimum size requirement for Predetermined Relative Indications 
from a tiered structure depending on the amount of price improvement, 
to a standard minimum size requirement of 100 shares, regardless of the 
amount of price improvement offered; (2) reprogram the System to reject 
trading interest marked as ``short'' or ``short exempt'' in any 
exchange-listed security eligible for participation in the InterMarket 
Trading System; and (3) modify proposed NASD Rule 5017 to be consistent 
with the system change relating to short sales set forth in Amendment 
No. 2. The amended rule text follows. New language is italicized; 
deleted language is in brackets.
5017. Short Sales
* * * * *
    (a) Participants [are responsible for] must properly identify 
trading interest as a long sale, short sale, or short sale exempt. 
[complying with applicable short sale rules when using the Application. 
No Participant shall submit to the Application an order for a security 
that, if executed, would result in a ``short sale'' as that term is 
defined in Exchange act Rule 3b-3, unless the transaction would be 
exempt from, or otherwise permissible under, the requirements of NASD 
Rule 3350 or Exchange Act Rule 10a-1, as applicable.]
    (b) The Application will not process trading interest to sell short 
a Nasdaq-listed security if the execution of such trading interest will 
violate Rule 3350.
    (c) The Application will reject trading interest identified as a 
short sale or short sale exempt in any exchange-listed security 
eligible for participation in the InterMarket Trading System.
5018. Responses and Indications
* * * * *
    (c) Indications--Indications are instructions, with the 
characteristics set forth below, submitted to the Application by 
Participants to interact with orders exposed in an Auction. An 
Indication may be a Predefined Relative Indication (``PRI'') or a Go-
Along Indication.
    (1) Predefined Relative Indications
    (A) No changes.
    (B) At the time of its original entry, each PRI submitted to the 
Application must be for at least 100 shares. [the following share 
amounts:
    (i) NBBO PRIs must be for at least 3000 shares upon entry;
    (ii) NBBO +/-.01 or .02 must be for at least 2000 shares upon 
entry;
    (iii) NBBO +/-.03 or greater must be for at least 1000 shares upon 
entry.]
    (C) No changes.
    (D) No changes.
    (E) No changes.
* * * * *
    Nasdaq represents that the graduated PRI size requirement was 
intended to make it less expensive to offer greater price improvement 
by requiring less of a share commitment as more price improvement was 
offered. Discussion with current and prospective users of Primex 
indicated to Nasdaq that the minimum size requirements are a 
disincentive to using PRIs because many of the trading strategies that 
would employ PRIs are most effective if the user has flexibility in the 
number of shares that must be committed. Nasdaq therefore proposes to 
eliminate the graduated, minimum size requirement and instead require a 
commitment of 100 shares, regardless of the amount of price improvement 
offered. With this change, Primex users would be able to enter PRIs for 
any round or mixed lot greater than 100 shares. Nasdaq believes this 
modification will encourage more users to submit PRIs, thus increasing 
the liquidity in Primex and the opportunities for price improvement.

VII. Discussion

    After careful consideration, the Commission finds, for the reasons 
discussed below, that the proposed rule change, as amended, is 
consistent with the Act and the rules and regulations applicable to the 
NASD, a registered securities association.\26\ We do not believe, as 
the NYSE suggests, that the

[[Page 8061]]

fact that Primex allows dealers to internalize customer orders should 
be viewed as a reason to deny permanent approval of Primex. The 
Commission believes that Primex may provide an opportunity for customer 
orders to receive price improvement, even if the customer order is 
internalized. In addition, the Commission believes that Primex may 
provide an opportunity for customer orders to be exposed to possible 
execution by market participants other than the Primex participant that 
brought the order to Primex. The Commission notes that its analysis of 
these issues may change in the context of Nasdaq's exchange 
application.
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    \26\ In this regard, the Commission disagrees with NYSE's 
argument that it must apply statutory requirements applicable to 
registered exchanges to Primex. The Commission notes that Nasdaq 
operates Primex as a facility of the NASD. The NASD is a registered 
securities association under Section 15A of the Act and is not a 
registered exchange under Section 6 of the Act. Nasdaq's application 
for registration as an exchange is pending with the Commission.
---------------------------------------------------------------------------

    In addition, the Commission believes the proposal is consistent 
with Rule 19b-5(f)(1) under the Act,\27\ because it has been submitted 
within two years after commencement of the operation of the System.
---------------------------------------------------------------------------

    \27\ 17 CFR 240.19b-5(f)(1).
---------------------------------------------------------------------------

    The Commission finds good cause for approving Amendment No. 1 of 
the proposed rule change prior to the thirtieth day after notice of the 
publication in the Federal Register. The language to be deleted by the 
amendment was inadvertently included; Amendment No. 1 reflects the 
current rules governing Primex's operation. The Commission also finds 
good cause for approving Amendment No. 2 of the proposed rule change 
prior to the thirtieth day after notice of the publication in the 
Federal Register. Amendment No. 2 also reflects the current rules 
governing Primex's operation. In addition, Amendment No. 2 removes a 
disincentive to participation in Primex by deleting a programming 
requirement associated with an end-of-day anonymity feature; assists 
participants in complying with the Short Sale Rule by adding a useful 
feature that prevents violative orders from executing on the System; 
promotes opportunities for greater order interaction and possible price 
improvement by allowing unexecuted Primex orders to be routed to 
SuperMontage; and enhances Primex as a potential order-routing 
destination by providing firms with additional time to program their 
internal systems to accommodate Primex. The Commission also finds good 
cause for approving Amendment No. 3 of the proposed rule change prior 
to the thirtieth day after notice of the publication in the Federal 
Register. Amendment No. 3 also reflects the current rules governing 
Primex's operation. In addition, Amendment No. 3 assists participants 
in complying with the Short Sale Rule and removes a disincentive to 
participation in Primex by implementing a less restrictive minimum size 
requirement for PRIs. The Commission believes Amendment Nos. 1, 2, and 
3 are consistent with Sections 15A(b)(6) and (11), and 11A(a)(1)(C) of 
the Act,\28\ and Rule 19b-5 under the Act,\29\ and therefore the 
approval of Amendment Nos. 1, 2, and 3 on an accelerated basis is 
appropriate.
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    \28\ 15 U.S.C. 78o-3(b)(6) and (11), and 15 U.S.C. 78k-
1(a)(1)(C).
    \29\ 17 CFR 240.19b-5.
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    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1, 2, and 3, including whether the 
proposed amendments are 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 amendments that are 
filed with the Commission, and all written communications relating to 
the amendments 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 at the 
Commission's Public Reference Room. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-2002-60 and 
should be submitted by March 12, 2003.

VIII. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\30\ that the proposed rule change (SR-NASD-2002-60) is approved 
and Amendment Nos. 1, 2, and 3 are approved on an accelerated basis.
---------------------------------------------------------------------------

    \30\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\31\
---------------------------------------------------------------------------

    \31\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-3945 Filed 2-18-03; 8:45 am]
BILLING CODE 8010-01-P