[Federal Register Volume 68, Number 59 (Thursday, March 27, 2003)]
[Notices]
[Pages 15024-15027]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-7345]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47554; File No. SR-NASD-2003-39]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change and Amendment No. 1 Thereto by 
National Association of Securities Dealers, Inc. Relating to Anti-
Internalization Qualifier Values

March 21, 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 March 12, 2003, The National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association''), through its subsidiary, The Nasdaq Stock 
Market, Inc. (``Nasdaq''), submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by Nasdaq. On March 14, 2003, Nasdaq filed Amendment No. 1 to the 
proposal.\3\ The Commission is publishing this notice, as amended, to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Thomas P. Moran, Associate General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated March 14, 2003 
(``Amendment No. 1''). In Amendment No. 1, Nasdaq clarified that the 
Anti-Internalization Qualifier (``AIQ'') ``I'' Value for Nasdaq 
Quoting Market Participants would be available on May 12, 2003. For 
the purposes of calculating the 60-day abrogation period, the 
Commission considers the proposed rule change to have been filed on 
March 14, 2003, the date Nasdaq filed Amendment No. 1.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq proposes to allow the Quotes/Orders of Nasdaq Quoting Market 
Participants and NNMS Order Entry Firms in its SuperMontage system to 
interact with Quotes/Orders entered by that same participant on the 
other side of the market based strictly on the execution algorithm 
selected. Nasdaq also proposes to codify the function that precludes 
the Quotes/Orders of Nasdaq Quoting Market Participant or NNMS Order 
Entry Firms from interacting with Quotes/Orders entered by the same 
participant on the other side of the market. The text of the proposed 
rule change follows.
    Proposed new language is italicized; proposed deletions are in 
[brackets].

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

[[Page 15025]]

NNMS Order Entry Firms, shall participate in the NNMS as follows:
    (i) NNMS Market Makers, 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 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. 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) through (iii) No Change.
    (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)] March 17, 
2003, 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. Nasdaq Quoting 
Market Participants may, and NNMS Order Entry Firms must, avoid any 
attempted automatic system matching permitted by this paragraph through 
the use of an anti-internalization qualifier (AIQ) quote/order flag 
containing the following values: ``Y'' or ``I'', subject to the 
following restrictions:
    Y--if the Y value is selected, the system will execute the flagged 
quote/order solely against attributable and non-attributable quotes/
orders (displayed and reserve) of Quoting Market Participants and NNMS 
Order Entry Firms other than the party entering the AIQ ``Y'' flagged 
quote/order. If the only available trading interest is that of the same 
party that entered the AIQ ``Y'' flagged quote/order, the system will 
not execute at an inferior price level, and will instead return the 
latest entered of those interacting quote/orders (or unexecuted 
portions thereof) to the entering party.
    I--if the I value is selected, the system will execute against all 
available trading interest, including the quote/orders of the NNMS 
Order Entry Firm or Nasdaq Quoting Market Participant that entered the 
AIQ ``I'' flagged order, based exclusively on the execution algorithm 
selected when entering the AIQ I flagged quote/order.
    The I value described above shall be available for the use of NNMS 
Order Entry Firms on March 17, 2003, and available for use by Nasdaq 
Quoting Market Participants on May 12, 2003.
    (b) through (c) No Change.
    (C) through (D) No Change.
    (2) through (8) No Change.
    (c) through (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 and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. Nasdaq has prepared summaries, set forth in sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    On January 31, 2003, the Commission approved File No. SR-NASD-2002-
173 on a 90-pilot basis,\4\ to allow NNMS Order Entry Firms to enter 
non-marketable limit orders into Nasdaq's SuperMontage system using the 
SIZE MMID.\5\ Under new processing set to commence on March 17, 2003, 
the quotes/orders of NNMS Order Entry Firms on opposite sides of the 
market will interact with each other only if such interaction would 
result based on the execution algorithm selected (price/time, price/
time with fee consideration, or price/size). This filing seeks to 
provide this same option to Nasdaq Quoting Market Participants, and 
codify current SuperMontage functionality related to the use of the 
Anti-Internalization Qualifier order flag.
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    \4\ See Securities Exchange Act Release No. 47301 (January 31, 
2003), 68 FR 6236 (February 6, 2003).
    \5\ 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 and Orders are not displayed in the Nasdaq 
Quotation Montage using the market participant's MMID. Instead, 
these are displayed next to the SIZE MMID.
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    Currently, SuperMontage market participants that do not wish to 
execute against themselves may voluntarily designate individual quotes/
orders so that they do not automatically interact

[[Page 15026]]

in SuperMontage with any quotes/orders entered by that same firm on the 
other side of the market by attaching an AIQ flag to the quote/order. 
The AIQ flag is designed to assist market participants in complying 
with certain rules and regulations of the Employee Retirement Income 
Security Act (``ERISA'') that preclude and/or limit managing broker-
dealers of such accounts from trading as principal with orders 
generated for those accounts. SuperMontage will not cross an AIQ-
flagged order with a ``Y'' value that resides in the system's book, or 
is entered for immediate execution, with another quote/order from that 
same market participant. Instead, the system executes against eligible 
trading interest of other market participants at that same price level. 
If there is no such interest, SuperMontage allows no execution, does 
not go the next price level, and rejects back to the entering party the 
most recently entered of its two interacting quote/orders.
    In order to accommodate potential interaction of bid and offer 
quote/orders of NNMS Order Entry Firms based solely on the execution 
algorithm selected as contemplated in File No. SR-NASD-2002-173, Nasdaq 
modified the AIQ flag. In addition to the current AIQ default value of 
``N'' (allow internalization), and the ability to enter, on an order-
by-order basis, an AIQ ``Y'' value (prohibit internalization), a new 
AIQ value of ``I'' (allow internalization based solely on execution 
algorithm) was created.\6\ Quotes/Orders designated with an AIQ value 
of I skip SuperMontage's automatic internalization function and match 
off against trading interest entered by that same firm on the other 
side of the market only if such buy and sell interest would naturally 
meet based on the selected execution algorithm. In short, the AIQ I 
value neither forces nor prohibits internalization, and on March 17, 
2003, will become the default value for NNMS Order Entry Firms.\7\
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    \6\ See Nasdaq Head Trader Alert 2003-026 (February 24, 
2003).
    \7\ NNMS Order Entry Firms will continue to be able to use the 
AIQ Y value on an order-by-order basis, but, in conformity with SR-
NASD-2002-173, will not be permitted to use the AIQ N value.
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    The following example illustrate how the AIQ I value works:
    [sbull] MMA enters 1000 share market order to buy with AIQ Y value 
(prohibit internalization), price/time.
Inside Offer
MMB--$20 x 500
ECN1--$20 x 400
MMA--$20 x 400

    Resulting executions: 500 against MMB; 400 against ECN1; 100 
rejected back to MMA because it would cross/internalize.
    [sbull] MMA enters 1000 share market order to buy with AIQ I value 
(internalize based only on execution algorithm selected), price/time.
Inside Offer
MMB--$20 x 500
ECN1--$20 x 400
MMA--$20 x 400

    Resulting executions: 500 against MMB; 400 against ECN1; 100 
executed against MMA because the interaction of MMA's buy order and its 
offer quote occurs naturally based on the price/time execution 
algorithm selected.
    This filing seeks to provide this same ``natural'' internalization 
option to Nasdaq Quoting Market Participants. Like the other AIQ values 
available to Nasdaq Quoting Market Participants, use of the AIQ I value 
would be purely voluntary and could be used on an order-by-order basis. 
Nasdaq believes that the AIQ I value provides additional flexibility 
for Nasdaq Quoting Market Participants to manage the interaction of 
quotes/orders submitted by them to better serve their customers. In 
addition, the natural quote/order interaction provided by the AIQ I 
value may also assist market participants in satisfying certain ERISA 
regulatory exemptions and thus permit them to interact with orders from 
otherwise restricted accounts since such executions would occur 
naturally in the SuperMontage system. Finally, Nasdaq notes that use of 
AIQ I value simply results in Nasdaq Quoting Market Participants having 
the option to have their orders execute pursuant to well-recognized and 
widely-used execution algorithms such as price/time and price/size that 
have already been approved by the Commission for the SuperMontage 
system.
2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of section 15A(b)(6) of the Act \8\ in that the proposal 
is designed to promote just and equitable principles of trade, foster 
cooperation and coordination with persons engaged in processing 
information with respect to and facilitating transactions in 
securities, as well as removing impediments to and perfect the 
mechanism of a free and open market, and, in general, to protect 
investors and the public interest.
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    \8\ 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 will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the foregoing proposed rule: (1) Does not significantly 
affect the protection of investors or the public interest; (2) does not 
impose any significant burden on competition; and (3) does not become 
operative for 30 days or such shorter time as the Commission may 
designate, if consistent with the protection of investors and the 
public interest, the proposed rule change has become effective pursuant 
to section 19(b)(3)(A) of the Act,\9\ and subparagraph (f)(6) of Rule 
19b-4 thereunder.\10\ At any time within 60 days of the filing of the 
proposed rule change, as amended, the Commission may summarily abrogate 
such rule change if it appears to the Commission that such action is 
necessary or appropriate in the public interest, for the protection of 
investors, or otherwise in furtherance of the purposes of the Act.
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    \9\ 15 U.S.C. 78s(b)(3)(A).
    \10\ 17 CFR 240.19b-4(f)(6).
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    Nasdaq has requested that the Commission waive the 30-day operative 
delay. The Commission believes that it is consistent with the 
protection of investors and the public interest to waive the 30-day 
operative delay.\11\ The Commission notes that the proposed AIQ I flag 
codifies the order interaction contemplated by Nasdaq in File No. SR-
NASD-2003-173 for NNMS Order Entry Firms, as well as provides Nasdaq 
Quoting Market Participants with the same option. Further, the AIQ Y 
flag codifies the existing function whereby Nasdaq Quoting Market 
Participants and, now Order Entry Firms, may avoid internalization 
entirely. The AIQ Y flag exists to assist certain market participants 
in complying with certain

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ERISA rules and regulations that preclude and/or limit managing broker-
dealers of such accounts from trading as principal.
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    \11\ For purposes of only accelerating the operative date of 
this proposal, the Commission has considered the proposed rule's 
impact on efficiency, competition and capital formation. 15 U.S.C. 
78c(f). As a result of the waiver, the effective and operative date 
of the filing is March 14, 2003, the date Nasdaq filed Amendment No. 
1.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NASD.
    All submissions should refer to File No. SR-NASD-2003-39 and should 
be submitted by April 17, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-7345 Filed 3-26-03; 8:45 am]
BILLING CODE 8010-01-P