[Federal Register Volume 68, Number 249 (Tuesday, December 30, 2003)]
[Notices]
[Pages 75299-75301]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-32037]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48967; File No. SR-NASD-03-191]


Self-Regulatory Organizations; Notice of Filing of a Proposed 
Rule Change by the National Association of Securities Dealers, Inc. 
Relating to an Extension of the Short Sale Rule and Continued 
Suspension of the Primary Market Maker Standards Set Forth in NASD Rule 
4612

December 22, 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 19, 2003, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its subsidiary, The Nasdaq 
Stock Market, Inc. (``Nasdaq'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by the Nasdaq. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Nasdaq is proposing to extend the pilot program of the National 
Association of Securities Dealers' short sale rule retroactively to 
December 15 and prospectively until June 15, 2004. The Nasdaq is also 
seeking to continue the suspension of the effectiveness of the Primary 
Market Maker (``PMM'') standards currently set forth in NASD Rule 4162, 
also retroactive to December 15, 2003 and prospective through June 15, 
2004. The text of the proposed rule change is as follows. Additions are 
italicized; deletions are bracketed.
* * * * *

NASD Rule 3350

    (a)-(k) No Change.
    (l) This section shall be in effect until June 15, 2004 [December 
15, 2003].
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the 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 III below. The 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
    Background and Description of the NASD's Short Sale Rule. Section 
10(a) of the Act \3\ gives the Commission plenary authority to regulate 
short sales of securities registered on a national securities exchange, 
as needed to protect investors. Although the Commission has regulated 
short sales since 1938, that regulation has been limited to short sales 
of exchange-listed securities. In 1992, the Nasdaq, believing that 
short-sale regulation is important to the orderly operation of 
securities markets, proposed a short sale rule for trading of its 
National Market securities that incorporates the protections provided 
by Rule 10a-1 under the Act.\4\ On June 29, 1994, the Commission 
approved the NASD's short sale rule (the ``Rule'') applicable to short 
sales \5\ in Nasdaq National Market (``NNM'') securities on an 
eighteen-month pilot basis through March 5, 1996.\6\ The NASD and the 
Commission have extended NASD Rule 3350 numerous times, most recently, 
until December 15, 2003.
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    \3\ 15 U.S.C. 78a(10)(A).
    \4\ 17 CFR 240.10a-1.
    \5\ A short sale is a sale of a security that the seller does 
not own or any sale that is consummated by the delivery of a 
security borrowed by, or for the account of, the seller. To 
determine whether a sale is a short sale members must adhere to the 
definition of a ``short sale'' contained in Rule 3b-3 of the Act, 
which is incorporated into Nasdaq's short sale rule by NASD Rule 
3350(k)(1).
    \6\ See Securities Exchange Act Release No. 34277 (June 29, 
1994), 59 FR 34885 (July 7, 1994) (``Short Sale Rule Approval 
Order'').
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    The Rule employs a ``bid'' test rather than a tick test because 
Nasdaq trades are not necessarily reported to the tape in chronological 
order. The Rule prohibits short sales at or below the inside bid when 
the current inside bid is below the previous inside bid. The Nasdaq 
calculates the inside bid from all market makers in the security and 
disseminates symbols to denote whether the current inside bid is an 
``up-bid'' or a ``down-bid.'' To effect a ``legal'' short sale on a 
down-bid, the short sale must be executed at a price at least $.01 
above the current inside bid. The Rule is in effect from 9:30 a.m. 
until 4:00 p.m. each trading day.
    In December of 2002, the Nasdaq modified the method it uses to 
calculate the last bid by having it refer to the ``Nasdaq Inside'' 
which is comprised of quotations from all participants in Nasdaq 
execution systems (e.g., SuperMontage), rather than referring to the 
National Best Bid and Offer (``NBBO''). The Nasdaq currently calculates 
and applies the Nasdaq-based bid tick indicator to all SuperMontage 
trades. With respect to trades executed outside Nasdaq execution 
systems and reported to the Nasdaq, Nasdaq participants have been 
permitted to transition from the NBBO-based bid tick to the Nasdaq-
based bid tick, provided that each firm select and apply a single bid 
tick indicator for all such trades executed by that firm. That 
transition has not been completed and, as explained below, in light of 
the Commission's proposal of Regulation SHO, the Nasdaq has alerted 
members that it would not be prudent to transition from the NBBO bid 
tick to the Nasdaq bid tick at this time.
    To reduce the compliance burdens on its members, the Rule also 
incorporates seven exemptions contained in Rule 10a-1 under the Act,\7\ 
and other exemptions that are relevant to trading

[[Page 75300]]

on the Nasdaq.\8\ For example, in an effort to not constrain the 
legitimate hedging needs of options market makers, the Rule also 
contains a limited exception for standardized options market makers. 
The Rule also contains an exemption for warrant market makers similar 
to the one available for options market makers.
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    \7\ 17 CFR 240.10a-1.
    \8\ See NASD Rule 3350(c)(2)-(8). The Rule also provides that a 
member not currently registered as a Nasdaq market maker in a 
security that has acquired the security while acting in the capacity 
of a block positioner shall be deemed to own such security for the 
purposes of the Rule notwithstanding that such member may not have a 
net long position in such security if and to the extent that such 
member's short position in such security is subject to one or more 
offsetting positions created in the course of bona fide arbitrage, 
risk arbitrage, or bona fide hedge activities. In addition, the NASD 
has recognized that Commission staff interpretations to Rule 10a-1 
under the Act dealing with the liquidation of index arbitrage 
positions and an ``international equalizing exemption'' are equally 
applicable to the NASD's short sale rule.
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    Background of the Primary Market Maker Standards. To ensure that 
market maker activities that provide liquidity and continuity to the 
market are not adversely constrained when the short sale rule is 
invoked, NASD Rule 3350 provides an exemption for ``qualified'' market 
makers (i.e., market makers that meet the PMM standards). Presently, 
NASD Rule 4612 provides that a member registered as a market maker 
pursuant to NASD Rule 4611 may be deemed a PMM if that member meets 
certain threshold standards.
    Since the Rule has been in effect, the Nasdaq has used three 
methods to determine whether a market maker is eligible for the market 
maker exemption. Specifically, from September 4, 1994 through February 
1, 1996, Nasdaq market makers that maintained a quotation in a 
particular NNM security for 20 consecutive business days without 
interruption were exempt from the Rule for short sales in that 
security, provided the short sales were made in connection with bona 
fide market making activity (``the 20-day'' test). From February 1, 
1996 until the February 14, 1997, the ``20-day'' test was replaced with 
a four-part quantitative test known as the PMM standards.\9\
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    \9\ Under the PMM standards, a market maker was required to 
satisfy at least two of the following four criteria each month to be 
eligible for an exemption from the short sale rule: (1) The market 
maker must be at the best bid or best offer as shown on Nasdaq no 
less that 35 percent of the time; (2) the market maker must maintain 
a spread no greater than 102 percent of the average dealer spread; 
(3) no more than 50 percent of the market maker's quotation updates 
may occur without being accompanied by a trade execution of at least 
one unit of trading; or (4) the market maker executes 1 1/2 times 
its ``proportionate'' volume in the stock. If a PMM did not satisfy 
the threshold standards after a particular review period, the market 
maker lost its designation as a PMM (i.e. the ``P'' next to its 
market maker identification was removed). Market makers could re-
qualify for designation as a PMM by satisfying the threshold 
standards in the next review period.
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    On February 14, 1997, the PMM standards were waived for all NNM 
securities due to the impact of the Commission's Order Handling Rules 
and corresponding NASD rule change and system modifications on the 
operation of the four quantitative standards.\10\ For example, among 
other impacts, the requirement that market makers display customer 
limit orders adversely affected the ability of market makers to satisfy 
the ``102% Average Spread Standard''. Since that time all Nasdaq Market 
Makers have been deemed to be PMMs.
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    \10\ See Securities Exchange Act Release No. 38294 (February 17, 
1997), 62 FR 8289 (February 24, 1997).
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    In March 1998, the Nasdaq proposed PMM standards that received 
substantially negative comments.\11\ In light of those comments, Nasdaq 
staff convened an advisory subcommittee to develop new PMM standards 
(``Subcommittee'') in August 1998. The Subcommittee met nine times and 
formulated new PMM standards. NASD/Nasdaq staff requested to meet with 
the Commission staff and the Subcommittee to receive informal feedback 
on the new PMM standards. This meeting occurred on December 9, 1998. At 
the conclusion of the meeting, Commission staff noted the progress made 
by the Subcommittee and requested time to digest and more carefully 
analyze the proposed new PMM standards.
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    \11\ See Securities Exchange Act Release No. 39189 (March 30, 
1998), 63 FR 16841 (April 6, 1998).
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    On July 29, 1999, members of the Nasdaq staff conducted a 
conference call with members of the Commission staff to receive 
feedback on the PMM standards that the Nasdaq presented at the December 
9, 1998 meeting. During the meeting, the Commission staff requested 
that the Nasdaq modify several of the proposed standards and analyze 
the impact of those modifications on the primary market maker 
determination. On September 27, 1999, the Nasdaq reported that the NASD 
Economic Research staff had analyzed data based on the Commission's 
recommended revisions, and concluded that the Commission's modified 
standards produced unfavorable results. The Nasdaq requested that the 
Commission comment on the outcome of this test ``as we intend to 
communicate your comments to the Subcommittee in an effort to resume 
the process of developing new standards.''\12\
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    \12\ See Letter, dated September 27, 1999 from John F. Malitzis, 
Assistant General Counsel, Nasdaq, to Richard Strasser, Assistant 
Director, Division of Market Regulation, Commission.
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    The Nasdaq suspended development of PMM standards in late-1999 
after the Commission signaled to the securities industry that it is 
considering fundamental changes to Rule 10a-1, changes that could 
impact the manner in which the Nasdaq and the other markets regulate 
short sales. In October 1999, the Commission issued a Concept Release 
on Short Sales in which it sought comment on, among other things, 
revising the definition of a short sale, extending short sale 
regulation to non-exchange listed securities, and eliminating short 
sale regulation altogether. The Nasdaq believed that it would be 
inappropriate for the Nasdaq to dramatically alter its regulation of 
short sales while the Commission is considering fundamentally changing 
Rule 10a-1. At the request of the staff of the Division of Market 
Regulation, the Nasdaq has resumed development of PMM standards and has 
been working with the Commission staff towards that goal.
    Proposal to Extend the Short Sale Rule and Suspend the PMM 
Standards. The Nasdaq believes that it is in the best interest of 
investors to extend the short sale regulation pilot program. When the 
Commission approved the NASD's short sale rule on a pilot basis, it 
made specific findings that the Rule was consistent with Sections 11A, 
15A(b)(6), 15A(b)(9), and 15A(b)(11) of the Act. Specifically, the 
Commission stated that, ``recognizing the potential for problems 
associated with short selling, the changing expectations of Nasdaq 
market participants and the competitive disparity between the exchange 
markets and the OTC market, the Commission believes that regulation of 
short selling of Nasdaq National Market securities is consistent with 
the Act.''\13\ In addition, the Commission stated that it ``believes 
that the NASD's short sale bid-test, including the market maker 
exemptions, is a reasonable approach to short sale regulation of Nasdaq 
National Market securities and reflects the realities of its market 
structure.''\14\ The benefits that the Commission recognized when it 
first approved NASD Rule 3350 apply with equal force today.
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    \13\ See Short Sale Rule Approval Order, supra note 2.
    \14\ Id.
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    The Nasdaq notes that the Commission has proposed Regulation SHO, a 
unified short sale rule that, if approved, would apply to Nasdaq-listed

[[Page 75301]]

securities and would supersede NASD Rule 3350. The Nasdaq has alerted 
market participants that the adoption of Regulation SHO would impact 
the regulation of short sales on the Nasdaq and on other markets in a 
number of ways. The adoption of Regulation SHO would supersede elements 
of this proposal, including requiring short sales on the Nasdaq to 
utilize an NBBO-based bid test and eliminating the application of 
primary market maker standards. The Nasdaq has encouraged firms to 
analyze the proposal and its impact on their execution and order 
management systems in anticipation of its adoption.
2. Statutory Basis
    The Nasdaq believes that the proposed rule change is consistent 
with the provisions of Section 15A of the Act,\15\ in general and with 
Section 15A(b)(6) of the Act,\16\ in particular, in that it is designed 
to prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, remove impediments to a free 
and open market and a national market system, and, in general, to 
protect investors and the public interest.
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    \15\ 15 U.S.C. 78o-3.
    \16\ 15 U.S.C. 78o-3(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Nasdaq does not believe that the proposed rule change will 
impose any burden on competition.

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

    The Nasdaq neither solicited nor received written comments with 
respect to the proposed rule change.

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

    Because the proposed rule change: (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 from the date of filing, 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 \17\ and Rule 19b-
4(f)(6)\18\ thereunder.
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    \17\ 15 U.S.C. 78s(b)(3)(A).
    \18\ 17 CFR 240.19b-4(f)(6).
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    A proposed rule change filed under Rule 19b-4(f)(6)\19\ normally 
does not become operative prior to 30 days after the date of filing. 
However, pursuant to Rule 19b-4(f)(6)(iii),\20\ the Commission may 
designate a shorter time if such action is consistent with the 
protection of investors and public interest. The Nasdaq seeks to have 
the proposed rule change become operative on or before December 16, 
2003, in order to allow the Pilot to continue in effect on an 
uninterrupted basis. In addition, under Rule 19b-4(f)(6)(iii),\21\ the 
Nasdaq is required to provide the Commission with written notice of its 
intent to file the proposed rule change at least five business days 
prior to the filing date or such shorter time as designated by the 
Commission. The Commission has waived the five-day pre-notice 
requirement for this proposed rule change. In addition, for the reasons 
discussed below, the Commission has also waived the thirty-day 
operative date requirement for this proposed rule change.
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    \19\ Id.
    \20\ 17 CFR 240.19b-4(f)(6)(iii).
    \21\ 17 CFR 240.19b-4(f)(6).
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    The Commission notes that unless extended, the Pilot will expire, 
and this could disrupt the proper operation of the Nasdaq. At any time 
within 60 days of the filing of the proposed rule change, 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.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change 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. 
Comments may also be submitted electronically at the following e-mail 
address: [email protected]. All comment letters should refer to 
File No. SR-NASD-2003-191. This file number should be included on the 
subject line if e-mail is used. To help the Commission process and 
review comments more efficiently, comments should be sent in hardcopy 
or by e-mail but not by both methods. 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-2003-191 and should be 
submitted by January 20, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-32037 Filed 12-29-03; 8:45 am]
BILLING CODE 8010-01-P