[Federal Register Volume 69, Number 53 (Thursday, March 18, 2004)]
[Notices]
[Pages 12879-12881]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-6068]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49406; File No. SR-NASD-2003-173]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment Nos. 1 and 2 Thereto by the National Association 
of Securities Dealers, Inc., Through Its subsidiary, The Nasdaq Stock 
Market, Inc., Relating to the Nasdaq Closing Cross

March 11, 2004.

I. Introduction

    On November 25, 2003, the National Association of Securities 
Dealers, Inc. (``NASD''), through its subsidiary, The Nasdaq Stock 
Market, Inc. (``Nasdaq''), filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to establish a Nasdaq closing 
cross for certain Nasdaq national market securities (``Nasdaq Closing 
Cross'').
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal 
Register on December 11, 2003.\3\ The Commission received two comment 
letters on the proposal.\4\ Nasdaq

[[Page 12880]]

submitted two letters responding to the comment letters.\5\ On February 
11, 2004, Nasdaq amended the proposed rule change.\6\ On March 4, 2004, 
Nasdaq again amended the proposed rule change.\7\ This order approves 
the proposed rule change, as amended by Amendment Nos. 1 and 2.
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    \3\ See Securities Exchange Act Release No. 48878 (December 4, 
2003), 68 FR 69098.
    \4\ See letter from Kim Bang, Bloomberg Tradebook LLC, to 
Jonathan G. Katz, Secretary, Commission, dated January 6, 2003 (sic) 
(``Bloomberg Letter''); and letter from Michael Ryan, Executive Vice 
President and General Counsel, American Stock Exchange, to Jonathan 
G. Katz, Secretary, Commission, dated January 6, 2004 (``Amex 
Letter'').
    \5\ See letter from Jeffrey S. Davis, Nasdaq, to Jonathan G. 
Katz, Secretary, Commission, dated January 23, 2004; and letter from 
Edward S. Knight, Executive Vice President, Nasdaq, to The Honorable 
William H. Donaldson, Chairman, Commission, dated February 10, 2004.
    \6\ See letter from Jeffrey S. Davis, Nasdaq, to Katherine 
England, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated February 11, 2004 (``Amendment No. 
1''). In Amendment No. 1, Nasdaq revised the proposed rule change to 
amend the ``circuit breaker'' for the Closing Cross to establish the 
Volume Weighted Average Price (``VWAP'') as the exclusive benchmark 
for determination of the threshold percentage, rather than rely on 
both the VWAP and the Volume Weighted Average NASDAQ Inside 
(``VWAI''), as initially proposed. This was a technical amendment 
and is not subject to notice and comment.
    \7\ See letter from Jeffrey S. Davis, Nasdaq, to Katherine 
England, Assistant Director, Division, Commission, dated March 4, 
2004 (``Amendment No. 2''). In Amendment No. 2, Nasdaq revised the 
text of the proposed rule change to make certain clarifying and 
technical changes. This was a technical amendment and is not subject 
to notice and comment. The language of the proposed rule change is 
attached as Exhibit A.
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II. Description of Proposed Rule Change

    The proposed rule change would establish the Nasdaq Closing Cross 
for certain Nasdaq national market securities. There would be three 
components of the Nasdaq Closing Cross: (1) The creation of on close 
and imbalance only order types; (2) the dissemination of an order 
imbalance indicator via electronic means; and (3) closing cross 
processing in SuperMontage at 4:00:00 that would execute the maximum 
number of shares at a single, representative price that would be the 
Nasdaq Official Closing Price.

III. Comment Summary

    The Bloomberg Letter raised an objection on several grounds to the 
requirement that trading interest be subject to automatic execution in 
order to take part in the Nasdaq Closing Cross. The Bloomberg Letter 
opined that, because the Nasdaq Closing Cross would exclude trades, and 
therefore liquidity, in Nasdaq securities that occur on electronic 
communications networks that have elected order delivery rather than 
auto-execution, the closing price would likely be inaccurate, 
incomplete and misleading. The Bloomberg Letter commented further that 
the proposed rule change would violate Section 15A(b)(6) of the Act \8\ 
which requires that the rules of a national securities association not 
be designed to permit unfair discrimination between customers, issuers, 
brokers or dealers. Finally, the Bloomberg Letter stated that the 
proposed rule change would constitute a constructive denial of access 
to ECNs, which would constitute, in turn, an unnecessary or 
inappropriate burden on competition in violation of Section 15A(b)(8) 
of the Act.\9\
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    \8\ 15 U.S.C. 78o-3(b)(6).
    \9\ 15 U.S.C. 78o-3(b)(8).
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    The Amex Letter's primary comment was that the Nasdaq Closing Cross 
would provide Nasdaq officials with too much discretion and that the 
adjustment process for the ``circuit breaker'' amounts would allow for 
too much subjectivity. Specifically, the Amex Letter objected to: (1) 
The fact that, in its opinion, a crossing price could be selected in a 
manner that does not reflect true market forces; (2) the potential it 
sees for manipulation of the crossing price determination; and (3) the 
potential it sees for the crossing price determination to be influenced 
by certain Nasdaq member firms who may intervene for their own 
interests. The Amex Letter stated further that the ``circuit breaker'' 
procedures, including the benchmark values of the VWAP and the VWAI, 
were subjective and confusing.
    In its response letters, Nasdaq spoke to the comments raised in the 
Bloomberg Letter, stating that Bloomberg's business decision to execute 
orders internally within Bloomberg's book rather than offering 
automatic execution on SuperMontage should not impede Nasdaq from 
proceeding with a market enhancement. Nasdaq suggested that there are 
multiple options that Bloomberg could pursue to satisfy its customers' 
interest in participating fully in the Nasdaq Closing Cross, such as 
(1) by participating in the Closing Cross on an automatic execution 
basis; (2) by routing standing limit orders through another participant 
that participates on an automatic execution basis, or (3) by discussing 
with Nasdaq the possibility of establishing a second market participant 
identifier for the entry of orders eligible to participate in the 
Closing Cross. Moreover, Nasdaq stated that the Closing Cross is 
inherently a ``match'' `` matching interest of buyers and sellers at a 
single instant in time `` and is not conducive to an iterative order 
delivery process, which would create substantial technical difficulties 
for Nasdaq and unwarranted risk for other market participants.
    Nasdaq's response letters also spoke to the concerns raised in the 
Amex Letter with respect to subjectivity, discretion of Nasdaq 
officials, and the circuit breaker. Nasdaq stated that the Closing 
Cross is designed to avoid ever triggering the circuit breaker and that 
the circuit breaker is intended as a prophylactic measure to protect 
investors. Nasdaq stated that the threshold percentage for the circuit 
breaker would be established well in advance and would be modified only 
in rare instances, such as index adjustments and options expirations. 
Moreover, rather than being subjective, the Closing Cross algorithm, 
including the threshold comparison, would be completely automated and 
closely tied to market values at the close of the trading day. In 
addition, in response to industry feedback, including the Amex Letter, 
Nasdaq amended the proposed rule change to establish the VWAP as the 
exclusive benchmark for determination of the threshold percentage, 
rather than rely on both the VWAP and the VWAI as initially proposed.

IV. Discussion and Commission's Findings

    After careful consideration of the proposed rule change, the 
comment letters, and Nasdaq's responses to the comment letters, the 
Commission finds that the proposed rule change is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities association.\10\ The Commission 
believes that the proposed rule change is consistent with Section 
15A(b) of the Act,\11\ in general, and furthers the objectives of 
Section 15A(b)(6),\12\ in particular, in that it is designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and in

[[Page 12881]]

general, to protect investors and the public interest.
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    \10\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \11\ 15 U.S.C. 78o-3(b).
    \12\ 15 U.S.C. 78o-3(b)(6).
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    The Commission believes that Nasdaq has adequately addressed the 
comments raised in the comment letters. The Commission also believes 
that the proposed rule change may provide useful information to market 
participants and may minimize price volatility on the close. In 
addition, the Commission believes that the proposed rule change may 
result in the public dissemination of information that more accurately 
reflects the trading in a particular security at the close.

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the requirements of the Act and rules 
and regulations thereunder applicable to a national securities 
association, and, in particular, Section 15A(b) of the Act.\13\
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    \13\ 15 U.S.C. 78o-3(b).
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    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR--NASD-2003-173) as amended 
by Amendment Nos. 1 and 2 is approved.
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    \14\ 15 U.S.C. 78s(b)(2).
    \15\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
Margaret H. McFarland,
Deputy Secretary.

Exhibit A

    Proposed new language is in italics.

Rule 4709 Nasdaq Closing Cross

    (a) Definitions. For the purposes of this rule the term:
    (1) ``Imbalance'' shall mean the number of shares of buy or sell 
MOC or LOC orders that cannot be matched with other MOC or LOC or IO 
order shares at a particular price at any given time.
    (2) ``Imbalance Only Order'' or ``IO'' shall mean an order to buy 
or sell at a specified price or better that may be executed only during 
the Nasdaq Closing Cross and only against MOC or LOC orders. IO orders 
can be entered between 9:30:01 a.m. and 3:59:59 p.m., but they cannot 
be cancelled or modified after 3:50:00 except to increase the number of 
shares or to increase (decrease) the buy (sell) limit price. IO sell 
(buy) orders will only execute at or above (below) the 4:00:00 
SuperMontage offer (bid). All IO orders must be available for automatic 
execution.
    (3) ``Limit On Close Order'' or ``LOC'' shall mean an order to buy 
or sell at a specified price or better that is to be executed only 
during the Nasdaq Closing Cross. LOC orders can be entered, cancelled, 
and corrected between 9:30:01 a.m. and 3:50:00 p.m. and will execute 
only at the price determined by the Nasdaq Closing Cross. All LOC 
orders must be available for automatic execution.
    (4) ``Market on Close Order'' shall mean an order to buy or sell at 
the market that is to be executed only during the Nasdaq Closing Cross. 
MOC orders can be entered, cancelled, and corrected between 9:30:01 
a.m. and 3:50:00 p.m. and will execute only at the price determined by 
the Nasdaq Closing Cross. All MOC orders must be available for 
automatic execution.
    (5) ``Nasdaq Closing Cross'' shall mean the process for determining 
the price at which orders shall be executed at the close and for 
executing those orders.
    (6) ``Order Imbalance Indicator'' shall mean a message disseminated 
by electronic means containing information about MOC, LOC, and IO 
orders and the price at which those orders would execute at the time of 
dissemination.
    (b) Order Imbalance Indicator. Beginning at 3:50 p.m., Nasdaq shall 
disseminate by electronic means an Order Imbalance Indicator every 30 
seconds until 3:55, and then every 15 seconds until 3:58, and then 
every 5 seconds until 3:59, and then every second until market close. 
The Order Imbalance Indicator shall contain the following real time 
information:
    (1) The number of shares represented by MOC, LOC, and IO orders 
that are paired at a single price that is at or within the current 
SuperMontage inside.
    (2) The size of any Imbalance;
    (3) The buy/sell direction of any Imbalance; and
    (4) Indicative prices at which the Nasdaq Closing Cross would occur 
if the Nasdaq Closing Cross were to occur at that time and the percent 
by which the indicative prices are outside the then current 
SuperMontage best bid or best offer, whichever is closer. The 
indicative prices will be:
    (A) The price at which the MOC, LOC, and IO orders in the Nasdaq 
Closing Book would execute, and
    (B) The price at which both the MOC, LOC, and IO orders and all 
executable orders in SuperMontage (excluding volume that is available 
only by order delivery) would execute.
    (C) If no price satisfies subparagraph (A) or (A) and (B) above, 
Nasdaq will disseminate the phrase ``market buy'' or ``market sell''.
    (c) Processing of Nasdaq Closing Cross.
    (1) The Nasdaq Closing Cross will begin at 4:00:00, and after hours 
trading will commence when the Nasdaq Closing Cross concludes.
    (2) The Nasdaq Closing Cross will occur at the price that
    (A) Maximizes the number of shares executed. If more than one such 
price exists, the Nasdaq Closing Cross shall occur at the price that:
    (B) Minimizes any Imbalance. If more than one such price exists, 
the Nasdaq Closing Cross shall occur at the price that:
    (C) Minimizes the distance from the 4:00:00 SuperMontage bid-ask 
midpoint.
    (D) If the Nasdaq Closing Cross price established by subparagraphs 
(A) through (C) above is outside the benchmarks established by Nasdaq 
by a threshold amount, the Nasdaq Closing Cross will occur at a price 
within the threshold amounts that best satisfies the conditions of 
subparagraphs (A) through (C) above. Nasdaq management shall set and 
modify such benchmarks and thresholds from time to time upon prior 
notice to market participants.
    (3) If the Nasdaq Closing Cross price is selected and fewer than 
all MOC, LOC and IO orders and fewer than all continuous orders that 
are available for automatic execution in SuperMontage would be 
executed, orders will be executed at the Nasdaq Closing Cross price in 
the following priority:
    (A) MOC orders, with time as the secondary priority;
    (B) LOC orders, limit orders, IO orders, displayed quotes and 
reserve interest priced more aggressively than the Nasdaq Closing Cross 
price;
    (C) LOC orders, IO Orders displayed interest of limit orders, and 
displayed interest of quotes at the Nasdaq Closing Cross price with 
time as the secondary priority;
    (D) Reserve interest at the Nasdaq Closing Cross price with time as 
the secondary priority; and
    (E) Unexecuted MOC, LOC, and IO orders will be canceled.
    (4) All orders executed in the Nasdaq Closing Cross will be 
executed at the Nasdaq Closing Cross price, trade reported with SIZE as 
the contra party, and disseminated via the consolidated tape. The 
Nasdaq Closing Cross price will be the Nasdaq Official Closing Price 
for stocks that participate in the Nasdaq Closing Cross.

[FR Doc. 04-6068 Filed 3-17-04; 8:45 am]
BILLING CODE 8010-01-P