[Federal Register Volume 69, Number 196 (Tuesday, October 12, 2004)]
[Notices]
[Pages 60692-60695]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-2571]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50478; File No. SR-NASD-2004-107]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing of a Proposed Rule Change Relating to 
Computer Generated Quoting in Exchange-Listed Securities

September 30, 2004.
    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 July 12, 2004, the National Association of Securities Dealers, Inc. 
(``NASD''), through its subsidiary, The Nasdaq Stock Market, Inc. 
(``Nasdaq''), filed

[[Page 60693]]

with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by Nasdaq. The Commission is publishing this 
notice 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.
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I. Self-Regulatory Organization's Statement of the Terms of the 
Substance of the Proposed Rule Change

    Nasdaq proposes to eliminate NASD Rule 6330(d) (``Obligations of 
CQS Market Makers'') to allow market makers to engage in Computer 
Generated Quoting (``CGQ'') in exchange-listed securities. The text of 
the proposed rule change is below. New text is in italics. Deleted text 
is in brackets.
* * * * *

6330. Obligations of CQS Market Makers

    (a)-(c) No Change.
[(d) Computer-Generated Quotations]
    [(1) General Prohibition--Except as provided below, this rule 
prohibits the automatic updating or tracking of inside quotations in 
CQS by computer-generated quote systems. This ban is necessary to 
offset the negative impact on the capacity and operation of Nasdaq 
systems regarding certain systems techniques that track changes to the 
inside quotation and automatically react by generating another quote to 
keep the market maker's quote away from the best market, without any 
cognizable human intervention.]
[(2) Exceptions to the General Prohibition
    Automated updating of quotations is permitted when:
    (A) The update is in response to an execution in the security by 
that firm (such as execution of an order that partially fills a market 
maker's quotation size);
    (B) It requires a physical, cognizable entry (such as a manual 
entry to the market maker's internal system which then automatically 
forwards the update to a Nasdaq system);
    (C) The update is to reflect the receipt, execution, or 
cancellation of a customer limit order;
    (D) It is used to expose a customer's market or marketable limit 
order for price improvement opportunities; or
    (E) It is used to equal or improve either or both sides of the 
national best bid or offer (``NBBO''), or add size to the NBBO.]
([e]d) Minimum Price Variation for Decimal-based Quotations
    (1) 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

Background

    Nasdaq proposes to eliminate NASD Rule 6330(d), which governs CGQ 
in exchange-listed securities. Currently, NASD Rule 6330 prohibits the 
practice of automatically, and without cognizable human intervention, 
updating a market maker's quote to keep the market maker away from the 
inside market. NASD Rule 6330(d)(2) contains five exceptions to the 
general prohibition, including exceptions for conduct that is 
consistent with the Commission's Order Handling Rules, and for CGQ that 
equals or improves either or both sides of the national best bid or 
offer (``NBBO'') or adds size to the NBBO.
    The limitations contained in NASD Rule 6330(d) were originally 
implemented because of capacity constraints that Nasdaq believes no 
longer persist. Under recent procedures implemented by the Consolidated 
Tape Association,\3\ Nasdaq now has the opportunity to request 
additional capacity to accommodate increased quoting. Since Nasdaq 
would bear the expense of the additional capacity under the new 
procedures, Nasdaq should be free to increase capacity without 
objection from the other markets that quote and trade exchange-listed 
securities.
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    \3\ See Securities Exchange Act Release No. 47030 (December 18, 
2002), 67 FR 78832 (December 26, 2002).
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    Nasdaq believes that the current restriction on CGQ in exchange-
listed securities not only reduces transparency in the National Market 
System, but also places a burden on highly automated participants that 
may wish to add liquidity in Nasdaq on a proprietary basis. Firms 
posting bids and offers using the Nasdaq Market Center are 
disadvantaged relative to firms using the other market centers, such as 
the regional stock exchanges and electronic communications networks.
    Under the proposal, market makers would be able to engage in CGQ 
without limitations. Broad use of CGQ has been permitted for two years 
in Nasdaq-listed securities \4\ and has benefited investors by 
improving liquidity, transparency, and order interaction in the Nasdaq 
Market Center. Market participants have developed sophisticated systems 
that generate quote updates through automated means. These market 
makers engage in trading strategies in which their quoted prices are 
based on several factors, such as the last sale, bids, offers, and 
sizes, where available, on stocks, futures and options, and certain 
statistically derived relationships among these instruments.
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    \4\ See NASD IM-4613(c).
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Compliance With ITS Plan

    Nasdaq believes that the proposed rule change is consistent with 
the Act and with the Intermarket Trading System (``ITS'') Plan. Nasdaq 
has examined the language in the ITS Plan and believes that nothing in 
the ITS Plan prohibits auto-quoting in exchange-listed securities. 
Subsection 8(d)(ii) of the ITS Plan, titled ``Adoption of Trade-Through 
Rules,'' references, inter alia, the practice of furnishing bid-asked 
quotations that are generated by an automated quotation system 
(functionality Nasdaq refers to as CGQ). According to Nasdaq, the sole 
purpose of Subsection 8(d)(ii) of the ITS Plan was to implement the 
trade-through rule, and not to banish entirely the whole practice of 
CGQ in exchange-listed securities. Nasdaq states that Subsection 
8(d)(ii) of the ITS Plan establishes that CGQ for more than 100 shares 
should be prohibited only inasmuch as CGQ might prevent the 
implementation of the trade-through rule. Nasdaq believes that, if CGQ 
does not prevent the implementation of the trade-through rule, then 
Subsection 8(d)(ii) of the ITS Plan, and the remaining sections of the 
ITS Plan, do not otherwise prohibit or restrict CGQ in exchange-listed 
securities.
    Nasdaq believes that a contrary interpretation would be difficult 
to support both in the context of the ITS Plan as a whole and in the 
context of past experience. According to Nasdaq, it is hard to believe 
that if the signatories

[[Page 60694]]

of the ITS Plan had actually intended to banish CGQ in exchange-listed 
securities entirely, they would have chosen to ``bury'' such a 
provision in Subsection 8(d)(ii) of the ITS Plan without any 
substantive discussion either in that Subsection or elsewhere within 
the document. Nasdaq notes that the ITS Plan runs for over a hundred 
pages, and that all of its important prohibitions and limitations on 
the ITS participants' conduct are carefully explained. Yet, according 
to Nasdaq, there is no section or subsection with the words ``computer 
generated quoting'' or ``auto-quoting'' in its title, there is no 
discussion whatsoever of this practice, and no substantive explanation 
or justification for banishing it is offered anywhere.
    Nasdaq believes that there have always been public policy reasons 
to permit CGQ in exchange-listed securities. For example, Nasdaq states 
that beginning in February 2000 and every year thereafter, the 
Commission has granted the NASD an exemption to allow CGQ in ITS.\5\ 
According to Nasdaq, each time the exemption was granted or extended, 
the Commission stated that, at least within the restrictions contained 
in the exemption, CGQ ``is consistent with the public interest, the 
protection of investors, the maintenance of fair and orderly markets 
and the removal of impediments to, and perfection of the mechanisms of, 
a national market system.'' Given these benefits of CGQ, Nasdaq does 
not believe that the ITS Plan could fairly or reasonably be construed 
as summarily prohibiting CGQ without any discussion.
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    \5\ See e.g., letter from Alden S. Adkins, Commission, to Eugene 
A. Lopez, Nasdaq, dated December 31, 2002 (explaining Nasdaq's need 
for the exemption by stating that ``[c]ertain ITS Participants 
interpret this section [Subsection 8(d)(ii) of the ITS Plan] as 
preventing Participants from employing automated quotation tracking 
systems that auto-quote for more than 100 shares''). It is Nasdaq's 
opinion that the Commission has viewed the exemption as a 
prophylactic measure needed to address the interpretations by 
certain unnamed participants.
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    Nasdaq believes that since CGQ does not automatically prevent the 
implementation of the trade-through rule, a total ban is not needed in 
order to implement the trade-through rule. For example, Nasdaq states 
that the trade-through rule is being observed even though CGQ in 
exchange-listed securities is currently permitted by Nasdaq (consistent 
with the Commission-granted exemptive relief referenced above). Nasdaq 
believes that this fact lends further support to its view of Subsection 
8(d)(ii) of the ITS Plan as only prohibiting CGQ if and when CGQ 
prevents trade-through rule implementation.
    Over the past several years Nasdaq has advocated and supported 
amending the ITS Plan to clarify its language and put this issue to 
rest. Nasdaq proposed, and the ITS Operating Committee (``ITSOC'') 
discussed and voted on a set of specific exceptions to a CGQ 
prohibition to be incorporated into the Plan. To date, no consensus for 
an amendment has been found.\6\ Further, as time has passed and the 
markets have evolved, Nasdaq has come to believe, as it has mentioned 
at the last two ITSOC meetings, that there should be no restrictions on 
CGQ in the ITS Plan. It appears to Nasdaq that there are other 
exchanges participating in ITS that permit forms of CGQ without having 
requested an exemption from the Commission.
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    \6\ A unanimous vote is required to amend the ITS Plan. See 
Subsection 4(c) of the ITS Plan.
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2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of Section 15A of the Act \7\ in general, and Section 
15A(b)(6) of the Act,\8\ which requires that the rules of the NASD 
foster cooperation and coordination with persons engaged in 
facilitating transactions in securities and remove impediments to and 
perfect the mechanism of a free and open market. Nasdaq believes that 
permitting market makers to use these systems should have several 
benefits. According to Nasdaq, market makers will be able to utilize 
existing computer models, or develop new models, to automatically 
generate and update their quotes, which should enhance the price 
discovery process and allow members to increase the number of stocks in 
which they are registered as market makers.
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    \7\ 15 U.S.C. 78o-3.
    \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.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

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. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-NASD-2004-107 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-NASD-2004-107. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 also will be available for inspection and copying at the 
principal office of the NASD. All

[[Page 60695]]

comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-NASD-2004-107 and should be 
submitted on or before November 2, 2004.
    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
 [FR Doc. E4-2571 Filed 10-8-04; 8:45 am]
BILLING CODE 8010-01-P