[Federal Register Volume 59, Number 149 (Thursday, August 4, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-18965]
[[Page Unknown]]
[Federal Register: August 4, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34453; File No. SR-NASD-94-13, Amendment No. 2]
Self-Regulatory Organizations; Notice of Proposed Rule Change by
the National Association of Securities Dealers, Inc. Relating to
Amendments to the NASD's Proposed NPROVE System for Price
Improvement and Execution of Small Orders
July 28, 1994.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on July 25, 1994,\2\ the
National Association of Securities Dealers, Inc. (``NASD'' or
``Association'') filed with the Securities and Exchange Commission
(``Commission'' or ``SEC'') Amendment No. 2 to the proposed rule change
as described in Items I, II, and III below, which Items have been
prepared by the NASD. 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) (1988).
\2\The NASD initially filed the proposed rule change on March 4,
1994. On March 28, 1994, the NASD filed Amendment No. 1, which
expands and clarifies the description of the system. Notice of the
original filing and Amendment No. 1 was provided by publication in
the Federal Register. Securities Exchange Act Release No. 34145
(June 1, 1994), 59 FR 29649 (June 8, 1994).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD and The Nasdaq Stock Market, Inc. (``Nasdaq'') propose to
amend the proposed rules governing the operation of The Nasdaq Primary
Retail Order View and Execution System (``NPROVE''), a new
Nasdaq system for execution and price improvement of small-sized
customer orders. Specifically, the NASD proposes to amend Sections 6.b
and 6.c. of the Rules of Operation and Procedures for the
NPROVE service to provide that a limit order entered at a price
between the best bid or offer displayed on Nasdaq will be immediately
executed against a limit order subsequently entered into NPROVE
on the opposite side of the market priced at or superior to the limit
price of the first limit order. Following is the text of the proposed
rule change. (Additions are in italics; deletions are bracketed.)
RULES OF OPERATION AND PROCEDURES FOR THE NPROVE SYSTEM
(6) EXECUTIONS OF NPROVE ORDERS
* * * * *
a. No change.
b. Limit orders may be entered into NPROVE. A limit order
priced at the Nasdaq inside market when the order is delivered to an
NPROVE market maker will be handled as a market order. Limit
orders priced outside the Nasdaq inside market will be stored in the
NPROVE limit order file, and when the inside market equals or
betters the limit price, the order will be handled as a market order.
Limit orders priced better than the inside market upon entry will
establish the price at which subsequent incoming market orders on the
other side of market may be priced and executed (e.g., a sell order
priced between the best bid and offer would improve the price of an
incoming buy order). Market makers will receive notification of the
existence of a limit order priced better than the inside market on
their quote retrieval screens; provided however, notification of the
existence of a preferenced limit order will only be delivered to the
designated market maker. [A limit order priced better than the inside
market in Nasdaq may also be matched and executed against an incoming
market or limit order, on the other side of the market, without the
participation of a market maker.] A limit order priced better than the
inside market on Nasdaq shall be automatically executed against a
subsequent limit order on the opposite side of the market at a price
equal or superior to the limit price of the initial limit order (a sell
(buy) limit order priced at or below (above) a limit order to buy
(sell)), up to the size of the initial limit order or the subsequent
limit order, whichever is smaller, and without the participation of a
market maker.
c. Market orders may be entered into NPROVE. A market order
will be delivered to a market maker for execution at the current inside
market (buy orders will be executed at the best offer and sell orders
at the best bid). If a limit order has previously been entered into
NPROVE at a price superior to the best bid or offer, the
incoming market order will be repriced to match the price of the limit
order and will be displayed for 15 seconds to all market makers [at]
whose current quotation equals the applicable inside quote, in the
case of an unpreferenced order, and to the preferenced market maker in
the case of a preferenced order. [That order will either be executed by
a market maker or will be matched and executed against the limit
order.] If no market maker accepts the incoming market order within the
15-second period, the market order will be automatically executed
against the limit order. All market orders entered into NPROVE
will be executed in compliance with market maker obligations as
established in subsection (4).
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 NASD 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. The NASD 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
The purpose of this amendment is to amend NPROVE's
execution algorithm for limit orders to provide that, upon receipt of
limit orders that match between the inside spread, the system will
automatically execute the matching limit orders against each other
without any delay or separate display to market makers. The NASD
believes this amendment will further enhance the price improvement and
limit order protection benefits afforded retail investors through
NPROVE.
As currently proposed, if a limit order is entered into
NPROVE between the inside spread on Nasdaq, a subsequent limit
order on the opposite side of the market priced at the same or a
superior price to the limit price of the pending limit order (e.g., a
sell limit order priced at or below a limit order to buy) will be
matched against that pending limit order. If the incoming limit order
is unpreferenced, all market makers at the inside quotation will have a
15-second opportunity to execute the incoming limit order. If the
incoming limit order is preferenced, only the preferenced market maker
will have a 15-second opportunity to execute the incoming limit order.
If no market maker elects to execute the incoming limit order, the
system would automatically execute the pending limit order against the
incoming limit order.\3\
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\3\For example, if the inside bid and offer were 20--20\1/2\,
and two limit orders were entered to buy and sell at 20\1/4\, the
system would allow the orders to match against each other within 15
seconds. In addition, if two limit orders crossed each other in
between the inside spread (i.e., a buy order priced at 20\3/8\ and a
sell order priced at 20\1/8\), the orders would be matched after 15
seconds and the price averaged between the orders (each would
receive 20\1/4\).
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This amendment will change the execution methodology for matched
limit orders by eliminating the 15 second window for the display of the
incoming limit order prior to execution and permitting an immediate
match of offsetting limit orders received by NPROVE. By
providing retail customers a greater opportunity to receive immediate
and automatic executions of their limit orders priced between the
spread, the NASD believes the proposal will enhance NPROVE's
price improvement capabilities and limit order protection features.
Moreover, to the extent the NPROVE has received two priced
orders from retail customers that match or cross each other inside the
spread, the NASD believes no market benefit would be served by delaying
the execution of this transaction. Indeed, the NASD believes the
amendment is in furtherance of Section 11A(a)(1)(C)(v) of the Act,
which provides that investors' orders should be executed without the
intervention of a dealer to the maximum extent possible consistent with
the achievement of other critical market structure objectives, such as
the economically efficient execution of securities transactions.
The proposed execution algorithm for matching incoming market
orders against limit orders priced better than the inside market will
remain the same. Specifically, as proposed, if a limit order is entered
into NPROVE at a price between the spread, the next incoming
market order on the opposite side of the market (e.g., the limit order
is to sell stock and the market order is to buy stock) would
automatically ``pass over'' or read the limit order file to see if
there are any orders residing in the limit order file at prices
superior to the best bid or offer in the Nasdaq marketplace. If a limit
order resides on the file at a superior price, then the market order
will be flashed on the screen at that superior price for acceptance
within a brief 15-second period, instead of at the inside bid or offer,
as the case may be. In that event, all market makers at the inside
quotation would have the opportunity for 15 seconds to execute the
market order at the superior limit price. If no market maker elected to
execute the order at that improved price, the system would execute the
orders against each other at the limit price.
The NASD notes that both the limit order and the market order are
better off with this execution process--customers placing market orders
receive price improvement and customers placing limit orders will be
assured that NPROVE executions will not occur at prices
inferior to their limit order prices. Accordingly, the NASD believes
this execution process for a market orders is wholly consistent with
the protection of investors and the maintenance of fair and orderly
markets.
A key consideration for retaining NPROVE's flash display
and automated execution feature for market orders is the need to
maintain the liquidity and depth of The Nasdaq Stock Market. One of the
cornerstones of the success of Nasdaq's competing dealer system has
been the availability of market maker capital to satisfy investors'
liquidity demands. The extent to which market maker capital is
available, in turn, is critically dependent on the ability of market
makers to interact with customer order flow. Without the ability of
market makers to trade with their customers' orders, orders presented
to them by other members, or orders entered into Nasdaq execution
systems, market-maker profitability will suffer and, as a result,
market liquidity will diminish and investors will receive inferior
executions of their orders. Accordingly, if market makers are denied
any opportunity, however brief, to interact with incoming market orders
entered into NPROVE, the NASD believes that liquidity on Nasdaq
will inevitably be affected in an adverse manner to the detriment of
investors.
The NASD notes that an objective for a National Market System
contained in Section 11A of the Act regarding the execution of
investors' orders without the intervention of a dealer is premised
upon, and necessarily incorporates the corresponding assurance that,
such executions will be fully consistent with the economically
efficient execution of such securities transactions. The NASD maintains
that affording market makers an extremely narrow 15-second window of
exposure within which they may view, evaluate, and respond to incoming
market orders prior to the automated match of two investors' orders is
appropriate in a competing dealer market environment. The ability of
market makers to interact with customer order flow is essential to the
long-term well-being of Nasdaq and the efficient execution of customer
orders that results from vigorous competition among viable, aggressive
Nasdaq market makers.
In sum, the NASD believes the proposal significantly enhances the
price improvement and limit order protection features of NPROVE
and eliminates the possibility that a pending limit order will remain
unexecuted while other public customer orders receive executions at the
order's limit price, while preserving the liquidity and orderliness of
Nasdaq by allowing a minimal, yet essential, opportunity for market
makers to interact with retail order flow.
The NASD also believes the proposed NPROVE system is
consistent with Sections 15A(b)(6), 15A(b)(9), 15A(b)(11), and
11A(a)(1)(C) of the Act. Section 15A(b)(6) requires that the rules of a
national securities association be 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 general to
protect investors and the public interest. Section 15A(b)(9) requires
that rules of an Association not impose any burden on competition not
necessary or appropriate in furtherance of the purposes of the Act.
Section 15A(b)(11) requires the NASD to formulate rules governing the
quality of fair and informative quotations. Section 11A(a)(1)(C) finds
that it is in the public interest to, among other things, assure
economically efficient execution of securities transactions. The
fundamental purpose of NPROVE is to assist investors in
achieving prompt, efficient executions of their small orders and to
provide an opportunity for price improvement within an automated
execution environment. The integrity and efficiency of Nasdaq for
public investors and market-making participants is critical and the
NASD believes that NPROVE will provide benefits to both
constituencies. The design of NPROVE is not anti-competitive as
it affords all market and limit orders an equal opportunity for price
improvement regardless of whether the orders are preferenced or
unpreferenced. In addition, to the extent that preferenced orders may
be handled differently than unpreferenced orders, because market makers
have entered into preferencing arrangements with known customers,
market maker's effectively will have waived the protections offered
them by the system. NPROVE may also enhance the quality of
quotations in the Nasdaq marketplace as market makers participating in
the service may be encouraged to narrow the spread and improve the best
inter-dealer quotations in Nasdaq in order to be first in priority and
continue to receive unpreferenced order flow through NPROVE.
Lastly, the NASD believes the NPROVE is fully consistent
with the significant national market system objectives contained in
Section 11A of the Act. The facilities of NPROVE would advance
these objectives by offering efficient execution of investors' small
orders, by maintaining market maker participation through the automated
delivery of orders with the ability to reject those orders if trades
have already occurred, and by offering the opportunity for price
improvement to NPROVE orders. The system's functionality will
more accurately reflect market makers' affirmative obligations to
provide liquidity to the market, without depriving market makers of
legitimate exceptions from the firmness requirements contained in SEC
Rule 11Ac1-1.
B. Self-Regulatory Organization's Statement on Burden on Competition
The NASD believes that the proposed rule change will not 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
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 NASD 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. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
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-94-13 and
should be submitted by August 25, 1994.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\4\
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\4\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-18965 Filed 8-3-94; 8:45 am]
BILLING CODE 8010-01-M