[Federal Register Volume 62, Number 36 (Monday, February 24, 1997)]
[Notices]
[Pages 8289-8291]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-4445]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38294; File No. SR-NASD-97-07]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Temporary Accelerated Approval of Proposed Rule Change by the
National Association of Securities Dealers, Inc. Relating to Rule 4612,
Primary Nasdaq Market Maker Standards Through October 1, 1997
February 14, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on January 31, 1997, the
Nasdaq Stock Market, Inc. (``Nasdaq'') filed with the Securities and
Exchange Commission (``SEC'' or ``Commission'') the proposed rule
change as described in Items I and II 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 and to
grant accelerated approval to the proposal.
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\1\ 15 U.S.C. Sec. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
Pursuant to the provisions of Section 19(b)(1) under the Act,
Nasdaq, a wholly owned subsidiary of the National Association of
Securities Dealers, Inc. (``NASD'' or ``Association''), is herewith
filing a proposed rule change to temporarily suspend the use of the
Primary Nasdaq Market Maker qualification criteria found in Rule 4612
(a) and (b) of the Nasdaq Market Maker Requirements of the NASD Rules
for all Nasdaq National Market securities for the remainder of the
current pilot period of the Nasdaq Short Sale Rule or until such
earlier time when new primary market maker qualification criteria can
be devised and adopted.
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
After the first week of trading under the new SEC rules regarding a
Nasdaq market maker's order handling obligations, i.e., Rule 11Ac1-4
(the customer limit order display rule) and amended Rule 11Ac1-1
(amendments to the firm quote rule regarding the display of priced
orders entered by market makers or specialists into electronic
communications networks (``ECNs'')),\2\ Nasdaq has re-evaluated its
existing qualification criteria in the primary market maker standards
rule, Rule 4612 (a) and (b), in those stocks that are not subject to
the primary market maker standard suspension approved in SR-NASD-96-
55.\3\ In that rule filing, Nasdaq noted that because of the potential
changes in quotation and trading activity in Nasdaq securities when the
new SEC Rules became effective, the existing numerical criteria used to
qualify a registered market maker as a primary market maker would be
significantly affected. Because the precise effects on market maker
quotes and trades were not possible to predict until Nasdaq could
develop practical experience with new patterns of activity under the
new rules, Nasdaq believed that it should attempt to minimize the
possible harmful unintended consequences that could occur by leaving
the current standards in place. Accordingly, Nasdaq proposed, and the
SEC approved, that the existing standards would be temporarily
suspended on the same schedule for the phase in of the SEC Rules
requirements.
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\2\ See Securities Exchange Act Release No. 37619A (September 6,
1996); 61 FR 48290 (September 12, 1996) (Order Handling Rules
Adopting Release).
\3\ See Securities Exchange Act Release No. 38175 (January 23,
1997); 62 FR 3548.
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However, based upon trading experience in the first week of trading
under the new SEC and NASD Rules, Nasdaq believes that the primary
market maker standards should be suspended immediately for all National
Market securities and all registered market makers in those securities
should be designated as primary market makers. Nasdaq bases this
proposed rule change on three factors that were not readily apparent at
the time it filed SR-NASD-96-55: (1) many market makers have
voluntarily chosen to display customer limit orders in their quotes
even though the SEC's Limit Order Display Rule does not yet require it;
(2) SOES decrementation for all Nasdaq stocks has significantly
affected market maker ability to meet several of the primary market
maker standards; and (3) with the inability to meet the existing
criteria for a larger number of securities, a market maker may be
prevented from registering as a primary market maker in an initial
public offering because it fails to meet the 80% primary market maker
test contained in Rule 4612(g)(2)(B).
Under existing Rule 4612, a registered Nasdaq Market Maker may be
deemed to be a Primary Market Maker in National Market securities if
the market maker meets two of three criteria: (1) the market maker
maintains the best bid or best offer as shown on Nasdaq no less than
35% of the time; (2) a market maker maintains a spread no greater than
102% of the average dealer spread; and (3) no more than 50% of a market
maker's quotation changes occur without a trade execution. In addition,
if a registered market maker meets only one of the above criteria, it
may nevertheless qualify as a primary market maker if the market maker
accounts for volume at least 1\1/2\ times its proportionate share of
overall volume in the stock. The review period for meeting any of these
criteria is one calendar month. Nasdaq notifies a market maker at the
beginning of the new calendar month if it does not meet the tests, and
one business day following the notification, Nasdaq withdraws the ``p''
designator.
The changes to market maker quotation and trading activities have
been dramatic in the first week of trading in the new environment. To
provide their customers with the greater transparency, many market
makers have begun to display customer limit orders in all Nasdaq
securities, not only those subject to the phase-in of the Limit Order
Display Rule, Rule 11Ac1-4. With the voluntary display of customer
limit orders in stocks not yet subject to Rule 11Ac1-4, Nasdaq market
makers are changing their quotes when they are in
[[Page 8290]]
receipt of customer limit orders that improve upon their current
quotations. Because more dealer quotes are now being driven not merely
by the market maker's proprietary interests, but also the interests of
customers that place limit orders with the market maker, Nasdaq
believes that a market maker's ability to meet the 102% of average
dealer spread test may be more difficult to meet. For example, because
a quote of a market maker driven by a customer limit order is
indistinguishable from that of a quote driven by a customer order, it
is impossible to tell when market maker quote changes are being driven
by customer interests that are entered and then subsequently canceled
without any execution. In addition, the test regarding the percentage
of time in which the market maker's quote is at the inside will also be
driven to some extent by customer limit order interest.
Moreover, the SOES decrementation feature is having a significant
impact on individual market maker quotations. Under the new SOES rules,
which apply to all securities, when SOES executes against a quotation,
whether it is on behalf of a customer or not, Nasdaq's system decreases
the quotation size. If the quote is decreased to zero, and the market
maker has the Nasdaq auto-refresh feature turned on, the market maker's
quote is changed pursuant to that execution, However, because the auto-
refresh moves only one side of the market maker's quote, the market
maker's quote is spread wider than many market makers want. Therefore,
market makers then change the quote to a narrower spread. While Nasdaq
believes that narrower spreads are beneficial for investors overall, in
this instance, the quote movement without a corresponding trade causes
the market maker to exceed the 50% quote to trade ratio established in
the primary market maker standards. If the market maker, on the other
hand, chooses not to narrow its quote after the auto-refresh, that
market maker runs the risk that it may not meet the 102% of the average
spread test. Finally, Nasdaq notes that if a market maker fails to meet
the standards and falls below the test regarding being a primary market
maker in 80% or more of the securities for which it is registered as a
market maker, it will not be allowed to register as a primary market
maker in an initial public offering, even if it is an underwriter of
that security and may be required to play an important liquidity
providing role in that stock's initial trading activity.
Nasdaq believes that it is in the public investor's best interests
to temporarily suspend the operation of the primary market maker
standards that currently exist. If the standards are not suspended, the
significant shift in the patterns of quotation and executions that
Nasdaq is beginning to experience is going to cause primary market
makers operating under the existing standards to lose that status. Loss
of the designation would mean that market makers without the designator
would not be permitted to avail themselves of the short sale exemption
for primary market makers. If a significant number of registered market
makers were to lose the short sale exemption, or if a single market
maker that handled a significant portion of the order flow in a
security were to lose the exemption, liquidity in that particular stock
could be seriously harmed.
Therefore, as of February 3, 1997, any registered market maker
would be able to avail itself of the short sale exemption for qualified
market makers found in Rule 3350(c)(1). In seeking to temporarily
suspend the use of the primary market maker qualification criteria,
Nasdaq believes that the suspension of the criteria is an appropriate
balance between the need for limitations on the market maker short sale
exemption and the potential for loss of liquidity and market disruption
in a period when new patterns and practices of trading are first being
developed. Nasdaq believes that the period of time in which the new SEC
Rules are first being implemented may be a period of uncertainty for
market makers and investors alike and that the prudent course of action
would be to identify and eliminate as many potential areas for
increasing that uncertainty as possible. Nasdaq has identified this
issue as a critical area of uncertainty and believes that the
suspension of the market maker qualification standards on a temporary
basis is an appropriate market quality response. This relief will
enable Nasdaq market makers to better satisfy investor liquidity
demands and could help to promote pricing efficiency.
Nasdaq also plans to develop new standards as soon as practicable
so that Nasdaq can obtain experience with the manner in which the new
SEC Rules affect market makers. The plan is to analyze the data from
January and February and discuss the practices among staff and with the
Quality of Markets Committee.
Nasdaq believes that the proposed rule change is consistent with
Section 15A(b)(6) of the Act in that it is designed to prevent
fraudulent and manipulative acts and facilities transactions in
securities. In particular, this temporary amendment to the existing
rule should provide market makers with certainty regarding whether they
are entitled to an exemption under the rule which should promote market
efficiency and enhance the orderliness of the market during a
transition period. It should also help in reducing investor confusion
at this time and thereby promote efficient and fair markets.
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. Commission's Findings and Order Granting Temporary Accelerated
Approval of Proposed Rule Change
The Commission has reviewed carefully Nasdaq's proposed rule change
and believes, for the reasons set forth below, that the proposed rule
change is consistent with the requirements of the Act and the rules and
regulations thereunder applicable to the NASD and, in particular, the
requirements of Section 15A(b)(6), 15A(b)(9), and 15A(b)(11). In
addition, the Commission finds that the rule change is consistent with
the Congressional objectives for the equity markets, set out in Section
11A of the Act, of achieving more efficient and effective market
operation, fair competition among brokers and dealers, and economically
efficient execution of investor orders in the best market. In
particular, this temporary amendment to the existing rule should avoid
frustrating the operation of the Order Handling Rules in light of the
existence of market factors not readily apparent at the time the NASD
requested more limited relief with respect to the suspension of primary
market maker standards.\4\ The Commission is approving the rule change
on a pilot basis through October 1, 1997. During this time, however,
the Commission expects that, as with the NASD's excess spread rule,\5\
the NASD must develop
[[Page 8291]]
new primary market maker standards well before the expiration of the
pilot.
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\4\ Id.
\5\ As with the primary market maker standards, there is also a
dealer spread test that is part of the NASD's ``excess spread
rule,'' Rule 4613(d). The Commission recently approved a proposed
rule change on a pilot basis through July 1, 1997, providing that a
registered market maker in a security listed on the Nasdaq stock
market shall be precluded from being a registered market maker in
that issue for twenty business days if its average spread in the
security over the course of any full calendar month exceeds 150
percent of the average of all dealer spreads in such issue for the
month. See Securities Exchange Act Release No. 38180 (January 16,
1997), 62 FR 3725. Although the Commission approved the proposed
rule change on a temporary basis to facilitate compliance with the
Commission's Order Handling Rules, the Commission stated that during
this time period, the NASD should monitor the effects of the pilot,
as well as study alternative methods that would enhance market
making performance while completely fulfilling the NASD's obligation
regarding the excess spread rule before the August 8, 1997, deadline
contained in the Commission's Order Instituting Public Proceedings
Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934,
Making Findings and Imposing Remedial Sanctions, Securities Exchange
Act Release No. 37538 (August 8, 1996).
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Nasdaq has requested that the Commission find good cause pursuant
to Section 19(b)(2) for approving the proposed rule change prior to the
30th day after publication in the Federal Register. The Commission
finds good cause for approving the proposed rule change prior to the
30th day after the date of publication of notice of filing thereof in
that accelerated approval will accommodate the Order Handling Rules,
which went into effect January 20, 1997.\6\
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\6\ The Division of Market Regulation issued an interim no-
action letter to the NASD and Nasdaq with respect to the enforcement
of the NASD's primary market maker standards during the
consideration of this proposed rule change. The approval of this
rule change supersedes that no-action position. See Letter from
Howard Kramer, Associate Director, Division of Market Regulation,
SEC, to Eugene A. Lopez, Assistant General Counsel, Nasdaq, dated
February 3, 1997.
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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, NW., Washington, DC 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 No. SR-NASD-97-07 and should
be submitted by March 17, 1997.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\7\ that the proposed rule change be, and hereby is, approved on an
accelerated basis, effective February 14, 1997 through October 1, 1997.
\7\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\8\
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\8\ 17 U.S.C. 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-4445 Filed 2-21-97; 8:45 am]
BILLING CODE 8010-01-M