[Federal Register Volume 64, Number 199 (Friday, October 15, 1999)]
[Notices]
[Pages 56000-56002]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-26891]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41990; File No. SR-NASD-99-44]
Self-Regulatory Organizations; Notice of Filing and Immediate
Effectiveness of Proposed Rule Change by the National Association of
Securities Dealers, Inc. Regarding Marketable Limit Orders
October 7, 1999.
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 September 10, 1999, the National Association of Securities Dealers,
Inc. (``NASDA'' or ``Association''), through its wholly owned
subsidiary Nasdaq Stock Market, Inc. (``Nasdaq '') filed with the
Securities and Exchange Commission (``SEC'' or ``Commission'') a
proposed rule change as described in Items I, II, and III below, which
Items have been prepared by Nasdaq. Nasdaq has designated this proposal
as one constituting a stated policy, practice, or interpretation with
respect to the meaning, administration, or enforcement of an existing
rule under Section 19(b)(3)(A) of the Act, which renders the rule
effective upon the Commission's receipt of this filing. On September
28, 1999, Nasdaq submitted Amendment No. 1 to the proposed rule
change.\3\ 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.
\3\ In Amendment No. 1, Nasdaq made a technical change to the
proposed rule language. See letter to Richard Strasser, Assistant
Director, Commission, from Robert E. Aber, Senior Vice President and
General Counsel, Nasdaq, dated September 24, 1999.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
Nasdaq is proposing to amend Interpretive Material 2110-2
(``Manning Rule'') of the NASD to provide an exclusion from the Manning
Rule for limit orders that are marketable upon time of receipt. Below
is the text of the proposed rule change. Proposed new language is in
italics; proposed deletions are in brackets.
IM-2110-2. Trading Ahead of Customer Limit Order
(a) General Application
There are no changes to the existing language.
(b) Exclusion for Limit Orders that are Marketable At Time of Receipt
The Association has previously recognized the functional
equivalency of marketable limit orders and market orders. Accordingly,
it has adopted the following interpretation. IM-2110-2 shall not apply
to a customer limit order if the limit order is marketable at the time
it is received by a market maker. These orders shall be treated as
market orders for purposes of determining execution priority, however,
these orders must continue to be executed at their limit price or
better.
The exclusion for marketable customer limit orders from the general
application of IM-2110-2 is limited solely to customer limit orders
that are marketable when received by a market maker. If a customer
limit order is not marketable when received by a market maker, the
limit order must be accorded the full protections of IM-2110-2. In
[[Page 56001]]
addition, if the limit order was marketable when received and then
becomes non-marketable, once the limit order becomes non-marketable it
must be accorded the full protections of IM-2110-2.
The following scenario illustrates the application of the exclusion
The market in XYZ stock is 25 bid--25\1/16\ ask, the volume of trading
in XYZ stock is extremely active, and Market Maker A (``MMA'') has a
queue of market orders to buy and sell. Assume the following order
receipt scenario. Each sell market order in the queue is for 1,000
shares and there are not special conditions attached to the orders. MMA
then receives a customer limit to sell 1,000 shares at 25. The customer
limit order is marketable at the time it is received by MMA. MMA hits
another market maker's bid at 25 for 1,000 shares. Normally, IM-2110-2
would require that the customer limit order be executed before the
market orders in the queue. However, because the marketable limit order
and the market orders should be treated as functionally equivalent in
determining execution priority, the marketable customer limit order
shall not be given execution priority over the market orders that were
already in the queue. When the limit order is executed, however, it
must be executed at the limit price or better.
In addition, if in the scenario just described the limit order does
not get executed and the inside market in XYZ becomes 24\7/16\ bid, the
market maker would have to protect the limit order as required by IM-
2110-2 if the market maker trades at the limit order price or better.
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
Nasdaq has received several inquiries from members about whether
the Manning Rule, which governs trading ahead of customer limit orders,
should be applicable in the following situation. A market maker
receives a market order to buy or sell a security and thereafter
receives a marektable \4\ customer limit order on the same side of the
market. The question is whether the marketable customer limit order
must be given preference over the first in time market order because of
the Manning Rule. Nasdaq believes the answer properly should be no.
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\4\ A marketable sell limit order is a limit order to sell a
security at a price that is equal to or less than the inside bid,
whereas, a marketable buy limit order is a limit order to buy a
security at a price that is equal to or greater than the inside ask.
For example, a limit order to sell at 25 when the inside bid is 25
or a limit order to buy at 30 when the inside ask is at 30.
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An example of a particular order receipt and execution scenario is
helpful in understanding the issue, which arises when there are
multiple orders in a market maker's order queue.
Assume that the market in XYZ stock is 25 bid--25\1/16\ ask, the
volume of trading in XYZ stock is extremely active, and Market Maker A
(``MMA'') has a queue of market orders to buy and sell. Assume the
following order receipt scenario. Each sell order in the queue is for
1,000 shares and there are no special conditions attached to the order.
MMA then receives a customer limit order to sell 1,000 shares at 25.
The customer limit order is marketable at the time it is received by
MMA. MMA hits several other market makers' bids at 25 and is filled for
a total of 5,000 shares (i.e., MMA has sold 5,000 shares at 25). MMA
then executives the first five market orders in its queue based upon
time priority (i.e., MMA buys 1,000 shares from each of the first five
market orders it received), but does not execute the customer limit
order. In hitting the other market makers' bids at 25, MMA has traded
at a price that is equal to the limit order price.
Manning Rule
The Manning Rule requires members acting as market makers to handle
their customer limit orders with all due care so that market makers do
not ``trade ahead'' of those limit orders. Thus, members acting as
market makers that handle customer limit orders, whether received from
their own customers or from another member, are prohibited from trading
at prices equal or superior to that of the limit order without
executing the limit order.
If the Manning Rule is applicable in the scenario described, MMA
would be in violation of Manning because it sold shares at 25, which is
the limit order price, and did not execute the limit order. MMA,
however, did fill the five market orders to sell (i.e., MMA bought
shares). To avoid a Manning Rule violation, MMA would have to execute
the marketable customer limit order before the market orders, even
though the market orders have time priority. If this is done, MMA would
not violate the Manning Rule because, even though it sold at the limit
order price to another market maker, MMA would have filled the limit
order at the limit order price. Nasdaq believes, however, that giving
the marketable customer limit order execution priority in order to
avoid a Manning Rule violation creates an inequitable result. In the
scenario described, the marketable customer limit order would jump
ahead of the five market orders that were in the execution queue before
the limit order was placed, and as discussed below, Nasdaq believes
marketable limit orders and market orders should be treated the same in
such a situation.
Proposed Interpretation
Nasdaq does not believe that market orders in the form of
marketable limit order should be afforded preferential status by virtue
of the Manning Rule. This is consistent with positions taken in the
past by the Commission and Nasdaq. The Commission recognized the
proposition that marketable limit orders and market orders are
equivalent when it approved Nasdaq's proposed changes to the Small
Order Execution System (``SOES'').\5\ These changes were necessary to
implement the SEC's Order Handling Rules. Prior to the changes, SOES
executed marketable limit orders ahead of market orders in the SOES
queue. To eliminate the disparate treatment of substantially identical
orders, Nasdaq proposed to redesign SOES so that market orders and
marketable limit orders would be executed on a time priority basis. In
the order approving the changes, the Commission stated that the
amendment would eliminate an unwarranted advantage that customers that
place marketable limit orders have over customers that place market
orders.\6\ The Commission also stated that the changes reflect the
functional equivalency of these two types of orders.\7\
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\5\ Securities Exchange Act Release No. 38156 (January 10,
1997), 62 FR 2415 (January 16, 1997) (Order approving SR-NASD-96-
43).
\6\ Id.
\7\ Id.
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In addition, Nasdaq also articulated this position in NASD Notice
to
[[Page 56002]]
Members 97-57.\8\ In that Notice of Members, Nasdaq presented several
examples of customer order scenarios and addressed members'
responsibilities under the Manning Rule, best execution principles, and
the SEC Order Handling Rules \9\ in executing customers' orders. In
analyzing a scenario in which one customer limit order could cross
another customer limit order, Nasdaq stated marketable limit orders are
the equivalent of market orders and should be treated as such under
best execution principles, which, in the example described above,
dictate that the order that is received first should be executed first.
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\8\ See Answer to Question Number 6 in NASD Notice to Members
97-57 (Interpretations of SEC Order Handling Rules, NASD Limit Order
Protection Rules, And Members Best Execution Responsibilities).
\9\ See Securities Exchange Act Rule 11Ac1-1, 17 CFR 240.11Ac1+1
and Securities Exchange Act Rule 11Ac1-4, 17 CFR 250.11Ac1-4.
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Accordingly, Nasdaq believes the Manning Rule, which is designed to
protect consumer limit orders, should not be applicable to marketable
customer limit orders because such orders are functionally equivalent
to market orders and should be treated as such. To find otherwise would
enable orders, which in reality are market orders, to be nominally
designated as limit orders and essentially jump the queue of market
orders for execution. In fact, in applying the exclusion, Nasdaq would
consider it a violation of a market maker's best execution obligation
if the market maker executes the marketable customer limit order before
market orders that are in the queue.
The proposed interpretation is limited to customer limit orders
that are already marketable when received by market makers. If the
limit order becomes marketable while in possession of the market maker,
the limit order would be protected under the Manning Rule.
Finally, nothing in the interpretation alters a market maker's
obligation to execute the customer limit order at the limit price or
better or to display the order as required by Rule 11Ac1-4 under the
Act.\10\
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\10\ Subject to certain exceptions, Rule 11Ac1-4(b)(2) requires
a market maker to display the full price and size of customer limit
orders that: (i) would improve the market maker's bid or offer; or
(ii) are equal to the market maker's bid or offer, the national best
bid or offer and represent more than a de minimis change in the
market maker's quoted size. 17 CFR 240.11Ac1-4(b)(2).
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2. Statutory Basis
Nasdaq believes that the proposed rule change is consistent with
the provisions of Section 15A(b)(6) \11\ of the Act in that the
proposed rule change is designed to prevent fraudulent and manipulative
acts and practices, to promote just and equitable principles of trade,
and to protect investors and the public interest by preventing orders,
which in reality are market orders, from receiving execution priority
by being nominally designated as limit orders. The proposal would
eliminate an unwarranted advantage that customers that place marketable
limit orders have over those customers that place market orders.
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\11\ 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, as amended.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were solicited or received with respect to the
proposed rule change.
II. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
The foregoing rule change has become effective upon filing pursuant
to Section 19(b)(3)(A) \12\ of the Act and subparagraph (f) of Rule
19b-4 \13\ thereunder in that it constitutes a stated policy, practice,
or interpretation with respect to the meaning, administration, or
enforcement of an existing rule. Specifically, the proposal is an
interpretation that harmonizes IM-2110-2 with the Commission's and the
Association's published positions regarding the proper handling of
marketable customer limit orders.
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\12\ 15 U.S.C. 78s(b)(3)(A).
\13\ 17 CFR 240.19b-4(f).
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At any time within 60 days of the filing of a rule change pursuant
to Section 19(b)(3)(A) of the Act, the Commission may summarily
abrogate the 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.
III. 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.\14\ Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW, Washington,
DC 20549-0609. 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-99-44 and should be submitted by November 5, 1999.
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\14\ In reviewing this proposal, the Commission has considered
its impact on efficiency, competition, and capital formation. 15
U.S.C. 78c(f).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
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\15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-26891 Filed 10-14-99; 8:45 am]
BILLING CODE 8010-01-M