SECURITIES AND EXCHANGE COMMISSION

   Release No. 34-38156; File No. SR-NASD-96-43
   January 10, 1997

   Self-Regulatory Organizations; National Association of
   Securities Dealers, Inc.; Order Granting Partial Approval and
   Notice of Filing and Order Granting Accelerated Approval of
   Amendment No. 1 to Proposed Rule Change Relating to
   Implementation of the Commission's Order Handling Rules

       On November 18, 1996, the National Association of

   Securities Dealers, Inc. ("NASD" or "Association") filed with

   the Securities and Exchange Commission ("Commission" or "SEC")

   a proposed rule change pursuant to Section 19(b)(1) of the

   Securities Exchange Act of 1934 ("Act")-[1]-, and Rule

   19b-4 thereunder.-[2]-  On January 9, 1997, the NASD

   submitted a letter amending the proposed rule

   change.-[3]-  The proposed rule change adopts a new rule,

   and amends existing NASD rules and The Nasdaq Stock Market's


        -[1]-    15 U.S.C.  78s(b)(1).

        -[2]-    17 CFR 240.19b-4.

        -[3]-    Letter from Robert E. Aber, NASD to Robert L.D.
                 Colby, Commission, dated January 9, 1997.  The
                 amendment would (1) establish a three month
                 pilot for reduction of the market maker minimum
                 quotation size in the fifty Nasdaq securities
                 subject to the first phase-in of the Order
                 Handling Rules; (2) state that a market maker's
                 obligation to maintain its displayed quotation
                 size at or above the applicable minimum
                 quotation size does not apply when the market
                 maker's quote size has been decremented by the
                 execution of SOES orders, until that quotation
                 size is decremented to zero; (3) make the
                 decrementing provision optional for market
                 makers whose quotation in a particular security
                 is equal to or greater than the SOES tier size
                 for that security; and (4) permit market makers
                 to enter riskless principal orders, in addition
                 to agency orders, into the Small Order
                 Execution System.

==========================================START OF PAGE 2======
   ("Nasdaq") Small Order Execution System ("SOES") and SelectNet

   Service to enable the NASD to implement on a timely basis the

   Commission's new limit order display rule, Rule 11Ac1-4 under

   the Act-[4]- ("Display Rule") and amendments to Rule

   11Ac1-1 under the Act-[5]- ("Quote Rule").

       Notice of the proposed rule change, together with the

   substance of the proposal as initially filed, was provided by

   issuance of a Commission release (Securities Exchange Act

   Release No. 38008, Dec. 2, 1996) and by publication in the

   Federal Register (61 FR 64550, Dec. 5, 1996).  The Commission

   received over 350 comment letters on the proposal.

   I.  INTRODUCTION AND BACKGROUND

       A. The Commission's Order Handling Rules

       On August 28, 1996, the Commission adopted the Display

   Rule, which requires the display of customer limit orders

   priced better than a market maker or specialist's quote, and

   adopted amendments to the Quote Rule to enhance the quality of

   published quotations for securities, and competition and

   pricing efficiency in U.S. securities markets.-[6]-


        -[4]-    17 CFR 240.11Ac1-4.

        -[5]-    17 CFR 240.11Ac1-1.

        -[6]-    See Securities Exchange Act Release No. 37619A
                 (September 6, 1996), 61 FR 48290 (September 12,
                 1996) ("Adopting Release").  See also
                 Securities Exchange Act Release Nos. 38110
                 (January 2, 1997), 62 FR 1279 (January 9, 1997)
                 (order revising the effective date of the Order
                 Execution Rules to January 13, 1997); and 38139
                 (January 8, 1997) (order revising the effective
                                                   (continued...)

==========================================START OF PAGE 3======
   These rules (collectively, "Order Handling Rules") were

   designed to address growing concerns about the handling of

   customer orders for securities.

       Specifically, the Display Rule-[7]- requires the

   display of a customer limit order priced better than a

   specialist's or over-the-counter ("OTC") market maker's quote

   or that adds to the size associated with such quote if that

   quote is at the national best bid or offer ("NBBO").  An OTC

   market maker who receives a customer limit order meeting these

   parameters must immediately: (1) change its quote and the size

   associated with its quote to reflect the limit order; (2)

   execute the limit order; (3) deliver the limit order to an
exchange-

    or association-sponsored system that complies with the

   requirements of the rule; (4) send the limit order to another

   market maker or specialist who complies with the requirements

   of the rule; or (5) deliver a limit order to an electronic

   communications network ("ECN") that meets certain requirements

   regarding the display of limit orders, as an alternative to

   representing the limit order in its quote.-[8]-


        -[6]-(...continued)
                 date of the Order Execution Rules until January
                 20, 1997).

        -[7]-    17 CFR 240.11Ac1-4.

        -[8]-    The Display Rule does not apply to limit orders
                 placed by customers requesting that they not be
                 displayed, limit orders for odd-lots, and limit
                 orders that are all-or-none orders.  The rules
                 do not require the display of limit orders of
                 block size (10,000 shares or $200,000) unless
                                                   (continued...)

==========================================START OF PAGE 4======
       One amendment to the Quote Rule-[9]- requires an OTC

   market maker to make publicly available any superior prices

   that a market maker privately quotes through ECNs ("ECN

   Amendment").  A market maker may comply with this amendment by

   changing its quote to display any such superior prices

   privately quoted.  Alternatively, a market maker can deliver

   better priced orders to an ECN without changing its public

   quote if that ECN: (i) ensures that the best prices market

   makers and specialists have entered therein are communicated

   to the public quotation system; and (ii) provides brokers and

   dealers equivalent access to orders entered by market makers

   and specialists into the ECN, so brokers and dealers that do

   not subscribe to the ECN can trade with those orders ("ECN

   Display Alternative").

       The ECN amendment becomes effective on January 20, 1997

   for exchange traded securities and 50 of the 1000 most

   actively traded OTC securities.  These 50 securities have been

   identified by Nasdaq.-[10]-  The phase-in date for the

   next 100 securities is scheduled for February 7, 1997.  On

   February 28, 1997, the additional 850 of the 1000 most

   actively traded securities will be phased in.  Finally, on


        -[8]-(...continued)
                 the customer requests that the order be
                 displayed.

        -[9]-    17 CFR 240.11Ac1-1.

        -[10]-   See Letter from S. William Broka, Senior Vice
                 President, Trading & Market Service, Nasdaq
                 Stock Market, Inc., dated December 23, 1996.

==========================================START OF PAGE 5======
   March 28, 1997, the ECN amendment will apply to all remaining

   OTC securities.

       The Limit Order Display Rule also becomes effective on

   January 20, 1997 for all exchange traded securities and 50 OTC

   securities identified by Nasdaq.  Other Nasdaq securities will

   become subject to the rule on a phased-in basis, with all

   Nasdaq securities phased in by August 28, 1997.

       B. Changes Required to NASD Rules and Systems

       The Adopting Release recognized that the Order Handling

   Rules would require the NASD, as well as national securities

   exchanges ("exchanges"), to change certain systems and rules

   to facilitate compliance with the Order Handling Rules by

   January 20, 1997.-[11]-  For example, the NASD's SOES

   system currently accepts limit orders.  If a limit order is

   not immediately executable, or non-marketable, (i.e., a limit

   order to buy priced below the offer price, or a limit order to

   sell priced above the bid price), it is placed in the SOES

   limit order file and subsequently executed if the best bid for

   a buy, or offer for a sell order becomes equal to the limit

   price.  Limit orders placed into SOES are never publicly

   disseminated, included in the calculation of the best bid or

   offer, or matched against incoming market orders.  Thus, an

   OTC market maker that places a customer limit order into the

   SOES limit order facility would not comply with the Display

   Rule.


        -[11]-   See supra note 6.

==========================================START OF PAGE 6======
       In addition, NASD Rule 4613 currently requires Nasdaq

   market makers to display continuous two-sided quotations in

   Nasdaq National Market ("NNM") securities (approximately the

   top 4000 Nasdaq securities) in sizes of 1,000, 500 or 200

   shares, depending upon the price and trading volume of the

   security.  However, the Display Rule may require a market

   maker to display in its quote a customer limit order that is

   smaller than the mandatory quotation size imposed by NASD Rule

   4613.  This creates the possibility that a market maker could

   be required to publish a quote at a price and size that it is

   otherwise unwilling to trade at for its own account.  The

   changes to the NASD's systems and rules approved today are

   intended to facilitate compliance with the Order Handling

   Rules and are intended to more closely tailor a market maker's

   obligations to the structure of the Nasdaq market anticipated

   to result from implementation of the Order Handling Rules.

   II.    PROPOSED RULE CHANGES TO IMPLEMENT THE DISPLAY RULE

       A. Minimum Quotation Size Requirements

          1.  Quote Size When Displaying Customer Limit Orders

       To facilitate the display of customer limit orders in

   accordance with the Display Rule, the NASD proposes to amend

   NASD Rules 4613 and 6330 to provide that Nasdaq market makers

   and CQS market makers may display a quotation size for one

   normal unit of trading (i.e., 100 shares) or a larger multiple

==========================================START OF PAGE 7======
   thereof to reflect the actual size of a customer limit

   order.-[12]-  Thus, if a market maker is bidding 20 for

   1000 shares and offering 1000 shares at 20 (20 bid - 20

   offered, 1000 x 1000), and the market maker receives a

   customer limit order to buy 100 shares at 20 , the market

   maker would be permitted to update its quote to 20  - 20, 100

   x 1000.  Market makers would not be responsible for executing

   any additional shares above the size of the limit order.  The

   NASD believes that this rule change will promote market maker

   acceptance of limit orders priced inside quoted markets,

   thereby furthering the investor protection and market

   transparency objectives of the Order Handling Rules.

   Moreover, without these rule changes, in instances where a

   customer limit order is smaller than the applicable minimum

   quotation size requirement and a market maker's quote is

   inferior to the limit order price, market makers would be

   obligated to execute trades at prices superior to their

   proprietary quotations.  The NASD and Nasdaq maintain that

   subjecting market makers to such an order execution


        -[12]-     As noted above, NASD Rule 4613 currently
requires
              each market maker in a Nasdaq issue to enter and
              maintain two-sided quotations with a minimum size
              equal to or greater than the applicable SOES tier
              size for the security (e.g., 1,000, 500, or 200
              shares for NNM issues and 500 or 100 shares for
              Nasdaq SmallCap Market issues).  NASD Rule 6330
              requires registered market makers in exchange-
              listed securities to display a minimum quotation
              size of 200 or 500 shares in each reported security
              (as established and published from time to time by
              the Association) depending on trading
              characteristics of the security.

==========================================START OF PAGE 8======
   requirement would be unfair and create a disincentive for

   firms to function as market makers.-[13]-

          2.  Quote Size When Displaying Proprietary Market Maker

   Quotes

       The NASD stated in its filing that market makers should

   not be subject to minimum quote size requirements greater than

   a normal unit of trading in an environment in which Nasdaq

   market makers will compete with customers to affect quotation

   prices.  The NASD also stated that the new order-driven nature

   of Nasdaq brought about by the Display Rule will obviate the

   regulatory justification for minimum quote size requirements

   because investors will have the capability to display their

   own orders in the marketplace.  The NASD stated that the

   inclusion of limit orders and ECN orders in Nasdaq quotations

   should also ensure that market liquidity and price continuity

   will not be harmed by the elimination of minimum quotation



        -[13]-   The Commission stated in the Adopting Release:

          The Commission believes that SROs should
          consider amending such rules and modifying
          certain systems to allow a specialist or market
          maker to quote in sizes smaller than the
          minimum quotation size when such quote
          represents a customer limit order.  With these
          changes, a specialist or market maker that
          displays a customer limit order in its quote
          pursuant to the Display Rule would not be
          responsible for executing as principal any
          additional shares at the limit price where the
          size of the customer limit order is less than
          the minimum quotation size set by the SRO.

       Adopting Release, supra note 6, 61 FR at 48301 n.144.

==========================================START OF PAGE 9======
   size requirements.  Therefore, it proposed to amend NASD Rule

   4613 to require market makers to quote in minimum trading

   increments of 100 shares.

       On January 9, 1997 the NASD filed an amendment to its

   filing that proposes allowing market makers to quote in

   minimum sizes of 100 shares for a three-month pilot program in

   the 50 Nasdaq stocks subject to the first phase-in under the

   Order Handling Rules.  The remaining securities would still be

   subject to the existing minimum quotation display requirements

   for proprietary quotes.

       B. Operation of SOES

          1.  Current Operation of SOES

       NASD Rule 4611(f) requires each market maker in an NNM

   security to register as a SOES market maker in that security.

   SOES is voluntary for market makers in Nasdaq SmallCap

   securities.  The maximum SOES order size for a NNM security is

   either 1,000, 500, or 200 shares, depending on the price and

   volume of the security; the maximum order size for a Nasdaq

   SmallCap Market security is 500 shares.-[14]-  SOES


        -[14]-   A 1,000 share maximum order size applies to NNM
                 securities with an average daily non-block
                 volume of 3,000 shares or more per day, a bid
                 price not exceeding $100 and with three or more
                 market makers.  A 500 share maximum order size
                 applies to NNM securities with an average daily
                 non-block volume of 1,000 shares or more per
                 day, a bid price not exceeding $150 and with
                 two or more market makers.  A 200 share maximum
                 order size applies to NNM securities with an
                 average daily non-block volume of less than
                 1,000 shares per day, a bid price not exceeding
                                                   (continued...)

==========================================START OF PAGE 10======
   automatically executes unpreferenced orders in rotation

   against those market makers who are at the best quoted bid or

   offer on Nasdaq at the time the order is entered.  With the

   agreement of the market maker, SOES orders also may be routed

   or "preferenced" to a particular market maker for execution at

   the inside market, regardless of what price the preferenced

   market maker is quoting.  A SOES market maker is obligated to

   execute SOES orders up to the minimum SOES exposure limit for

   that stock or such greater exposure limit established by the

   market maker.  The minimum exposure limit for a particular

   stock is two times the applicable maximum SOES order size

   (e.g., 2,000 shares for stocks in the 1,000 share tier size).

   If a market maker's exposure limit is exhausted, it is

   temporarily suspended from SOES, placed in a "closed quote

   state," and permitted a five-minute period to restore its

   exposure limit.  If a market maker does not restore its

   exposure limit within five minutes, it is automatically

   withdrawn from the stock and cannot re-enter quotes in the

   issue for at least twenty business days.

       Thus, SOES is currently designed to execute orders against

   market makers based on the tier size for a particular stock,

   without regard to the quotation size displayed by a market

   maker.  Because the minimum quotation sizes for market makers

   are presently aligned with the maximum SOES order sizes, it


        -[14]-(...continued)
                 $250 and with two or more market makers.  See
                 NASD Notice to Members 88-43 (June 22, 1988).

==========================================START OF PAGE 11======
   would not be possible to enter into SOES an order greater in

   size than the market maker's quote.

          2.  Changes to SOES in Response to the Order Handling

   Rules

       Because market maker quotes will at times reflect customer

   limit orders under the Display Rule, the NASD proposed to

   modify SOES to execute market orders only against market

   makers' displayed quotation sizes.

              a.     Decrementation of Displayed Quotation Sizes
                     After SOES Executions

       To avoid instances where a market maker could

   automatically receive multiple SOES executions because it

   displayed a customer's limit order at a price superior to the

   market maker's proprietary quote or increased its quote size

   because of the limit order, the NASD has proposed to modify

   SOES to decrement-[15]- a market maker's displayed quote

   size upon the execution of unpreferenced SOES orders.  For

   example, if a market maker's quote in security ABCD is 20 -

   20 (1000 x 1000), and it receives a customer limit order to

   buy 500 shares at 20 , it would update its quote to 20  - 20

   (500 x 1000).-[16]-  Thereafter, if the market maker

   received a SOES execution at 20  for 500 shares, the size of


        -[15]-   The term "decrement" is used here to mean to
                 automatically reduce the quote by the number of
                 shares executed against it.

        -[16]-   The market maker could elect to quote a size of
                 1500 x 1000 if it wished to also represent its
                 own proprietary trading interest at the price
                 established by the customer limit order.

==========================================START OF PAGE 12======
   its bid would be depleted to zero and the market maker would

   have to re-enter a new quotation within five minutes, or

   withdraw from the stock for 20 days.-[17]-  The NASD

   states that this change is intended to encourage market makers

   to accept and display customer limit orders because they will

   not be subject to mandatory SOES executions larger than the

   size of the limit orders they display or at prices at which

   the market maker is not willing to trade for its proprietary

   account.-[18]-

       The NASD filed a letter amending the proposal to make

   decrementing optional for market makers whose quotation in a

   particular security is equal to or greater than the SOES tier

   size for that security.  Thus, market makers who are willing

   to commit greater capital will have the option of accepting

   repeated orders at their quoted price and size on a stock-by-

   stock basis.

       In the NASD's proposal for a pilot program for the

   quotation requirement, the non-pilot stocks would still be

   subject to the decrementing proposal.  Thus, market makers


        -[17]-   If the market maker is using the auto-refresh
                 feature, described below, the update would be
                 automatic.

        -[18]-     The NASD and Nasdaq also propose that
displayed
              quotations not be decremented after the execution
              of an odd-lot order (i.e., an order for less than
              100 shares) and that the execution of a mixed lot
              order (i.e., an order for greater than 100 shares
              but in an increment other than 100 shares) will
              only decrement a market maker's quotation by the
              number of shares represented by the number of round
              lots contained in the mixed lot order.

==========================================START OF PAGE 13======
   would be required to publish a quote in non-pilot stocks in

   the required quote size, but this quote could be decremented.

   Once the quote was decremented to zero, or the market maker

   chose to manually change the price or size of the proprietary

   quote, the market maker would be required to enter at least

   the minimum quote size.

              b. Split Order Execution

       The NASD proposal would limit a market maker's SOES

   exposure to its displayed quotation size, even if less than

   the SOES maximum order size.  In addition, SOES would be

   modified to decrement market makers' displayed quotation sizes

   in response to unpreferenced SOES executions.  To ensure that

   a SOES order can be executed in full in an environment in

   which SOES maximum order sizes may be greater than a market

   maker's displayed quote, the NASD has proposed changes to SOES

   that would allow one order to be executed against multiple

   market makers.  In addition, the NASD has proposed to change

   SOES to reject "all-or-none" orders.-[19]-

       For example, if the inside market for ABCD is 20 - 20 and

   two market makers are each at the inside bid for 500 shares, a

   SOES market order to sell 1,000 shares of ABCD would be

   executed at 20, with both market makers buying 500 shares.  In

   addition, because all market maker quotations at the inside

   could be depleted by the execution of a SOES order, SOES is


        -[19]-   An "all or none" order is a buy or sell order
                 marked to provide that no partial transaction
                 is to be executed.

==========================================START OF PAGE 14======
   being modified to permit market orders to be filled at

   multiple price levels.  For example, if the inside market for

   ABCD is 20 - 20 and Market Makers A and B are each at the

   inside bid for 100 shares, with Market Maker C bidding at 19

   for 800 shares, a SOES market order to sell 1,000 shares of

   ABCD would be executed against all three market makers.

   Market Makers A and B would each buy 100 shares at 20 and

   Market Maker C would buy 800 shares at 19 .  Finally, a

   marketable limit order entered into SOES that exceeds the size

   of market maker quotes at the limit price receives a partial

   fill.  The unfilled portion of the order is returned to the

   entering firm.

              c. Displayed Quotation Sizes Will Constitute

                 Exposure Limits

       Under the proposal, decrementing market maker quotes after

   unpreferenced SOES executions will cause each market maker's

   displayed quotation size to become its exposure limit.  SOES

   will cease executing orders against a market maker once its

   quote size has gone to zero.  Therefore, the NASD has proposed

   to amend the SOES rules to replace references to exposure

   limits with references to a market maker's displayed size.

              d. Prohibition Against the Entry of Non-Marketable
                 Limit Orders into SOES

       SOES currently accepts both market orders and limit

   orders.  If a limit order is not immediately executable, or

   non-marketable, (i.e., a limit order to buy priced below the

   offer price, or a limit order to sell priced above the bid

==========================================START OF PAGE 15======
   price) it is placed in the SOES limit order file and

   subsequently executed if the limit price becomes equal to the

   best bid or offer.  Limit orders placed into SOES are never

   publicly disseminated, included in the calculation of the best

   bid or offer, or matched against incoming market orders.  The

   NASD maintains that the processing of such orders conflicts

   with the requirements of the Display Rule and with the duty of

   best execution as articulated in the Adopting

   Release.-[20]-   Therefore, the NASD has proposed that

   SOES no longer accept non-marketable limit orders.

              e. Modifications to the SOES Automated Quotation

          Update Feature

       Currently, the "auto-refresh" feature of SOES updates both

   sides of a market maker's quotation in parallel by a pre-

   determined amount after a SOES execution.  The NASD has

   proposed that, with regard to the fifty stocks that would be

   included in the pilot, the Nasdaq Stock Market would re-

   establish the market maker's quote, when it is exhausted, for

   one normal unit of trading.  For those securities not subject

   to the pilot, the market maker's quote would be refreshed for

   the SOES tier size.  For both pilot stocks and all other

   securities the auto-refresh feature would be modified to only

   update the side of a market maker's quote that has been






        -[20]-     See Adopting Release, supra note 6, 61 FR at
48324.

==========================================START OF PAGE 16======
   decremented.-[21]-

       In its amendment, the NASD proposes to refresh all stocks

   for the SOES tier size, because most stocks would remain

   subject to initial quotation requirements at this size.  The

   NASD would refresh stocks subject to the pilot at the SOES

   tier size, because of difficulties programming its system to

   provide different refresh sizes for particular stocks.

              f. Allowing SOES Market Makers to Enter Agency
                 Orders into SOES

       A SOES market maker currently is prohibited from entering

   agency orders into SOES unless a locked or crossed market

   exists.  This rule was intended to prevent market makers from

   engaging in "fair weather" market making by executing unwanted

   orders against other market makers through SOES.  However, a

   market maker's disseminated quote may now reflect a customer

   limit order displayed in accordance with the Display Rule.

   The NASD has proposed to amend NASD Rule 4730 to permit a SOES

   market maker to enter agency orders into SOES to ensure that a

   customer's order has access to a better-priced customer limit

   order displayed in a market maker's quote regardless of

   whether the customer's broker-dealer is a SOES market maker.



        -[21]-   The NASD has also proposed to amend the auto-
                 refresh feature to allow a market maker to
                 maintain its quote at the inside market.  With
                 this auto-refresh feature, those market makers
                 seeking to buy or sell more stock than its
                 displayed quotation could auto-refresh at its
                 same quotation price if the market maker
                 entered a quotation size equal to or greater
                 than the maximum SOES order size.

==========================================START OF PAGE 17======
   Pursuant to the amendment, market makers would be able to

   enter riskless principal orders into SOES if these orders

   reflect customer agency orders.-[22]-

              g. Processing of Marketable Limit Orders

       SOES currently is designed to execute marketable limit

   orders ahead of market orders queued in SOES.  Although a

   marketable limit order is functionally equivalent to a market

   order when the limit price is equal or superior to the inside

   market,-[23]- SOES currently provides preferential

   treatment to marketable limit orders.  To eliminate the

   disparate treatment of substantively identical orders, the

   NASD proposed to amend SOES to execute market and marketable

   limit orders on a time priority basis.

              h. Market Maker Withdrawal from Nasdaq SmallCap
                 Market Securities

       Because SOES is voluntary for Nasdaq SmallCap Market

   securities, when a market maker's exposure limit is exhausted

   in one of these securities, the NASD does not deem the market

   maker to have voluntarily withdrawn from the stock, because

   the market maker can continue to quote the issue without

   participating in SOES.  If market maker quotations are

   decremented after SOES executions, however, it will now be

   possible for a market maker in a SmallCap security to go into



        -[22]-   See supra note 3.

        -[23]-     That is, a limit order to buy priced at or
above
              the offer and a limit order to sell priced  at or
              below the bid.

==========================================START OF PAGE 18======
   a "closed quote" state because its quotation size has been

   depleted.  Accordingly, the NASD proposal would amend NASD

   Rule 4730(b) to specify that a market maker in a SmallCap

   security shall be deemed to have voluntarily withdrawn from a

   stock if its quote size remains at zero at the close of the

   trading day, thereby precluding the market maker from being a

   market maker in the issue for twenty business days.

       C. Proposed Rule Changes to Implement the ECN Amendment

       The NASD also proposed to amend certain rules and

   characteristics of the SOES and SelectNet systems to

   facilitate the development of a means for ECNs to comply with

   the requirements of the ECN Display Alternative.  As noted

   above, the ECN Display Alternative relieves an exchange

   specialist or OTC market maker of the requirement to publicly

   quote any superior prices that it privately displays through

   an ECN if that ECN:  (1) ensures that the best priced orders

   entered by market makers and specialists into the ECN are

   communicated to an exchange or Nasdaq for public

   dissemination; and (2) provides brokers and dealers access to

   orders entered by exchange specialists and OTC market makers

   into the ECN, so that brokers and dealers who do not subscribe

   to that ECN can trade with those orders.  This access must be

   equivalent to the access that would have been available had

   the market makers or specialists reflected these superior

   prices in their public quotes.-[24]-


        -[24]-   See Adopting Release, supra note 6.

==========================================START OF PAGE 19======
       The NASD has proposed to implement, on an interim basis, a

   linkage to facilitate the operation of the ECN Display

   Alternative-[25]- based on existing Nasdaq system

   platforms, SOES and SelectNet ("SelectNet Linkage").  The

   methodology for establishing the SelectNet Linkage and the

   rule changes proposed by the NASD are described below.

          1.  Overview of the Operation of the SelectNet Linkage

       The SelectNet Linkage is intended to provide a means for

   an ECN to disseminate publicly the price and full size of the

   orders entered by specialists and OTC market makers to the

   NASD and to provide access to other broker-dealers to trade at

   those prices, equivalent to that provided in the market where

   the prices are disseminated.  The SelectNet Linkage would

   disseminate ECN prices and sizes by utilizing the methodology

   currently used for displaying Unlisted Trading Privileges

   ("UTP") exchange quotes,-[26]- and would provide access

        -[25]-     The NASD stated in the filing that they
              continue to
              examine other means to develop a longer-term
              mechanism that would provide a permanent means to
              establish an ECN Display Alternative that meets
              every aspect of the Commission's rule.  The NASD
              stated that it would propose a permanent approach
              separately from the instant filing.

        -[26]-     Pursuant to the Joint Self-Regulatory
Organization
              Plan Governing the Collection, Consolidation and
              Dissemination of Quotation and Transaction
              Information For Exchange Listed Nasdaq/National
              Market System Securities Traded On Exchanges On An
              Unlisted Trading Privileges Basis ("Nasdaq/NMS/UTP
              Plan"), Nasdaq acts as the facilities manager for
              itself and the UTP Exchanges in collecting,
              consolidating and disseminating quotes from Nasdaq
              market makers and UTP exchange specialists that
                                                   (continued...)

==========================================START OF PAGE 20======
   to ECN prices in the same manner that broker-dealers currently

   may preference orders through SelectNet.

       The SelectNet Linkage would allow an ECN to enter its

   best-priced orders into Nasdaq for display on the Nasdaq

   Workstation.  To effect transactions against these displayed

   prices, an NASD member that subscribes to the Nasdaq

   Workstation II service would be permitted to access the ECN

   prices by directing orders through SelectNet to the ECN.  New

   NASD Rule 4623 would provide for display of and access to ECN

   prices and sizes and would articulate the standards for ECN

   participation in the SelectNet Linkage.

       Proposed NASD Rule 4623 provides that an ECN that wishes

   to use the SelectNet Linkage, or any future system Nasdaq

   develops to facilitate compliance with the ECN Display

   Alternative, must: (1) demonstrate to the NASD that it meets

   the ECN definition found in the Quote Rule; (2) be registered

   as an NASD member; (3) enter into and comply with the terms of

   a Nasdaq Workstation Subscriber Agreement; (4) agree to

   provide for Nasdaq's dissemination in the quotation data

   stream that it makes available to quotation vendors, the






        -[26]-(...continued)
              trade Nasdaq securities pursuant to Section 12(f)
              of the Act.  The prices quoted by UTP exchange
              specialists appear on the Nasdaq montage with those
              quoted by Nasdaq market makers.  Currently, UTP
              exchange specialists are not subject to SOES
              executions.

==========================================START OF PAGE 21======
   prices and sizes of Nasdaq market maker orders-[27]- at

   the highest buy price and the lowest sell price for each

   Nasdaq security entered in and widely disseminated by the ECN;

   and (5) provide an automated execution of priced orders

   displayed through the linkage or, if the price is no longer

   available, an automated rejection of any order routed to the

   ECN through the Nasdaq-provided display alternative.

          a.  Display of ECN Prices

       For quotation display purposes, ECNs would deliver prices

   to Nasdaq reflecting customer orders in their systems, and

   Nasdaq would display and disseminate rounded

   prices.-[28]-  Nasdaq would furnish ECNs with market

        -[27]-     The ECN Amendment does not require an ECN to
              provide non-market maker interest in the data that
              would be provided under the ECN Display
              Alternative.  Nasdaq has been informed, however, by
              several ECNs that have non-NASD member
              participants, e.g., institutional investors, that
              these ECNs will deliver to Nasdaq the best prices
              for each security for which they permit orders to
              be entered, whether those best prices are from a
              market maker subject to the rule or an entity not
              subject to the rule.  If the ECN so chooses, it may
              send priced orders to Nasdaq from other entities
              that are not Nasdaq market makers or exchange
              specialists.  Nasdaq will display such prices as it
              does other ECN-provided prices.

        -[28]-     ECNs often display priced orders that are
quoted in
              finer increments (e.g., 1/16, 1/32, 1/64) than the
              minimum variation for Nasdaq (currently   for
              stocks over $10).  Under the ECN Amendment, Nasdaq
              would not be required to display the actual price
              of the finer-incremented order; instead, it would
              round the order to the nearest standard quote
              increment (rounding down for increments on the
              better-priced bids and up for better-priced
              offers).  The Commission in the Adopting Release
                                                   (continued...)

==========================================START OF PAGE 22======
   maker identifiers ("MMIDs").  While ECNs would be assigned

   MMIDs, ECNs would not be registered as market makers.  With

   the exception of certain rules such as the NASD's firm quote

   rule, the two-sided quote requirement,-[29]- and the

   locked and crossed markets rule discussed below, ECNs would

   not be subject to standard market maker requirements in the

   NASD's Rules.  Nasdaq would include the ECN prices and sizes

   in the Nasdaq Workstation II quote montage with the ECN MMID

   and incorporate the ECN price in the Nasdaq best price

   calculation.  When the ECN is at the best bid or offer in the


        -[28]-(...continued)
              stated that Nasdaq should develop a capability in
              its quote dissemination system to flag or specially
              denote that an ECN priced order is rounded, but
              noted that this capability does not currently
              exist.  Nasdaq has stated that it is developing a
              rounding indicator.  See Letter from Alfred R.
              Berkeley, President, NASD to Richard R. Lindsey,
              Director, Division of Market Regulation, SEC, dated
              November 18, 1996, and letter from Richard R.
              Lindsey to Alfred R. Berkeley, dated November 22,
              1996 (regarding display of rounded prices in public
              quotes).

        -[29]-     The requirement for ECNs to display two-sided
              quotes is a temporary requirement, contingent on
              Nasdaq's development of a capability that permits
              ECNs to display a one-sided quote.  Nasdaq
              recognizes that ECNs often have orders only on one
              side of the market.  Currently, however, because
              Nasdaq's quote display system was built to display
              market maker quotations and market makers are
              required by rule to furnish both a bid and offer,
              Nasdaq's system would be unable to recognize an ECN
              price unless that price were also entered with a
              corresponding bid or offer.   Accordingly, until
              such time as Nasdaq builds a one-sided ECN priced
              order display capability, ECNs must enter two-sided
              "quotations."  The NASD and Nasdaq believe that the
              one-sided ECN order entry capability should be
              available sometime in the first quarter of 1997.

==========================================START OF PAGE 23======
   market, its price would be included in the NBBO.

       For example:

         NBBO 20  - 20  1000 x 1000

          ABCD   19  - 20  1000 x 1000

          EFGH   20  - 20  1000 x 1000

          ECNA   20  - 20  1000 x 1000  (an ECN)

       Following current practices for UTP exchanges, Nasdaq

   would not include the ECN as a SOES market maker.

   Consequently, an ECN participating in the SelectNet Linkage

   would not be subject to SOES executions.  The NASD stated in

   its filing that it would not subject ECNs to SOES executions

   because the ECN would be exposed to the risk of double

   executions and the consequent need to take a principal

   position, which is inconsistent with the ECN's role of acting

   solely as agent on behalf of its customers.  The NASD stated

   that the risk of double executions arises because, with

   electronic order entry capabilities, once an order is

   displayed in multiple execution systems, such as SOES and an

   ECN's own system, the same order can be accessed nearly

   simultaneously by different counterparties.

              b. Access to ECN Prices

       NASD members would be able to reach ECN prices displayed

   in Nasdaq by directing orders through SelectNet, up to the

   size displayed in the ECN quote.  The ECN would have the

   ability to accept orders at the displayed price, or accept

   orders at an improved price if its actual price is at an

==========================================START OF PAGE 24======
   increment better than that displayed.-[30]-  The ECN

   would review its own file to determine whether the priced

   order displayed in Nasdaq has already been executed in the

   ECN's own system.  The ECN could reject the order if the order

   residing in its own system already has been executed by the

   time the SelectNet order is delivered to the ECN.  An ECN

   cannot decline an order delivered through the SelectNet

   Linkage because it may find a better order elsewhere. The

   Commission understands that ECNs that wish to utilize the

   SelectNet Linkage will be required to provide virtually

   immediate responses to members entering orders seeking to

   access publicly displayed ECN orders.-[31]-  The Nasdaq

   Workstation Subscriber Agreement would require prompt and non-

   discriminatory execution of linkage orders by the ECN.

       In addition, as NASD members and subscribers to the Nasdaq

   Workstation II service, ECNs would be subject to contractual

   obligations to demonstrate that their systems are properly

   designed to operate in high volume trading environments and

   that they have adequate security and other operational



        -[30]-     See discussion below regarding the execution
of
              SelectNet orders at rounded ECN prices when such
              orders are priced at increments finer than those
              permitted to be displayed in the consolidated quote
              system.

        -[31]-   An ECN is expected to respond on an automated
                 basis to orders delivered through the SelectNet
                 Linkage much more rapidly than a market maker
                 that receives an order delivered through
                 SelectNet.

==========================================START OF PAGE 25======
   procedures in place to maintain the integrity of Nasdaq

   systems.  ECNs that are not willing or are unable to comply

   with such system requirements would not be permitted to

   establish a SelectNet Linkage for ECN Display Alternative

   purposes.

          2.  Other Rule Changes Necessitated By Development of
              the SelectNet Linkage

              a. SelectNet Changes

                 i.  Current Operation of SelectNet

       SelectNet is an automated order routing and execution

   system that allows a member to direct buy or sell orders in

   Nasdaq securities to a single market maker (preferenced

   orders) or broadcast orders to all market makers in the

   security.  Upon receiving a SelectNet order, a member can

   accept the order, decline it (if consistent with its firm

   quote obligations), or send a counter-offer to the originating

   member.

                 ii.     Elimination of SelectNet Broadcast

                         Feature

       The NASD has proposed to eliminate the SelectNet Broadcast

   feature and allow only the entry of a SelectNet order directed

   to a specific market maker or ECN.  The NASD offered several

   reasons for eliminating the Broadcast feature in its rule

   filing.  The NASD noted that with the Broadcast feature,

   SelectNet falls within the definition of an ECN-[32]-



        -[32]-     SEC Rule 11Ac1-1(a)(8).

==========================================START OF PAGE 26======
   because it is an "electronic system that widely disseminates

   to third parties orders entered therein by an exchange

   specialist or OTC market maker, and permits such orders to be

   executed against in whole or in part."  The NASD stated that

   it would be unable to make the systems changes necessary to

   permit a market maker to rely upon the ECN Display Alternative

   if it entered a priced order into SelectNet.  Consequently,

   market makers that entered priced orders into SelectNet

   Broadcast would be required to change their quotes in the

   Nasdaq Workstation display.  The NASD also stated that the

   SelectNet Broadcast feature is a very significant drain on

   Nasdaq network capacity resources, and in the face of

   potentially heavy additional system usage pursuant to the

   Order Handling Rules, network resources are more appropriately

   devoted to establishing the ECN linkage for directed orders.

                 iii.    Acceptance of Orders at Improved Prices

       The NASD has also proposed a modification to SelectNet to

   permit an ECN or market maker receiving an order through

   SelectNet at a specific price to execute that order at a price

   reflecting price improvement without having to go through the

   currently designed counter-offer mechanism.  Currently, when a

   market maker receives a SelectNet order, it can accept at the

   price sent by the order entry firm; or it can counter with a

   different price or size.  As soon as the market maker puts in

   a different price, however, the current system treats the new

   price as a counter-offer message.  Because ECNs are likely to

==========================================START OF PAGE 27======
   hold orders at increments that cannot currently be shown in

   Nasdaq, when an ECN attempts to accept an order at a better

   price, e.g., 1/16th better, the extant SelectNet system would

   treat the new price as a counter-offer.  Accordingly, to

   comply with the ECN Amendment requirement that orders be

   executed at their actual prices, Nasdaq will change SelectNet

   to prevent the counter-offer mechanism from operating in such

   a situation and will deliver to the order entry firm and the

   ECN an execution report at the improved price.

              b. SOES Rule Change

       The NASD also has proposed an amendment to NASD Rule 4730

   to modify the SOES system to reject orders entered when an ECN

   or UTP Exchange alone sets the price of the NBBO.  Although

   UTP exchanges and ECNs can establish the best price in Nasdaq,

   they are not required to participate in SOES as market makers

   and therefore are not accessible through SOES.  Proposed Rule

   4730(b)(10) provides that if there are no SOES market makers

   at the best bid or offer that is being disseminated by Nasdaq,

   orders entered into SOES will be returned to the order entry

   firm to permit the order entry firm to direct the order to the

   entity establishing the best price.

       Because the ECN quote is incorporated in Nasdaq's inside

   price but is not accessible through SOES under this approach,

   and SOES is programmed to execute at the best price displayed,

   SOES, as currently designed and operating, would execute

   orders against the next available Nasdaq market maker at the

==========================================START OF PAGE 28======
   inside price established by an ECN whether that Nasdaq market

   maker is at the better ECN price or at an inferior price.  The

   NASD expressed concern that a person could "game" SOES by

   entering an order into an ECN that drives the Nasdaq inside

   quote and obtain multiple SOES automated executions at that

   price against Nasdaq market makers even though they are not

   quoting the ECN price.

       Therefore, the NASD has proposed to modify SOES to return

   unexecuted SOES orders to the entering member when the inside

   quote consists of a SOES-inaccessible price.  Order entry

   firms that enter orders into SOES during the period when there

   is no SOES market maker at the inside market will be informed

   that the order has been rejected and may choose to route that

   order into SelectNet to access the ECN order driving the

   inside market or take other measures, such as routing the

   order to a market maker that guarantees the best

   price.-[33]-  The NASD stated that it believes that

   order entry firms could avoid submitting orders to SOES during

   times that a SOES-inaccessible price drives the inside by

   developing automated means to determine when an ECN or UTP

   exchange is alone at the inside and delivering orders at such

   times to an ECN through the SelectNet directed order




        -[33]-     The NASD and Nasdaq have committed to continue
to
              develop a longer-term approach to the ECN Display
              Alternative that would better integrate various
              electronic systems.

==========================================START OF PAGE 29======
   capability.-[34]-

              c. Locked and Crossed Markets Rule Amendments

       The NASD has proposed amendments to its locked and crossed

   markets rule, Rule 4613(e), to state that the locked and

   crossed markets rule applies to any NASD member, when that

   member enters into an ECN a priced order that is displayed in

   Nasdaq.  The proposed amendment also states that the locked

   and crossed markets rule would apply to ECNs when the ECN, as

   an NASD member acting as agent, represents an institutional

   order or other non-NASD member order the price of which would

   lock or cross the best bid or offer in Nasdaq.  Therefore,

   under the proposed locked and crossed markets rule, NASD

   members using ECNs, and ECNs themselves for non-member orders,

   must comply with Nasdaq's rule that before a market is locked

   or crossed, the locking or crossing party must first make

   reasonable efforts to execute the quote that would be locked.

       The NASD believes that locked or crossed markets can cause

   investor confusion because investors will not know the true

   price of the security at the time when a locked or crossed

   quote is publicly displayed.  The NASD also notes that broker-

   dealers operating internal order execution systems may be


        -[34]-   The NASD considered the alternative of
                 modifying SOES to ignore the ECN or UTP quote
                 and execute SOES orders at the Nasdaq market
                 maker's inferior price.  The NASD expressed
                 concern that this approach would raise best
                 execution concerns because the customer's order
                 entered in SOES would be executed at a price
                 inferior to the best price displayed in
                 Nasdaq's inside market.

==========================================START OF PAGE 30======
   foreclosed from operating those systems when the market for a

   particular security is locked or crossed.

       The NASD and Nasdaq believe that an ECN should be

   prohibited from entering an institutional order into Nasdaq

   until the ECN has made a reasonable effort to reach the entity

   on the other side of the market whose quote would be locked or

   crossed.  It should be noted that if an ECN locks or crosses

   the market, is alone at that price, and a SOES order is

   entered against the ECN price that is causing the lock or

   cross, SOES will be programmed to reject such orders, rather

   than executing them against a Nasdaq market maker at a

   different price level.

       3. Modifications to Autoquote Policy

       Currently, the NASD's Autoquote Policy - which prohibits

   computer generated quotes - does not allow a market maker to

   autoquote to display a customer limit order.  Although the

   NASD has previously interpreted the policy to permit a

   customer limit order to be displayed on an automated basis,

   because of the requirements of the Display Rule and the

   benefits to investors and the marketplace to be derived from

   the Display Rule, the NASD has proposed an amendment to the

   Autoquote Policy to clarify that it is permissible to

   autoquote to display a customer limit order.

       Another amendment to the Autoquote Policy proposed by the

   NASD clarifies that ECNs may autoquote to maintain a

   continuous two-sided quote for as long as Nasdaq requires ECNs

==========================================START OF PAGE 31======
   to enter two-sided quotes because of existing systems

   limitations.  Once Nasdaq develops a system capability that

   permits ECNs to display a one-sided quote, this exception

   would lapse.

   III.  COMMENTS

       The Commission received 366 comment letters.-[35]-

   A separate summary of comments has been prepared and is

   available in the public file.  The specific issues addressed

   by commenters will be discussed in the appropriate sections of

   this order.-[36]-

   IV.  DISCUSSION


        -[35]-   The Commission received comment letters from
                 numerous broker-dealer firms, some of which are
                 market makers, and others that are order entry
                 firms.  The Commission received comment letters
                 from a large number of individuals who could be
                 identified as SOES traders.  The Commission
                 also received comment letters from one self-
                 described entrepreneur, several individual
                 investors and academic commenters.  In
                 addition, comment letters were received from
                 several professional associations.  The
                 Commission also received comment letters from a
                 member of Congress, Instinet, the American
                 Stock Exchange ("Amex") and the Chicago Board
                 Options Exchange ("CBOE").

        -[36]-   Several commenters asked that the Commission
                 extend the comment period to allow additional
                 comment.  See letter from the Honorable Ralph
                 Hall to Arthur Levitt, Chairman, SEC, dated
                 January 8, 1997.  The Commission provided the
                 full comment period required under the statute
                 and received over 350 comments.  The Commission
                 also has considered numerous comments received
                 after the close of the comment period.  In view
                 of the importance of considering the NASD's
                 proposals before the effective date of the
                 Order Handling Rules, however, a longer comment
                 period was not practicable.

==========================================START OF PAGE 32======
       The standard by which the Commission must evaluate

   proposed rule changes is set forth in Section 19(b) of the

   Act.  The Commission must approve a proposed NASD rule change

   if it finds that the proposal is consistent with the

   requirements of the Act and the rules and regulations

   thereunder that govern the NASD.-[37]-  In evaluating a

   given proposal, the Commission examines the record before it

   and all relevant factors and necessary

   information.-[38]-  After carefully considering all of

   the comments, and based on the Commission's experience and

   knowledge of current market practices and conditions, the

   Commission believes the NASD's proposed rule changes are

   consistent with the Act.  As noted earlier, the Commission is


        -[37]-   15 U.S.C.  78s(b).  The Commission's statutory
                 role is limited to evaluating the rules as
                 proposed against the statutory standards, and
                 does not require the SRO to prove its proposal
                 is the least burdensome solution to a problem.

        -[38]-   In the Securities Acts Amendments of 1975
                 ("1975 Amendments"), Congress directed the
                 Commission to use its authority under the Act,
                 including its authority to approve SRO rule
                 changes, to foster the establishment of a
                 national market system and promote the goals of
                 economically efficient securities transactions,
                 fair competition, and best execution.  Congress
                 granted the Commission "broad, discretionary
                 powers" and "maximum flexibility" to develop a
                 national market system and to carry out these
                 objectives.  Furthermore, Congress gave the
                 Commission "the power to classify markets,
                 firms, and securities in any manner it deems
                 necessary or appropriate in the public interest
                 or for the protection of investors and to
                 facilitate the development of subsystems within
                 the national market system."  S.Rep. No. 75,
                 94th Cong., 1st. Sess., at 7 (1975).

==========================================START OF PAGE 33======
   not acting at this time on the NASD's proposed change to the

   SelectNet broadcast feature.

       Section 15A of the Act, which incorporates by reference

   Section 11A of the Act, establishes specific standards for

   NASD rules against which the Commission must measure the NASD

   proposal.-[39]-  As discussed below, the Commission has

   evaluated the NASD's proposed changes in light of the

   standards and objectives set forth in Sections 15A and 11A of

   the Act.

       In enacting the 1975 Amendments and establishing the

   objective of achieving a national market system, Congress

   focused closely on the concept of best execution.  To this

   end, Section 11A provides, among other things, that it is in

   the public interest and appropriate for the protection of

   investors and the maintenance of fair and orderly markets to

   assure economically efficient execution of securities

   transactions; fair competition among market participants; the

   availability to brokers, dealers and investors of information

   with respect to quotations in securities; and the practicality

   of brokers executing orders in the best market.-[40]-

       Further, as discussed in the Adopting Release for the

   Order Handling Rules, the 1975 Amendments contain an explicit

   statutory mandate for the establishment of a national market

   system.  Congress considered mandating certain minimum


        -[39]-   See 15 U.S.C.  78k-1 and 78o-3.

        -[40]-   15 U.S.C.  78k-1(a)(1).

==========================================START OF PAGE 34======
   components of the national market system, but instead created

   a statutory scheme granting the Commission broad authority to

   oversee the implementation, operation and regulation of the

   national market system.-[41]-  In accordance with this

   mandate, the Commission adopted the Order Handling Rules last

   year.

       The Commission believes that the rule changes proposed by

   the NASD are consistent with the NASD's obligations under the

   Order Handling Rules and with the regulatory framework for a

   national market system established by Congress in the 1975

   Amendments.  Congress envisioned a national market system

   supported by accurate and reliable public quotation and

   transaction information, and the practicability of brokers

   executing investors' orders in the best market.-[42]-

   The Commission expects that the NASD's rule changes will

   enhance transparency and facilitate best execution of customer

   orders, thereby contributing to the achievement of the full

   potential of the national market system.  Further, the NASD's

   rule changes will bring its systems in compliance with the

   Order Handling Rules and ensure that its members will be able

   to meet their obligations under the Order Handling Rules.

       The Commission also believes that the proposal advances




        -[41]-   S. Rep. No. 75, 94th Cong., 1st Sess. 8-9
                 (1975) ("Senate Report").

        -[42]-   Exchange Act Section 11A(a)(1)(C)(iii) & (iv),
                 15 U.S.C.  78k-1(a)(1)(C)(iii) & (iv).

==========================================START OF PAGE 35======
   the objectives of Section 11A of the Act.-[43]-  The

   Commission believes that in furthering the objectives of the

   Order Handling Rules, the proposed changes submitted by the

   NASD are designed to remove impediments to the operation of a

   free and open market and a national market system, enhance the

   protection of investors and the public interest, and produce

   fair and informative quotations, consistent with Sections

   15A(b)(6)-[44]- and 15A(b)(11)-[45]- of the Act.

   In addition, the Commission believes that the benefits of the

   proposal in terms of making the systems and regulatory changes

   necessary to provide for the enhanced opportunities for price

   improvement and greater transparency of customer limit orders



        -[43]-   See 15 U.S.C.  78k-1.

        -[44]-   Section 15A(b)(6) authorizes the NASD to adopt
                 rules 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.
                 Furthermore, the rules of the NASD must not be
                 designed to permit unfair discrimination
                 between customers, issuers, brokers, or
                 dealers.

        -[45]-   Section 15A(b)(11) authorizes the NASD to adopt
                 rules relating to quotations.  Such rules must
                 be designed to produce fair and informative
                 quotations, to prevent fictitious or misleading
                 quotations, and to promote orderly procedures
                 for collecting, distributing, and publishing
                 quotations.

==========================================START OF PAGE 36======
   under the Commission's Order Handling Rules outweigh any

   potential burden on competition or costs to customers or

   broker-dealers affected adversely by the proposal.  Thus, the

   Commission believes that the proposal is consistent with

   Section 15A(b)(9) of the Act in that it does not impose a

   burden on competition that is not necessary or appropriate in

   furtherance of the purposes of the Act.-[46]-

       The Commission has determined at this time to approve the

   NASD's proposed rule change.-[47]-  The Commission

   believes that the rules being approved today are consistent

   with the Act, in particular, with Sections 11A(a),-[48]-






        -[46]-   S.Rep. at 13-14.  In weighing the competitive
                 effects of an SRO rule filing, the Commission
                 must balance any perceived anti-competitive
                 effects against other statutory objectives.
                 The statute does not require the NASD to
                 achieve its objective by selecting the least
                 anti-competitive alternative.  See infra notes
                 86-87 and accompanying text.

        -[47]-   The Commission is not approving, however, the
                 exception of the proposed elimination of the
                 SelectNet broadcast feature, which the
                 Commission is still considering.  Furthermore,
                 the Commission is approving the elimination of
                 the minimum quotation requirement only for the
                 NASD's pilot program for 50 stocks for a three-
                 month period.

        -[48]-   Section 11A(a)(1)(C) provides that it is in the
                 public interest among other things, to assure
                 the economically efficient execution of
                 securities transactions and the availability to
                 brokers, dealers, and investors of information
                 with respect to quotations for and transactions
                 in securities.

==========================================START OF PAGE 37======
   15A(b)(6),-[49]- 15A(b)(9)-[50]- and

   15A(b)(11)-[51]- of the Act and Rules 11Ac1-1 and 11Ac1-

   4 thereunder.

       Various commenters supported the proposed rule change,

   including market makers, broker-dealers and associations

   representing broker-dealers.  Most of these commenters

   believed that the proposed rule change would facilitate the

   implementation of the Order Handling Rules.  Many commenters

   opposed to the proposed rule change cited a concern for

   decreased liquidity and increased volatility as a potential

   result of approving the proposed rule change.  Still other

   commenters, including broker-dealers, individual investors and

   day traders, supported various aspects of the proposed rule

   change while opposing others.  The Commission has determined,



        -[49]-   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.

        -[50]-   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.

        -[51]-   Section 15A(b)(11) requires the NASD, among
                 other things, to formulate rules designed to
                 produce fair and informative quotations.

==========================================START OF PAGE 38======
   for the reasons discussed below, to partially approve the

   proposal, and to approve Amendment No. 1 on an accelerated

   basis.

       Most of the favorable comments, as discussed below,

   supported the NASD's efforts to implement the Order Handling

   Rules by providing mechanisms for the display of customer

   limit orders and orders placed in ECNs by market makers within

   the time frame set forth by the Commission in the Adopting

   Release.  In light of all the comment letters received, the

   Commission believes that the proposal represents a workable

   first step in the implementation of the Order Handling Rules.

   In adopting the Order Handling Rules, the Commission firmly

   believed that they would increase investor protection by

   ensuring that customer limit orders were immediately displayed

   in the markets, thus narrowing the quote and increasing quote

   competition and customer interaction, and by providing

   investors information about and access to superior prices that

   specialists and market makers displayed in ECNs.  To provide

   these benefits to the public as soon as possible, the

   Commission set an accelerated implementation period that was

   brief in view of the magnitude of the changes necessary to

   prepare for the Order Handling Rules.

       In responding to the established deadlines with the

   necessary changes to its systems and rules, the NASD was

   subject to several significant constraints.  First, the NASD

   sought to create a linkage with ECNs by modifying its existing

==========================================START OF PAGE 39======
   systems because the schedule for implementation of the rules

   precluded developing new systems or making extensive revisions

   to its existing systems.  Second, the redesign of the NASD's

   SOES and SelectNet systems ("Legacy systems"), which the NASD

   has proposed to replace with a newer NAqcess system, was

   limited by these existing Legacy systems' age and

   inflexibility.  Third, the Nasdaq system has experienced rapid

   growth in trading and message volume, and has struggled to

   maintain sufficient capacity for this growth.  The significant

   quote changes resulting from the Order Handling Rules are

   expected to place serious additional demands on Nasdaq system

   capacity.  Because of these significant constraints and the

   need to comply with the Order Handling Rules' effective dates,

   the NASD made a number of compromises in adapting its systems

   and rules to the Order Handling Rule requirements.  These

   compromises underlie many of the issues raised by commenters

   regarding the amendments.  In a number of instances, the NASD

   intends to revise its systems after the rules go into effect,

   which will reduce some of the concerns raised by the
commenters.

       A. Changes to Minimum Quote Size Requirements

          1.  Comments

       Commenters favoring this aspect of the proposal include

   market makers, professional associations, institutions and

   Instinet.  These commenters generally agreed with the NASD

   that the Order Handling Rules will transform Nasdaq into more

   of an order-driven market, and that market makers should no

==========================================START OF PAGE 40======
   longer be required to quote more than 100 shares because

   investor orders will be displayed to the market and included

   in Nasdaq quotations.  These commenters did not believe that

   liquidity would be adversely affected by the amendment.

       These commenters believe that the amendment will motivate

   market makers to display a size commensurate with their

   interest whether as principal or agent.  They note that this

   will enhance price discovery, as market makers will not be

   forced to a quotation size that is not reflective of their

   actual trading interest, nor will market makers be restricted

   in their ability to commit capital without also having an

   opportunity to negotiate an appropriate clearing

   price.-[52]-  Making the quotation requirement the


        -[52]-   Letter from Peter W. Jenkins, Chairman, and
                 Holly A. Stark, Vice Chairman, Security Traders
                 Association Institutional Committee, to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 24, 1996 ("STAIC Letter"); letter from
                 William H. Sulya, Vice President-Manager &
                 Director, Nasdaq/OTC Department, A.G. Edwards &
                 Sons, Inc., to Jonathan G. Katz, Secretary,
                 SEC, dated December 23, 1996 ("A.G. Edwards
                 Letter");  letter from Taymond V. Wilmarth,
                 Vice President and Manager, Equity Trading,
                 Stephens Inc., to Jonathan G. Katz, Secretary,
                 SEC, dated December 23, 1996 ("Stephens
                 Letter"); letter from Antonio Cecin, Managing
                 Director, Equity Trading, Piper Jaffray Inc.,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 December 24, 1996 ("Piper Jaffray Letter");
                 letter from Paul Schott Stevens, Senior Vice
                 President and General Counsel, Investment
                 Company Institute, to Jonathan G. Katz,
                 Secretary, SEC, dated December 26, 1996 ("ICI
                 Letter"); letter from Robert J. McCann,
                 Managing Director, Co-Head, Global Equity
                 Markets, Merrill Lynch, to Jonathan G. Katz,
                                                   (continued...)

==========================================START OF PAGE 41======
   lowest unit of trading, rather than an artificial minimum

   decreed by regulation, also conforms to the practices of other

   markets (e.g., the NYSE and Amex).-[53]-  Finally, these

   commenters believe that the competitive environment that will

   result from allowing market makers to quote in sizes equal to

   their own freely determined trading interest will enhance

   pricing efficiency.-[54]-

       One supporting commenter noted that liquidity will not be


        -[52]-(...continued)
                 Secretary, SEC, dated January 7, 1997 ("Merrill
                 Lynch Letter").

        -[53]-   Letter from Dennis Marino, Chairman, and John
                 N. Tognino, President, Security Traders
                 Association, to Jonathan G. Katz, Secretary,
                 SEC, dated December 24, 1996 ("STA Letter");
                 letter from Dennis Marino, President and Chief
                 Executive Officer, Sherwood Securities Corp.,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 December 24, 1996 ("Sherwood Securities
                 Letter"); letter from Bart Green, Manager, OTC
                 Trading, and Phil Schwab, Principal, Edward
                 Jones, to Jonathan G. Katz, Secretary, SEC,
                 dated December 24, 1996 ("Edward Jones
                 Letter"); Merrill Lynch Letter.

        -[54]-   Letter from Robert Padala, President, The
                 Security Traders Association of New York, Inc.,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 December 24, 1996 ("STANY Letter"); letter from
                 Alan B. Levenson, Esq. and Robert H. Rosenblum,
                 Esq., Fulbright & Jaworski L.L.P., on behalf of
                 Herzog, Hein, and Geduld, Inc., to Jonathan G.
                 Katz, Secretary, SEC, dated December 26, 1996
                 ("Herzog, Heine, Geduld Letter"); letter from
                 the Denver Security Traders Association, Inc.,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 December 24, 1996 ("DSTA Letter"); letter from
                 George K. Jennison, Managing Director, Nasdaq
                 Trading, Wheat First Butch Singer, to Jonathan
                 G. Katz, Secretary, SEC, dated December 31,
                 1996 ("Wheat First Letter"); Merrill Lynch
                 Letter.

==========================================START OF PAGE 42======
   reduced because many firms provide automated execution at the

   quote for small and medium sized customer orders and to other

   dealers in the market through systems other than

   SOES.-[55]-  This commenter believes many dealers will

   continue this practice for competitive reasons.

       Commenters opposing the proposal include several order

   entry firms, some academics, certain individual investors, the

   Amex and the CBOE.  Most of these commenters argued that the

   proposal would adversely impact liquidity and create

   volatility.  Several commenters were concerned that with the

   100-share minimum quotation size all SOES market makers'

   quotations would easily be exhausted and result in a closed

   quote state.-[56]-  The NASD rule, in the view of some,

   would reduce the value of displayed market maker quotes,

   provide no incentive to quote larger sizes and undermine the







        -[55]-   Wheat First Letter.

        -[56]-   See Letters from Scott Dishner, to Jonathan G.
                 Katz, Secretary, SEC, dated December 16, 1996
                 ("Dishner Letter"); Patrick G. Dolan, to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 30, 1996 ("Dolan Letter"); Joseph
                 Pellechia, to Jonathan G. Katz, Secretary, SEC,
                 dated December 23, 1996 ("Pellechia Letter");
                 Ishtaj Rahman, to Jonathan G. Katz, Secretary,
                 SEC, dated December 19, 1996 ("Rahman Letter");
                 Joel Rebhun, to Jonathan G. Katz, Secretary,
                 SEC, dated December 17, 1996 ("J. Rebhun
                 Letter"); letter from Timothy Whelan, to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 18, 1996 ("Whelan Letter").

==========================================START OF PAGE 43======
   Quote Rule.-[57]-  A few order entry firms asserted that

   the proposal effectively reduces market maker risk by

   90%.-[58]-  A number of commenters said that reducing

   the minimum quote size would effectively eliminate investors'


        -[57]-   Letter from Bruce L. Miller, to Jonathan G.
                 Katz, Secretary, SEC, dated December 23, 1996
                 ("B. Miller Letter"); letter from David K.
                 Whitcomb, Professor of Finance, Graduate School
                 of Management, Rutgers University, to Dr.
                 Richard Lindsey, Director, Division of Market
                 Regulation, SEC, dated November 21, 1996
                 ("Whitcomb Letter (11/21/96)"); letter from
                 Ilian Petrov, to Jonathan G. Katz, Secretary,
                 SEC, dated December 16, 1996 ("Petrov Letter");
                 letter from Sayan Bhattacharya, to Jonathan G.
                 Katz, Secretary, SEC, dated December 16, 1996
                 ("Bhattacharya Letter"); letter from John
                 Geisler, to Jonathan G. Katz, Secretary, SEC,
                 dated December 20, 1996 ("Geisler Letter");
                 letter from William Turner, President, Turner
                 Vision, to Jonathan G. Katz, Secretary, SEC,
                 dated December 26, 1996 ("Turner Vision
                 Letter"); letter from Paul Schultz, Associate
                 Professor of Finance, College of Business, The
                 Ohio State University, to Richard Lindsey,
                 Director, Division of Market Regulation, SEC,
                 dated December 13, 1996 ("Paul Schultz
                 Letter"); letter from Winston Meyer, to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 20, 1996 ("Meyer Letter").

        -[58]-   Letter from Linda Lerner, General Counsel, All-
                 Tech Investment Group, Inc., to Jonathan G.
                 Katz, Secretary, SEC, dated November 22, 1996
                 ("All-Tech Letter (11/22/96)"); letter from
                 Marina Kaneti, to Jonathan G. Katz, Secretary,
                 SEC, dated December 17, 1996 ("Kaneti Letter");
                 letter from Michael O'Reilly, to Jonathan G.
                 Katz, Secretary, SEC, dated December 16, 1996
                 ("O'Reilly Letter"); letter from Tolga Erman,
                 to Jonathan G. Katz, Secretary, SEC, undated
                 ("Erman Letter"); letter from David Sciortino,
                 to Jonathan G. Katz, Secretary, SEC, December
                 19, 1996 ("Sciortino Letter"); letter from
                 Frederick N. Balbi, President, FNB Managment
                 [sic] Inc., to Jonathan G. Katz, Secretary,
                 SEC, undated ("FNB Letter").

==========================================START OF PAGE 44======
   ability to execute orders against market makers' quotes

   through SOES during volatile trading conditions in individual

   stocks or market-wide, under the theory that there would be no

   trading interest in the market from customers or market makers

   during such times.  These commenters argue that this was the

   very reason that SOES was made mandatory after the 1987 Market

   Break.-[59]-  One commenter representing a group of SOES

   users argued that the display of a limit order does not

   obviate the need for market maker quotes and that the

   Commission, in the Adopting Release, seemed to suggest that a

   need for market maker quotes would continue.  This commenter

   argued that the NASD's proposal is thus inconsistent with the

   Adopting Release.-[60]-

       Amex and CBOE expressed concern over the rule's impact on

   options market makers' ability to trade at the

   quote.-[61]-  Several commenters believed the


        -[59]-   See e.g., letter from Jason Goldstein, to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 19, 1996 ("Jason Goldstein Letter");
                 letter from Rob Lindauer, to Jonathan G. Katz,
                 Secretary, SEC, dated December 17, 1996
                 ("Lindauer Letter"); letter from Bryan
                 Hollander, to Jonathan G. Katz, Secretary, SEC,
                 dated December 16, 1996 ("Hollander Letter");
                 letter from James R. Gibbs, Jr., to Jonathan G.
                 Katz, Secretary, SEC, dated December 15, 1996
                 ("Gibbs Letter"); letter from Alexander Goor,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 December 18, 1996 ("Goor Letter").

        -[60]-   J. Lee Letter.

        -[61]-   The Amex also asked the Commission to clarify
                 that the Limit Order Protection Interpretation
                                                   (continued...)

==========================================START OF PAGE 45======
   requirement will hurt small order entry firms without order

   routing arrangements.-[62]-

       Many commenters, while opposed to the change in the

   minimum quote size requirement for the market maker's

   proprietary quote, were not opposed to the change in the

   minimum quote size for market makers displaying a customer

   limit order.-[63]-


        -[61]-(...continued)
                 of the NASD (Manning II) still requires market
                 makers to fill customer limit orders at the
                 quote prior to or at the same time as trading
                 for its dealer account.  The Commission notes
                 that the present proposal has no effect on the
                 outstanding Limit Order Protection
                 Interpretation of the NASD.  Letter from James
                 F. Duffy, Executive Vice President and General
                 Counsel, American Stock Exchange, Inc., to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 26, 1996 ("Amex Letter").

        -[62]-   Letter from Raymond L. Hope, Jr., to Jonathan
                 G. Katz, Secretary, SEC, dated December 21,
                 1996 ("Hope Letter"); Turner Vision Letter;
                 letter from David K. Whitcomb, Professor of
                 Finance, Graduate School of Management, Rutgers
                 University, to Richard Lindsey, Director,
                 Division of Market Regulation, SEC, dated
                 January 7, 1997 ("Whitcomb Letter (1/7/97)").
                 See also letter from Yusif Simaan, Associate
                 Professor of Finance, Fordham University, to
                 Richard Lindsey, Director, Division of Market
                 Regulation, SEC, dated December 9, 1996
                 ("Simaan Letter"); letter from John M. Lang,
                 President, I.Q. Management, Inc., to Jonathan
                 G. Katz, dated December 19, 1996 ("I.Q.
                 Letter").

        -[63]-   Letter from Elizabeth Erwin, President,
                 Momentum Securities, Inc., to Jonathan G. Katz,
                 Secretary, SEC, dated December 23, 1996
                 ("Momentum Letter"); letter from James H. Lee
                 et al., to Jonathan G. Katz, Secretary, SEC,
                 dated December 24, 1996 ("J. Lee Letter");
                                                   (continued...)

==========================================START OF PAGE 46======
       Finally, a number of commenters opposed to the rule

   suggested an alternative under which a market maker would

   separately display both its own proprietary quote and any

   customer limit orders it holds.-[64]-  They suggested

   that this could be accomplished either through separate quotes

   with separate market maker identifiers or as a separate field

   in the Nasdaq display.

          2.  Commission Analysis

       The Commission has determined to approve the amendment to

   reduce quotation size requirements for market makers

   displaying customer limit orders.  The Commission believes

   there are substantial reasons, as explained below, to expect

   that reducing market makers' proprietary quotation size

   requirements in light of the shift to a more order-driver

   market would be beneficial to investors.  To gain practical

   experience with the proposal, the Commission has determined to

   approve, on a three-month pilot basis, the amendment reducing


        -[63]-(...continued)
                 letter from Dongsoo Lee, to Jonathan G. Katz,
                 Secretary, SEC, dated  December 16, 1996
                 ("Dongsoo Lee Letter").

        -[64]-   Whitcomb Letter (11/21/96); letter from Michael
                 F. Frey, President, A.J. Michaels & Co., Ltd.,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 November 20, 1996 ("A.J. Michaels Letter");
                 letter from Dennis Grossman, President,
                 Grossman & Co., to Jonathan G. Katz, Secretary,
                 SEC, dated December 21, 1996 ("Grossman
                 Letter"); letter from Wesley Jordan, to
                 Jonathan G. Katz, Secretary, SEC, undated ("W.
                 Jordan Letter"); letter from David T.K. Lu, to
                 Jonathan G. Katz, Secretary, SEC, undated ("Lu
                 Letter").

==========================================START OF PAGE 47======
   quotation size requirements for market makers displaying

   proprietary quotes for the 50 securities first subject to the

   Limit Order Display Rule.-[65]-  During this pilot

   program, the Commission, the NASD and Nasdaq will evaluate the

   effect of reduced quotation sizes on the market for these

   securities.  As discussed below, factors to be considered in

   this evaluation include, among others, the impact of reduced

   quotation sizes on liquidity, volatility and quotation

   spreads.  The Commission believes that the quote size

   amendment is consistent with the Sections 11A and 15 of the

   Act both for proprietary and limit order quotes because, in

   the context of the implementation of the Order Handling Rules,

   it is designed to encourage fair competition and improved

   quotation prices, thus improving the quality of executions for

   investors.

       The Commission believes that when an OTC market maker

   displays a customer limit order, it is appropriate to relieve

   the market maker of the obligation to quote a minimum size at

   the limit price.  As noted by the NASD and many commenters, if

   the limit order is smaller than the minimum required quotation

   size, the quotation requirement would expose the market maker

   to a principal execution at a price established by the limit



        -[65]-   These securities, selected by Nasdaq from the
                 500 most actively traded securities, range in
                 median daily dollar volume from first to 478th,
                 cover a range of industry sectors, and have an
                 average spread ranging from 1/8 to over one
                 dollar.

==========================================START OF PAGE 48======
   order, not by its own proprietary trading interest.  In

   adopting the Limit Order Display Rule, the Commission did not

   intend to increase market makers' principal exposure and

   indeed expressly noted that the SROs should consider amending

   their rules as necessary to allow market makers displaying

   customer limit orders to quote in smaller size

   increments.-[66]-

       The Commission is also approving, on a limited basis, the

   NASD's reduction of minimum quotation sizes for proprietary

   market maker quotes.  The Commission recognizes the concerns

   of many of the opposing commenters regarding the provision's

   potential impact on liquidity and volatility.  The Commission,

   based on its experience with the markets and discussions with

   market participants, believes that decreasing the required

   quote size will not result in a reduction in liquidity that

   will hurt investors.  As discussed in its release adopting the

   Order Handling Rules, the Commission expects the public

   display of market makers' ECN orders and customer orders to

   add significant depth and stability to the market in OTC

   stocks.  Indeed, the display of customer limit orders provides

   an unprecedented opportunity in the Nasdaq market for customer

   interest to interact without the intervention of a dealer.  In

   this regard, the Commission also anticipates that many market

   makers will choose to display larger quotes as a competitive

   matter.  For these reasons, the Commission also does not


        -[66]-   Adopting Release, supra note 6, at n. 144.

==========================================START OF PAGE 49======
   believe that the amendments will result in smaller quotes that

   will prevent investors from obtaining executions in market

   crises.  The Commission also notes that brokers often use

   other means, such as directing orders to market makers through

   SelectNet, routing orders on a pre-agreed basis through the

   NASD's ACES systems, or using private order routing systems,

   to obtain automated executions for retail investors at sizes

   larger than market makers' published quotations.

       The Commission recognizes that with the shift to a more

   order driven market, the role of market makers in providing

   liquidity changes substantially.  Currently, Nasdaq market

   makers are the principal source of liquidity for investors

   seeking immediacy (i.e., seeking to buy or sell at the best

   currently available market price).  In contrast, on exchanges,

   where the specialist market maker typically displays most

   customer orders, those orders provide the principal source of

   liquidity.  With the display of ECN orders and retail and

   institutional customer limit orders in the Nasdaq market,

   Nasdaq market makers may frequently find themselves in a

   similar situation, with customer orders providing the primary

   source of liquidity and market makers providing liquidity

   during temporary imbalances in supply and demand.

       The Commission believes that it is appropriate to consider

   whether, in a market displaying customer orders in competition

   with market maker quotes, there is justification for requiring

   market makers to quote at a mandatory size.  Neither the Act

==========================================START OF PAGE 50======
   nor the Commission's rules require a quote size larger than

   100 shares.  Historically, because customer trading interest

   was not displayed in the Nasdaq market, the NASD determined

   that it was appropriate that market makers display at least a

   minimum size in their quotes that would be representative of

   their trading interest in that security.  In contrast, the

   exchanges have not imposed such a requirement on their own

   order-driven markets, where specialist market makers are

   permitted to quote sizes as small as one round lot (100

   shares) when they are not representing customer orders.  The

   Commission recognizes, of course, that exchange specialists,

   in consideration for their central role in a particular

   security on the exchange, are subject to various trading

   requirements which are intended to ensure the maintenance of

   stable and liquid markets.-[67]-  However, a substantial

   factor contributing to market depth on the exchanges is the

   peer allocation review process on many of the exchanges, under

   which specialists are rated on their performance in

   maintaining stable and liquid markets, and risk forfeiting

   their stock allocations should their performance lag.  The

   Commission notes that on Nasdaq, not only will customer orders


        -[67]-   For example, New York Stock Exchange Rule
                 104.10 requires a specialist to maintain, as
                 far as reasonably practicable, a fair and
                 orderly market, as measured by price continuity
                 and depth, and minimization of the effects of
                 any temporary disparity between supply and
                 demand.  See Division of Market Regulation,
                 SEC, The October 1987 Market Break Report,
                 (February 1988) p.4-2.

==========================================START OF PAGE 51======
   provide liquidity, but multiple market makers compete in

   various securities.  Consequently, even though market makers

   do not risk losing a stock allocation to another market maker

   by regulation, they nevertheless risk losing business in the

   stock to another market maker, an ECN, or a customer order if

   they are not quoting competitive prices and significant size

   at those prices.  In other words, given a choice between two

   market makers quoting different sizes at the same price, all

   else equal, a customer would be more likely to approach the

   market maker quoting the larger size.-[68]-

   Accordingly, at this time the Commission believes that there

   may be substantial reason to expect that various competitive

   pressures would encourage market makers to maintain deep

   markets.

       The economic impact on the market of reducing the minimum

   market maker quote size from 1000 shares to 100 shares raises

   several issues.  The Commission recognizes that the 1000-share

   quote minimum applicable to many Nasdaq stocks has been viewed

   as a means of providing liquidity to orders seeking the quoted

   price.  However, the Commission preliminarily believes that a


        -[68]-   While, as pointed out by commenters, a
                 significant share of retail order flow in the
                 Nasdaq market is internalized or otherwise
                 subject to predetermined order routing
                 arrangements, the Commission nevertheless
                 believes that market maker quotes should serve
                 an important function in attracting trading
                 interest, especially in an order driven
                 environment where there is less incentive and
                 flexibility for market makers to avoid
                 displaying actual trading interest.

==========================================START OF PAGE 52======
   number of factors may well prevent a significant loss of

   liquidity in moving to 100-share quote minimums.

       First, the presence of limit orders mitigates the loss of

   displayed trading interest by market makers.  The Commission

   believes that the increased representation of customer limit

   orders is likely to add depth to the markets.  As customer

   limit orders that are priced better than existing market maker

   quotes are displayed in the public quote, greater flexibility

   in market maker quotation size may increase trading interest

   from market professionals at the inside quotation, thereby

   adding to market depth.  As noted by one commenter, revising

   minimum quote size will increase the information content of

   market maker quotes by facilitating different quote sizes from

   dealers who have a substantial interest in the stock at a

   particular time and those who do not.-[69]-  This same

   commenter notes, and the Commission agrees, that for the most

   liquid Nasdaq securities, "the ability to interact with live

   bids and offers that represent real orders, where size is

   revealed at all price levels (depth of book) is the most fair

   for all market participants."-[70]-

       Second, the 1000 share minimum quote size represents a

   barrier to entry for market making.  Lowering this barrier to

   entry could attract more market makers, thereby increasing

   liquidity and competition across the market.  Similarly, with


        -[69]-   STAIC Letter.

        -[70]-   STAIC Letter.

==========================================START OF PAGE 53======
   large minimum quotes, smaller firms cannot effectively compete

   on a price basis for stocks with a high per-share price.  For

   example, if security ABCD is trading at $85 per share, the

   market maker would be exposed at its quote for executions at a

   minimum of $85,000 when subject to a minimum quote size of

   1000.  If the minimum quote size is only 100 shares, the

   market maker's minimum capital exposure at its quote would be

   reduced to $8500.  The Commission believes that a lower

   minimum quotation size will likely attract smaller firms into

   the market, increasing both price competition and liquidity.

       Moreover, a significant motivation for the Commission s

   approval, on a limited basis, of the reduction of minimum

   quotation sizes for market maker quotes is the belief that

   greater quotation flexibility is likely to lead to narrowing

   of the spread.  Reducing the quotation size requirement

   reduces the risk that market makers must take, and should

   encourage them to quote more aggressive prices.-[71]-

   Thus, the Commission believes even if there were a decline in

   quoted depth in certain securities, many investors in those

   securities may well receive better executions with narrower

   spreads.

       Even if the spread is not narrowed, reducing the required

   quotation size could encourage continued and even increased


        -[71]-   See All-Tech Letter (11/22/96); Kaneti Letter;
                 Petrov Letter.  See supra note 58.  Even
                 opponents of change recognize that reducing the
                 mandatory size for quotations reduces market
                 maker risk.

==========================================START OF PAGE 54======
   market maker participation at the inside market other prices

   to the extent that the minimum quotation size requirement

   poses a barrier to entry.  Thus, this change could help

   maintain or increase liquidity in the stock.  This could be

   particularly significant if the display of customer limit

   orders reduces the profitability of market making in OTC

   securities, a possibility predicted by the Commission in the

   Adopting Release.-[72]-  The reduction in risk resulting

   from reducing the required quotation size and the concomitant

   reduced exposure to automated executions should help preserve

   market maker participation that might otherwise be eroded by

   the display of limit orders and a larger market maker quote

   size.  As noted below, the Commission has requested that the

   NASD study include information on the spreads and number of

   market makers of the 50 stocks that are the subject of the

   pilot program.-[73]-

       Although the Commission preliminarily believes that the

   proposal will not adversely affect market quality and


        -[72]-   Adopting Release, supra note 6.

        -[73]-   The Commission is aware of several articles
       associating smaller quote sizes with narrower spreads. See
       Bacidore, The Impact of Decimalization on Market Quality:
       An Empirical Investigation of the Toronto Stock Exchange
       (Revised: July 1996); Harris, Minimum Price Variations,
       Discrete Bid-Ask Spreads, and Quotation Sizes, Review of
       Financial Studies 7 (1994); Copeland, T. and Galai D.,
       Information Effects of the Bid-Ask Spread, 38 Journal of
       Finance (1983).  Although cognizant of distinctions in the
       relevant markets involved in these studies that make
       comparisons with the Nasdaq market nondefinitive, the
       Commission believes that these studies provide additional
       support for the proposed pilot program.

==========================================START OF PAGE 55======
   liquidity, the Commission believes that it is appropriate to

   take steps to further assess the effect on the markets.

   Therefore, the Commission is approving a lowering of the

   minimum quote size in a limited number of securities at this

   time to assess this provision's impact on a select group of

   Nasdaq securities.  Thus, the Commission has determined that

   it is appropriate to allow the NASD to implement its proposed

   rule change reducing minimum quotation sizes for market

   makers' proprietary orders for the 50 stocks included in the

   first phase of the Limit Order Display Rule for a three-month

   period.-[74]-  The Commission believes that these

   securities, all of which are among the 500 most actively

   traded Nasdaq securities, provide the most appropriate basis

   on which to assess the potential for any negative impact

   suggested by opposing commenters.  The three-month pilot will

   give the Commission, the NASD and Nasdaq time to assess the

   impact of the change on the market, before considering the

   rule change on a broader or permanent basis.  The Commission

   is approving this pilot program to begin at the same time as

   the first phase of the Order Handling Rules because the

   Commission believes that it is important for the markets and

   the Commission, in its oversight role over these markets, to

   be able to evaluate the combined impact of the NASD's proposed


        -[74]-   The Commission notes that at the conclusion of
                 the three-month pilot, the market makers must
                 quote the previously required size unless the
                 Commission approves the change on an extended
                 or permanent basis.

==========================================START OF PAGE 56======
   changes to Nasdaq and the Order Handling Rules in a limited

   group of securities.

       The Commission requests that the NASD and Nasdaq conduct a

   study during this pilot to gauge the effect of the reduction

   in minimum quote size on the market for these 50 stocks.  The

   Commission notes that these 50 stocks were chosen to provide a

   broad cross section of the most liquid Nasdaq securities.  The

   number of market makers in these stocks presently ranges from

   a low of three to a high of 49.  The inside spread ranges from

   1/8 to $1 and the price ranges from approximately $9 to $141

   with an average price of $44.50.  The current 1000 share

   minimum for these stocks therefore represents, on average,

   approximately $44,000 per trade, a substantial amount in the

   retail context.

       Specifically, the NASD study should include an analysis

   of:  (1) the number of market makers in each of the 50

   securities, and any change in the number over time; (2) the

   average aggregate dealer and inside spread by stock over time;

   (3) the average spread for each market maker by stock; (4) the

   average depth by market maker (including limit orders), and

   any change in the depth over time; (5) the fraction of volume

   executed by a market maker who is at the inside quote by

   stock; and (6) a measure of volume required to move the price

   of each security one increment (to determine the overall

   liquidity and volatility in the market for each stock).  The

   Commission expects that these factors be contrasted over the

==========================================START OF PAGE 57======
   time period immediately preceding the pilot and after the

   beginning of the pilot.  Further, the Commission notes that

   beginning three weeks after the commencement of the pilot on

   50 stocks, market makers will be required to display customer

   limit orders in 100 additional stocks pursuant to Rule 11Ac1-

   4.  These 100 stocks will not be part of the pilot that the

   Commission is approving today, and therefore provide an

   opportunity for direct comparison with the stocks in the

   pilot.  Thus, the Commission requests that the NASD and Nasdaq

   include in the study a matched pairs analysis of the 50 stocks

   in the pilot with 50 stocks in the second phase-in.  This

   analysis should encompass the six factors enumerated above.

   The Commission will consider the results of the study in

   determining whether to extend or expand the pilot.

       Some commenters suggested that the Commission establish a

   system of dual quotes so that market makers could separately

   display limit orders and proprietary trading

   interest.-[75]-  The Act does not require an exchange or

   association to separately display these two types of trading

   interest.  These changes also could require extensive systems

   changes on the part of Nasdaq, and could absorb substantial

   additional Nasdaq systems capacity at a time when Nasdaq

   capacity may potentially be under strain.  The Commission also

   does not believe that the NASD is statutorily required to move

   toward a central limit order book or "black box" system, as


        -[75]-   See supra note 64.

==========================================START OF PAGE 58======
   favored by some commenters.-[76]-  It should be noted

   that the Commission was recently urged to adopt such

   approaches as alternatives to its Order Handling proposals.

   The Commission determined that at present it is in the best

   interest of investors, and consistent with the Act, to require

   the display of customer limit orders through the quotations

   communicated by market makers to the consolidated quotation

   stream, directly or through market or ECN systems.-[77]-

       B. Changes to SOES in Response to the Order Handling

   Rules

       Many commenters addressed the NASD's proposed changes to

   SOES in response to the Order Handling Rules.  Specific areas

   of concern are discussed below.

          1.     Decrementation of Displayed Quotation Sizes

                 After SOES Executions

              a.  Comments

       As noted above, the rule change provides that a market

   maker's displayed size will be decremented after each

   unpreferenced SOES execution.  Market makers generally, and

   the DSTA and STA, expressed support for the amendment.



        -[76]-   Whitcomb Letter (11/21/96); All-Tech Letter
                 (11/22/96).

        -[77]-   Adopting Release, supra note 6.  The Commission
                 also does not believe that the liquidity
                 available to options market makers, like other
                 investors, will be reduced by the Amendments.
                 Nor do thee amendments approved today alter the
                 access of options market makers to Nasdaq
                 systems such as SOES or SelectNet.

==========================================START OF PAGE 59======
   Several other market makers, while supportive of the

   provision, argued that a market maker should have the option

   to set a higher exposure limit than just its displayed quote

   size.-[78]-  One market maker and the SIA argued that

   there is no reason to distinguish between preferenced and

   unpreferenced orders in decrementing the quote, and that a

   market maker's quote should be decremented upon execution of

   preferenced orders as well as non-preferenced

   orders.-[79]-

       Academics, order entry firms and SOES traders opposed the

   amendment to make the displayed quotation size a firm's

   exposure limit.  Several commenters argued that the proposed

   reduction of minimum quotation sizes to 100 shares, together

   with the proposal to establish a market maker's displayed

   quotation size as its exposure limit, would effectively

   eliminate SOES.-[80]-  One order entry firm expressed


        -[78]-   Letter from Edward J. Johnsen, Vice President
                 and Counsel, Morgan Stanley & Co. Incorporated,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 December 20, 1996 ("Morgan Stanley Letter");
                 Stephens Letter; Piper Jaffray Letter

        -[79]-   Letter from Bernard L. Madoff, Chairman,
                 Trading Committee, Securities Industry
                 Association, to Jonathan G. Katz, Secretary,
                 SEC dated December 26, 1996 ("SIA Letter");
                 letter from Lon Gorman, Chief Executive Office,
                 and Leonard Mayer, President, Mayer &
                 Schweitzer, Inc., to Jonathan G. Katz,
                 Secretary, SEC, dated December 27, 1996 ("Mayer
                 & Schweitzer Letter").

        -[80]-   All-Tech Letter (11/22/96); Whitcomb Letter
                 (11/21/96); Simaan Letter; Momentum Letter;
                                                   (continued...)

==========================================START OF PAGE 60======
   concern that it is not clear what maximum order size limits

   order entry firms will be held to in the future.  In addition,

   several SOES traders suggested that if this amendment is

   adopted, the NASD interpretation limiting order entry firms to

   one 1000-share trade per security every five minutes ("five

   minute rule") should be eliminated.-[81]-

       Several SOES traders argued that in light of the

   decrementing provision, the 15-second quote update period

   following an execution is too long and should be reduced or

   eliminated.-[82]-  In addition, some of these commenters


        -[80]-(...continued)
                 letter from Mark K. Sydenstricker, Vice
                 President and Chief Financial Officer, The
                 Exchange House, Inc., to Jonathan G. Katz,
                 Secretary, SEC, dated December 20, 1996
                 ("Exchange House Letter").

        -[81]-   See e.g., letter from Adam Raichel, to Jonathan
                 G. Katz, Secretary, SEC, dated December 19,
                 1996 ("Raichel Letter"); letter from Michael
                 Gleeson, to Jonathan G. Katz, SEC, dated
                 December 19, 1996 ("Gleeson Letter"); letter
                 from Paul R. Rudd, to Jonathan G. Katz,
                 Secretary, SEC, dated December 18, 1996 ("P.
                 Rudd Letter"); letter from Chris Boran, to
                 Jonathan G. Katz, Secretary, SEC, undated
                 ("Boran Letter"); letter from Arthur E.
                 Herrmann, to Jonathan G. Katz, Secretary, SEC,
                 dated December 10, 1996 ("Herrmann Letter");
                 letter from Feral Talib, to Jonathan G. Katz,
                 SEC, undated ("Talib Letter").

        -[82]-   Letter from Gil Shapiro, to Jonathan G. Katz,
                 Secretary, SEC, dated December 17, 1996
                 ("Shapiro Letter"); letter from Joshua Pohl, to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 16, 1996 ("Pohl Letter"); Joseph
                 Walsh, to Jonathan G. Katz, Secretary, SEC,
                 dated December 17, 1996 ("Walsh Letter");
                 Raichel Letter; letter from Nancy Tom, to
                                                   (continued...)

==========================================START OF PAGE 61======
   argued that the five minutes during which a market maker goes

   into a "closed quote" status following decrementation to zero

   is too long.-[83]-

              b.  Commission analysis

       The NASD has proposed to replace its current mandatory

   quote size and SOES exposure limits with voluntary quote size,

   decremented as executions occur against this quote size.  As a

   result, the maximum exposure at the quote will be reduced from

   twice the SOES tier size to the displayed quote size.  The

   NASD redesigned the SOES exposure limits to reflect the

   introduction of customer limit orders required by the Order

   Handling Rules.  Decrementing the quote will ensure that

   quotes reflecting limit orders are withdrawn once the limit

   order is fully executed, consistent with display of customer

   limit orders.  The NASD applied decrementing to market maker

   proprietary quotes as well as customer limit orders in part



        -[82]-(...continued)
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 24, 1996 ("Tom Letter"); letter from
                 Charles Rhyee, to Jonathan G. Katz, Secretary,
                 SEC, dated December 20, 1996 ("Rhyee Letter");
                 Whelan Letter

        -[83]-   Letter from Matthew Kansler, to Jonathan G.
                 Katz, Secretary, SEC, dated December 20, 1996
                 ("Kansler Letter"); letter from John Parente,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 December 19, 1996 ("Parente Letter"); letter
                 from Alexis Theofilactidis, to Jonathan G.
                 Katz, Secretary, SEC, dated December 20, 1996
                 ("Theofilactidis Letter"); letter from Marcie
                 D. Rebhun, to Jonathan G. Katz, Secretary, SEC,
                 dated December 15, 1996 ("M. Rebhun Letter").

==========================================START OF PAGE 62======
   because of the inability of the system to differentiate

   between market maker limit order and proprietary quotes.  In

   addition, the NASD believes that reducing the quotation to

   reflect SOES executions more accurately reflects the nature of

   the market maker quote when limit orders are required to be

   displayed.

       The Commission believes that allowing both proprietary and

   customer quote sizes to be reduced to reflect executions may

   encourage more competitive market maker quotes because, as

   discussed previously, market makers can control more precisely

   the extent of their exposure in SOES at the quoted price.

   This in turn may improve customer execution prices and

   increase investor participation in the market.  In addition,

   market makers may be encouraged to continue or increase their

   market making role, mitigating the competitive pressure

   resulting from the display of ECN prices and customer limit

   orders.

       In addition, the Commission believes that the display of

   customer limit orders should result in an increase in the

   displayed quotation size, offsetting at least in part the

   reduced exposure limits for market maker quotes.  The

   Commission believes that these potential benefits from quotes

   more representative of market makers' actual trading interest

   and the display of limit orders offsets the potential for

   reduced execution size against the quote in SOES.  Therefore,

   the Commission believes that the decrementing of quote size is

==========================================START OF PAGE 63======
   consistent with the Act, in particular Section 11A.

       In response to commenters who recommended that market

   makers have an option of setting a higher exposure limit, the

   NASD has amended the proposal to make the decrementing

   provision optional for quotes displaying size equal to or more

   than the SOES tier size for the security.-[84]-  The

   Commission agrees that this modification is consistent with

   the Act.  The Commission believes that allowing market makers

   that quote in substantial size to opt out of decrementing will

   encourage the display of greater quote size and allow market

   makers to maintain quotes that add depth to the markets.

       The Commission notes that the NASD did not propose in the

   current filing any amendments to the 15-second period

   following an execution during which a marker maker may update

   its quote, or the five-minute "closed quote" provision.  These

   provisions thus are not under review at this time.  Similarly,

   amendment of the five minute rule is not part of the current

   proposal, and thus not under review at this time.-[85]-

   However, the Commission believes that these time periods are

   not inappropriately long in the context of the instant SOES

   revisions.  The Commission also believes that dropping a

   market maker with a zero quote to the bottom of the display

   screen helps reduce confusion and makes clear which market


        -[84]-   See supra note 3.

        -[85]-   The Commission notes that the NASD has proposed
                 substantial revisions to small order execution
                 in its NAqcess proposal.

==========================================START OF PAGE 64======
   makers are "in the market."

       Finally, the Commission believes that it is consistent

   with the Act to modify the quotation requirements for

   unpreferenced orders only.  The Commission recognizes that

   many firms have arrangements with correspondents by which they

   agree to execute order flow at the prevailing quote.  These

   preferencing arrangements are wholly voluntary, and can be

   subject to conditions if so desired by the market maker.  The

   Commission has considered such arrangements in the

   past,-[86]- and has not found them to be violative of

   the investor protection goals of the statute.  For firms

   executing high volumes of trades pursuant to such

   arrangements, mandatory decrementing pursuant to such activity

   would require the market maker to repeatedly update its quote

   in response to orders executed at its quote.  The Commission

   does not believe this outcome is compelled by the statute.  In

   any event, the NASD's current proposal does not include an

   optional decrementing provision for preferenced order flow,

   and thus this issue is not currently before the Commission.

          2.  Split Order Execution

              a.  Comments

       Order entry firms and SOES traders argued against allowing

   SOES executions at split prices.  These commenters stated that



        -[86]-   See Securities Exchange Act Release No. 29810
                 (October 10, 1991), 56 FR 52098 (October 17,
                 1991) (order approving SR-NASD-91-18 and SR-
                 NASD-91-26, amendments to SOES).

==========================================START OF PAGE 65======
   order entry firms and their customers would experience added

   expense and delay because their orders could be subject to

   multiple executions against multiple parties.-[87]-

   Several commenters stated that a SOES order of 1000 shares

   could be split up into as many as 10 trades and executed

   against 10 separate market makers at a price inferior to the

   best displayed quote at the time the order was

   sent.-[88]-  Several commenters also objected to the

   elimination of "all or none" orders from SOES.-[89]-


        -[87]-   Letter from Kelly Jordan, to Jonathan G. Katz,
                 Secretary, SEC, dated December 18, 1996 ("K.
                 Jordan Letter"); letter from Michael P. Doyle,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 December 18, 1996 ("Doyle Letter"); letter from
                 Brian Schartz, to Jonathan G. Katz, Secretary,
                 SEC, undated ("Schartz Letter"); letter from
                 Drew Sohn, to Jonathan G. Katz, Secretary, SEC,
                 dated December 17, 1996 ("Sohn Letter");
                 Bhattacharya Letter, All-Tech Letter
                 (11/22/96); letter from Paul Nadan, to Jonathan
                 G. Katz, Secretary, SEC, dated December 18,
                 1996 ("P. Nadan Letter"); letter from Steve
                 Dworkin, to Jonathan G. Katz, Secretary, SEC,
                 undated ("Dworkin Letter"); Petrov Letter, W.
                 Jordan Letter; letter from Nicola Victory, to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 16, 1996 ("Victory Letter"); letter
                 from Cornel Catrina, to Jonathan G. Katz,
                 Secretary, SEC, dated December 16, 1996
                 ("Catrina Letter").

        -[88]-   Whitcomb Letter (11/21/96); Simaan Letter.

        -[89]-   Letter from Ed Chui, to Jonathan G. Katz,
                 Secretary, SEC, dated December 19, 1996 ("Chui
                 Letter"); letter from Tracy Clarke, to Jonathan
                 G. Katz, Secretary, SEC, undated ("Clarke
                 Letter"); letter from Robert Beers and Stephen
                 Wilk, to Jonathan G. Katz, Secretary, SEC,
                 dated December 26, 1996 ("Beers & Wilk
                 Letter"); letter from Michael T. Studer,
                                                   (continued...)

==========================================START OF PAGE 66======
              b.  Commission analysis

       The Commission is approving the proposed amendment because

   it is a necessary adjunct to eliminating required quote sizes

   for market makers, and allowing display of customer limit

   orders of less than the SOES order size.  As discussed

   previously, the Commission does not believe that in a market

   displaying limit orders the Act compels a market maker to

   trade at a size greater than the minimum trading unit, thus

   assuming greater risk than it would otherwise.  Although split

   order executions can result in somewhat greater execution

   costs for an order entry firm, these split executions

   accurately reflect trading interest in the market at that

   time.  In addition, the amendment is necessary to ensure the

   smooth functioning of SOES in an environment where market

   makers must regularly update their quotes to reflect customer

   limit orders and assess their own desire to assume market

   risk.  Finally, if a customer wants to assure that it does not

   receive split executions, it may enter orders at the size of

   the best displayed quotes, or request that its order not be

   executed through SOES.

       The NASD has proposed to prohibit entry of all-or-none



        -[89]-(...continued)
                 President, Castle Securities Corp., to
                 Secretary, SEC, dated December 24, 1996
                 ("Castle Letter"); letter from Russell A.
                 Grigsby, President, Cornerstone Securities
                 Corporation, to Jonathan G. Katz, Secretary,
                 SEC, dated December 20, 1996 ("Cornerstone
                 Letter"); FNB Letter.

==========================================START OF PAGE 67======
   orders in SOES because it believes that most users of all-or-

   none market orders do not expect execution of all-or-none

   orders at multiple prices.  The amendment to the SOES system

   to allow split executions, combined with the proposed

   elimination of minimum quote size, could result in SOES orders

   being executed at more than one price.  In addition, revising

   the SOES system to provide all-or-none executions in the

   context of the modified SOES system would require substantial

   Nasdaq resources.  The Commission believes that the NASD's

   decision to not provide for all-or-none orders in the revised

   SOES system reduces the possibility of investor confusion

   regarding the execution prices that could result and, thus, is

   consistent with the directive in Section 15A(b)(6) that the

   NASD's rules be designed to facilitate the maintenance of fair

   and orderly markets.

          3.  Prohibition Against the Entry of Non-Marketable

              Limit Orders into SOES

              a.  Comments

       Several market makers expressed support for prohibiting

   entry of non-marketable limit orders into SOES while several

   order entry firms and a SOES trader argued against it.  These

   latter commenters generally argued that the NASD should not

   prohibit the entry of non-marketable limit orders into SOES

   and therefore should not eliminate the SOES limit order

==========================================START OF PAGE 68======
   file.-[90]-  One commenter said that the concept is not

   adequately described.-[91]-

              b.  Commission analysis

       The Commission believes the prohibition is consistent with

   the Act because, as noted by the NASD, limit orders held in

   the SOES limit order file are not displayed in the public

   quote, thus making the file inconsistent with the Limit Order

   Display Rule.  Further, because of its inherent limitations,

   the limit order file also was infrequently used, undermining

   its potential usefulness.  Thus, the Commission agrees that it

   is appropriate to eliminate the file to assure compliance with

   the Order Handling Rules.-[92]-

          4.  Modifications to the SOES Automated Quotation

              Update Feature

              a.  Comments

       Several market makers supported the proposal to allow




        -[90]-   Letter from Warren E. Spehar and Michael J.
                 Schunk, Managing Partners, First Westchester
                 Securities, to Jonathan G. Katz, Secretary,
                 SEC, dated December 18, 1996 ("First
                 Westchester Letter"); letter from Seth Hurwitz,
                 to Jonathan G. Katz, Secretary, SEC, dated
                 December 18, 1996 ("Hurwitz Letter"); FNB
                 Letter.

        -[91]-   Grossman Letter.

        -[92]-   The Commission notes that the NASD's NAqcess
                 proposal, which would create a publicly
                 displayed limit order book, is still under
                 consideration.  See Securities Exchange Act
                 Release No. 37302 (June 11, 1996), 61 FR 31574
                 (June 20, 1996).

==========================================START OF PAGE 69======
   auto- refreshing of the market maker's quote.-[93]-  One

   market maker commented that automation facilitates the

   efficient operation of the multiple market making system and

   fosters efficiency and liquidity.  Without this modification,

   according to this commenter, market making would become

   prohibitively expensive for many firms.-[94]-  Another

   market maker argued that if a market maker could have one side

   of its quote refreshed at an inferior price without also

   adjusting the other side of its quote, then the NASD also

   should modify Rule 4613(d), the NASD excess spread parameters

   rule.-[95]-  Several commenters were concerned about the

   NASD's proposal to refresh market maker quotes for 100 shares

   instead of tier size.-[96]-

              b.  Commission analysis

       The Commission is approving the modification because it



        -[93]-   DSTA Letter; Edward Jones Letter; Herzog,
                 Heine, Geduld Letter.

        -[94]-   Edward Jones Letter.

        -[95]-   Morgan Stanley Letter.

        -[96]-   Castle Letter; Gleeson Letter; letter from
                 Wayne Hong, to Jonathan G. Katz, Secretary,
                 SEC, dated December 20, 1996 ("Hong Letter");
                 letter from James B. Carpenter, to Jonathan G.
                 Katz, Secretary, SEC, undated ("Carpenter
                 Letter"); letter from Tai Truong, to Jonathan
                 G. Katz, Secretary, SEC, dated December 15,
                 1996 ("Truong Letter"); letter from Daniel
                 Balber, to Jonathan G. Katz, Secretary, SEC,
                 undated ("Balber Letter"); letter from John
                 Cassimatis, to Jonathan G. Katz, Secretary,
                 SEC, dated December 16, 1996 ("Cassimatis
                 Letter").

==========================================START OF PAGE 70======
   believes an automatic quote update feature, which is currently

   available in SOES, is consistent with the Act.  As originally

   proposed, the auto-refresh capability will update the quote

   for only the required minimum quote size.  In the NASD's

   amendment establishing the pilot, however, for programming

   reasons the NASD proposed to auto-refresh the quotation up to

   the SOES order size for all securities, including the 50 pilot

   stocks.  The market maker would be allowed to reduce the size

   in these 50 pilot stocks if it wished to quote at a smaller

   size.  The Commission believes that auto-refresh will be a

   helpful tool for market making in this new environment, and is

   consistent with the Act.

          5.  Allowing SOES Market Makers to Enter Agency Orders

              into SOES

              a.  Comments

       Several market makers expressed support for the proposal

   to allow SOES market makers to enter customer orders into

   SOES.-[97]-  The SIA and several market makers argued

   that market makers should be allowed to enter riskless

   principal orders into SOES as well as agency orders, as these

   orders are the economic equivalent of agency

   orders.-[98]-  Several market makers argued that market


        -[97]-   See e.g., Herzog, Heine, Geduld Letter; Edward
                 Jones Letter.

        -[98]-   SIA Letter; letter from Peter C. Cohan,
                 Managing Director, Pershing to Jonathan G.
                 Katz, Secretary, SEC, dated January 2, 1997
                 ("Pershing Letter"); Mayer & Schweitzer Letter.

==========================================START OF PAGE 71======
   makers should also be permitted to enter proprietary orders

   into SOES.-[99]-

       Several SOES traders opposed the proposal.-[100]-

   One SOES trader suggested that verification procedures were

   needed to assure that orders entered by market makers were

   legitimate agency orders.-[101]-

              b.  Commission analysis

       In the Adopting Release for the Order Handling Rules, the

   Commission suggested that the NASD consider revising SOES to

   allow market makers to enter customer orders into SOES in

   particular to execute against displayed customer limit

   orders.-[102]-  The Commission was concerned that firms

   operating internal automated execution systems could execute

   substantial customer orders based on individual limit orders

   establishing a best bid or offer price.  The Commission

   suggested that while under best execution principles the firm


        -[99]-   Letter from Dan B. Franks, Senior Vice
                 President, Equity Trading, Scott &
                 Stringfellow, Inc., to Jonathan G. Katz,
                 Secretary, SEC, dated December 23, 1996 ("Scott
                 & Stringfellow Letter"); letter from Leslie
                 Seff, Fidelity Capital Markets, to Jonathan G.
                 Katz, dated December 23, 1996 ("Fidelity
                 Capital Letter").

        -[100]-  Gleeson Letter; letter from Stephen Kovacs, to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 20, 1996 ("Kovacs Letter"); Grossman
                 Letter.

        -[101]-  Letter from Hendrickson, to Jonathan G. Katz,
                 Secretary, SEC, dated December 18, 1996
                 ("Hendrickson Letter").

        -[102]-  Adopting Release, supra note 6.

==========================================START OF PAGE 72======
   would be expected to match the displayed quote up to its size,

   the firm should be provided a mechanism to instead execute the

   customer limit order directly against the superior displayed

   quote.  The NASD proposal is consistent with this suggestion.

   The NASD has not permitted market makers to enter orders into

   SOES for their own account, because to date the NASD has

   concluded that automated execution by one market maker against

   another would expose market makers to excessive risk and thus

   would discourage market making.  Therefore, the proposal is

   limited to market maker riskless principal orders reflecting

   agency orders held by the market maker.  The NASD intends to

   monitor for compliance with this condition as part of its

   regular examination program for market makers.

       The Commission believes it is consistent with the Act to

   eliminate differentiating between agency orders entered in

   SOES by market makers or order entry firms.  Accordingly, the

   Commission is approving the amendment.  Furthermore, the

   Commission notes that riskless principal orders entered by

   market makers on behalf of customer orders will be accorded

   like treatment under the rule.  The Commission agrees with the

   NASD that the amendment will help to ensure that all customer

   orders receive the benefit of interaction with other interest

   in the market and enhanced price improvement opportunities.



          6.  Processing of Marketable Limit Orders

              a.  Comments

==========================================START OF PAGE 73======
       Only one commenter addressed the issue of eliminating the

   priority accorded marketable limit orders over market orders

   in SOES, expressing support for the proposal.-[103]-

              b.  Commission analysis

       The Commission believes the amendment is consistent with

   the Act, and therefore approves this modification.  This

   amendment will eliminate an unwarranted advantage to investors

   placing marketable limit orders over those placing market

   orders.  This result recognizes the functional equivalency of

   these two types of orders.

          7.  Market Maker Withdrawal from Nasdaq SmallCap Market

              Securities

              a.  Comments

       Only one commenter addressed this issue; this market maker

   believed the provision should be modified such that a market

   maker would be deemed to have voluntarily withdrawn from the

   market if its quote remained at zero at the opening of the

   following trading day.-[104]-

              b.  Commission analysis

       The Commission believes this amendment is consistent with

   the Act, and therefore approves this modification.  The

   Commission does not believe that requiring a market maker to

   reenter a quote in a SmallCap security by the close of trading

   for the day presents a significant hardship to market makers


        -[103]-  Herzog, Heine, Geduld Letter.

        -[104]-  Herzog, Heine, Geduld Letter.

==========================================START OF PAGE 74======
   in a security.  Furthermore, establishing an outer time frame

   by which a market maker must reenter its quote makes it clear

   to the market which market makers in a security are willing to

   continue market making in the security.

       C. Implementing the SelectNet Linkage

       As noted above, the NASD proposed to change certain rules

   and aspects of the SOES and SelectNet systems to implement the

   SelectNet Linkage, which is intended to facilitate the

   operation of the ECN Display Alternative based on existing

   Nasdaq system platforms, SOES and SelectNet.  The nature of

   this linkage was constrained by the needs of the ECNs and the

   limitations on the Nasdaq computer systems discussed

   previously.

          1.  Display of ECN Prices

              a.  Comments

       Several market makers and the SIA supported the proposal

   for the display of ECN prices and characterized it as a

   "reasonable interim approach."-[105]-  Those favoring

   the proposal praised the consolidated market maker/ECN quote

   as increasing market transparency.

       Comments criticizing the proposal were submitted by

   Instinet, individual investors, academics, order entry firms

   and SOES traders.  The majority of critical comments concerned

   the rounding indicator.  Many commenters objected to the



        -[105]-  Herzog, Heine, Geduld Letter; Mayer &
                 Schweitzer Letter; SIA Letter; Pershing Letter.

==========================================START OF PAGE 75======
   determination of the NASD not to disseminate the actual prices

   displayed by ECNs if those prices are in increments finer than

   the NASD's minimum quotation increments.-[106]-  Some

   commenters argued that the failure to display the actual price

   or an indicator that a price was rounded would make it

   impossible for brokers to find the best price for retail

   customers.-[107]-  These commenters requested either

   that rounding not be approved without the indicator, or

   encouraged the NASD and Nasdaq to implement the rounding

   indicator as soon as possible, and move to finer increments or

   decimal pricing as soon as feasible.-[108]-  One

   commenter, noting that ECNs with rounded prices will not have

   display priority over market makers at an inferior, displayed

   price, but instead will be treated as if their rounded price

   were their actual price and entered according to time

   priority, questioned whether any technological reason existed

   for this approach.-[109]-  One order entry firm


        -[106]-  A.J. Michaels Letter; All-Tech (12/23/96);
                 Grossman Letter; Hope Letter; I.Q. Letter;
                 Hurwitz Letter; Simaan Letter; Whitcomb Letter
                 (11/21/96).

        -[107]-  All-Tech Letter (12/23/96), Whitcomb Letter
                 (11/21/96); Simaan Letter; letter from Seth
                 Modlin, to Jonathan G. Katz, Secretary, SEC,
                 dated December 19, 1996 ("Modlin Letter").

        -[108]-  A.J. Michaels Letter; All-Tech Letter
                 (12/23/96); Simaan Letter; Whitcomb Letter
                 (11/21/96).  See also Hope Letter; I.Q. Letter;
                 Hurwitz Letter.

        -[109]-  Whitcomb Letter (12/10/96).  See also Instinet
                 Letter.

==========================================START OF PAGE 76======
   suggested that rounding without an indicator permits an ECN to

   "hide its market" which is inconsistent with the Order

   Handling Rules.-[110]-  This firm also suggested that

   once the rounding indicator is available, market makers should

   be allowed to quote with the indicator.  Finally, several

   order entry firms suggested that rounding permits the market

   maker to trade at the superior price with the ECN, give its

   customer a fill at the posted quote, and keep the "hidden"

   fraction.-[111]-

              b.  Commission analysis

       While recognizing and sharing concern about the lack of a

   rounding indicator, the Commission believes that this

   amendment represents a significant step forward in the public

   display of prices entered into ECNs.  For the first time, a

   consolidated montage displaying both quotes of market makers

   and ECN prices will enable investors and market professionals

   alike to view in one place all the trading interest in a

   particular security in the market.  In addition to providing

   improved transparency, the proposed Nasdaq linkage will enable

   investors to access prices that previously were available only

   to subscribers to an ECN.  Thus, investors will have access to

   better prices and the goal of best execution for all customers

   will be advanced.

       The Commission has determined the NASD's proposal to


        -[110]-  All-Tech Letter (12/23/96).

        -[111]-  A.J. Michaels Letter; First Westchester Letter.

==========================================START OF PAGE 77======
   develop the SelectNet linkage is consistent with Act and,

   thus, is approving the proposal.  The Commission believes the

   SelectNet linkage furthers the Section 11A objective of

   achieving more efficient and effective market operations, fair

   competition among brokers and dealers, and the economically

   efficient execution of investor orders in the best market.

   Specifically, the development of the SelectNet linkage will

   facilitate the display of customer limit orders, thereby

   advancing the national market system goal of the public

   availability of quotation information, as well as fair

   competition, market efficiency, and best execution.  The

   enhanced transparency of these orders also increases the

   likelihood that limit orders will be executed because contra-

   side market participants will have a more accurate picture of

   trading interest in a given security.

       In adopting the Order Handling Rules, the Commission

   recognized that ECNs may display orders in increments smaller

   than the minimum quotation increments used in the public

   trading markets.  The Order Handling Rules sought to publicize

   the ECN prices in the existing public quotation systems, but

   in doing so did not require the SROs to alter their existing

   trading increment.  Rather, the Commission allowed market

   makers' and specialists' quotes in ECNs at finer increments to

   be displayed in the SROs markets at prices rounded to the

   SROs' quotation increment, with a rounding

==========================================START OF PAGE 78======
   indicator.-[112]-  The NASD and other SROs have

   indicated that, as a technical matter, display of a rounding

   indicator is not possible by the implementation date of the

   rules.

       Many commenters stated that the lack of a rounding

   indicator will make it difficult to determine if an improved

   price is available from an ECN.  The NASD and Nasdaq have

   acknowledged this difficulty and have committed to resolving

   this problem by implementing a rounding indicator as soon as

   possible.  The Commission believes the NASD and Nasdaq are

   acting in good faith and have granted the SROs no-action

   relief concerning the lack of a rounding indicator until July

   31, 1997.-[113]-  The Commission believes that there is

   much to be gained by going forward with the SelectNet linkage

   without the indicator, pending Nasdaq's development of an

   appropriate format for such a notation.  The Commission notes

   that, consistent with the Order Handling Rules, when an order

   is sent through SelectNet to an ECN and a market maker or

   specialist has entered an order at a better price, which is

   rounded for display in Nasdaq, the order sent through

   SelectNet will receive the better price available in the ECN.

   Moreover, broker-dealers will be able to enter orders through

   the SelectNet linkage priced at finer increments than the

   rounded quotes.  Broker-dealers and their customer can use


        -[112]-  Adopting Release, supra note 6.

        -[113]-  See supra note 28.

==========================================START OF PAGE 79======
   such orders to define the prices at which they are willing to

   trade.

          2.  Access to ECN Prices

              a.  Comments

       Some commenters criticized the lack of an electronic

   linkage between the ECNs and SOES, and argued that it should

   be possible for SOES orders to be electronically routed to an

   ECN.-[114]-  Several commenters noted that the lack of

   the linkage could eliminate the market maker's risk of

   exposure to executions at the ECN price.-[115]-

   Furthermore, commenters argued that without automated

   execution through the linkage, ECNs would be able to favor

   their own customers in executions.-[116]-  Other

   commenters expressed concern that because a SOES/SelectNet

   linkage was not required, the execution of small orders

   entered into SOES, but rejected on the basis of a superior ECN

   quote, will be delayed while they are manually rerouted to

   SelectNet.-[117]-  In contrast, Instinet argued that

   the proposal's requirement that ECNs automate SelectNet

   response functions is costly and excessively burdensome.


        -[114]-  Morgan Stanley Letter; Instinet Letter;
                 Exchange House Letter; Grossman Letter; Lu
                 Letter.

        -[115]-  See e.g., Grossman Letter; Hurwitz Letter.

        -[116]-  See e.g., Cornerstone Letter; All-Tech Letter
                 (12/23/96).

        -[117]-  All-Tech Letter (11/22/96); Pompeo Letter;
                 Beers & Wilk Letter; Edward Jones Letter.

==========================================START OF PAGE 80======
   Instinet further maintained that ECNs should be given

   flexibility to evaluate the credit worthiness of non-ECN

   subscribers.

              b.  Commission analysis

       As discussed above, some commenters criticized the lack of

   an automated execution between SOES and the ECNs.  The

   Commission, in the Adopting Release, stated that ECNs must

   provide broker-dealers who use SOES with equivalent automated

   access to the best priced market maker orders in the ECN for

   NNM and SmallCap securities.-[118]-  This could be

   accomplished either through an electronic linkage to SOES or

   by other means agreed upon with the NASD.-[119]-  The

   Commission recognizes that the SelectNet Linkage does not

   include an electronic linkage to SOES.  The SelectNet linkage

   was developed to accommodate the ECNs, at least on an interim

   basis, to receive an order rather than an automated execution

   such as provided by SOES.  The ECNs by definition provide

   automated executions of orders internally.  Linking to an

   external automated execution system would create the risk of

   two simultaneous executions against the same order, thereby

   forcing the ECN operator to trade as principal without an

   order on the other side.  Because the Commission expressed

   strong support for an effective ECN display alternative as an


        -[118]-    Adopting Release, supra note 6.  The
Commission
              also discussed the provision of telephonic access
              to ECN prices.

        -[119]-  Id.

==========================================START OF PAGE 81======
   element of the Order Handling Rules,-[120]- the NASD

   determined to create the SelectNet linkage as an interim

   measure to implement the ECN display alternative by the

   implementation date of the rules.  Because of the age and

   inflexibility of the SOES and SelectNet systems, the NASD was

   unable to link its SOES system to the SelectNet system by the

   effective date of the rules, in order to allow SOES orders to

   be routed to the ECN via SelectNet when the ECN displayed a

   superior price.  The NASD has indicated that the existing

   linkage is in its view an interim measure, and that it intends

   to link these functions in the future.  The NASD also intends

   to include in its proposed ECN addendum to the Nasdaq

   Workstation subscriber agreement requirements that the ECN

   respond promptly to a SelectNet linkage order.

       In response to Instinet's comment opposing the requirement

   of automated responses from ECNs, the Commission believes that

   this requirement is necessary to assure the smooth functioning

   of the SelectNet linkage.  The Commission believes that,

   because the SelectNet linkage does not provide automated

   executions, any significant delay in response to a SelectNet

   order from the ECN will unreasonably prolong execution time

   for the customer.  However, the Commission believes that the

   NASD requirements for ECNs will result in execution response

   times of a matter of seconds, so that use of the linkage will

   be virtually immediate.


        -[120]-  Adopting Release, supra note 6.

==========================================START OF PAGE 82======
       The Commission takes very seriously the concern expressed

   that ECNs could potentially favor their own customers.  The

   Commission is satisfied, however, that adequate safeguards are

   in place to prevent ECNs from discriminating between customers

   in a manner inconsistent with the Order Handling Rules.

   First, ECNs will be required to execute an ECN addendum to the

   Nasdaq Workstation subscriber agreement providing that they

   cannot prefer their own customers in executions or

   discriminate against linkage orders.  Second, the subscriber

   agreement requires prompt responses to linkage orders.

   Finally, the Quote Rule only excepts a broker-dealer from

   honoring its quote if it is effecting a transaction or is in

   the process of updating its quote.  If an ECN cannot

   demonstrate that one of these exceptions applies, it will be

   liable for a violation of its Quote Rule obligations as well

   as the NASD ECN subscriber agreement.

       In response to Instinet's concern about the need for time

   to examine the credit worthiness of customers, the Commission

   notes that a key condition of performing as a display

   alternative under the Order Handling Rules is that the ECN

   provide access to its prices to broker-dealers equivalent to

   that provided by market makers and specialists.  Market makers

   and specialists must be firm at their quotes for orders from

   at a minimum all brokers and dealers.  The ECN must satisfy

   the same standard.  The Commission staff has interpreted the

   Quote Rule to allow a narrow exception so that the market

==========================================START OF PAGE 83======
   maker may take into account the substantial likelihood that a

   counterparty may not perform in determining whether to trade

   with the counterparty at its quote.-[121]-  The

   SelectNet linkage and the NASD ECN addendum would not preclude

   an ECN from declining an order from a counterparty if it had a

   substantial basis for believing the counterparty would not

   perform; indeed, an ECN could program its system to reject

   linkage orders from particular counterparties if the ECN can

   satisfy this narrow exception from the Quote Rule.  Rejection

   of linkage orders for generalized credit concerns would not

   constitute providing equivalent access as required to qualify

   as an ECN display alternative.

          3.  Implementation of the ECN Linkage

              a.  Comments

       Instinet argued that the Workstation Subscriber Agreement

   required by the rule should not contain substantive conditions

   not imposed on other users Nasdaq workstation users.  Instinet

   also objected to the characterization of the linkage by the

   NASD and Nasdaq as "interim," and expressed its opposition to

   further modifications that may make the linkage resemble a

   consolidated limit order file.  Instinet requested that the


        -[121]-  The Commission staff interpreted the Quote Rule
                 as permitting a market maker from refraining
                 from trading at its displayed quote if it had a
                 substantial basis for believing that the
                 counterparty to the transaction will not be
                 able to honor the trade.  Letter from Richard
                 Lindsey, Director, Division of Market
                 Regulation, SEC, to Richard Grasso, Chairman
                 and CEO, NYSE, dated November 22, 1996, p. 17.

==========================================START OF PAGE 84======
   SEC monitor negotiations regarding further modification

   between the ECNs and the NASD.

              b.  Commission analysis

       In its November interpretive letter,-[122]- the

   Commission staff recognized that the SROs should have the

   ability to establish reasonable conditions on ECNs linking

   with the SRO pursuant to the ECN display alternative.  The

   Commission believes that the NASD's Workstation Subscriber

   Agreement addendum is an appropriate vehicle for establishing

   reasonable conditions for ECNs linking with Nasdaq.  Regarding

   Instinet's concerns about the NASD's further modifications to

   the interim approach, the Commission believes it is premature

   to consider the nature of potential revisions at this time.

   The Commission believes that it is important to enhance the

   SelectNet linkage to connect the market order executions

   systems with the ECN linkages; however, the design of these

   future enhancements has not been determined and is not before

   the Commission in the present filing.  Any future changes

   would be filed by the NASD and Nasdaq as a rule filing with

   the Commission and published for comment.  The Commission will

   fully consider the issues presented by, and comments on, such

   a filing at that time.  The Commission intends to monitor

   future negotiations between the ECNs and the NASD regarding



        -[122]-  See letter from Richard R. Lindsey, Director,
                 Division of Market Regulation, SEC, to Richard
                 Grasso, Chairman and CEO, NYSE, dated November
                 22, 1996.

==========================================START OF PAGE 85======
   the design of this linkage.

          4.  Eliminating SelectNet Broadcast Feature

              a.  Comments

       Several market makers, the STA and the DSTA favor the

   elimination of the SelectNet broadcast feature.-[123]-

   Several commenters expressed support for the elimination of

   the counter-offer function.-[124]-

       Many commenters, including academics, order entry firms

   and SOES traders, objected to eliminating the SelectNet

   broadcast feature.-[125]-  Several commenters argued that

   eliminating the SelectNet broadcast feature effectively

   eliminated the ability of SelectNet to function as an

   electronic stock market.-[126]-  These commenters



        -[123]-  A.G. Edwards Letter; letters from Daryl
                 Andersen (Nasdaq Equity Trading), Joseph G.
                 Geelan (Vice President, Institutional Trading),
                 Jeff Peterson (Vice President, Senior Trader),
                 Daniel L. Henn (Vice President, Nasdaq Equity
                 Trading), Dede Yurecko (Vice President, Senior
                 Trader), Art Kearney (Executive Vice President,
                 Director of Capital Markets), Beth McCann (Vice
                 President, Institutional Trading), John G.
                 Kinnard & Co., to Secretary, SEC, dated
                 December 24, 1996 ("Kinnard Letters"); DSTA
                 Letter, Edward Jones Letter; Mayer & Schweitzer
                 Letter; STA Letter; STAIC Letter; STANY Letter.

        -[124]-  Edward Jones Letter.

        -[125]-  See e.g., All-Tech Letter (12/23/96); Boran
                 Letter; Frame Letter; Grossman Letter; letter
                 from Gerard Hunter, to Jonathan G. Katz,
                 Secretary, SEC, dated December 19, 1996 ("G.
                 Hunter Letter"); FNB Letter, W. Jordan;
                 Cornerstone Letter.

        -[126]-  Whitcomb Letter (11/21/96); Simaan Letter.

==========================================START OF PAGE 86======
   argued that the proposal turns SelectNet into "nothing more

   than a message routing system."-[127]-

       It was argued that eliminating the SelectNet broadcast

   feature, together with eliminating the SOES limit order file,

   meant that public orders could be entered into the market only

   if a market maker or ECN chose to accept that order in its

   sole discretion.-[128]-  Another order entry firm echoed this

   comment and stated that order entry firms will now have no

   means of displaying orders between the spread.-[129]-

   Several order entry firms stated that the elimination of the

   broadcast function forces order entry firms to subscribe to an

   ECN.-[130]-

              b.  Commission analysis

       The Commission is not taking action on the SelectNet

   broadcast feature at this time, pursuant to an NASD consent to

   an extension of time for consideration of this portion of its

   proposal.  The NASD said that a major basis for its proposal

   to eliminate the SelectNet broadcast feature was concern that

   the Nasdaq system had inadequate capacity to continue all

   current functions once the Order Handling Rules went into


        -[127]-  Simaan Letter, Whitcomb Letter (11/21/96);
                 letter from Jerry Putnum, Terra Nova Trading,
                 LLC, to Jonathan G. Katz, Secretary, SEC, dated
                 December 9, 1996 ("Terra Nova Letter").

        -[128]-  See e.g. First Westchester Letter; Cornerstone
                 Letter.

        -[129]-  Cornerstone Letter.

        -[130]-  First Westchester Letter; Grossman Letter

==========================================START OF PAGE 87======
   effect.  The NASD indicated that the SelectNet broadcast

   feature uses substantial systems capacity.  The Commission

   intends to monitor the impact on Nasdaq systems capacity and

   quote traffic of the phase-in of the Order Handling Rules

   before reaching a determination regarding elimination of the

   SelectNet broadcast feature.

          5.  Rejection of SOES Orders When ECN or UTP Exchange

              is at the Inside Quote

              a.  Comments

       Market makers generally were in favor of the proposal to

   reject SOES orders when no Nasdaq market maker was quoting at

   the inside quote.  They believe it is appropriate for the

   order to be returned to the entering firm when an exchange or

   ECN is driving the inside.  Order entry firms and SOES traders

   generally opposed the proposal.  One order entry firm argued

   that it would be possible for an order to be sent to an ECN

   through the SelectNet Linkage, rejected by the ECN, returned

   to the broker who then enters the order into SOES, which then

   rejects the order because in the interim, an ECN established a

   better price.-[131]-  Another stated that the proposal


        -[131]-  All-Tech Letter (11/22/96).  See also Beers &
                 Wilk Letter; letter from Geoffrey Dubey, to
                 Jonathan G. Katz, Secretary, SEC, dated
                 December 20, 1996 ("Dubey Letter"); Edward
                 Jones Letter, Lu Letter; letter from Michael
                 McLoughlin, to Jonathan G. Katz, Secretary,
                 SEC, dated December 16, 1996 ("McLoughlin
                 Letter"); letter from Dario Pompeo, to Jonathan
                 G. Katz, Secretary, SEC, dated December 18,
                 1996 ("Pompeo Letter") (discussing the delay
                 involved with this aspect of the proposal).

==========================================START OF PAGE 88======
   would render SOES unusable for most large issues for many

   periods if market makers use the display

   alternative.-[132]-  Several commenters believed this

   aspect of the proposal creates a risk that some market makers

   would improperly use ECNs to avoid being subject to SOES

   executions.-[133]-  Another order entry firm claimed

   that the proposal undermines competition and legitimizes

   collusive behavior.-[134]-  One order entry firm argued

   that the rule change moves the market from an environment

   where a customer cannot hope to obtain best execution to an

   environment where the customer must obtain best execution or

   no execution at all.-[135]-  This commenter stated that

   the customer preferring speed and certainty of execution over

   price improvement is disadvantaged.

              b.  Commission analysis

       The Commission is approving the amendment to effect this

   change as consistent with the Act and the rules thereunder,

   particularly the Order Handling Rules.  As discussed below,

   the NASD was unable to link the SOES system with the SelectNet

   linkage by the implementation date for the Order Handling

   Rules.  Therefore, when an ECN or a UTP exchange is alone at

   the best quote, the SOES system must either reject orders,


        -[132]-  Exchange House Letter.

        -[133]-  Cornerstone Letter; Morgan Stanley Letter

        -[134]-  First Westchester Letter.

        -[135]-  All-Tech Letter (11/22/96).

==========================================START OF PAGE 89======
   execute them against Nasdaq market makers at the ECN or UTP

   exchange quote, or execute them at the Nasdaq market makers'

   best quote even though that quote is inferior to the NBBO.

   The Commission agrees with the NASD's analysis that to hold

   the market maker to a SOES execution at a price that is being

   driven by the ECN or exchange would be competitively unfair,

   and to execute SOES orders at the market maker's own quote

   would result in customer executions at a price that is

   inferior to the NBBO, generally violating best execution

   duties of broker-dealers entering the orders.

       The Commission recognizes that the shutdown of SOES when

   better ECN or UTP exchange quotes are displayed in the NBBO

   will reduce the ability to execute customer orders immediately

   on an automated basis.  At the same time, it will contribute

   to competitive quotations by encouraging customer orders to be

   routed to the ECN or UTP exchange displaying the best quote.

   Market makers that want to attract SOES order flow in these

   securities will be encouraged to publish a Nasdaq quote equal

   to or better than that displayed by the ECN or UTP exchange.

   This competition could improve market quotation quality and

   produce better prices for investors.

       The proposed amendment is intended to address a problem

   arising from the lack of an interconnectivity between the SOES

   system and the SelectNet linkage.  As discussed previously,

   the NASD was unable to complete the programming for the

   SelectNet linkage and the necessary changes to the SOES rules,

==========================================START OF PAGE 90======
   and also link the separate SelectNet and SOES systems, both of

   which are aging Legacy systems.  As discussed previously, the

   NASD has indicated that it plans to develop a revised system

   that will connect its market order execution system with its

   linkage to ECNs.  When this system is developed, it should be

   possible to route market orders directly to the best market

   maker or ECN quote prevailing at that time.

       In the meantime, the Commission believes that order entry

   firms should be able to reprogram their systems to scan the

   quote line and direct their order either into SOES or the

   SelectNet link, depending on where the best quote is at the

   time of the order's entry.  In this manner, order entry firms

   can improve the efficiency of order routing and reduce the

   number of rejections received in the SOES system.  The

   Commission notes that many SOES users are already frequent

   SelectNet users for orders not eligible for SOES.

       The Commission also notes that during the initial stages

   of implementation of the Order Handling Rules when the

   rounding indicator is not available, SOES orders will be

   rejected only when ECN prices are a full quotation increment

   better than the best bid or offer.  When a price is displayed

   in an ECN at a superior price at a smaller increment, such as

   20 1/16, and rounded to a price reflecting a standard trading

   increment, such as 20 1/8, SOES executions will not stop if

   the best market maker quote is also at 20 1/8.  This should

   substantially reduce the number of SOES rejections resulting

==========================================START OF PAGE 91======
   from superior ECN prices, because ECN prices often are

   superior to Nasdaq by only a smaller quotation increment.

       The Commission acknowledges that this provision creates a

   risk that market makers could enter orders into ECNs to avoid

   being subject to SOES executions.  The Commission

   preliminarily believes that such activity would raise concerns

   under a broker-dealer's obligation to observe SRO just and

   equitable principles of trade.-[136]-  The Commission

   encourages the NASD to monitor such activity carefully and to

   consider disciplinary action where warranted.

          6.  Summary and Effect on SOES Users

       A number of commenters argued that the NASD was using the

   proposed changes as a whole to limit the ability of customers

   of order entry firms to trade efficiently through SOES.  In

   particular, these commenters argue that the reduction in

   market makers' minimum quote size to 100 shares, the potential

   that SOES orders would receive split executions, the inability

   to enter all-or-none orders, and the inability to enter SOES

   orders when one or more ECNs are alone at the inside quote

   would limit their ability to execute orders rapidly and at low

   cost over SOES.

       As discussed above, the Commission has reviewed each of

   these proposed revisions individually and has determined each

   of them to be consistent with the purposes of the Act.

   Furthermore, the Commission does not believe that these


        -[136]-  NASD Rule 2110.

==========================================START OF PAGE 92======
   revisions, taken together, necessarily adversely affect the

   ability of customers of order entry firms to trade through

   SOES.  As noted above, far from commenters' predictions of a

   market of uniform 100-share quotes, the Commission believes

   that the display of ECN orders and customer limit orders in

   the market should increase liquidity and narrow spreads in

   Nasdaq securities.  In such an environment, customers entering

   orders through SOES would be expected to benefit from the

   better prices in the market.  To the extent a SOES order would

   be subject to multiple executions, any improved prices could

   in fact offset the increased transactions costs attributable

   to split executions.  Finally, as discussed above, the

   Commission believes that order entry firms should be able to

   program their systems to reroute SOES orders through SelectNet

   when SOES is disabled because one or more ECNs are alone at

   the inside price.

       Therefore, while it is true that the NASD's proposed

   revisions will require changes in how orders are executed

   through SOES, the Commission does not believe that the

   revisions, individually or in the aggregate, impose unfair

   competitive burdens on SOES order entry firms or their

   customers, nor do they unfairly discriminate against investors

   who actively trade on the SOES system or the broker-dealers

   which service these investors.

       After considering the comments, the Commission believes

   that at this time the NASD's proposed amendment is necessary

==========================================START OF PAGE 93======
   to promptly effectuate the Order Handling Rules given the

   abbreviated time frames and the limitations on the NASD's

   system.  The Commission also believes that the ultimate

   benefits of the availability to the customer of superior

   quotes resulting from display of ECN prices outweigh the

   inefficiencies resulting from rejections of SOES orders when

   ECNs are at better prices.

          7.  Locked and Crossed Markets Rule Amendments

              a.  Comments.

       Several market makers, the STA and the STANY commented in

   favor of applying the locked and crossed markets rule to

   market makers and other NASD members entering orders into

   ECNs, and to ECNs that are displaying orders in Nasdaq for

   non-NASD members.-[137]-  The STANY supports the

   application of the locked and crossed markets rule to ECNs,

   because of the market confusion and inefficiency that results

   from locked and crossed quotes in Nasdaq.  A few commenters

   offered suggestions to modify the rule,-[138]-

   including a requirement that a locking or crossing market

   maker should be required to notify the NASD, which notifies

   the potentially locked or crossed market maker, before



        -[137]-  DSTA Letter; Herzog, Heine, Geduld Letter;
                 letter from David Kuang, to Jonathan G. Katz,
                 Secretary, SEC, dated December 19, 1996 ("Kuang
                 Letter"); Mayer & Schweitzer Letter; STA
                 Letter; STANY Letter.

        -[138]-  STA Letter; Herzog, Heine, Geduld Letter;
                 Morgan Stanley Letter.

==========================================START OF PAGE 94======
   entering the quote.-[139]-  Another market maker

   supported the amendment as a first step, and suggested that

   the NASD should have authority to halt trading in locked and

   crossed markets, as do the exchanges.-[140]-

       Instinet argued that an ECN does not trade as principal

   and does not have the ability to make "reasonable efforts" to

   avoid a locked or crossed market.  Two commenters questioned

   the meaning of the exception for "extraordinary

   circumstances."-[141]-  Another order entry firm stated

   that the rule is unclear.-[142]-

       Amex and CBOE argued that applying the locked and crossed

   markets rule, Rule 4613(e), to ECNs, would inhibit the ability

   of options specialists and market makers to hedge in an ECN.

   Amex stated that it is impractical to require an options

   market maker to first "clear the Street" of all Nasdaq market

   maker quotes that it might cross when entering a hedging order

   into an ECN.  It argued that the effects of the proposed

   application of the locked and crossed markets rule to ECNs and

   their users during volatile markets are uncertain and may

   cause a disruption in the ECN trading of Nasdaq stocks and may

   further disrupt trading in their options.

              b.  Commission analysis


        -[139]-  Morgan Stanley Letter.

        -[140]-  Herzog, Heine, Geduld Letter.

        -[141]-  Amex Letter; Cornerstone Letter.

        -[142]-  Grossman Letter.

==========================================START OF PAGE 95======
       The NASD has proposed the amendment to the locked and

   crossed markets rule to reduce the potential for a very

   significant and disruptive incidence of locked and crossed

   markets arising from ECN prices.  The NASD argues that locked

   and crossed quotes interfere with the operation of the Nasdaq

   market by obscuring the true bid and offer prices at the time,

   and also may impact the use of firm, automated order execution

   systems.  The NASD thus believes that NASD members, including

   ECNs, should attempt to trade with a market maker quote before

   locking or crossing that quote.  The Commission believes that

   it is consistent with the purposes of the Act to maintain

   Nasdaq quotations that are informative and reliable.  The

   Commission further believes that the NASD's proposal is

   reasonably designed to maintain the integrity of Nasdaq quotes

   by reducing the incidence of locking and crossing quotations

   displayed in Nasdaq by ECNs.  The Commission urges the NASD to

   consider other means of reducing the incidence of locked and

   crossed quotes such as efficient means of executing against

   market maker quotes before entering a locking or crossing

   order.

       The Commission notes that the term "extraordinary

   circumstance" is existing language in the locked and crossed

   markets rule.  It would encourage any market participants

   unclear about the meaning of this language to seek

   interpretive guidance from the NASD.

          7.  Modifications to Autoquote Policy

==========================================START OF PAGE 96======
              a.  Comments

       Several commenters expressed support for the modification

   to the autoquote policy to permit computer generated display

   of limit orders, responses to executions and ECN

   prices.-[143]-  One order entry firm argued that

   autoquoting should not be available in response to a partial

   fill.-[144]-  One academic argued that the temporary

   requirement permitting ECNs to autoquote to post two-sided

   quotes (until technical modifications can permit one-sided

   quotes) forces ECNs to post "phantom" quotes, further debasing

   the meaning of quotes in the Nasdaq market.-[145]-

              b.  Commission analysis

       The Commission has determined that the NASD's proposal is

   consistent with the Act and, therefore, is approving the

   amendment.  The proposed amendments are narrow exceptions to

   the autoquote policy designed to help effectuate the Order

   Handling Rules.  In the Adopting Release, the Commission urged

   the NASD to reconsider its general ban on computer generated

   quotes to allow members to use computer generated quotes that

   add value to the market.-[146]-  The Commission

   understands that the NASD continues to consider this policy

   generally, while proposing these specific modifications to


        -[143]-  Herzog, Heine, Geduld Letter; Kuang Letter.

        -[144]-  All-Tech Letter (12/23/96).

        -[145]-  Whitcomb Letter (11/21/96).

        -[146]-  Adopting Release, supra note 6.

==========================================START OF PAGE 97======
   facilitate the Order Handling Rules.

       The Commission also notes that the NASD's method of

   adapting its existing quotation system to accept quotes from

   ECNs, by permitting ECNs to autoquote to maintain two-sided

   quotes is only a temporary solution until the NASD can modify

   its system to accept one-sided quotes from ECNs.

   V.  AMENDMENT NO. 1

       The Commission finds good cause for approving Amendment

   No. 1 prior to the thirtieth day after the date of publication

   of notice thereof in the Federal Register.  Commission

   approval of the request made in Amendment No. 1 to grant

   temporary approval, on a three-month pilot basis, to the

   minimum quotation size requirements will allow market

   participants and the Commission to assess the effects of these

   changes.  In addition, the Order Handling Rules will become

   effective on January 20, 1997.  To facilitate the

   implementation of these rules, the NASD must make changes to

   its current rules that will affect manner of operation of its

   systems.  The Commission believes that industry participants

   must be provided sufficient time to acclimate to these

   changes.  Therefore, the Commission believes that granting

   accelerated approval to Amendment No. 1 is appropriate and

   consistent with Section 15A and Section 19(b)(2) of the

   Act. -[147]-

       Interested persons are invited to submit written data,


        -[147]-  15 U.S.C.  78o-3, 78s(b)(2).

==========================================START OF PAGE 98======
   views and arguments concerning Amendment No. 1 to the proposed

   rule change.  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 Amendment No. 1 that are

   filed with the Commission, and all written communications

   relating to Amendment No. 1 between the Commission and any

   persons, 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-96-43 and should be submitted by [insert date 21 days

   from date of publication].

   VI.    CONCLUSION

       For all of the aforementioned reasons, 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.

   Specifically, the Commission believes the proposed rule change

   is consistent with Section 15A(b)(6) of the Act-[148]-

   because it is designed to promote just and equitable

   principles of trade, to foster cooperation and coordination


        -[148]-  15 U.S.C.  78o-3(b)(6).

==========================================START OF PAGE 99======
   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, in

   general, to protect investors and the public

   interest.-[149]-  In addition, the Commission believes

   the proposed rule change is consistent with Section

   15A(b)(9)-[150]- and Section 15A(b)(11)-[151]-

   of the Act because it does not impose any burden on

   competition not necessary or appropriate in furtherance of the

   purposes of the Act and because it is designed to produce fair

   and informative quotations.

       IT IS THEREFORE ORDERED, pursuant to Section 19(b)(2) of

   the Act,-[152]- that the proposed rule change (SR-NASD-96-43)

   is partially approved, including Amendment No. 1 on an

   accelerated basis.  The Commission is not approving at this

   time the NASD's elimination of the SelectNet broadcast feature

   and the elimination of minimum market maker quotation size for

   securities other than those covered by Amendment No. 1.  The

   pilot program established by Amendment No. 1 expires on



        -[149]-  In making this finding, the Commission notes
                 that the proposal should promote efficiency and
                 competition in the securities markets.  15
                 U.S.C.  78c(f).

        -[150]-  15 U.S.C.  78o-3(b)(9).

        -[151]-  15 U.S.C.  78o-3(b)(11).

        -[152]-  15 U.S.C.  78s(b)(2).

==========================================START OF PAGE 100======
   April 18, 1997.

       By the Commission.

                            Jonathan G. Katz
                            Secretary


   Dated: January 10, 1997