[Federal Register Volume 65, Number 108 (Monday, June 5, 2000)]
[Notices]
[Pages 35690-35692]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-13956]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42847; File No. SR-NASD-00-30]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. to 
Include UTP Exchanges in the Nasdaq National Market Execution Service

May 26, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on May 25, 2000, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association''), through its wholly owned subsidiary, the 
Nasdaq Stock Market, Inc. (``Nasdaq''), filed a proposed rule change 
with the Securities and Exchange Commission (``SEC'' or 
``Commission''). The proposed rule change is described in Items I, II, 
and III below, which Items have been prepared by Nasdaq. The Commission 
is publishing this notice to solicit comments on the proposed rule 
changes from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Nasdaq is proposing to provide for the inclusion of national 
securities exchanges trading Nasdaq-listed securities pursuant to 
grants of unlisted trading privileges (``UTP'') in the automatic-
execution functionality of the Nasdaq National Market Execution System 
(``NNMS''). Below is the text of the proposed rule change. Proposed 
deletions are in brackets and proposed addition are in italics.
    4720. SelectNet Serve
    (a)-(b) No Change
    (c) Prohibition Regarding the Entry of Certain Preferenced Orders 
to Nasdaq National Market Execution System Market Makers
    (i) No member [may] shall direct a SelectNet preferenced order to a 
Nasdaq

[[Page 35691]]

National Market Execution System (``NNMS'') market maker including that 
market maker's Agency Quote (as defined in NASD Rule 4613), a Full 
Participant ECN (as defined in NASD Rule 4701), or a UTP Exchange that 
participates in the automatic execution functionality of the NNMS, 
unless that order is designated as:
    A[(i)] an ``All-or-None'' order (``AON'') and is at least one 
normal unit of trading (i.e. 100 shares) in excess of the displayed 
quote to which the preferenced order is directed; or
    B[(ii)] a ``Minimum Acceptable Quantity'' order (``MAQ''), with a 
MAQ value of at least one normal until of trading in excess of the 
displayed quote to which the preferenced order is directed.
    (ii) The prohibition of this paragraph shall not apply to:
    (A) preferenced order sent by a UTP Specialist that does not 
participate in the automatic execution functionality of the NNMS, to an 
NNMS market maker; or
    (B) [to] preferenced order sent by an NNMS market maker to a TUP 
Specialist that does not participate in the automatic execution 
functionality of the NNMS.
    (iii) For purposes of this rule a ``UTP Specialist'' shall mean a 
broker/dealer registered as a specialist in Nasdaq securities pursuant 
to the rules of an exchange that is a signatory 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 Privilege Basis (``Nasdaq/NMS/UTP 
Plan'').
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, Nasdaq included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. Nasdaq has prepared summaries, set forth in Sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Nasdaq is proposing to amend the NASD rules governing the NNMS, to 
enable UTP Exchanges to participate in the automatic execution 
functionality of the NNMS. Nasdaq represents that currently, the 
Chicago Stock Exchange (``MWSE'') is the only exchange that trades 
Nasdaq-listed securities 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 Privilege Basis (``Nasdaq UTP Plan'').
    On January 14, 2000, the Commission approved the new NNMS trading 
platform, which is to be implemented in July 2000. \3\ As approved, the 
NNMS will be an automatic execution system that will serve as the 
primary trading platform for Nasdaq National Market securities. Under 
the NNMS rules, participation in the NNMS will be mandatory for Nasdaq 
market makers, and those market makers will be required to participate 
in the automatic-execution functionality of the system.
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    \3\ See Securities Exchange Act Release No. 42344 (Jan 14, 
2000), 65 FR 3987 (January 25, 2000).
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    ECNs will have two options for participating in NNMS. Specifically, 
ECNs can choose to be Order-Entry ECNs or Full-Participant ECNs. Order-
Entry ECNs will participate in Nasdaq in substantially the same manner 
as ECNs do today. That is, market participants will be able to access 
Order Entry ECN quotes via the SelectNet linkage and to send 
preferenced SelectNet messages of any size (up to 999,999 shares) to 
such ECNs. The oversized order requirement for a preferenced SelectNet 
order would not apply to Order Entry ECNs. Order Entry ECNs that want 
to access other market maker quotes will need to request order-entry 
capability in NNMS. That is, they will enter orders into NNMS for 
automatic execution against quotes of market makers and Full 
Participant ECNs (i.e., those ECNs that choose to accept automatic 
execution against their quotes). Order Entry ECNs can also send 
preferenced SelectNet orders to NNMS Market Makers subject to the over-
sized order restriction described below.
    Full-Participant ECNs will agree to provide automatic execution 
against their quotes for orders entered into NNMS, similar to market 
makers. Like Order Entry ECNs, Full-Participant ECNs will use NNMS to 
obtain automatic execution of orders they send to NNMS Market Makers or 
other Full-Participant ECNs. Full-Participant ECNs will use SelectNet 
to deliver liability orders to Order Entry ECNs.
    To avoid dual liability, market makers and Full Participant ECNs 
are only eligible to receive preferenced/directed orders through 
SelectNet that are either: (1) an ``All-or-None'' orders (``AON'') and 
at least one normal unit of trading (i.e., 100 shares) in excess of the 
displayed quote to which the preferenced order is directed; or a 
``Minimum Acceptable Quantity'' order (``MAQ''), with a MAQ value of at 
least one normal unit of trading in excess of the displayed quote to 
which the preferenced order is directed (``Over-Sized Order 
Requirement''). It is the NASD's view that orders that meet the Over-
Sized Order Requirement are not liability orders under the NASD's and 
Commission's firm quote rule. Thus, the main purpose of the Oversized-
Order Requirement is to limit dual liability for market participants 
that are required to (i.e., market makers), or chose to (i.e,, Full 
Participant ECNs), take automatic execution against their quotes 
through the NNMS \4\ The underlying premise of the NNMS rule change is 
to establish (in most cases) only one point of (or system for) delivery 
of a liability order against the quote of a market maker, ECN, or UTP 
Exchange.
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    \4\ Such dual liability could occur if a market maker or ECN 
receives an order through SelectNet to which it owes an obligation 
under the NASD's and Commission's firm quote rule, and immediately 
thereafter receives an execution through the NNMS against the same 
quote.
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    As originally proposed and approved, UTP Exchanges will only 
receive orders through Nasdaq's SelectNet system. This is because UTP 
Exchanges have traditionally received orders against their quotes 
through the order-delivery functionality of SelectNet. Because 
SelectNet is an order-delivery system--as opposed to an automatic-
execution system like the NNMS--UTP Exchanges that receive SelectNet 
orders must manually respond to the order to complete a trade.
    Under the approved NNMS rules (and similar to how SOES currently 
operates), when UTP Exchanges and/or Order Entry ECNs are alone at the 
best bid/best offer, the NNMS will stop processing orders that are in 
the NNMS system and will hold those orders in queue for 90 seconds. 
During this 90 seconds, the system essentially pauses to see if a 
market maker or Full Participant ECN will join the inside or the UTP 
Exchange or Order Entry ECN

[[Page 35692]]

will drop away from the inside, thereby establishing a new inside 
market. \5\ If after 90 seconds a market maker or Full Participant ECN 
does not join the inside, the NNMS will return the orders that are in 
queue and the system will shut down. If during the 90 seconds a market 
maker joins the inside or establishes a new (better priced) inside, the 
system resumes automatic-execution processing of orders.
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    \5\ This pause occurs because UTP Exchange and Order Entry ECN 
quotes are not reachable through the automatic-execution 
functionality of the NNMS, but only through the order-delivery 
portion of the system.
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    After the Commission approved the NNMS, the MWSE and Nasdaq began 
discussing the possibility of the MWSE participating in the automatic-
execution functionality of the NNMS. Both Nasdaq staff and the MWSE 
recognized that there could be delays in processing orders if the MWSE 
is alone at the inside and does not respond, within 90 seconds, to 
orders delivered to its quote. \6\ This could occur if the MWSE is 
experiencing system problems, is slow to process an order, or if there 
are delays in Nasdaq systems. \7\ Commission staff also raised this 
concern. In light of the above, Nasdaq is proposing a rule change to 
permit the MWSE to participate in the automatic-execution functionality 
of the NNMS.
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    \6\ While this is also a concern with ECNs, the concern is 
substantially smaller because ECNs are required to provide an 
automated response to SelectNet messages, and, in Nasdaq's 
experience, they generally respond in 5 second or less to orders 
presented to their quotes. UTP Exchanges are not under the same 
explicit obligation.
    \7\ As an illustration of the potential problem, assume the MWSE 
is alone at the inside bid of $20 for 1000 shares, Market Maker A 
enters an order into the automatic-execution functionality of the 
system, and Market Maker B directs (or preferences) 1,000 shares to 
the MWSE. No other market maker joins the inside bid of $20; this 
causes the system to stop processing orders for 90 seconds. 
Thereafter, the MWSE waits 2 minutes before responding to MMB's 
directed/preferenced order either by filing or declining the order. 
(This delay could occur if there are equipment problems at the MWSE, 
in Nasdaq, or both.) In this instance, the market effectively is 
held up for 2 minutes and the automatic-execution functionality is 
shut off (after 90 seconds) because the MWSE did not respond to the 
direct/preferenced orders within 90 seconds.
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    In the NNMS, the quotes of market makers, Full Participants ECNs, 
and UTP Exchanges are accessed in general price/time priority. We note 
that this is unlike the exchange environment where markets are required 
to sweep the floor before accessing the quotes of a competing exchange. 
We also recognize that the approach in this filing differs from our 
proposal in SR-NASD-99-53, regarding the Nasdaq Order Display Facility, 
where the system would execute against the propriety quotes of UTP 
Exchanges behind the quotes and orders of Nasdaq market makers, ECNs, 
and agency interest of UTP Exchange specialists. While we believe that 
the approach in SR-NASD-99-53 is more appropriate given the precedent 
established in the listed environment regarding order routing, we are 
proposing a strict price/time approach in this filing as a short-term 
solution to the potentially significant and crippling problems outlined 
above.\8\
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    \8\ The rules clarify that if a UTP Exchange participates in the 
automatic-execution functionality of the NNMS, orders preferenced to 
the UTP Exchange's quotes must meet the Oversized Order Requirement. 
This is to limit the potential for dual liability (described above) 
for UTP Exchanges. In addition, Nasdaq is proposing non-substantive 
rule changes to correct drafting errors in the original rule 
proposal to clarify that orders sent to quotes of Order Entry ECNs 
are not subject to the Oversized Order Requirement in the rule, 
while orders sent to Full Participant ECNs are subject to this 
requirement.
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2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
Section 15A(b)(6) \9\ of the Act in that the proposed rule change is 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in the 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. The rule 
change will eliminate the potential for order queuing or for this 
system to stop processing orders, when UTP Exchanges are alone at the 
inside. Thus, the rule change is designed to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and to protect investors and the public interest.
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    \9\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. 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-
0609. Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-00-30 and should 
be submitted by June 26, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-13956 Filed 6-2-00; 8:45 am]
BILLING CODE 8010-01-M