35690 Federal Register / Vol. 65, No. 108 / Monday, June 5, 2000 / Notices

19 In approving this rule, the Commission has

considered its impact on efficiency, competition,

and capital formation. 15 U.S.C. 78c(f).

20 15 U.S.C. 78f(b)(5).

21 Id.

22 Id.

23See SA&B Letter at 8.

24 15 U.S.C. 78f(b)(5).

25 15 U.S.C. 78s(b)(2).

26 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

thereunder applicable to a national

securities exchange.19 In particular, the

Commission finds the proposal is

consistent with Section 6(b)(5) of the

Act.20

Under Section 6(b)(5) of the Act,21 a

registered national securities exchange

must have rules that are 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.

The Commission finds that ISE’s

proposed amendments to ISE Rule

717(d) and (e) reducing the exposure

time (i.e., the amount of time EAMs are

required to expose agency orders on the

Exchange before executing them as

principal or against a solicited order)

from two minutes to 30 seconds are

consistent with Section 6(b)(5) of the

Act.22 The Commission recognizes that,

on floor-based exchanges, there are no

rules that govern the extent to which a

given trading crowd has an opportunity

to interact with a proposed crossing of

orders. Because the ISE operates a

unique electronic options market, it

must define an order exposure time

period. The Commission finds that a 30

second exposure period is a reasonable

time frame for participants in ISE’s

market to assess market conditions and

their own trading interest, and to allow

a reasonable opportunity for price

improvement from interested

participants. The Commission finds that

a 30 second exposure period strikes a

reasonable balance between maintaining

liquidity and efficiency in the ISE

market and preventing impediments to

a free and open market, while providing

the appropriate safeguards for investors

and the public.

In determining that a 30-second

exposure period is reasonable, the

Commission has considered carefully

the commenters’ concern that market

makers might be able to subvert the 30

second exposure period by posting bids

or offers for a very short period of time,

and arranging to receive agency orders

simultaneously when they are

executable against the market maker as

principal, or against other agency orders

held by the market maker.23 In such a

scenario, EAMs allegedly would prescreen order flow, and hold orders until

they can be internalized, denying the

order any exposure in the market and

the opportunity for price improvement.

The Commission is not persuaded by

this argument. The ISE allows for only

one exception to the 30 second exposure

period, in the scenario where an EAM

has previously disseminated proprietary

trading interest on the ISE for at least 30

seconds prior to receipt of a customer

order. Under this limited exception, a

firm will have placed itself ‘‘at risk’’ to

the public by having disseminated

trading interest available to all customer

orders at a stated price. ISE Rule 717(d)

states that a member must have been

bidding or offering on the Exchange for

at least 30 seconds prior to receiving an

agency order that is executable against

such bid or offer. The Commission finds

that an EAM’s execution of its own

customer order under this particular

scenario would not deprive the public

of the opportunity to trade at the same

price.

The Commission also has considered

carefully the commenters’ concerns

about the potential for internalization of

order flow where there is a 30 second

exposure period, and finds that the

proposal provides sufficient safeguards

against such activity. The ISE’s system

is designed to ensure that, once

customer orders are entered into the

system, any limit orders that do not

improve upon the ISE best bid or offer

automatically are placed into the ISE’s

electronic limit order book last in time

priority behind any existing customer

orders at the same price. Therefore, an

EAM has no guarantee that it will be

able to trade against its agency orders.

Because ISE’s system automatically

provides reasonable safeguards to

prevent EAMs from executing against

their own customer orders, the

Commission finds that a 30 second

exposure period does not pose an

unreasonable risk of increasing the

internalization of order flow. For these

reasons, the Commission finds that ISE’s

proposal is consistent with Section

6(b)(5) of the Act.24

V. Conclusion

It Is Therefore Ordered, pursuant to

Section 19(b)(2) of the Act,25 that the

proposed rule change (SR–ISE–00–04),

as amended, is approved.

Margaret H. McFarland.

Deputy Secretary.

For the Commission, by the Division

of Market Regulation, pursuant to

delegated authorty.26

[FR Doc. 00–13959 Filed 6–2–00; 8:45 am]

BILLING CODE 8010–01–M

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.

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

Federal Register / Vol. 65, No. 108 / Monday, June 5, 2000 / Notices 35691

3See Securities Exchange Act Release No. 42344

(Jan 14, 2000), 65 FR 3987 (January 25, 2000).

4Such 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.

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 ExchangeListed 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 automaticexecution functionality of the system.

ECNs will have two options for

participating in NNMS. Specifically,

ECNs can choose to be Order-Entry

ECNs or Full-Participant ECNs. OrderEntry 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 orderentry 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 FullParticipant 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 (‘‘OverSized 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.

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

35692 Federal Register / Vol. 65, No. 108 / Monday, June 5, 2000 / Notices

5This 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.

6While 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.

7As 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.

8The 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.

9 15 U.S.C. 78o–3(b)(6). 10 17 CFR 200.30–3(a)(12).

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.

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.

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

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.

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

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 00–13956 Filed 6–2–00; 8:45 am]

BILLING CODE 8010–01–M