[Federal Register Volume 65, Number 16 (Tuesday, January 25, 2000)]
[Notices]
[Pages 3987-4001]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-1697]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42344; File No. SR-NASD-99-11]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment Nos. 1, 2, and 3 to the Proposed Rule Change by the National 
Association of Securities Dealers, Inc., To Modify the NASD's Small 
Order Execution System and SelectNet Service

January 14, 2000.

I. Introduction

    On February 5, 1999, the National Association of Securities 
Dealers, Inc. (``NASD''), through its wholly-owned subsidiary, The 
Nasdaq Stock Market, Inc. (``Nasdaq''), filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') 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\ to amend the rules 
governing Nasdaq's Small Order Execution System (``SOES'') and 
SelectNet Service (``SelectNet''). Notice of the proposed rule change 
was published for comment in the Federal Register on April 22, 1999.\3\ 
The Commission received 79 comment letters regarding the proposal.\4\ 
On August 24, 1999, December 8, 1999, and January 4, 2000, Nasdaq filed 
Amendment Nos. 1, 2, and 3 to the proposal.\5\ This order approves the 
proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 41296 (April 15, 
1999), 64 FR 19844. In addition to providing notice of the current 
proposal, Securities Exchange Act Release No. 41296 also re-opened 
the comment period for File No. SR-NASD-98-17, regarding Nasdaq's 
proposal to establish an integrated order delivery and execution 
system (``IODES Proposal''). The IODES Proposal was published for 
comment in the Federal Register on March 12, 1998. See Securities 
Exchange Act Release No. 39718 (March 4, 1998), 63 FR 12124. 
Subsequently, the Commission extended the comment period for the 
IODES Proposal through May 8, 1998. See Securities Exchange Act 
Release No. 39794 (March 25, 1998), 63 FR 15471 (March 31, 1998).
    \4\ A list of the commenters appears in Appendix A.
    \5\ See letter from Robert E. Aber, General Counsel, Nasdaq, to 
Belinda Blaine, Associate Director, Division of Market Regulation 
(``Division''), Commission, dated August 24, 1999 (``Amendment No. 
1''); letter from Thomas P. Moran, Assistant General Counsel, 
Nasdaq, to Katherine A. England, Assistant Director, Division, 
Commission, dated December 8, 1999 (``Amendment No. 2''); and letter 
from Thomas P. Moran, Assistant General Counsel, Nasdaq, to Richard 
Strasser, Assistant Director, Division, Commission, dated January 4, 
2000 (``Amendment No. 3''). Amendment Nos. 1 and 2 responded to 
concerns raised by the commenters. Specifically, Amendment No. 1 
discussed electronic communication network (``ECN'') participation 
in the proposed Nasdaq National Market System (``NNMS''); ECN 
reserve size interaction with NNMS; unlisted trading privilege 
(``UTP'') exchange participation in NNMS; the elimination of 
SelectNet preferencing; NNMS fees; order entry firm participation in 
NNMS; the timeframe for implementing NNMS; and the continuation of 
SelectNet. Amendment No. 2 discussed the five-second interval delay 
between automatic executions; the elimination of SelectNet liability 
orders; SelectNet preferencing away from the inside market; 
technology concerns; the potential for manipulative order entry 
strategies; the reserve size feature; the maximum order size for 
NNMS; and the elimination of the No Decrementation functionality. 
Amendment No. 3 revised NASD Rule 4730 (to be renumbered as NASD 
Rule 4753) to provide that the delay between SOES executions during 
locked and crossed markets for market makers in SmallCap securities 
will remain at five seconds.
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II. Description of the Proposal

A. Background

    The NASD implemented SOES in 1984 to provide for the automatic 
execution of small retail agency orders at the best bid or offer (the 
``inside market'').\6\ Orders entered into SOES generally are routed 
automatically on a rotating basis to the SOES market makers displaying 
the best bid or ask price. SOES also allows market participants to 
``preference'' (i.e., direct) an order to a designated market maker.\7\ 
SOES currently provides for ``tiered'' maximum order sizes in Nasdaq 
National Market (``NNM'') securities of 1000, 500, or 200 shares, 
depending on the trading characteristics of a security.\8\ The maximum 
SOES order size for Nasdaq SmallCap securities is 500 shares.\9\ SOES 
participation is mandatory for all market makers in NNM securities \10\ 
and voluntary for market makers in Nasdaq SmallCap securities. SOES 
reports trades for public dissemination and sends both sides of a 
transaction to the applicable clearing corporations designated for 
clearance and settlement.
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    \6\ See Securities Exchange Act Release Nos. 21433 (October 29, 
1984), 49 FR 44042 (November 1, 1984) (File No. SR-NASD-84-26) 
(notice of proposal to implement SOES); and 21743 (February 12, 
1985), 50 FR 7432 (February 22, 1985) (order approving File No. SR-
NASD-84-26).
    \7\ See Securities Exchange Act Release No. 25791 (June 9, 
1988), 53 FR 22594 (June 16, 1988) (order approving File No. SR-
NASD-88-1) (``1988 Order'').
    \8\ See 1988 Order and NASD Rule 4710(g).
    \9\ See NASD Rule 4710(g).
    \10\ See 1988 Order and NASD Rule 4611(f).
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    SelectNet is an electronic, screen-based order routing system that 
allows market makers and order entry firms (referred to collectively as 
``participants'') to negotiate securities transactions in Nasdaq 
securities through computer communications rather than by 
telephone.\11\ Unlike SOES, SelectNet does not provide automatic 
executions. SelectNet allows participants to negotiate for a larger 
size or a price superior to the current inside quote. In addition, 
SelectNet participants may indicate that an order or counter-offer will 
be in effect from between three and 99 minutes, specify a day order, 
and indicate whether price or size are negotiable or whether a specific 
minimum quantity is acceptable. Participants may accept, price improve, 
counter, or decline a

[[Page 3988]]

SelectNet order. If a participant elects to counter an offer, SelectNet 
allows the participants to negotiate by exchanging counter-offers until 
they reach an agreement. After the participants reach an agreement, the 
execution is ``locked in,'' reported to the tape for public 
dissemination, and sent to the clearing organization for comparison and 
settlement.
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    \11\ The Commission approved SelectNet, which originally was 
referred to as the Order Confirmation Transaction Service, on a 
permanent basis in 1988. See Securities Exchange Act Release No. 
25690 (May 11, 1988), 53 FR 17523 (May 17, 1988) (order approving 
File No. SR-NASD-88-11). See also Securities Exchange Act Release 
Nos. 28636 (November 21, 1990), 55 FR 49732 (November 30, 1990) 
(order approving File No. SR-NASD-90-51) (implementing enhancements 
to SelectNet); and 30581 (April 14, 1992), 57 FR 14596 (April 21, 
1992) (order approving File No. SR-NASD-91-51) (expanding 
SelectNet's hours of operation to include a pre-opening session from 
9:00 a.m. to 9:30 a.m. Eastern Time and an after-hours session from 
4:00 p.m. until 5:15 p.m. Eastern Time).
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    SelectNet currently allows participants to broadcast orders to all 
market participants or to preference an order to a designated market 
maker. Although SelectNet is an order delivery service rather than an 
order execution service, Nasdaq believes that a preferenced SelectNet 
order presented to a market maker at its displayed quote generally 
gives rise to liability under Exchange Act Rule 11Ac1-1 (``Firm Quote 
Rule'') for the market maker to execute the transaction at that 
price.\12\ As discussed more fully below, Nasdaq proposes to eliminate 
most SelectNet liability orders.
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    \12\ Nasdaq notes that the Firm Quote Rule does not apply if: 
(1) prior to the receipt of an order in a security, a broker or 
dealer has communicated to its exchange or association a revised 
quotation size or a revised bid or offer; or (2) at the time an 
order in a security is presented, a broker or dealer is in the 
process of effecting a transaction in that security, and immediately 
after the completion of that transaction, the broker or dealer 
communicates to its exchange or association a revised quotation size 
or a revised bid or offer for the security.
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    Nasdaq has designated SelectNet as the link to the electronic 
communications networks (``ECNs'') pursuant to the Commission's Order 
Handling Rules.\13\ SelectNet also allows exchanges that trade Nasdaq 
securities on an unlisted trading privilege (``UTP'') basis to access 
Nasdaq market makers.\14\ As discussed more fully below, SelectNet will 
continue to perform both of these functions under the current proposal.
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    \13\ See Securities Exchange Act Release No. 38156 (January 10, 
1997), 62 FR 2415 (January 16, 1997) (order approving File No. SR-
NASD-96-43).
    \14\ See Securities Exchange Act Release No. 38191 (January 22, 
1997), 62 FR 4562 (January 30, 1997) (notice of filing and immediate 
effectiveness of File No. SR-NASD-97-02).
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    Nasdaq maintains that although SOES and SelectNet provide valuable 
services to market participants, the operation of two separate and 
independent execution systems has resulted in the long-standing problem 
of potential dual liability for market makers. According to Nasdaq, 
multiple access points to a market maker's quote, through SOES and 
SelectNet as well as a firm's internal order delivery and telephone 
facilities, can routinely subject market makers to unintended double 
liability for orders that reach a market maker's quote at or near the 
same time through different systems. Nasdaq asserts that the potential 
for unexpected and increased order liability reduces market maker 
incentives to commit capital and display larger quote sizes, thereby 
depriving the Nasdaq market of valuable liquidity.
    Nasdaq proposes to implement a new trading environment to address 
these problems. Specifically, Nasdaq proposes to modify SOES and 
SelectNet to (1) Re-establish SelectNet as a non-liability order 
delivery and execution system for NNM securities; and (2) Recast SOES 
as it is used to trade NNM securities.\15\ The recast SOES will be 
called the Nasdaq National Market Execution System (``NNMS''). Nasdaq 
believes that the proposed changes will reduce instances of dual 
liability in the most active Nasdaq securities while improving the 
speed of executions and increasing the access of all market 
participants to the full depth of a security's trading interest.
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    \15\ For Nasdaq SmallCap securities, SOES generally will remain 
unchanged.
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    B. NNMS
    As proposed, NNMS would: (1) Increase the maximum order size for 
NNM securities that are eligible for automatic execution to 9,900 
shares; \16\ (2) Allow market makers and order entry firms to enter 
proprietary orders into NNMS and obtain automatic executions for 
proprietary and agency orders in NNM securities; (3) Reduce the current 
17-second delay between executions against the same market maker to 
five seconds; \17\ (4) Enable NNM orders to interact automatically with 
a market maker's displayed size and reserve size, including, if 
approved by the Commission in a separate pending proposal, a market 
maker's agency quotes,\18\ after yielding priority to displayed 
quotations at the same price; (5) Eliminate the No Decrementation (``No 
Dec'') feature for NNM securities, which currently allows continuous 
executions against a market maker's quote at the same price without 
decrementing the quoted size; and (6) Eliminate the SOES preferencing 
feature for NNM securities. Several of these changes are discussed in 
more detail below.
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    \16\ The current order size maximums for NNM securities through 
SOES are 1,000, 500, or 200 shares.
    \17\ After SOES executes an unpreferenced market order or 
marketable limit order against a SOES market maker, the market maker 
currently is not required to execute another unpreferenced SOES 
order in that security at the same bid or offer until 17 seconds 
have elapsed, absent a quotation update by the market maker within 
the 17-second period. See Securities Exchange Act Release No. 39490 
(December 24, 1997), 63 FR 897 (January 7, 1998) (order approving 
File No. SR-NASD-97-50).
    \18\ Nasdaq filed a proposal with the Commission that would 
permit the separate display of customer orders by market makers in 
Nasdaq through a market maker agency identification symbol (``agency 
quote''). See Securities Exchange Act Release No. 41128 (March 2, 
1999), 64 FR 12198 (March 11, 1999) (notice of filing of SR-NASD-99-
09) (``Agency Quote Proposal''). The Commission subsequently 
extended the comment period for the Agency Quote Proposal. See 
Securities Exchange Act Release No. 41243 (April 1, 1999), 64 FR 
17428 (April 9, 1999). The Agency Quote Proposal currently is 
pending with the Commission.
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    1. Automatic Executions for Orders of up to 9,900 Shares in NNM 
Securities
    SOES currently permits the automatic execution of retail agency 
orders of 200, 500, or 1,000 shares at the inside market. NNMS will 
provide automatic executions at the inside market for orders of up to 
9,900 shares in NNM securities. Automatic executions through NNMS will 
be available not only for retail agency orders, but also for market 
makers' proprietary orders and for the orders of order entry firms.
    2. Reserve Size
    The NNMS reserve size functionality would allow a market maker or 
its customer to display publicly part of the full size of its order or 
interest with the remainder of its order or interest held in 
undisplayed reserve. The undisplayed portion of the order or interest 
would be displayed in whole or in part as the displayed portion of the 
order or interest is executed. To use the reserve size function, a 
market maker must initially display a minimum of 1,000 shares in its 
quotation, or in its agency quotation, if the Commission approves the 
display of separate agency quotes, and it must refresh its proprietary 
or agency quote to a minimum of 1,000 shares. After a market maker's or 
its customer's displayed quotation was decremented to zero due to NNMS 
executions, Nasdaq would refresh the market maker's or its customer's 
displayed size from reserve size to a level designated by the market 
maker or its customer or, in the absence of such a designation, to the 
automatic refresh size (i.e., 1,000 shares).\19\ A market maker that 
wished to refresh a displayed proprietary or agency quote at the inside 
market at the same price level would be required to refresh his 
proprietary or agency quotation at the level of 1,000 shares or more to 
continue using reserve size. A market maker that wished to refresh and 
display his proprietary or agency quote at the same inside price at

[[Page 3989]]

a size less than 1,000 shares would be permitted to do so, but would 
not be permitted to use NNMS's reserve size feature.\20\
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    \19\ In addition, NNMS's autoquote refresh function would allow 
a market maker whose displayed proprietary quotation and reserve 
size have been decremented to zero due to NNMS executions to elect 
to have Nasdaq refresh the market maker's quotation (1) at a price 
interval designated by the market maker; and (2) to the size level 
designated by the market maker or, in the absence of such a size 
level designation, to the automatic refresh size.
    \20\ This restriction would not apply for interim executions 
against a market maker's non-updated proprietary or agency quote. 
For example, if a market maker displaying an initial proprietary or 
agency quotation of 1,000 shares with 5,000 shares in reserve were 
accessed automatically by NNMS for 300 shares in displayed size, the 
market maker or its customer would be allowed to continue to display 
its remaining 700 shares and keep 5,000 shares available in reserve 
size. If the market maker or its customer subsequently updated 
either its displayed or reserve size, or its quoted price, the 
market maker would be obligated to increase the displayed size of 
its proprietary or agency quote to 1,000 shares to continue to use 
NNMS's reserve size feature.
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    Orders entered in NNMS would be executed automatically against 
displayed quotations and reserve size (including agency quotes, if the 
Commission approves the display of separate agency quotes), in price/
time priority. For quotations at the same price level, NNMS would yield 
priority to all displayed quotations over reserve size, so that NNMS 
would execute against displayed quotations in time priority and then 
against reserve size in time priority.
3. Elimination of the No Dec Feature for NNM Securities
    The No Dec feature allows continuous executions against a market 
maker's quotation at the same price without decrementing the quoted 
size. Nasdaq proposes to eliminate the No Dec feature for NNM 
securities. Nasdaq believes that the No Dec feature has become less 
important because market makers now are able to manage their quotations 
by displaying their actual size. In addition, Nasdaq believes that the 
No Dec feature will become less important in a market where market 
makers will have the ability to refresh their quotations at a size they 
determine. Nasdaq also believes that the No Dec feature inhibits quote 
competition among market participants and discourages the full display 
of trading interest.
4. Elimination of SOES Preferencing
    Nasdaq proposes to eliminate the existing SOES preferencing feature 
for NNM securities because it is inconsistent with the processing of 
orders in time priority as contemplated in Nasdaq's new trading 
environment. Nasdaq also believes that preferencing in an automatic 
execution system reduces incentives for market makers to compete 
aggressively for orders by showing the full size and true price of 
their trading interest. Moreover, Nasdaq believes that the preferencing 
feature might place the agency quotes of public customers at a 
disadvantage.
5. Execution Fees
    NNMS would impose a $0.50 per side fee for each execution. To 
reduce user cost and facilitate the use of NNMS's reserve size 
functionality, a simultaneous and instantaneous execution against an 
NNMS participant's displayed size and reserve size would be treated for 
billing purposes as a single execution.
6. Penalties for Withdrawals
    Like today, under the proposal, a market maker's failure to update 
a fully exhausted quote would result in the system placing the market 
maker's quote in a ``closed'' state that, if not updated within five 
minutes, would be cause for suspension of the market maker's quote for 
20 business days.\21\
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    \21\ Market makers will continue to have the ability, through 
Nasdaq's automatic quote update facility, to pre-select a tick value 
and have Nasdaq refresh the market maker's proprietary quote away 
from the inside market. This capability will not apply to a market 
maker's agency quote because that quotation would represent agency 
interest. If a market maker's quote is refreshed to a different 
price or size level, another order will not be delivered to that 
market maker for five seconds after that quote is refreshed at the 
new price or size level. Nasdaq recently proposed an order display 
facility (``Order Display Facility Proposal'') that would eliminate 
the 20-day suspension. See Securities Exchange Act Release No. 42166 
(November 22, 1999), 64 FR 69125 (December 6, 1999) (notice of 
filing of File No. SR-NASD-99-53). Under the Order Display Facility 
Proposal, if a market maker's quote/order decremented to zero, and 
the market maker did not update its principal quote/order, transmit 
an attributable revised quote/order to Nasdaq, or have another 
principal (i.e., non-agency quote) attributable quote/order in the 
system, Nasdaq would place the market maker's quote (both sides) in 
a closed state for three minutes. At the end of that time, if the 
market maker did not voluntarily update or withdraw its quote from 
the market, Nasdaq would refresh the market maker's quote/order to 
100 shares at the lowest market maker bid and highest market maker 
offer being displayed in that security at that time and reopen the 
market maker's quote.
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C. Modifications to SelectNet

    Through rule changes requiring the use of ``oversized'' preferenced 
SelectNet orders, Nasdaq proposes to eliminate the use of most 
SelectNet liability orders and thereby re-establish SelectNet as an 
order delivery and negotiation system. Specifically, subject to the 
exceptions discussed below, Nasdaq proposes to revise its rules to 
implement an ``oversized order requirement,'' which will prohibit 
members from directing a SelectNet preferenced order to an NNMS market 
maker, including the market maker's agency quote, if the Commission 
approves the display of separate agency quotes, unless the preferenced 
order is designated as either (1) ``All-or-None'' (``AON'') of a size 
that is at least 100 shares greater than the displayed amount of the 
NNMS market maker's quote to which the order is directed; or (2) 
``Minimum Acceptable Quantity'' (``MAQ'') with a MAQ value of at least 
100 shares greater than the displayed amount of the NNMS market maker's 
quote to which the order is directed. SelectNet will be programmed to 
reject preferenced messages that fail to satisfy these 
requirements.\22\ In Nasdaq's view, the oversized order requirement 
will ensure that market makers are not subject to liability under the 
Firm Quote Rule for SelectNet preferenced orders directed to them. 
Accordingly, Nasdaq believes that the proposal will reduce instances of 
dual liability resulting from the receipt of orders through 
asynchronous systems. Nasdaq notes that the recipient of an oversized 
NNM SelectNet order may choose to execute the incoming order or 
initiate an electronic negotiation in response to the message.\23\
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    \22\ SelectNet will continue to accept orders of any size 
(subject to the current 999,999-share system limit) for Nasdaq 
SmallCap securities.
    \23\ Nasdaq notes that this is not to be understood to prohibit 
liability for each of potentially two quotes displayed by market 
makers under the Agency Quote Proposal.
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    As discussed below, the oversized order requirement will not apply 
to UTP exchanges, which will be able to send and receive SelectNet 
liability orders. In addition, market participants will continue to use 
SelectNet liability orders to access ECNs that choose to participate in 
Nasdaq's new trading environment as order entry ECNs.

D. UTP Exchange Participation

    Under the proposal, SelectNet will continue to serve as the primary 
linkage between UTP exchanges and Nasdaq. UTP exchanges will continue 
to receive and be obligated to execute preferenced SelectNet liability 
orders, and they will retain their ability to send SelectNet 
preferenced liability orders to Nasdaq market makers. Although a market 
maker may be subject to dual liability if a UTP exchange accesses the 
market maker with a SelectNet liability order and, at the same time, an 
NNMS market maker or order entry firm accesses the market maker via 
NNMS, Nasdaq believes that the potential dual liability will be 
manageable.

E. ECN Participation

    An ECN will be able to participate in NNMS as either an order entry 
ECN or as a full participant ECN. The manner in which an ECN chooses to 
participate in NNMS will be governed by an

[[Page 3990]]

addendum to the Nasdaq Workstation II Subscriber Agreement for 
ECNs.\24\
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    \24\ See NASD Rule 4623(b)(3).
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    An order entry ECN will participate in Nasdaq in substantially the 
same manner as ECNs participate in Nasdaq today. Market participants 
will continue to access order entry ECNs via the SelectNet linkage and 
will be able to send preferenced SelectNet messages (i.e., liability 
orders) of up to 999,999 shares to order entry ECNs. Unlike a full 
participant ECN, an order entry ECN will not provide automatic 
executions for orders received from NNMS participants. An order entry 
ECN will be able to send oversized SelectNet orders to NNMS market 
makers and other ECNs. In addition, an order entry ECN may request 
order entry capability in NNMS, which will allow the ECN to obtain 
automatic executions against the quotations of NNMS market makers, 
including agency quotations, if the Commission approves the display of 
separate agency quotes.
    A full participant ECN will agree to provide automatic executions 
for orders the ECN receives from other NNMS participants through NNMS. 
A full participant ECN will not receive SelectNet preferenced liability 
orders.\25\ Like an order entry ECN, a full participant ECN may request 
order entry capability in NNMS, which will allow the ECN to obtain 
automatic executions against the quotations of NNMS market makers, 
including agency quotations, if the Commission approves the display of 
separate agency quotes.
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    \25\ Telephone conversation between Thomas P. Moran, Assistant 
General Counsel, Nasdaq, and Yvonne Fraticelli, Special Counsel, 
Division, Commission, on October 5, 1999.
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    Due to the time and the technology constraints affecting some ECNs, 
Nasdaq believes that, on an interim basis, ECNs should have an option 
regarding their manner of participation in Nasdaq's new system. 
Accordingly, Nasdaq does not propose at this time to require all ECNs 
to register as full participant ECNs, although Nasdaq will reconsider 
this issue in the future.

F. Nasdaq SmallCap Securities

    For Nasdaq SmallCap securities, the trading rules for automatic 
execution through SOES will remain unchanged. Accordingly, 
participation in the automatic execution system for SmallCap securities 
will continue to be voluntary, and automatic executions will be 
available only for the small orders of public customers. The current 
maximum order size limits also will remain in effect. After Nasdaq has 
had experience with NNMS, it will consider whether the functionality of 
the NNMS system should be made available for the trading of SmallCap 
securities.
    Nasdaq originally proposed to revise NASD Rule 4730(b)(3) (to be 
renumbered as NASD Rule 4753(b)(3)) to provide that during locked and 
crossed markets, SOES will execute orders against the quotations of 
market makers in SmallCap securities that are locked or crossed at 17-
second intervals, rather than five-second intervals, as currently 
required. Nasdaq amended its proposal to maintain the current five-
second delay between SOES executions during locked and crossed 
markets.\26\
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    \26\ See Amendment No. 3, supra note 5. The proposal, as 
amended, retains proposed changes to the rule text of renumbered 
NASD Rule 4753(b)(3) to clarify that the interval for execution of 
orders against the quotations of market makers that have locked or 
crossed the market applies to SmallCap securities as well as NNM 
securities. Telephone conversation between Thomas P. Moran, 
Assistant General Counsel, Nasdaq, and Ira L. Brandriss, Division, 
Commission, on January 14, 2000.
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G. Technical Amendments

    Nasdaq proposes technical, non-substantive changes to several rules 
in the NASD Rule 4600 Series and throughout the NASD Manual. In 
particular, Nasdaq proposes to revise NASD Rule 4613, ``Character of 
Quotations,'' to eliminate the references to SOES tier sizes for the 
NNM quotations of market makers. In addition, Nasdaq will rescind or 
conform other rules that refer to SOES, including NASD Rule 4611(f), 
``Registration as a Nasdaq Market Maker,'' NASD Rule 4619, ``Withdrawal 
of Quotations and Passive Market Making,'' NASD Rule 4620, ``Voluntary 
Termination of Registration,'' NASD Rule 4632, ``Trade Reporting,'' 
NASD Rule 4618(c), ``Clearance and Settlement,'' and the NASD Rule 4700 
Series (SOES).

III. Summary of Comments

    The Commission received 79 comment letters regarding the proposed 
rule change. The commenters included broker-dealers, registered 
representatives, ECNs, academics, professional associations, and a 
registered national securities exchange.\27\ Nineteen commenters, 
including the Trading Committee of the Securities Industry Association 
(''SIA''),\28\ the Investment Company Institute (``ICI''),\29\ and 
Charles Schwab,\30\ supported the proposal.\31\ The Trading Committee 
of the SIA, for example, believed that the proposal would reduce the 
problem of dual liability for market makers and improve the speed of 
executions.\32\ Similarly, the ICI maintained that the proposal would 
increase the speed of executions and enhance access to the full depth 
of a security's trading interest by all market participants.\33\ One 
trader and investor believed that the proposal would result in a more 
liquid and more transparent Nasdaq market.\34\
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    \27\ A list of the commenters appears in Appendix A.
    \28\ The SIA is comprised of over 740 North American securities 
firms.
    \29\ 29 The ICI is an association of 7,576 mutual fund 
companies, 479 closed-end investment companies, and 8 sponsors of 
unit investment trusts.
    \30\ See Schwab Letter, Appendix A.
    \31\ Thirteen commenters who supported the proposal are persons 
associated with a Nasdaq market maker, the Security Investment 
Company of Kansas City. These commenters submitted identical letters 
which maintained that the proposal will provide prompt access to the 
best prices in the Nasdaq market, reduce the potential dual 
liability of market makers, and improve the speed of executions. See 
Halford Letter, Cave Letter, Gaines Letter, Hook Letter, Kitzmiller 
Letter, Frankel Letter, Schmidt Letter, Mytinger Letter, McCann 
Letter, Turpin Letter, Malmstrom Letter, Boyle Letter, Means Letter, 
and Weisenborn Letter, Appendix A. The Kansas City Securities 
Association (``KCSA'') submitted a similar letter. See KCSA Letter, 
Appendix A.
    \32\ See SIA Letter, Appendix A.
    \33\ See ICI Letter, Appendix A.
    \34\ See Mktmaven Letter, Appendix A.
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    Fourteen commenters supported the proposal but voiced concerns with 
some aspects of the proposed changes. Morgan Stanley Dean Witter 
(``Morgan Stanley''), for example, generally supported the proposed 
rule change because it will reduce instances of double liability for 
market makers, but recommended several modifications to the 
proposal.\35\ Similarly, the Electronic Traders Association (``ETA'') 
supported the proposal but expressed reservations regarding, among 
other things, the operation of the fee system for NNMS.\36\ Donaldson, 
Lufkin & Jenrette (``DLJ'') believed that the proposal ``can bring 
substantial benefits'' to Nasdaq but noted that the proposal fails to 
eliminate all instances of dual liability.\37\ The

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Electronic Trading Group (``ETG''), a proprietary trading firm that 
makes markets in listed and Nasdaq securities, ``strongly support[ed]'' 
the proposal but maintained that the proposed changes fail to create a 
level playing field for all market participants.\38\
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    \35\ See Morgan Stanley Letter, Appendix A. Morgan Stanley 
believed that the proposal should be modified to (1) retain the 
existing 17-second delay in executions against a market maker; (2) 
retain the No Dec feature for market makers' proprietary quotations; 
(3) provide a firm quote compliance facility that would allow a 
market maker to indicate that it has received a telephone order to 
trade at its displayed quotation; and (4) modify the availability of 
the 9,900-share NNMS maximum order size.
    \36\ See ETA Letter, Appendix A. The ETA is an association of 
order entry and other related firms.
    \37\ See DLJ Letter, Appendix A. DLJ believed that Nasdaq should 
not implement the proposed changes to SOES and SelectNet prior to 
the year 2000. In addition, DLJ stated that it would require at 
least six months from the time Nasdaq publishes its changes to the 
Application Programming Interface (``API'') for DLJ to program, 
test, and install new systems. As discussed more fully below, other 
commenters also expressed concern regarding the time for 
implementing the proposed changes.
    \38\ See ETG Letter, Appendix A. Among other things, ETG 
supported the implementation of a consolidated order book to provide 
price protection and time priority of orders. See also Sierra Nevada 
Letter (supporting the proposed changes as an interim measure).
---------------------------------------------------------------------------

    Forty-one commenters opposed or noted concerns with the proposal 
without expressing general support for the proposed changes.\39\ One 
commenter stated that it did not support any of the features in the 
proposed system and recommended that Nasdaq instead adopt its 
previously proposed IODES system, excluding the proposed limit order 
book.\40\ Another commenter urged the Commission to reject the current 
proposal.\41\
---------------------------------------------------------------------------

    \39\ In addition, six comment letters related solely to Nasdaq's 
IODES Proposal. See Lek Letter, USCC Trading I and II, Hill Letter, 
and Knight I and II, Appendix A. As noted above, the notice of 
filing for the current proposal also re-opened the comment period 
for Nasdaq's IODES Proposal. See note 3, supra.
    \40\ See A.G. Edwards Letter, Appendix A.
    \41\ See Weil Letter I and Weil Letter II, Appendix A.
---------------------------------------------------------------------------

    Nasdaq responded to the commenters in Amendment Nos. 1 and 2 to the 
proposal.\42\ The views of the commenters are discussed below.
---------------------------------------------------------------------------

    \42\ See note 5, supra.
---------------------------------------------------------------------------

A. Elimination of SelectNet Liability Orders

    Thirty-two commenters objected to the elimination of most 
preferenced SelectNet liability orders for NNM securities. Many of the 
commenters asserted that the elimination of SelectNet liability orders 
will limit their ability to obtain executions at quotes outside the 
current inside market (i.e., the best bid or offer), a capability that 
the commenters believed is crucial for investors.\43\ In this regard, 
several commenters maintained that investors are willing to forego the 
inside price for the ability to access the liquidity outside the inside 
market, or to obtain an execution when a stock's price is moving 
rapidly.\44\ One commenter maintained that an order might not be 
executable at the current inside price if a market maker at the inside 
is slow to update its 100-share quotation.\45\ Accordingly, the 
commenter found it ``imperative that investors be able to enter orders 
at prices outside the current inside market.'' \46\
---------------------------------------------------------------------------

    \43\ See, e.g., Chung Letter, Deeney Letter, Erman Letter, 
Fennell Letter, King Letter, Lin Letter, Mt. Pleasant Letter, Mack 
Letter, Nemcic Letter, Norman Letter, O'Reilly Letter, Rudd Letter, 
Schiller Letter, Swenson Letter, Teitelman Letter, Vercellone 
Letter, Wolverton Letter, and Zucker Letter, Appendix A.
    \44\ See e.g., Weintraub Letter, Swenson Letter, Haber Letter, 
Deeney Letter, King Letter, Nemcic Letter, Schiller Letter, 
Vercellone Letter, Snell Letter, and Teitelman Letter, Appendix A.
    \45\ See Atreya Letter, Appendix A.
    \46\ See Atreya Letter, Appendix A.
---------------------------------------------------------------------------

    Other commenters maintained that the oversized order requirement 
might fail to provide an effective means for accessing a quotation 
because, in some instances, it would require an investor to assume an 
unwanted short position. For example, an investor seeking to sell 500 
shares would be required to assume an 800-share short position to 
SelectNet preference a market maker quoting 1200 shares.\47\
---------------------------------------------------------------------------

    \47\ See Catrina Letter, Appendix A. Similarly, the commenters 
expressed concern that the proposed rule may require an investor to 
purchase or sell more shares than the investor intended to purchase 
or sell. See Mack Letter, Lin Letter, and Catrina Letter, Appendix 
A. Moreover, the commenters noted that a short sale on a downtick 
would violate the short sale rule. See, e.g., Atreya Letter, 
Vercellone Letter, Deeney Letter, Lin Letter, and Schiller Letter, 
Appendix A.
---------------------------------------------------------------------------

    Other commenters believed that the proposed changes could undermine 
the integrity of the Nasdaq market. For example, one commenter feared 
that the elimination of SelectNet liability orders would produce a 
market that could permit market makers to refuse to fill an order and 
not move their quote.\48\ The commenter also asserted that a market 
maker would be able to ``hold'' the market by repeatedly entering 100-
share quotations at five-second intervals.\49\ Another commenter stated 
that market makers would be able to ``ignore'' oversized orders 
preferenced to them through SelectNet.\50\ Similarly, another 
commenter, asserting that the oversized order requirement ``opens up 
numerous possibilities for [market maker] manipulation,'' maintained 
that market makers might post artificially inflated quotes because they 
will not be required to trade at their quotations.\51\
---------------------------------------------------------------------------

    \48\ See Whitcomb Letter, Appendix A. Similarly, the ETA 
asserted that the failure of market makers to honor their quotations 
in a manner consistent with the Firm Quote Rule would result in 
misleading and inaccurate quotations that would reduce the 
efficiency of the Nasdaq market and undermine investor confidence. 
See ETA Letter, Appendix A.
    \49\ See Whitcomb Letter, Appendix A.
    \50\ One commenter asserted, for example, that market makers 
``can and will ignore'' non-liability SelectNet orders. See Mount 
Pleasant Letter, Appendix A. Another commenter maintained that it 
would have no recourse when non-liability SelectNet orders go 
unfilled. See ACIM Letter, Appendix A.
    \51\ See Haber Letter, Appendix A. The commenter noted that a 
market maker could withdraw its quotation when the inside market 
approached the market maker's quotation.
---------------------------------------------------------------------------

    One commenter recommended that the proposed system be designed to 
require a market maker to honor all orders in a manner consistent with 
the Firm Quote Rule at the price and up to the size the market maker 
elects to display until the market maker exhausts or changes his 
quotation.\52\ In addition, the commenter asserted that the elimination 
of SelectNet liability orders is unnecessary because the existing 
exceptions to the Firm Quote Rule adequately address the issue of 
potential double liability when a market maker is in the process of 
effecting an execution, after which he will update his quote.\53\
---------------------------------------------------------------------------

    \52\ See ETA Letter, Appendix A.
    \53\ See ETA Letter, Appendix A.
---------------------------------------------------------------------------

    Other commenters suggested that Nasdaq address the issue of dual 
liability by retaining SelectNet liability orders only for quotations 
outside the current inside market.\54\ Because automatic executions 
through NNMS will be available only for quotations at the inside 
market, these commenters believed that retaining SelectNet liability 
orders solely for quotations outside the current inside market would 
eliminate the potential for dual liability while allowing market 
participants to continue using the existing SelectNet preferencing 
feature for quotations outside the current inside market.
---------------------------------------------------------------------------

    \54\ See Norman Letter and O'Reilly Letter, Appendix A.
---------------------------------------------------------------------------

    Other commenters expressed concern that market makers will continue 
to be exposed to potential double liability through SelectNet liability 
orders from UTP exchanges.\55\
---------------------------------------------------------------------------

    \55\ See, e.g., DLJ Letter, A.G. Edwards Letter, and STA Letter, 
Appendix A. The STA asserted that any possibility of dual liability 
must be eliminated.
---------------------------------------------------------------------------

B. ECN Participation

    As noted above, the proposal will allow ECNs to participate in NNMS 
either as full participants or as order entry participants. Several 
ECNs criticized both alternatives. One commenter, for example, asserted 
that full participation would disadvantage an ECN because (1) The ECN's 
reserve quotations would not participate in the NNMS sweep of the ECN's 
top-of-the-file orders; \56\ (2) The ECN would be subject to potential 
double executions; \57\ and (3) The ECN would be required to provide 
access through NNMS to brokers that pay no ECN

[[Page 3992]]

fees.\58\ On the other hand, the commenter maintained that order entry 
participation would ``marginalize'' an ECN by omitting the ECN's orders 
from the NNMS sweep.\59\
---------------------------------------------------------------------------

    \56\ See Bloomberg Letter, Appendix A.
    \57\ Double liability could arise due to the time lag between 
the execution of an order on the ECN's own system and the subsequent 
receipt of an execution for the same order from Nasdaq. See 
Bloomberg Letter, Appendix A. Other ECNs also criticized the 
potential for double liability. See Instinet Letter and BRUT Letter, 
Appendix A (asserting that dual liability is inappropriate for ECNs 
because ECNs act solely as agents).
    \58\ See Bloomberg Letter, Appendix A.
    \59\ See Bloomberg Letter, Appendix A.
---------------------------------------------------------------------------

    Similarly, another commenter asserted that an order entry ECN would 
be able to execute transactions against preferenced SelectNet orders 
but, unlike market makers and full participant ECNs, would not be able 
to interact automatically with other NNMS orders on the basis of strict 
price/time priority.\60\ A third commenter believed that order entry 
participation is not a viable alternative because an ECN must be 
accessible by widely used order delivery and execution systems to 
remain competitive.\61\ Several ECNs recommended that Nasdaq implement 
an order delivery system, rather than a system that provides for 
automatic executions.\62\
---------------------------------------------------------------------------

    \60\ See Instinet Letter, Appendix A.
    \61\ See BRUT Letter, Appendix A.
    \62\ See Instinet Letter and Archipelago Letter, Appendix A. See 
also Bloomberg Letter, Appendix A.
---------------------------------------------------------------------------

    On the other hand, other commenters criticized the proposal for 
providing two levels of participation for ECNs. One commenter asserted 
that because the proposal allows ECNs, but not other market 
participants, to choose between two levels of participation in NNMS, 
the proposal fails to promote fair competition between market 
participants and therefore is inconsistent with the Congressional 
finding in Section 11A(a)(1)(C) under the Act.\63\ In addition, the 
commenter expressed concern that lack of uniform access to ECN quotes 
would provide opportunities for manipulative and fraudulent quotation 
and order entry strategies similar to those noted in Nasdaq's IODES 
proposal.\64\ The commenter believed that Nasdaq should revise its 
proposal to require the full participation of ECNs and UTP exchanges in 
NNMS.\65\
---------------------------------------------------------------------------

    \63\ See Knight Letter II, Appendix A.
    \64\ See Knight Letter II, Appendix A. In the IODES Proposal, 
Nasdaq stated that the dichotomy between market makers, which 
provide automatic executions, and ECNs, which do not provide 
automatic executions, had resulted in anomalies in the processing of 
orders through SOES. Nasdaq noted that because ECNs and UTP 
exchanges do not provide automatic executions, Nasdaq had 
implemented systems changes designed to suspend executions in SOES 
whenever an ECN or UTP exchange was alone at the inside market. 
Nasdaq noted that because an ECN quote at the inside effectively 
halted SOES executions for a security, it might also cause SOES 
orders to be rejected back to the sending firm. Accordingly, Nasdaq 
stated that an ECN customer potentially could enter an order to 
control the inside price and create an advantage in SOES for the ECN 
customer or another order entry firm to jump ahead of orders that 
would have been executed if they had not been returned. The ECN 
customer could then change its quote before the quote could be 
accessed through SelectNet or the ECN's internal system. After a new 
dealer inside price had been established, a new SOES order that 
entered the system would be executed as the first order against the 
first market maker at the new inside price. Under these 
circumstances, customer orders could be disadvantaged because orders 
entered earlier in time would be forced to go to the back of the 
queue. Nasdaq noted in the IODES Proposal that it had addressed this 
problem through a software modification that holds customer orders 
sent through SOES in queue for up to 90 seconds when an ECN or UTP 
participant is alone at the inside, instead of immediately rejecting 
the order. In addition, Nasdaq noted in the IODES Proposal Nasdaq 
that SOES users had alleged that some traders might be using ECNs to 
affect the way that SOES handles automatic executions. To avoid this 
potential problem, Nasdaq proposed to require all participants 
receiving orders through the proposed IODES system, including ECNs, 
to be subject to automatic executions. See IODES Proposal, supra 
note 3. See also Mack Letter, Appendix A (asserting that market 
makers should not be permitted to use an ECN to block or stop a 
stock).
    \65\ See Knight Letter II, Appendix A.
---------------------------------------------------------------------------

    Other commenters also believed that Nasdaq should require ECNs to 
become full participants in NNMS, and, accordingly, subject to 
automatic executions.\66\ One commenter expressed concern that a market 
maker might post its quotes in an order entry ECN to avoid automatic 
executions,\67\ and other commenters asserted that automatic executions 
against an ECN's quotes are ``essential to provide equal access to all 
market participants.'' \68\
---------------------------------------------------------------------------

    \66\ See, e.g., ACIM Letter, King Letter, Mack Letter, and 
Vercellone Letter, Appendix A.
    \67\ See King Letter, Appendix A.
    \68\ See ACIM Letter, Appendix A. See also Vercellone Letter, 
Appendix A.
---------------------------------------------------------------------------

C. UTP Exchange Participation

    The Chicago Stock Exchange (``CHX'') asserted that the proposal 
improperly excludes the UTP exchanges, including the CHX, from full 
participation in NNMS. \69\ The CHX noted that the proposal will allow 
UTP specialists to send preferenced orders through SelectNet but will 
not permit them to use NNMS, which, unlike SelectNet, provides for 
automatic executions. The CHX maintained that the inability of its 
specialists to participate in NNMS will ``cripple the CHX's UTP 
program.'' \70\
---------------------------------------------------------------------------

    \69\ See CHX Letter, Appendix A.
    \70\ See CHX Letter, Appendix A.
---------------------------------------------------------------------------

D. Technology Concerns

    Several commenters raised technology issues in connection with the 
proposal, including concerns regarding the capability of Nasdaq's 
systems to promptly deliver messages relating to the trading process. 
In this regard, one commenter recommended that Nasdaq ``demonstrate 
that it has the capability to deliver immediately to market makers and 
executing broker-dealers executions, quote updates, size decrements, 
and other message traffic that is critical to the trading process.'' 
\71\ The commenter maintained that prompt message delivery is crucial 
in light of the proposed reduction in time delays between executions 
against a market maker from 17 seconds to five seconds.\72\ Noting that 
there can be a time delay of five seconds or more between the entry of 
a SOES order and the market maker's receipt of notice of the execution, 
another commenter expressed concern that an increase in messaging 
traffic resulting from the proposed changes will increase the delay in 
providing notice of an execution and, accordingly, will increase the 
potential for double liability.\73\
---------------------------------------------------------------------------

    \71\ See STA Letter, Appendix A.
    \72\ See STA Letter, Appendix A. Another commenter stated that 
it is unclear whether Nasdaq's systems capacity will accommodate the 
greater speed of automatic execution. See Morgan Stanley Letter, 
Appendix A.
    \73\ See ASC Letter, Appendix A. See also BRUT Letter (noting 
that the issue of dual liability centers on Nasdaq's delay in 
communicating notices of SOES executions to market makers, and that 
the delay in notification may increase with an increase in SOES 
messages), and Archipelago Letter (maintaining that any Nasdaq 
routing system must route messages as quickly as possible), Appendix 
A.
---------------------------------------------------------------------------

    Two commenters expressed concern that SOES, which uses technology 
inferior to that used by SelectNet, will replace SelectNet as the 
primary means of inter-participant trading.\74\ One commenter feared 
that the impact of existing problems associated with SOES technology 
would be exacerbated by the increased use of SOES.\75\
---------------------------------------------------------------------------

    \74\ See Archipelago Letter, Appendix A. See also ASC Letter, 
Appendix A.
    \75\ See ASC Letter, Appendix A. The commenter noted several 
problems associated with SOES technology, including the following: 
(1) The Permanent Virtual Circuits connecting Nasdaq and market 
participants fail to indicate whether the opposite party is able to 
receive data, thereby permitting one party to send messages without 
realizing that the other party has not received the messages due to 
a malfunctioning application; (2) due to the lack of automatic re-
route facilities, messages must be re-routed manually when a circuit 
is down, which may result in extended outages; (3) retransmitted 
messages may be unrecoverable due to the system's procedures for 
numbering missing messages; (4) the system's sequence number field 
is unable to fully represent numbers above 9999, so that an 
application cannot determine the correct sequence number of a 
retransmission once the total messages received exceeds 10,000; (5) 
execution messages do not include a unique identifier to prevent 
duplicate trade reports; and (6) due to delays in message 
processing, it may take up to 30 minutes to retransmit a message. 
See also Archipelago Letter, Appendix A.
---------------------------------------------------------------------------

    In addition, several commenters noted that firms must have 
sufficient time to modify their computer systems to implement the 
proposed changes. In

[[Page 3993]]

this regard, one commenter estimated that it would require at least six 
months from the time Nasdaq publishes it changes to the Application 
Programming Interface (``API'') to program, test, and install new 
systems.\76\
---------------------------------------------------------------------------

    \76\ See DLJ Letter, Appendix A. See also STA Letter, ASC Letter 
(noting that implementation of the proposed changes will require 
considerable effort by market participants), and BancBoston Letter 
(noting that Order Audit Trail System, extended trading hours, Year 
2000, and decimalization have placed significant resource strains on 
BancBoston and other market participants), Appendix A.
---------------------------------------------------------------------------

E. NNMS System Features

1. Automatic Execution for Orders up to 9,900 Shares
    Although many commenters supported Nasdaq's proposal to establish a 
maximum automatic execution order entry size of 9,900 shares for NNMS 
securities, one commenter maintained that the 9,900-share order entry 
size was arbitrary,\77\ and another asserted that Nasdaq provided no 
basis for the 9,900-share maximum order size.\78\
---------------------------------------------------------------------------

    \77\ See ACIM Letter, Appendix A.
    \78\ See Archipelago Letter, Appendix A. The commenter 
maintained that wholesale market makers and ECNs, the market 
participants that most frequently post large quoted sizes, wish to 
make quotes fully accessible for the entire size, and, accordingly, 
the 9,900-share maximum size is an impediment to prompt access to 
liquidity.
---------------------------------------------------------------------------

    Other commenters believed that allowing automatic executions for 
orders of up to 9,900 shares would drastically reduce small investors' 
access to executions \79\ and prevent small investors from competing 
with market makers, a purpose inconsistent with the original purpose 
for establishing SOES.\80\
---------------------------------------------------------------------------

    \79\ See O'Leary Letter, Appendix A. The commenter asserted that 
in fast market conditions, several 9,900-share orders would absorb 
the highest quality executions ahead of an individual investor's 
order.
    \80\ See Galchen Letter, Appendix A.
---------------------------------------------------------------------------

    On the other hand, Charles Schwab maintained that increasing the 
availability of the automatic execution system would provide market 
makers with a crucial tool to access the best available prices in the 
market, and, consequently, to manage risk and obtain liquidity for 
customer orders.\81\
---------------------------------------------------------------------------

    \81\ See Schwab Letter, Appendix A.
---------------------------------------------------------------------------

2. Availability of Automatic Execution
    Several commenters believed that the proposed rule change would 
allow market makers, but not order entry firms, to engage in 
proprietary trading against market makers' quotes on NNMS.\82\
---------------------------------------------------------------------------

    \82\ See, e.g., Miller Letter, Whitcomb Letter, ETA Letter, 
Sierra Nevada Letter, Mount Pleasant Letter, and Sudit Letter, 
Appendix A.
---------------------------------------------------------------------------

3. Reducing the Delay Between Automatic Executions From 17 Seconds to 
Five Seconds
    Although many commenters supported the proposed reduction in the 
delay between automatic executions against a market maker from 17 
seconds to five seconds, Morgan Stanley expressed concern that the 
reduction would provide market makers with insufficient time to react 
to virtually continuous executions against their quotations and would 
create significant difficulty for market makers in maintaining control 
over their positions and effectuating a coherent market making 
strategy.\83\
---------------------------------------------------------------------------

    \83\ See Morgan Stanley Letter, Appendix A.
---------------------------------------------------------------------------

4. Reserve Size Feature
    Several commenters supported the reserve size feature, asserting 
that it would increase liquidity and facilitate more rapid executions 
of larger-sized orders.\84\ Other commenters, however, expressed 
concern regarding Nasdaq's ability to monitor and ensure the proper use 
of the reserve size feature.\85\ In addition, some commenters asserted 
that reserve size is inconsistent with market transparency. Morgan 
Stanley, for example, stated that ``[r]eserve size hides the true depth 
of trading interest from the marketplace and acts as a disincentive to 
display liquidity.'' \86\ Similarly, one market maker maintained that 
the reserve size feature would hinder proprietary trading by market 
makers, which make their proprietary trading decisions based upon the 
size of an order being offered.\87\ Accordingly, the commenter believed 
that the proposal would diminish liquidity on Nasdaq.\88\
---------------------------------------------------------------------------

    \84\ See, e.g., Samarasinghe Letter, Haber Letter, and Lin 
Letter. One commenter supported executions against a market maker's 
reserve size, but argued that reserve size feature may present 
misleading information. See Wilson Letter, Appendix A.
    \85\ See, e.g., King Letter (asserting that the reserve size 
feature will foster manipulative and fraudulent practices), Snell 
Letter (questioning the enforcement of the reserve size feature), 
and Wolverton Letter (maintaining that the reserve size feature will 
permit market makers to ``hide'' shares behind their displayed 
quotes), Appendix A. See also Sievers Letter.
    \86\ See Morgan Stanley Letter, Appendix A. See also Mack Letter 
and Wilson Letter, Appendix A.
    \87\ See Sievers Letter, Appendix A.
    \88\ See Sievers Letter, Appendix A.
---------------------------------------------------------------------------

5. Elimination of the No Dec Feature
    Archipelago asserted that Nasdaq should retain the No Dec feature 
because it reduces quote update traffic, thereby mitigating the 
capacity strain on Nasdaq's network. Morgan Stanley believed that the 
No Dec feature serves as a useful quote maintenance tool that Nasdaq 
should retain in a modified form.\89\ Another commenter asserted that 
the elimination of the No Dec feature would make it more difficult for 
market makers to provide orderly markets.\90\
---------------------------------------------------------------------------

    \89\ See Morgan Stanley Letter, Appendix A. Morgan Stanley 
believed that Nasdaq should retain the No Dec feature, but that it 
should be available only to market makers displaying a size of at 
least 1,000 shares.
    \90\ See Caris Letter, Appendix A.
---------------------------------------------------------------------------

    However, two commenters favored the elimination of the No Dec 
feature.\91\ One commenter asserted that the elimination of the No Dec 
feature would prevent a market maker at the inside from repeatedly 
renewing a 100-share quote.\92\ The commenter believed that the 
elimination of the No Dec feature, combined with the reserve size 
feature, would improve the functioning of the market.\93\
---------------------------------------------------------------------------

    \91\ See Wilson Letter and Lin Letter, Appendix A.
    \92\ See Lin Letter, Appendix A. The commenter asserted that a 
market maker at the inside might repeatedly renew a 100-share quote 
in an effort to sustain the price of a stock. The commenter noted 
that the repeated renewal of the quotation might hinder the efforts 
of other market participants to fill larger-sized orders in the 
stock.
    \93\ See Lin Letter, Appendix A.
---------------------------------------------------------------------------

F. NNMS Fees

    One commenter expressed concern that the fee system for NNMS might 
operate in a discriminatory and anticompetitive manner.\94\
---------------------------------------------------------------------------

    \94\ See ETA Letter, Appendix A.
---------------------------------------------------------------------------

IV. Discussion

    After carefully considering all of the comments, the Commission 
finds, for the reasons discussed below, that the proposed rule change 
is consistent with the Act and the rules and regulations applicable to 
the NASD. In particular, the Commission finds that the proposal is 
consistent with the requirements of Sections 15A(b)(6) and (11), and 
11A(a)(1)(C) of the Act.\95\ Section 15A(b)(6) requires that the rules 
of a registered 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. In Section 11A(a)(1)(C), 
Congress found that it is in the public interest and appropriate for 
the protection of investors and the

[[Page 3994]]

maintenance of fair and orderly markets to assure: (1) The economically 
efficient execution of securities transactions; (2) Fair competition 
among brokers and dealers; (3) The availability to brokers, dealers, 
and investors of information with respect to quotations and 
transactions in securities; (4) The practicability of brokers executing 
investors' orders in the best market; and (5) An opportunity for 
investors' orders to be executed without the participation of a 
dealer.\96\
---------------------------------------------------------------------------

    \95\ 15 U.S.C. 78o-3(b)(6) and (11), and 15 U.S.C. 78k-
1(a)(1)(C).
    \96\ In approving the proposal, the Commission has considered 
the proposal's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    Specifically, as discussed more fully below, the Commission finds 
that the proposed changes are designed to protect investors and the 
public interest and to assure the economically efficient execution of 
securities transactions by allowing market makers, public customers, 
and order entry firms to obtain automatic executions for orders of up 
to 9,900 shares in NNM securities. By reducing instances of double 
liability for market makers in NNM securities, the proposal potentially 
may encourage market makers in NNM securities to display larger sized 
quotations, thereby adding liquidity to the market for NNM securities 
and helping to assure the economically efficient execution of 
transactions in NNM securities. In addition, by reducing the delay 
between executions against a market maker from 17 seconds to five 
seconds, the proposal may facilitate the price discovery process and 
promote quote competition among market makers, thus helping to ensure 
the best execution of customer orders. The Commission believes that the 
proposed changes potentially may enhance the efficiency and increase 
the depth and liquidity of the market for NNM securities, to the 
benefit of all market participants.

A. Automatic Executions for Orders of up to 9,900 Shares in NNM 
Securities

    SOES currently permits the automatic execution of retail agency 
orders of 200, 500, or 1,000 shares at the inside market. NNMS will 
provide automatic executions at the inside market for orders of up to 
9,900 shares in NNM securities. Automatic executions through NNMS will 
be available not only for retail agency orders, but also for market 
makers' proprietary orders and for the orders of order entry firms.
    Several commenters expressed concerns regarding the automatic 
execution feature of NNMS. Specifically, the commenters maintained that 
the 9,900-share order entry size was arbitrary,\97\ that it would 
reduce small investors' access to executions,\98\ and that it would 
prevent small investors from competing with market makers, a purpose 
inconsistent with the original purpose for establishing SOES.\99\ In 
addition, some commenters believed that NNMS would be available for the 
proprietary trading of market makers, but not for order entry 
firms.\100\
---------------------------------------------------------------------------

    \97\ See ACIM Letter, Appendix A. See also Archipelago Letter, 
Appendix A.
    \98\ See O'Leary Letter, Appendix A.
    \99\ See Galchen Letter, Appendix A.
    \100\ See, e.g., Miller Letter, Whitcomb Letter, ETA Letter, 
Sierra Nevada Letter, Mount Pleasant Letter, and Sudit Letter, 
Appendix A.
---------------------------------------------------------------------------

    In response to the concern about the availability of NNMS, Nasdaq 
clarified that NNMS will be available to all NASD member firms, 
including order entry firms.\101\ In addition, in response to the 
concerns regarding the 9,900-share maximum order size entry in NNMS, 
Nasdaq stated that the 9,900-share maximum is a technological system 
constraint of the NNMS automatic execution platform.\102\ Nasdaq also 
maintained that because the current average size of a SelectNet 
execution is 800 shares, the 9,900-share maximum NNMS order size should 
be sufficient to handle the majority of SelectNet orders that will 
migrate to NNMS.\103\ Nasdaq noted that orders of over 10,000 shares 
would be processed through a combination of NNMS, SelectNet, and other 
means.\104\
---------------------------------------------------------------------------

    \101\ See Amendment No. 1, supra note 5.
    \102\ See Amendment No. 2, supra note 5.
    \103\ See Amendment No. 2, supra note 5.
    \104\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

    The Commission believes that the proposed automatic execution 
feature of NNMS is consistent with Section 15A(b)(6) of the Act because 
it is designed to protect investors and the public interest. In 
addition, the Commission believes that the proposed automatic execution 
feature of NNMS is consistent with Congress's finding in Section 
11A(a)(1)(C)(i) of the Act that it is in the public interest and 
appropriate for the protection of investors and the maintenance of fair 
and orderly markets to assure the economically efficient execution of 
securities transactions. In this regard, the Commission believes that 
the immediacy and certainty of order execution for NNM orders of up to 
9,900 shares should strengthen the Nasdaq market and benefit market 
participants by permitting the prompt, efficient execution of orders of 
up to 9,900 shares at the best available price. Because NNMS will 
provide automatic executions against displayed quotations and against 
reserve size, NNMS's automatic execution feature will provide prompt 
access to all of the available liquidity in a security at the current 
inside market.
    In addition, the Commission notes that the proposal will extend the 
benefits associated with automatic executions to order entry firms and 
to the proprietary orders of market makers. The Commission agrees with 
the NASD that allowing automatic executions for broker-dealers' 
proprietary trades potentially may encourage broker-dealers to commit 
capital to the market, thereby adding to the depth and liquidity of the 
market for NNM securities.
    Further, the Commission believes that the 9,900-share maximum order 
size is reasonable in light of the system constraint of the NNMS 
automatic execution platform. According to the NASD, the 9,900-share 
maximum order size should accommodate the size of the orders that are 
likely to be processed through NNMS.
    With regard to small investors' access to executions, the 
Commission notes that NNMS's automatic execution feature will be 
available equally for the orders of market makers, order entry firms, 
and public customers. Accordingly, the Commission believes that the 
automatic execution feature of NNMS is reasonably designed to provide 
market makers, order entry firms, and public customers with equal 
access to the current inside market in NNM securities.

B. Reserve Size Feature of NNMS

    The reserve size feature of NNMS will allow an NNMS market maker or 
its customer to display publicly part of the full size of its order or 
interest with the remainder held in reserve on an undisplayed basis to 
be displayed in whole or in part as the displayed part is executed. To 
use the reserve size feature, a market maker's quotation, including its 
agency quotation, if the Commission approves the display of separate 
agency quotes, initially must display a minimum of 1,000 shares, and 
the quotation must be refreshed to 1,000 shares to continue using the 
reserve size feature.
    Several commenters expressed concerns with the reserve size 
feature. In particular, some commenters questioned Nasdaq's ability to 
monitor and ensure the proper use of the reserve size feature.\105\ One 
commenter contended that reserve size is inconsistent with market 
transparency and that reserve size would hide the

[[Page 3995]]

depth of trading interest and act as a disincentive to display 
liquidity.\106\ One market maker maintained that reserve size would 
hinder proprietary trading by market makers and, accordingly, would 
diminish liquidity on Nasdaq.\107\
---------------------------------------------------------------------------

    \105\ See, e.g., King Letter, Snell Letter, and Wolverton 
Letter, Appendix A.
    \106\ See Morgan Stanley Letter, Appendix A.
    \107\ See Sievers Letter, Appendix A.
---------------------------------------------------------------------------

    In response to the commenters, Nasdaq asserted that reserve size 
would be likely to increase the amount of shares market participants 
commit to the market because the non-display of the reserve shares 
would lessen the potential negative price impacts associated with the 
display of larger trading interest.\108\ In addition, Nasdaq maintained 
that the requirement that a market participant seeking to use reserve 
size in NNMS display a minimum of 1,000 shares also would serve to 
increase liquidity by providing an incentive to display a larger 
quotation size.\109\
---------------------------------------------------------------------------

    \108\ See Amendment No. 2, supra note 5.
    \109\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

    The Commission believes that the reserve size feature will 
encourage participation in NNMS by providing market makers and their 
customers with greater flexibility in the handling of large orders. 
Increased participation in NNMS should, in turn, enhance the depth and 
the liquidity of the market for NNM securities, to the benefit of all 
market participants. The requirement that a market participant display 
a minimum of 1,000 shares to use the reserve size feature should 
encourage market participants to display orders of at least 1,000 
shares, which may reduce volatility and enhance market depth at a given 
price. In addition, because all displayed quotations in NNMS at the 
same price level will have priority over reserve size quotations at 
that price level, NNMS will provide an incentive for market 
participants to display their orders.
    The Commission also believes that reserve size could prove useful 
to institutions wishing to minimize the market impact of their orders. 
In addition, the reserve size feature of NNMS will allow market makers 
quoting in Nasdaq to compete more effectively with alternative trading 
systems that provide a reserve size feature. The Commission expects 
NASD Regulation to monitor trading to ensure the proper use of the 
reserve size feature (particularly priority rules) and compliance with 
the requirements applicable to the use of reserve size.

C. Reduction of the 17-Second Delay Between Executions Against a Market 
Maker

    Nasdaq proposes to reduce the current 17-second delay between 
executions against the same market maker to five seconds. As noted 
above, one commenter believed that the proposed five-second delay 
between executions against a market maker would provide market makers 
with insufficient time to react to executions against their quotations 
and would create significant difficulty for market makers in 
maintaining control over their positions and effectuating a coherent 
market making strategy.\110\ In addition, several commenters expressed 
concerns regarding the ability of Nasdaq's systems to promptly notify 
market participants of executions against their quotations.\111\
---------------------------------------------------------------------------

    \110\ See Morgan Stanley Letter, Appendix A.
    \111\ See STA Letter, Morgan Stanley Letter, ASC Letter, and 
BRUT Letter, Appendix A.
---------------------------------------------------------------------------

    In response, Nasdaq maintained that a five-second interval delay 
(with an additional two-second internal Nasdaq system processing time) 
is an appropriate compromise between the need for fast executions and 
the need to provide market makers with adequate time to manage their 
capital risk through monitoring and updating their quotes in response 
to rapidly changing market conditions.\112\ Nasdaq stated that it would 
monitor market performance in NNMS as it related to the five-second 
interval delay and would consider modifying that time period, in 
consultation with Commission staff.\113\ As discussed more fully in 
Section IV.I, infra, Nasdaq stated that proposed enhancements to its 
systems, including a new central message switch that will provide 
faster delivery of automatic execution confirmation messages, will help 
to ensure that Nasdaq has the technological capability to promptly 
deliver notices of automatic executions.\114\
---------------------------------------------------------------------------

    \112\ See Amendment No. 2, supra note 5.
    \113\ See Amendment No. 2, supra note 5.
    \114\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

    The Commission believes that the proposal to reduce the delay 
between executions against the same market maker from 17 seconds to 
five seconds will help to ensure that a market maker has no more time 
than is necessary after an execution before it must update its quotes. 
This requirement will help to ensure that a market maker cannot attempt 
to avoid its market making obligations by delaying after an NNMS 
execution before entering an updated quote.\115\ As a result, the 
reduced time delay between executions against a market maker's quote 
should increase a market maker's compliance with its obligation to make 
continuous, two-sided markets and promote quote competition among 
market makers. Such competition among market makers should, in turn, 
enhance the integrity of the Nasdaq market by helping to ensure the 
best execution of customer orders and improving the price discovery 
process for NNM securities.
---------------------------------------------------------------------------

    \115\ A market maker that can avoid updating its quote for a 
period of time can take advantage of its temporary ability to avoid 
NNMS executions and wait to see how other market makers update their 
quotes. This delay could serve to lessen competition among market 
makers. See Securities Exchange Act Release No. 39490 (December 24, 
1997), 63 FR 897 (January 7, 1998) (order approving File No. SR-
NASD-97-50).
---------------------------------------------------------------------------

    As discussed more fully in Section IV.I, infra, the Commission 
believes, based on Nasdaq's representations, that planned enhancements 
to Nasdaq's systems, including the planned implementation of a new 
central message switch in January 2000, should enable Nasdaq to 
promptly deliver execution messages to market participants.\116\ 
Accordingly, based on Nasdaq's representations, the Commission believes 
that Nasdaq will have the technological capability to implement the 
proposed five-second delay between executions against a market maker's 
quotation.
---------------------------------------------------------------------------

    \116\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

D. Elimination of the No Dec Feature for NNM Securities

    Nasdaq proposes to eliminate the No Dec feature for NNM securities. 
The No Dec feature allows continuous executions against a market 
maker's quotation at the same price without decrementing the quoted 
size. Nasdaq believes that the No Dec feature has become less important 
because market makers are able to manage their quotations by displaying 
their actual size. In addition, Nasdaq believes that the No Dec feature 
will become less important in a market where market makers will have 
the ability to refresh their quotations at a size they determine.
    Several commenters questioned the elimination of the No Dec 
feature. One commenter maintained that Nasdaq should retain the No Dec 
feature because it reduces quote update traffic, thereby mitigating the 
capacity strain on Nasdaq's network.\117\ Other commenters maintained 
that the No Dec feature serves as a useful quote maintenance tool and 
that the elimination of the No Dec feature would make it more difficult

[[Page 3996]]

for market makers to provide orderly markets.\118\
---------------------------------------------------------------------------

    \117\ See Archipelago Letter, Appendix A.
    \118\ See Morgan Stanley Letter and Caris Letter, Appendix A.
---------------------------------------------------------------------------

    In response, Nasdaq asserted that the elimination of the No Dec 
feature will allow market participants to more easily execute multiple 
customer orders at the inside and move the market to new quote levels, 
thereby aiding the price discovery process.\119\ In addition, Nasdaq 
maintained that the No Dec feature is incompatible with the NNMS 
processing functions that immediately access displayed and reserve size 
and move through different price levels. Nasdaq noted that in NNMS the 
full size of reserve share amounts will be immediately and 
automatically accessible (after executions against displayed 
quotations), while the No Dec feature makes additional shares available 
on a piecemeal basis each time a quote is accessed and only after an 
interval delay between executions. Thus, Nasdaq concluded that NNMS's 
reserve size feature would speed executions, while the No Dec feature 
would result in slower executions.\120\
---------------------------------------------------------------------------

    \119\ See Amendment No. 2, supra note 5.
    \120\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

    The Commission believes that it is reasonable for Nasdaq to 
eliminate the No Dec feature for NNM securities. Specifically, the 
Commission believes that the elimination of the No Dec feature should 
result in quicker executions and prompt access to the available 
liquidity at the current inside market. The Commission also believes 
that the elimination of the No Dec feature may allow the market to 
adjust more quickly to information, thereby facilitating price 
discovery and improving the efficiency of the Nasdaq market.
    The Commission notes that market makers now have the ability to 
quote in actual size, and therefore have an enhanced ability to manage 
their quotations. In addition, NNMS's reserve size refresh and 
autoquote refresh features should help market makers that elect to use 
reserve size to manage their quotations.\121\ Because the reserve size 
refresh function and the autoquote refresh function, as well as the 
ability to quote actual size, will assist market makers, the Commission 
believes that market makers will be able to manage their quotations 
after Nasdaq eliminates the No Dec feature.
---------------------------------------------------------------------------

    \121\ The reserve size refresh function will refresh a market 
maker's displayed proprietary or agency quote, if the Commission 
approves the display of separate agency quotes, from its reserve 
size at the automatic refresh size or at a size level designated by 
the market maker. The autoquote refresh function will allow a market 
maker whose displayed proprietary quotation and reserve size have 
been decremented to zero to elect to have Nasdaq refresh the market 
maker's quotation price by an interval designated by the market 
maker and to refresh the market maker's displayed size to a level 
designated by the market maker or to the automatic refresh size 
(i.e., 1,000 shares).
---------------------------------------------------------------------------

    With regard to the commenter's concern that the elimination of the 
No Dec feature might strain the capacity of Nasdaq's network, the 
Commission does not believe, based on Nasdaq's representations 
regarding planned enhancements to its systems \122\ (as discussed more 
fully in Section IV.I, infra), that the elimination of the No Dec 
feature will result in a capacity strain on Nasdaq's network.
---------------------------------------------------------------------------

    \122\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

E. Elimination of SOES Preferencing for NNMS Securities

    Nasdaq proposes to eliminate the SOES preferencing feature for NNM 
securities because it is inconsistent with the processing of orders in 
time priority and because the preferencing feature might place the 
agency quotations of public customers, if the Commission approves the 
display of separate agency quotes, at a disadvantage. In addition, 
Nasdaq believes that preferencing in an automatic execution system 
reduces incentives for market makers to compete aggressively for orders 
by showing the full size and true price of their trading interest.
    The Commission believes that it is reasonable for Nasdaq to 
eliminate the SOES preferencing feature to provide for the processing 
of orders in price/time priority. The processing of orders in price/
time priority should help to ensure that all orders are processed in a 
fair, equal, and orderly manner. Accordingly, the Commission finds that 
the elimination of SOES preferencing is designed to protect investors 
and the public interest by helping Nasdaq to maintain a fair and 
orderly market.

F. SelectNet Liability Orders

    Nasdaq proposes to revise SelectNet to require the use of 
``oversized'' preferenced SelectNet Orders. As discussed above, the 
proposed oversized order provisions will allow members to direct a 
SelectNet preferenced order to an NNMS market maker, including the 
market maker's agency quote, if the Commission approves the display of 
separate agency quotes, only if the order is designated as AON or MAQ 
for a size that is at least 100 shares greater than the displayed 
amount of the quote to which the order is directed. The oversized order 
requirement is designed to reduce instances of double liability for 
market makers. UTP exchanges, however, will continue to send and 
receive SelectNet liability orders. In addition, order entry ECNs will 
be able to receive SelectNet liability orders.
    As discussed above, thirty-two commenters objected to the 
elimination of SelectNet liability orders. Among other things, the 
commenters argued that (1) the ability to preference outside the 
current inside market is crucial to investors who, in some cases, would 
be willing to forego the inside price to access the liquidity outside 
the current inside market;\123\ (2) the oversized order requirement 
might require an investor to assume an unwanted position;\124\ (3) the 
elimination of SelectNet liability orders might undermine the integrity 
of the Nasdaq market because market participants will not be required 
to trade at their quotations;\125\ (4) the elimination of SelectNet 
liability orders is unnecessary because the Firm Quote Rule addresses 
the issue of potential double liability when a market maker is 
effecting an execution;\126\ (5) Nasdaq should retain SelectNet 
liability orders for quotations outside the current inside market;\127\ 
(6) market makers will not be obligated to respond to non-liability 
SelectNet orders;\128\ and (7) a market maker at the inside would be 
able to ``hold'' the market by repeatedly entering 100-share quotations 
at five-second intervals.\129\
---------------------------------------------------------------------------

    \123\ See, e.g., Weintraub Letter, Swenson Letter, Haber Letter, 
Deeney Letter, King Letter, Nemcic Letter, Schiller Letter, 
Vercellone Letter, Snell Letter, and Teitelman Letter, Appendix A. 
See also Chung Letter, Deeney Letter, Erman Letter, Fennell Letter, 
Lin Letter, Mt. Pleasant Letter, Mack Letter, Norman Letter, 
O'Reilly Letter, Rudd Letter, and Zucker Letter, Appendix A.
    \124\ See Catrina Letter, Mack Letter, and Lin Letter, Appendix 
A.
    \125\ See Whitcomb Letter and Haber Letter, Appendix A. See also 
ETA Letter, Appendix A.
    \126\ See ETA Letter, Appendix A.
    \127\ See Norman Letter and O'Reilly Letter, Appendix A.
    \128\ See Mount Pleasant Letter, Appendix A.
    \129\ See Whitcomb Letter, Appendix A.
---------------------------------------------------------------------------

    In response to the commenters, Nasdaq maintained that the 
elimination of SelectNet preferencing was essential to achieving two of 
the proposal's goals, the reduction of dual liability \130\ and the 
establishment of a single order execution system.\131\ Nasdaq concluded 
that neither the Firm Quote Rule nor the retention of SelectNet 
liability orders for quotations outside the inside market offered 
viable means for preserving SelectNet liability orders. Specifically, 
Nasdaq asserted that retaining SelectNet liability orders for 
quotations outside the current inside market would create confusion in 
a fast-moving market and could result in significant unanticipated dual 
liability for market makers during

[[Page 3997]]

periods of rapid price change.\132\ Nasdaq also believed that the Firm 
Quote Rule would not eliminate the potential for double liability 
because Nasdaq currently maintains two systems, SOES and SelectNet, 
that deliver liability orders. Thus, according to Nasdaq, a market 
maker who receives a SelectNet message at its price and size, followed 
immediately by a SOES execution against its quote, would be obligated 
to fill both orders.\133\
---------------------------------------------------------------------------

    \130\ See Amendment No. 1, supra note 5.
    \131\ See Amendment No. 2, supra note 5.
    \132\ See Amendment No. 1, supra note 5.
    \133\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

    In response to the commenters' concerns regarding their ability to 
access quotations outside the inside market in the absence of SelectNet 
liability orders, Nasdaq stated that market participants may attempt to 
access such quotations through oversized SelectNet orders or through 
traditional means of communication.\134\ In addition, Nasdaq noted that 
market participants will be able to enter limit orders in NNMS outside 
the current inside market that will be entitled to execution at the 
limit price or better if the inside market rises or falls to the price 
level of the limit order.\135\ Nasdaq also maintained that SelectNet 
preferencing outside the inside market would be inconsistent with the 
orderly and fair processing of orders in the Nasdaq market and that, in 
light of NNMS' reserve size feature, efforts to access a quotation 
outside the current inside market without attempting to exhaust 
interest at the inside could be inconsistent with a broker's duty of 
best execution.\136\ Nasdaq acknowledged that market makers will not be 
obligated to respond to non-liability SelectNet messages, but 
maintained that the implementation of a single liability/execution 
system is essential to reduce dual liability.\137\
---------------------------------------------------------------------------

    \134\ See Amendment No. 1, supra note 5.
    \135\ See Amendment No. 2, supra note 5.
    \136\ See Amendment No. 2, supra note 5.
    \137\ See Amendment No. 2, supra note 5. Nasdaq also noted that 
the elimination of SelectNet liability orders would apply equally to 
all market participants. Id.
---------------------------------------------------------------------------

    In response to the commenters who raised concerns about the 
potential for manipulative activity in NNMS, Nasdaq asserted that NASD 
Regulation would closely monitor quotation and order entry activity to 
ensure the protection of all market participants.\138\ In addition, in 
response to the commenter who believed a market maker would be able to 
``hold'' the market by repeatedly renewing a 100-share quotation at 
five-second intervals because market participants would not be able to 
use SelectNet liability orders to exhaust the market maker's quotation, 
Nasdaq maintained that the commenter's description of trading activity 
was inaccurate and provided examples supporting its position.\139\
---------------------------------------------------------------------------

    \138\ See Amendment No. 2, supra note 5.
    \139\ Specifically, Nasdaq provided scenarios indicating that a 
market maker could not ``hold'' the market at a price level. In 
Nasdaq's first scenario, NNMS receives a market order to sell 1,200 
shares. Market maker A (``MMA'') is alone at the inside bid of $20 
for 100 shares, with 1,100 shares in reserve (the example assumes a 
previous partial execution against MMA's non-updated quote because 
reserve size would not be available unless MMA initially displayed a 
minimum of 1,000 shares). In this case, the order would execute 
automatically in full at $20 against displayed and reserve size and 
MMA's quote would be decremented to zero and refreshed or placed in 
a closed quote status. In the second scenario, NNMS receives a 
market order to sell 1,200 shares and MMA is alone at the inside bid 
of $20 for 100 shares, with no shares in reserve. In this case, NNMS 
would execute against MMA's quote and then move immediately to 
execute against the quotes at the next lower price level. Thus, the 
market would not be held at $20. If the inside offer moved to $20, 
MMA would violate NASD Rule 4613(e) (regarding locked and crossed 
markets) if MMA entered a locking bid of $20. See Amendment No. 2, 
supra note 5.
---------------------------------------------------------------------------

    The Commission believes that the oversized order requirement and 
the resulting elimination of most SelectNet liability orders is a 
reasonable means to address the problem of double liability.\140\ As 
noted above, Nasdaq has stated that double liability is a ``significant 
and ongoing problem'' and that reducing double liability is one of the 
proposal's primary goals. The Commission believes that reducing double 
liability may encourage market makers to display larger sized 
quotations, thereby providing greater liquidity to the market for NNM 
securities. The reduction in double liability also may enhance market 
makers' ability to reflect size in their quotations based on market and 
business factors with less concern for the potential for double 
liability. In addition, by preventing market participants from 
preferencing a quotation outside the current inside market, the 
elimination of most SelectNet liability orders may facilitate the fair 
and orderly processing of orders in the Nasdaq market.
---------------------------------------------------------------------------

    \140\ As discussed above, UTP exchanges will continue to send 
and receive SelectNet liability orders. In addition, market 
participants will access order entry ECNs through SelectNet 
liability orders.
---------------------------------------------------------------------------

    With regard to obtaining access to liquidity outside the current 
inside market, the Commission notes that market participants may 
attempt to access quotations outside the current inside market through 
the use of oversized SelectNet orders or through traditional means of 
communication (e.g., telephone orders). Accordingly, the Commission 
believes that the availability of oversized SelectNet orders, as well 
as traditional means of communication, should provide market 
participants with adequate means to access quotations outside the 
current inside market.
    As discussed above, several commenters believed that the proposed 
reduction in SelectNet liability orders would result in misleading or 
inaccurate quotations because market makers would not be required to 
trade at their quotations.\141\ In response, Nasdaq stated that NASD 
Regulation would closely monitor quotation and order entry activity to 
ensure the protection of all market participants.\142\ The Commission 
expects NASD Regulation to carefully monitor the conduct of market 
participants and to bring appropriate disciplinary action against any 
market participant who enters false or misleading quotations in NNMS or 
engages in other conduct that is inconsistent with just and equitable 
principles of trade.
---------------------------------------------------------------------------

    \141\ See Whitcomb Letter, ETA Letter, and Haber Letter, 
Appendix A.
    \142\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

G. ECN Participation in NNMS

    Under the proposal, an ECN may participate in NNMS as either an 
order entry ECN or as a full participant ECN. Market participants will 
access an order entry ECN through SelectNet liability orders, and an 
order entry ECN will not provide automatic executions for orders 
received from those participants. An order entry ECN may request order 
entry capability in NNMS, which will allow it to obtain automatic 
executions against the quotations of NNMS market makers, including 
agency quotes, if the Commission approves the separate display of 
agency quotes.
    A full participant ECN will provide automatic executions for orders 
the ECN receives through NNMS. Like an order entry ECN, a full 
participant ECN may request order entry capability in NNMS to obtain 
automatic executions for orders it sends through NNMS.
    As discussed more fully above, ECNs and other market participants 
criticized the provisions of the proposal relating to ECN participation 
in NNMS. Two ECNs asserted that order entry participation would 
marginalize an ECN and was not a viable means for participating in 
NNMS.\143\ One ECN maintained that full participation would 
disadvantage an ECN because (1) the ECN's reserve quotations would not 
participate in the NNMS sweep of the ECN's top-of-the-file orders; (2) 
the ECN would be subject to potential double executions; and (3)

[[Page 3998]]

the ECN would be required to provide access through NNMS to brokers 
that pay no ECN fees.\144\
---------------------------------------------------------------------------

    \143\ See Bloomberg Letter and BRUT Letter, Appendix A.
    \144\ See Bloomberg Letter, Appendix A.
---------------------------------------------------------------------------

    One market maker criticized the proposal for providing two levels 
of participation for ECNs but not for other market participants.\145\ 
Several commenters believed that Nasdaq should require ECNs to be full 
participants in NNMS and, accordingly, subject to automatic 
executions.\146\ In addition, one commenter expressed concern that lack 
of uniform access to ECN quotes would provide opportunities for 
manipulative and fraudulent quotation and order entry strategies. \147\ 
Another commenter asserted that a market maker might post its quotes in 
an order entry ECN to avoid automatic executions.\148\
---------------------------------------------------------------------------

    \145\ See Knight Letter II, Appendix A.
    \146\ See Knight Letter II, ACIM Letter, King Letter, Mack 
Letter, and Vercellone Letter, Appendix A.
    \147\ See Knight II, Appendix A. See also Mack Letter, Appendix 
A.
    \148\ See King Letter, Appendix A.
---------------------------------------------------------------------------

    In response to the concerns regarding ECN participation, Nasdaq 
stated that it proposed two levels of ECN participation after some ECNs 
indicated that their systems were not capable of supporting a full 
automatic execution interface with Nasdaq at this time.\149\ In 
addition, Nasdaq indicated that it would monitor ECN activity in NNMS 
with a view towards fully integrating all ECNs in the future through 
enhanced automation.\150\ Nasdaq maintained that the proposal balances 
the benefits of ECN participation in NNMS with current technological 
constraints and provides maximum flexibility for ECNs while reducing 
market makers' dual liability concerns.\151\
---------------------------------------------------------------------------

    \149\ See Amendment No. 1, supra note 5.
    \150\ See Amendment No. 1, supra note 5.
    \151\ See Amendment No. 1, supra note 5.
---------------------------------------------------------------------------

    With regard to the interaction of an ECN's reserve size with NNMS, 
Nasdaq stated that ECNs currently do not allow Nasdaq access to the 
reserve size share amounts residing in their systems.\152\ Nasdaq 
indicated that to the extent that an ECN agrees to share its reserve 
size information with Nasdaq and subject the reserved shares to the 
automatic execution parameters outlined in the proposal, Nasdaq would 
be willing to program NNMS to interact with the ECN's reserve 
size.\153\
---------------------------------------------------------------------------

    \152\ See Amendment No. 1, supra note 5.
    \153\ See Amendment No. 1, supra note 5.
---------------------------------------------------------------------------

    In response to concerns that NNMS will provide an opportunity for 
manipulative and fraudulent quotation and order entry activity, Nasdaq 
stated, as noted above, that NASD Regulation would closely monitor 
quotation and order entry activity to ensure the protection of all 
market participants.\154\
---------------------------------------------------------------------------

    \154\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

    The Commission finds that Nasdaq's proposal for ECN participation 
in NNMS provides an effective means for integrating ECNs into NNMS. By 
allowing an ECN to participate in NNMS either as a full participant ECN 
or as an order entry ECN, the proposal provides ECNs with the 
flexibility to determine the method of participation in NNMS that is 
most appropriate for the ECN at this time. The Commission also believes 
that providing two options for ECN participation in NNMS is reasonable 
and necessary because, according to Nasdaq, some ECNs currently are not 
capable of supporting a full automatic execution interface with Nasdaq. 
Moreover, it is not likely that ECNs that choose order entry 
participation will be marginalized because ECNs are frequently at the 
best quote in the market. Further, these ECNs have the ability to 
obtain automatic executions against the quotes of NNMS market makers if 
they so choose.
    With regard to the concern that the lack of uniform access to ECN 
quotes will provide opportunities for manipulative and fraudulent 
quotation and order entry strategies in NNMS, the Commission expects 
NASD Regulation to carefully monitor trading in NNMS to detect 
manipulative quotation or order entry strategies and to bring 
appropriate disciplinary action against a market participant who 
engages in such strategies or other conduct that is inconsistent with 
just and equitable principles of trade.

H. UTP Exchange Participation in NNMS

    Under the proposal, SelectNet will continue to serve as the primary 
linkage between UTP exchanges and Nasdaq. UTP exchanges will receive 
and be obligated to execute preferenced SelectNet liability orders and 
they will retain their ability to send SelectNet preferenced liability 
orders to Nasdaq market makers.
    The CHX asserted that the proposal improperly excludes the UTP 
exchanges, including the CHX, from full participation in NNMS.\155\ The 
CHX noted that the proposal would allow UTP specialists to send 
preferenced orders through SelectNet but will not permit them to use 
NNMS, which, unlike SelectNet, provides for automatic executions.
---------------------------------------------------------------------------

    \155\ See CHX Letter, Appendix A.
---------------------------------------------------------------------------

    In response, Nasdaq noted that Nasdaq market makers currently are 
not able to obtain automatic executions against exchange 
specialists.\156\ Nasdaq asserted that it would be inappropriate and 
inconsistent with the fair competition mandate of the Act for Nasdaq to 
provide CHX specialists with the ability to obtain automatic executions 
against Nasdaq members while the CHX and the other exchanges decline to 
provide Nasdaq members with automatic execution access to the quotes of 
exchange specialists through the Intermarket Trading System.\157\
---------------------------------------------------------------------------

    \156\ See Amendment No. 1, supra note 5.
    \157\ See Amendment No. 1, supra note 5.
---------------------------------------------------------------------------

    The Commission believes that it is reasonable for Nasdaq to 
continue to use SelectNet as the primary linkage between Nasdaq and the 
UTP exchanges, allowing UTP exchange specialists to access the Nasdaq 
market through SelectNet liability orders. The Commission believes that 
the use of SelectNet linkage will provide UTP exchange specialists with 
adequate access to the Nasdaq market.

I. Technology Concerns

    Several commenters expressed concerns regarding Nasdaq's 
technological capability to implement the proposed changes. In 
particular, one commenter noted that Nasdaq's systems must be able to 
promptly deliver critical message traffic, including messages relating 
to executions, size decrements, and quote updates.\158\ The commenters 
argued that prompt message delivery is critical in light of the 
proposed reduction in time delays between executions against a market 
maker from 17 seconds to five seconds,\159\ and they noted that a delay 
in providing notice of an execution increases the potential for double 
liability.\160\ One commenter feared that the impact of existing 
problems associated with SOES technology will be exacerbated by the 
increased use of SOES under the proposal.\161\ In addition, several 
commenters noted that firms must have sufficient time to modify their 
computer systems to implement the proposed changes.\162\
---------------------------------------------------------------------------

    \158\ See STA Letter, Appendix A.
    \159\ See STA Letter, Appendix A.
    \160\ See ASC Letter, Appendix A. See also BRUT Letter, Appendix 
A.
    \161\ See ASC Letter, Appendix A. See also BRUT Letter, Appendix 
A.
    \162\ See DLJ Letter, Appendix A. See also STA Letter and 
BancBoston Letter, Appendix A.
---------------------------------------------------------------------------

    In response, Nasdaq indicated that it has and will continue to take 
all appropriate steps to assure the adequacy and sufficiency of the 
proposed systems changes.\163\ Specifically, Nasdaq represented that 
its current automatic execution platform can be expanded

[[Page 3999]]

rapidly to add sufficient capacity to handle the increased volume of 
message traffic moving into automatic execution under NNMS.\164\ In 
this regard, Nasdaq noted that it plans to replace its current Tandem 
K-Series host processors with new Tandem S-Series models, resulting in 
an approximate 25% increase in system capacity and processing 
speed.\165\ Nasdaq stated that this increase would be augmented further 
by software application tuning (e.g., the addition of more parallel 
processes to handle order flow) that will expand capacity well beyond 
the needs of NNMS.\166\ In addition, because SelectNet uses more 
message capacity than SOES due to SelectNet's broadcast, negotiation, 
and response capabilities, Nasdaq believes that the movement of order 
traffic to the SOES-based automatic execution platform will reduce 
overall network traffic levels, thereby increasing the speed and 
reliability of the entire Nasdaq market.\167\
---------------------------------------------------------------------------

    \163\ See Amendment No. 1, supra note 5.
    \164\ See Amendment No. 2, supra note 5.
    \165\ See Amendment No. 2, supra note 5.
    \166\ See Amendment No. 2, supra note 5.
    \167\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

    In response to the commenters' concerns regarding Nasdaq's ability 
to provide prompt notice of an execution, Nasdaq asserted that the 
delays in execution report delivery result from competition for system 
resources in the Nasdaq central message switch.\168\ Nasdaq maintained 
that the migration of message traffic from SelectNet to NNMS would 
significantly reduce the message traffic causing these delays.\169\ In 
addition, Nasdaq indicated that it expects to roll out an improved 
central message switch in January 2000, which should dramatically 
increase the speed of automatic execution confirmation messages and 
more closely synchronize automatic execution transactions with 
execution updates to market makers and ECNs.\170\
---------------------------------------------------------------------------

    \168\ See Amendment No. 2, supra note 5.
    \169\ See Amendment No. 2, supra note 5.
    \170\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

    Nasdaq also noted that it is in the process of testing a 
Transmission Control Protocol/Internet Protocol (``TCP/IP'')-based, API 
communications protocol for NNMS, which Nasdaq expects to implement by 
the end of February 2000.\171\ Nasdaq stated that the API would allow 
NNMS participants to more seamlessly link their internal systems with 
NNMS for trading, risk management, and regulatory compliance 
purposes.\172\ Nasdaq asserted that the TCP/IP protocol should increase 
the speed and reliability of NNMS and remove most, if not all, of the 
technological objections to NNMS.\173\
---------------------------------------------------------------------------

    \171\ See Amendment No. 2, supra note 5.
    \172\ See Amendment No. 2, supra note 5.
    \173\ See Amendment No. 2, supra note 5.
---------------------------------------------------------------------------

    The Commission believes that the proposed enhancements to Nasdaq's 
systems, including the new Tandem S-Series host processors and software 
modifications, the improved central message switch, and the TCP/IP-
based, API communications protocol for NNMS, will help to ensure that 
Nasdaq has the technological capability to implement the proposed 
changes. The Commission expects that Nasdaq will implement these 
changes before it moves to the new NNMS trading platform. The 
Commission also expects Nasdaq to provide sufficient lead time for 
market participants before implementing NNMS, and to closely monitor 
operation of NNMS and to implement additional technological changes as 
necessary.

J. NNMS Fees

    One commenter expressed concern that the fee system for NNMS may 
operate in a discriminatory and anticompetitive manner.\174\
---------------------------------------------------------------------------

    \174\ See ETA Letter, Appendix A.
---------------------------------------------------------------------------

    In response, Nasdaq noted that the fees to be assessed under NNMS 
mirror the current fees for Nasdaq's automatic execution facilities 
(i.e., $0.50 per side) and SelectNet ($1.00 per execution, order entry 
side only).\175\ Nasdaq will treat a simultaneous execution against an 
NNMS participant's displayed and reserve sizes as a single execution. 
For example, a 5,000-share NNMS automatic execution order that 
interacts with the quotes of three market participants will result in a 
$0.50 fee for the order entry firm and a $0.50 fee for each of the 
three market participants whose quotes were accessed, regardless of 
whether the order also interacted with any of the market participants' 
reserve sizes.\176\ Nasdaq indicated that it is reviewing modifications 
that may reduce NNMS fees in the future.\177\
---------------------------------------------------------------------------

    \175\ See Amendment No. 1, supra note 5.
    \176\ See Amendment No. 1, supra note 5.
    \177\ See Amendment No. 1, supra note 5.
---------------------------------------------------------------------------

    The Commission believes that the proposed NNMS fees provide for the 
equitable allocation of reasonable dues, fees, and other changes, 
consistent with Section 15A(b)(5) of the Act.

K. Executions Against SOES Market Makers During Locked and Crossed 
Markets

    The Commission believes that it is reasonable for Nasdaq to retain 
the current five-second delay between SOES executions against the 
quotation of market maker in SmallCap securities during locked and 
crossed markets.\178\ The Commission believes that retaining the five-
second delay between SOES executions during locked and crossed markets 
will help to ensure that locked or crossed markets are resolved 
promptly, thereby improving market quality, providing more informative 
quotation information, and contributing to the maintenance of a fair 
and orderly market. In addition, the Commission believes, as it has 
concluded previously, that the five-second delay between SOES 
executions during locked and crossed markets provides market makers 
with a brief period to update their quotations while encouraging market 
makers to quickly remedy a locked or crossed market.\179\ Accordingly, 
the Commission believes that the proposal to retain the five-second 
delay between SOES executions during locked and crossed markets is 
reasonably designed to protect investors and the public interest and to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system.
---------------------------------------------------------------------------

    \178\ See Amendment No. 3, supra note 5.
    \179\ See Securities Exchange Act Release No. 38115 (January 3, 
1997), 62 FR 1351 (January 9, 1997) (order approving File No. SR-
NASD-95-54).
---------------------------------------------------------------------------

L. Technical Amendments

    The Commission believes that the proposed technical, non-
substantive amendments to the NASD Manual will clarify the NASD's rules 
to reflect the proposed changes. Because these changes will reduce 
confusion and help to ensure compliance with the NASD's rules, the 
Commission finds that the changes are designed to protect investors and 
the public interest.
    The Commission finds good cause for approving Amendment Nos. 1, 2, 
and 3 to the proposal prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment Nos. 1 and 2 respond to the concerns raised by the 
commenters, provide additional representations concerning the operation 
of the proposal, and clarify the proposed changes. Among other things, 
Amendment No. 1 makes clear that order entry firms will be able to 
participate in NNMS and that Nasdaq would be willing to program NNMS to 
interact with an ECN's reserve size to the extent that the ECN agrees 
to share its reserve size information with Nasdaq and subject the 
reserved shares to the automatic execution parameters outlined in the 
proposal. Amendment No. 2 describes Nasdaq's technological capability 
to implement the proposed changes and provides additional

[[Page 4000]]

explanations concerning the rationale for the proposed changes. 
Amendment No. 3 strengthens the proposal by retaining the current five-
second delay between SOES executions during locked and crossed markets, 
thereby encouraging market makers to quickly correct locked or crossed 
quotations. Accordingly, the Commission believes that granting 
accelerated approval of Amendment Nos. 1, 2, and 3 is appropriate and 
consistent with Sections 15A(b)(6) and 19(b)(2) of the Act.\180\
---------------------------------------------------------------------------

    \180\ 15 U.S.C. 78o-3(b)(6) and 78s(b)(2).
---------------------------------------------------------------------------

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1, 2, and 3, including whether 
Amendment Nos. 1, 2, and 3 are 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. Sec. 552, will be available for 
inspection and copying in the Commission's Public Reference Room. 
Copies of such filing will also be available for inspection and copying 
at the principal office of the NASD. All submissions should refer to 
File No. SR-NASD-99-11 and should be submitted by February 15, 2000.

VI. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal is consistent with the Act (specifically, Sections 11A and 15A 
of the Act) and the rules and regulations thereunder applicable to a 
national securities association.
    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\181\ that the proposed rule change (SR-NASD-99-11), as amended, be 
and hereby is approved.
---------------------------------------------------------------------------

    \181\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\182\
---------------------------------------------------------------------------

    \182\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.

Appendix A--Comment Letters Regarding SR-NASD-99-11

    1. Letter from John M. Schaible, President, NexTrade, to Jonathan 
G. Katz, Secretary, SEC, dated May 3, 1999.
    2. Letter from Steven Weil to SEC, dated May 8, 1999 (``Weil Letter 
I'').
    3. Letter from Steven Weil to Jonathan G. Katz, Secretary, SEC, 
dated May 7, 1999. (``Weil Letter II'').
    4. Letter from Kenneth D. Pasternak, President, and Walter F. 
Raquet, Chief Operating Officer, Knight Securities, Inc., to Jonathan 
G. Katz, Secretary, SEC, dated May 21, 1999 (``Knight Letter I'').
    5. Letter from James M. Hensley, President, Sierra Nevada 
Securities, Inc., to Jonathan G. Katz, Secretary, SEC, dated May 24, 
1999 (``Sierra Nevada Letter'').
    6. Letter from Brent M. Weisenborn, Chairman, Security Investment 
Company of Kansas City (``KCMO''), to Jonathan G. Katz, Secretary, SEC, 
dated May 25, 1999 (``Weisenborn Letter'').
    7. Letter from Mktmaven to SEC (sent by e-mail) dated May 24, 1999 
(``Mktmaven Letter'').
    8. Letter from Samuel F. Lek, Chief Executive Officer, Lek Schoenau 
& Company, Inc., to Jonathan G. Katz, Secretary, SEC, dated May 27, 
1999 (``Lek Letter'').
    9. Letter from James F. Mytinger, Treasurer, Kansas City Securities 
Association, to Jonathan G. Katz, Secretary, SEC, dated May 26, 1999 
(``KCSA Letter'').
    10. Letter from Christopher Halford, KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Halford Letter'').
    11. Letter from Stuart Cave, KCMO, to Jonathan G. Katz, Secretary, 
SEC, dated May 27, 1999 (``Cave Letter'').
    12. Letter from Ludwell G. Gaines III, KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Gaines Letter'').
    13. Letter from Steven R. Hook, KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Hook Letter'').
    14. Letter from Richard Kitzmiller, KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Kitzmiller Letter'').
    15. Letter from Jeffrey Frankel, KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Frankel Letter'').
    16. Letter from Bruce K. Schmidt, KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Schmidt Letter'').
    17. Letter from James F. Mytinger, KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Mytinger Letter'').
    18. Letter from Trent McCann, KCMO, to Jonathan G. Katz, Secretary, 
SEC, dated May 27, 1999 (``McCann Letter'').
    19. Letter from Lance Turpin, KCMO, to Jonathan G. Katz, Secretary, 
SEC, dated May 27, 1999 (``Turpin Letter'').
    20. Letter from Kyle Malmstrom, KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Malmstrom Letter'').
    21. Letter from Ron F. Boyle III, KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Boyle Letter'').
    22. Letter from Carl L. Means, Jr., KCMO, to Jonathan G. Katz, 
Secretary, SEC, dated May 27, 1999 (``Means Letter'').
    23. Letter from Oren Galchen to Jonathan G. Katz, Secretary, SEC, 
dated May 22, 1999 (``Galchen Letter'').
    24. Letter from Richard Y. Roberts, Thelen Reid & Priest LLP, on 
behalf of the Electronic Traders Association (``ETA''), to Jonathan G. 
Katz, Secretary, SEC, dated May 28, 1999 (``ETA Letter'').
    25. Letter from Robin Roger, Principal and Counsel, Morgan Stanley 
Dean Witter, to Jonathan G. Katz, Secretary, SEC, dated May 28, 1999 
(``Morgan Stanley Letter'').
    26. Letter from Dan Liu, Executive Vice President, et. al., 
Automated Securities Clearance Ltd., to Jonathan G. Katz, Secretary, 
SEC, dated May 28, 1999 (``ASC Letter'').
    27. Letter from David K. Whitcomb, Professor of Finance and 
Economics, Rutgers University, Faculty of Management, Department of 
Finance and Economics, to Jonathan G. Katz, Secretary, SEC, dated June 
1, 1999 (``Whitcomb Letter'').
    28. Letter from Brian Hyndman, President, et al., The Brass 
Utility, L.L.C., to Jonathan G. Katz, Secretary, SEC, dated May 28, 
1999 (``BRUT Letter'').
    29. Letter from Diane Murphy, Managing Director/Nasdaq Trading, 
BancBoston Robertson Stephens, to Jonathan G. Katz, Secretary, SEC, 
dated June 1, 1999 (``BancBoston Letter'').
    30. Letter from Bruce Miller, Professor of Accounting, The Anderson 
School at UCLA, to Jonathan G. Katz, Secretary, SEC, dated May 28, 1999 
(``Miller Letter'').

[[Page 4001]]

    31. Letter from Timothy J. Wilson to Jonathan G. Katz, Secretary, 
SEC, dated May 23, 1999. (``Wilson Letter'').
    32. Letter from Craig S. Tyle, General Counsel, Investment Company 
Institute, to Jonathan G. Katz, Secretary, SEC, dated June 1, 1999 
(``ICI Letter'').
    33. Letter from Dinuka L. Samarasinghe to Jonathan G. Katz, 
Secretary, SEC, dated May 23, 1999 (``Samarasinghe Letter'').
    34. Letter from Gregg Giaquinto, In-House Counsel, Electronic 
Trading Group, L.L.C. (``ETG''), to Jonathan G. Katz, Secretary, SEC, 
dated June 1, 1999 (``ETG Letter'').
    35. Letter from Paul R. Rudd to Jonathan G. Katz, Secretary, SEC, 
dated May 23, 1999 (``Rudd Letter'').
    36. Letter from William B. Norman to Jonathan G. Katz, Secretary, 
SEC, dated May 25, 1999 (``Norman Letter'').
    37. Letter from Michael O'Reilly to Jonathan G. Katz, Secretary, 
SEC, dated May 25, 1999 (``O'Reilly Letter'').
    38. Letter from Gabriel Levin to Jonathan G. Katz, Secretary, SEC, 
dated May 21, 1999 (``Levin Letter'').
    39. Letter from Jeremy Zucker to Jonathan G. Katz, Secretary, SEC, 
dated March 29, 1999 (``Zucker Letter'').
    40. Letter from David O'Leary to Jonathan G. Katz, Secretary, SEC, 
undated, received June 3, 1999 (``O'Leary Letter'').
    41. Letter from Tolga Erman to Jonathan G. Katz, Secretary, SEC, 
dated May 25, 1999 (``Erman Letter'').
    42. Letter from Piers Fennell to Jonathan G. Katz, Secretary, SEC, 
dated May 28, 1999 (``Fennell Letter'').
    43. Letter from Mike Wolverton to Jonathan G. Katz, Secretary, SEC, 
dated May 28, 1999 (``Wolverton Letter'').
    44. Letter from Neal King to Jonathan G. Katz, Secretary, SEC, 
dated May 24, 1999 (``King Letter'').
    45. Letter from Nikhil Atreya to Jonathan G. Katz, Secretary, SEC, 
dated May 27, 1999 (``Atreya Letter'').
    46. Letter from Joel Haber to Jonathan G. Katz, Secretary, SEC, 
dated May 28, 1999 (``Haber Letter'').
    47. Letter from Joshua Weintraub to Jonathan G. Katz, Secretary, 
SEC, undated, received June 2, 1999 (``Weintraub Letter'').
    48. Letter from Bryan D. Chung to Jonathan G. Katz, undated, 
received June 2, 1999 (``Chung Letter'').
    49. Letter from Jeffrey A. Deeney to Jonathan G. Katz, Secretary, 
SEC, dated May 28, 1999 (``Deeney Letter'').
    50. Letter from Steven Weil to Jonathan G. Katz, Secretary, SEC, 
dated May 28, 1999 (``Weil Letter III'').
    51. Letter from Bob Sievers, Access Securities, to SEC, dated June 
2, 1999 (``Sievers Letter'').
    52. Letter from Steve Swanson, President, Mount Pleasant Brokerage 
Services, LP, to Jonathan G. Katz, Secretary, SEC, dated June 1, 1999 
(``Mt. Pleasant Letter'').
    53. Letter from Arthur J. Kearney, Chairman, and Leopold Korins, 
President and CEO, Security Traders Association (``STA'') to Jonathan 
G. Katz, Secretary, SEC, dated June 3, 1999 (``STA Letter'').
    54. Letter from Howard Teitelman to Jonathan G. Katz, Secretary, 
SEC, dated May 20, 1999 (``Teitelman Letter'').
    55. Letter from Justin Schiller to Jonathan G. Katz, Secretary, 
SEC, undated, received June 4, 1999 (``Schiller Letter'').
    56. Letter from James T. Snell, Registered Representative, 
Heartland Securities, to Jonathan G. Katz, Secretary, SEC, dated May 
24, 1999 (``Snell Letter'').
    57. Letter from Matthew D. Nemcic to Jonathan G. Katz, Secretary, 
SEC, undated, received June 3, 1999 (``Nemcic Letter'').
    58. Letter from Kenneth D. Pasternak, President, and Walter F. 
Raquet, Chief Operating Officer, Knight Securities, Inc., to Jonathan 
G. Katz, Secretary, SEC, dated June 4, 1999 (``Knight Letter II'').
    59. Letter from Richard D. Schenkman, Executive Vice President, 
Instinet Corporation, to Jonathan G. Katz, Secretary, SEC, dated June 
7, 1999 (``Instinet Letter'').
    60. Letter from Paul B. O'Kelly, Chicago Stock Exchange (``CHX''), 
to Jonathan G. Katz, Secretary, SEC, dated June 7, 1999 (``CHX 
Letter'').
    61. Letter from Bernard L. Madoff, Chairman, Trading Committee, 
Securities Industry Association (``SIA''), to Jonathan G. Katz, 
Secretary, SEC, dated June 2, 1999 (``SIA Letter'').
    62. Letter from Brian L. Mack to Jonathan G. Katz, Secretary, SEC, 
dated May 28, 1999 (``Mack Letter'').
    63. Letter from Jon Vercellone to Jonathan G. Katz, Secretary, SEC, 
undated, received June 4, 1999 (``Vercellone Letter'').
    64. Letter from Yu-Hui J. Lin to Jonathan G. Katz, Secretary, SEC, 
dated May 30, 1999 (``Lin Letter'').
    65. Letter from Cornel Catrina to Jonathan G. Katz, Secretary, SEC, 
dated May 29, 1999 (``Catrina Letter'').
    66. Letter from William H. Sulya, Senior Vice President and 
Director of Nasdaq/OTC Trading, A.G. Edwards & Sons, Inc. (``A.G. 
Edwards''), to Margaret H. McFarland, Deputy Secretary, SEC, dated June 
7, 1999 (``A.G. Edwards Letter'').
    67. Letter from Greg Swenson to Jonathan G. Katz, Secretary, SEC, 
undated, received June 8, 1999 (``Swenson Letter'').
    68. Letter from Kevin M. Foley, Bloomberg L.P. (``Bloomberg''), to 
Jonathan G. Katz, Secretary, SEC, dated June 4, 1999 (``Bloomberg 
Letter'').
    69. Letter from Hill, Thompson, Magid & Co., Inc. (``Hill''), to 
Jonathan G. Katz, Secretary, SEC, dated June 7, 1999 (``Hill Letter'').
    70. Letter from Mike Cormack, Manager, Equity Trading, American 
Century Investment Management (``ACIM''), to Jonathan G. Katz, 
Secretary, SEC, dated June 3, 1999 (``ACIM Letter'').
    71. Letter from Ephraim F. Sudit, Ph.D., Professor of Accounting 
and Information Systems, Rutgers University, to Jonathan G. Katz, 
Secretary, SEC, dated June 1, 1999 (``Sudit Letter'').
    72. Letter from Matthew D. Lang, Senior Compliance Officer, USCC 
Trading, to Jonathan G. Katz, Secretary, SEC, dated June 8, 1999 
(``USSC Trading Letter I'').
    73. Letter from Robert L. Padala, Managing Director, Over-the-
Counter Trading, Donaldson, Lufkin & Jenrette (``DLJ''), to Jonathan G. 
Katz, Secretary, SEC, dated June 14, 1999 (``DLJ Letter'').
    74. Letter from Gerald D. Putnam, Chief Executive Officer, 
Archipelago, L.L.C. (``Archipelago''), to Jonathan G. Katz, Secretary, 
SEC, dated June 14, 1999 (``Archipelago Letter'').
    75. Letter from Darren Caris, Torrey Pines Securities, to Jonathan 
G. Katz, Secretary, SEC, dated June 16, 1999 (``Caris Letter'').
    76. Letter from Neil C. Feldman, President, USCC Trading, to 
Jonathan G. Katz, Secretary, SEC, dated June 17, 1999 (``USCC Trading 
Letter II'').
    77. Letter from Lon Gorman, Executive Vice President, Charles 
Schwab (``Schwab''), to Jonathan G. Katz, Secretary, SEC, dated June 
16, 1999 (``Schwab Letter'').
    78. Letter from Michael T. Dorsey, Senior Vice President and 
General Counsel, Knight Securities, Inc., to Jonathan G. Katz, 
Secretary, SEC, dated June 23, 1999 (``Knight Letter III'').
    79. Letter from Maria A. Silverstein, The Security Traders 
Association of New York, to Jonathan G. Katz, Secretary, SEC, and 
Robert Colby, Deputy Director, Division of Market Regulation, SEC, 
dated March 22, 1999.

[FR Doc. 00-1697 Filed 1-24-00; 8:45 am]
BILLING CODE 8010-01-P