[Federal Register Volume 62, Number 189 (Tuesday, September 30, 1997)]
[Notices]
[Pages 51170-51172]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-25794]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39120; File No. SR-NSAD-97-70]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the National 
Association of Securities Dealers, Inc. Relating to an Extension of the 
Effectiveness of the NASD's Excess Spread Rule Until October 13, 1997

September 23, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act''), 15 U.S.C.. 78s(b)(1), notice is hereby given that 
on September 15, 1997, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association'') filed with the Securities and 
Exchange Commission (``Commission'' or ``SEC'') the proposed rule 
change as described in Items I, II, and III below, which items have 
been prepared by The Nasdaq Stock Market, Inc. (``Nasdaq''). The 
Commission is publishing this notice to solicit comments from 
interested persons and to grant accelerated approval of the proposed 
rule change.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD proposes to amend NASD Rule 4613(d) to extend the 
effectiveness of its current excess spread rule through October 13, 
1997. The excess spread rule is applicable to Nasdaq National Market 
(``NNM'') securities and provides that a registered market maker in a 
security listed on Nasdaq shall be precluded from being a registered 
market maker in that issue for twenty (20) business days if its average 
spread in the security over the course of any full calendar month 
exceeds 150 percent of the average of all dealer spreads in such issue 
for the month. The text of the proposed rule change is as follows. 
Additions are italicized and deletions bracketed.
NSAD Rule 4613
    (d) Reasonably Competitive Quotations.
    A registered market maker in a Nasdaq National Market security will 
be withdrawn as a registered market maker and precluded from re-
registering as a market maker in such issue for 20 business days if its 
average spread in the security over the course of any full calendar 
month exceeds 150 percent of the average of all dealer spreads in such 
issue for the month. This subparagraph shall not apply to market makers 
in Nasdaq SmallCap securities.
    (1) If a registered market maker has not satisfied the average 
spread requirement set forth in this subparagraph (d) for a particular 
Nasdaq National Market security, its registration in such issue shall 
be withdrawn commencing on the next business day following the business 
day on which the market maker was sent notice of its failure to comply 
with the requirement. A market maker may request reconsideration of the 
withdrawal notification. Requests for reconsideration will be reviewed 
by the Market Operations Review Committee, whose decisions are final 
and binding on the members. A request for reconsideration shall not 
operate as a stay of the withdrawal or toll the twenty business day 
period noted in subparagraph (d) above.
    (2) Grounds for requests for reconsideration shall be limited to 
claims that Nasdaq's calculation of the market maker's average spread 
for the month was in error.
    (3) This subparagraph (d) shall be in effect until October 13, 1997 
(September 30, 1997).

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

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

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

    Prior to January 20, 1997, the NASD's excess spread rule (the 
``Rule'' or the ``Excess Spread Rule'') provided that registered market 
makers in Nasdaq securities could not enter quotations that exceeded 
125 percent of the average of the three narrowest market maker spreads 
in that issue, provided, however, that the maximum allowable spread 
could never be less than \1/4\ of a point (``125% Rule''). The Rule was 
originally designed to bring a measure of quality to the Nasdaq market 
by preventing firms from holding themselves out as market makers 
without having a meaningful quote in the system. Despite the regulatory 
objectives underlying the rule, however, many market participants 
believed the rule produced a variety of unintended consequences that 
undermined the integrity of Nasdaq. Most notably, the SEC found in its 
21(a) Report on the NASD and Nasdaq that ``the interdependence of 
quotes mandated by the rule may deter market makers from narrowing 
their dealer spreads, because, once the spread is tightened, the rule 
in some instances precludes a market maker from widening the spread to 
earlier levels.'' \1\ As a result, the SEC found that the Excess Spread 
Rule created an economic incentive for market makers to discourage one 
another from narrowing their quotes, thereby interfering with the 
``free flow of prices in the market and imped[ing] attempts by the 
market to reach the optimal competitive spread.'' \2\ Accordingly, the 
SEC requested that the NASD ``modify the rule to eliminate its 
undesirable effects, or to repeal it.'' \3\
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    \1\ See ``Appendix to Report Pursuant to Section 21(a) of the 
Securities Exchange Act of 1934 Regarding the NASD and The Nasdaq 
Stock Market,'' at p. 98 (``21(a) Report'') (S.E.C., Aug. 8, 1996).
    \2\ Id. at p. 99.
    \3\ Id.
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    In response to the SEC's 21(a) Report, the NASD submitted a 
proposal, which was approved by the SEC and which amended the Excess 
Spread Rule on a pilot basis through July 1, 1997.\4\ Under the revised 
Excess Spread Rule, a registered market marker in a Nasdaq security is 
precluded from being a registered market maker in that issue for twenty 
business days if its average spread in the security over the course of 
any full calendar month exceeded 150 percent of the average of all 
dealer spreads in such issue for the month (``150% Rule).\5\
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    \4\ See Securities Exchange Act Rel. No. 38180 (January 16, 
1997), 62 FR 3725 (``Pilot Program Approval Order''). The pilot 
originally was set to expire on July 1, 1997, but was extended 
through September 30, 1997. See Securities Exchange Act Rel. No. 
38804 (July 1, 1997), 62 FR 36588.
    \5\ On February 28, 1997, the SEC approved the NASD's proposal 
to exclude Nasdaq Small-Cap Securities from the Excess Spread Rule. 
This rule change was necessary because, unlike the manner in which 
Nasdaq National Market securities are handled for purposes of the 
rule, Nasdaq does not presently calculate and display through the 
Nasdaq system the average spread of all market makers in a 
particular SmallCap issue or a comparison of the size of an 
individual market maker's quoted spread relative to the average 
spread of all market makers. Thus, Nasdaq does not presently afford 
market makers in SmallCap securities with any indication as to 
whether they are satisfying the requirements of the 150% Rule.
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    In formulating the 150% Rule, Nasdaq Committees and Nasdaq staff 
felt that it was important to strike a reasonable balance between the 
need to eliminate any constraints that the Excess Spread

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Rule places on firms to adjust their quotations and the need to avoid 
fostering a market environment where registered market makers can 
maintain inordinately wide spreads and still receive the benefits of 
being a market maker (e.g., affirmative determination exemption and 
preferential margin treatment). Nasdaq also believed it was critical to 
transform the Excess Spread Rule into a performance standard used to 
determine market maker eligibility, instead of a strict regulatory 
requirement applicable to every quote update in a Nasdaq security, 
violations of which were punishable by disciplinary action. Based on 
its experience with the Rule, the Nasdaq Board of Directors in June 
1997 approved a resolution to seek permanent approval of the 150% Rule 
``as is,'' without modifications. In addition, the NASD ratified the 
Nasdaq Board resolution in July of 1997 and Nasdaq planned to seek 
permanent approval shortly thereafter.
    However, the Commission has expressed, and continues to express, 
serious concerns about the effects of the Rule on market maker 
activity. More specifically, in its approval order of the 150% Rule, 
the SEC stated that ``[a]lthough the amended excess spread rule may 
reduce some of the anticompetitive concerns outlined in the 21(a) 
Report, the Commission believes that the amendment * * * may not 
completely satisfy the NASD'S obligations under the Commission's Order 
with regard to the excess spread rule. Specifically, it may not remove 
completely the anticompetitive incentives for market makers to refrain 
from narrowing quotes because the market makers' quotation obligation 
continues to be dependent to some extent upon quotations of other 
market makers in the stock.'' \6\
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    \6\ Pilot Program Approval Order, supra note 4.
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    Additionally, in recent discussions, SEC staff has indicated that 
it believes that the 150% Rule may not have completely eliminated the 
concerns outlined in the 21(a) Report and may not completely satisfy 
the NASD's obligations under the Commission's Order. SEC staff further 
has stated that it believes that the Rule should be completely 
eliminated, or at the very least, be eliminated for stocks with a small 
number of market makers.
    In light of the foregoing, the NASD is proposing to extend the 
Excess Spread Rule only until October 13, 1997. Additionally, Nasdaq 
staff will ask the Nasdaq Board of Directors (``Board'') at its 
September 23, 1997 board meeting to reconsider its previous decision to 
seek permanent approval of the Rule, in light of the Commission's 
concerns that the Rule does not remove completely incentives for market 
makers to refrain from narrowing quotes. Nasdaq will inform the 
Commission by letter of the final disposition of the Board's 
reconsideration of this matter as soon as possible.
    The NASD and Nasdaq believe that the proposed rule change is 
consistent with Sections 15A(b)(6), 15A(b)(9), 15A(b)(11) and 
11A(a)(1)(C) of the Exchange Act. Among other things, Section 15A(b)(6) 
requires that the rules of a national securities association be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to, and facilitating 
transactions in securities, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system and in 
general to protect investors and the public interest. Section 15A(b)(9) 
provides that the rules of the Association may not impose any burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act. Section 15A(b)(11) empowers the NASD to adopt 
rules governing the form and content of quotations relating to 
securities in the Nasdaq market. Such rules much be designed to produce 
fair and informative quotations, prevent fictitious and misleading 
quotations, and promote orderly procedures for collecting and 
distributing quotations. Section 11A(a)(1)(C) provides that it is in 
the public interest to, among other things, assure the economically 
efficient execution of securities transactions and the availability to 
brokers, dealers, and investors of information with respect to 
quotations for and transactions in securities.
    Specifically, the NASD and Nasdaq believe that the 150% Rule has 
promoted the integrity of quotations on the Nasdaq market and has 
enhanced competition among market makers, thereby contributing to 
greater market liquidity, improved price discovery, and the best 
execution of customer orders. The Rule has helped to ensure that all 
registered market makers are providing some threshold level of market 
making support in their issues, and has helped to avoid a market 
environment where registered market makers can maintain inordinately 
wide spreads and still receive the benefits of being a market maker. 
Thus, a continuation of the Rule until October 13, 1997, will address 
the Commission's aforementioned concerns while preserving the Rule's 
benefits (such as ensuring meaningful market maker quotes) until the 
Nasdaq Board reconsiders its previous position on the Rule. 
Additionally, the proposed to extend the pilot program for a limited 
period is consistent with the Exchange Act and will ensure continuity 
of regulation until the Nasdaq Board reconsiders its previous position 
on the Rule.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD believes that the proposed rule change will not result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Exchange Act.

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

    Comments were neither solicited nor received.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of submission, all subsequent amendments, all written statements 
with respect to the proposed rule change that are filed with the 
Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to file number SR-NASD-97-70 and 
should be submitted by October 21, 1997.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    The Commission has determined to approve the extension of the 150% 
Rule pilot until October 13, 1997. As noted previously, the Commission 
has identified anticompetitive concerns associated with the 125% Rule 
in place prior to January 20, 1997. Further, in the Pilot Program 
Approval Order, the Commission recognized that while the

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150% Rule could reduce, to some degree, the Commission's concerns 
regarding the 125% Rule, the Commission was not convinced that 
permanent approval of the 150% rule would sufficiently address those 
concerns. The Commission believes that the pilot should continue to 
operate on a temporary basis through October 13, 1997, while the Nasdaq 
Board reconsiders its position on permanent approval. Consequently an 
extension will ensure that the Rule remains in effect on an 
uninterrupted basis until the Nasdaq Board has had an opportunity to 
fully evaluate the most appropriate permanent solution regarding the 
excess spread rule.
    In addition, the Commission believes that the temporary rule can 
remain limited to National Market securities. Due to Nasdaq's current 
systems limitations, market makers in Nasdaq SmallCap securities are 
unable to monitor compliance with the Rule. However, the NASD has 
stated that it anticipates that market makers in Nasdaq SmallCap 
securities will be subject to the same excess spread requirements, if 
any, as market makers in Nasdaq National Market securities when a 
permanent resolution is reached.
    Accordingly, the Commission finds that the NASD's proposal is 
consistent with Sections 11A and 15A of the Exchange Act and the rules 
and regulations thereunder applicable to the NASD and, in particular, 
Sections 11A(a)(1)(C), 15A(b)(6), 15A(b)(9), and 15A(b)(11). Further, 
the Commission finds good cause for approving the proposed rule change 
prior to the thirtieth day after the date of publication in the Federal 
Register. In addition to the reasons discussed above, the Commission 
believes that accelerated approval of the NASD's proposal is 
appropriate given the fact that the proposal is a temporary extension 
of the 150% Rule that has been in effect since January 1997. An 
uninterrupted application of the 150% Rule for a short period of time 
should be less disruptive to market makers while the Nasdaq Board 
reconsiders its permanent approach to the concerns raised by the 
Commission regarding the excess spread rule.\7\
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    \7\ The Commission notes that a failure to extend the 150% Rule 
past the October 13, 1997 date would result in no excess spread 
standard for Nasdaq market makers.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act, that the proposed rule change (SR-NASD-97-70) is approved 
through October 13, 1997.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-25794 Filed 9-29-97; 8:45 am]
BILLING CODE 8010-01-M