59932 Federal Register / Vol. 62, No. 214 / Wednesday, November 5, 1997 / Notices

22 15 U.S.C. 78s(b)(2).

23 17 CFR 200.30–3(a)(12).

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

2 17 CFR 240.19b–4.

3November 18, 1996, the NASD filed with the

Commission a proposed rule change to implement

the Actual Size Rule on a pilot basis. (SR–NASD–

96–43). Among other things, the filing and

subsequent amendments proposed to allow market

makers to quote in minimum sizes of 100 shares for

a three-month pilot Program in the 50 Nasdaq

securities subject to mandatory compliance with

Exchange Act Rule 11Ac1–4 (‘‘Limit Order Display

Rule’’) on January 20, 1997. The remaining

securities were still subject to the existing

minimum quotation display requirements for

proprietary quotes. The proposed rule change was

intended by the NASD to facilitate the display of

customer limit orders in accordance with the Limit

Order Display Rule. The Commission approved the

pilot through April 18, 1997. Securities Exchange

Act Release 38512 (April 15, 1997) 62 FR 19373

(April 21, 1997) (SR–NASD–97–25).

On April 15, 1997, the Commission issued an

order granting accelerated approval to a NASD

proposed rule change that extended the pilot from

April 18, 1997, to July 18, 1997. Securities

Exchange Act Release 38512 (April 15, 1997) 62 FR

19373 (April 21, 1997) (SR–NASD–97–25).

On July 18, 1997, the Commission approved a

rule change proposed by the NASD to extend the

pilot from July 18, 1997 to December 31, 1997.

Securities Exchange Act Release No. 38851 (July 18,

1997) 62 FR 39565 (July 23, 1997) (SR–NASD–97–

49). The Commission did so to give it additional

time to evaluate the economic studies and review

the public’s comments on the NASD’s June 3, 1997,

study. In addition, the Commission stated that it

believed that extending the pilot would benefit the

markets by providing more experience with the

Actual Size Rule before a decision is made

regarding approval.

4See Letter from Robert E. Aber, Vice President

and General Counsel, the Nasdaq Stock Market,

Inc., to Katherine England, Assistant Director,

Office of Market Supervision, Division of Market

Regulation, Commission, dated July 10, 1997.

5See Letter from Robert E. Aber, Vice President

and General Counsel, the Nasdaq Stock Market,

Inc., to Katherine England, Assistant Director,

Office of Market Supervision, Division of Market

Regulation, Commission, dated July 17, 1997.

6Securities Exchange Act Release No. 38872 (July

24, 1997) 62 FR 40879 (July 30, 1997) (SR–NASD–

97–26).

7See Letter from Robert E. Aber, Vice President

and General Counsel, the Nasdaq Stock Market,

Inc., to Katherine England, Assistant Director,

Office of Market Supervision, Division of Market

Regulation, Commission, dated September 15, 1997.

member issue a fairness opinion

regarding the acquisition price.

B. Amendment to Rule 2720

The Commission believes that it is

appropriate to amend Rule 2720 to state

that in any exchange offer, merger and

acquisition transaction or corporate

reorganization subject to Rule 2720, the

provision which requires that the price

or yield of the securities be established

based on the recommendation of a

qualified independent underwriter shall

not apply and, instead, the exchange

values of the securities being offered in

the transaction shall not be less than

that recommended by a qualified

independent underwriter. The

Commission believes that the proposed

new provision would clarify that the

obligation of the qualified independent

underwriter is to ensure that the

recipient of the exchange offer, which is

the party intended to be protected by

the participation of a qualified

independent underwriter, shall not

receive fewer of the securities being

issued in exchange for each security

held by the recipient than is

recommended by the qualified

independent underwriter.

IV. Conclusion

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,22 that the

proposed rule change (SR–NASD–97–

38) is approved.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.23

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–29197 Filed 11–4–97; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39285; File No. SR–NASD–

97–26]

Self-Regulatory Organizations;

National Association of Securities

Dealers, Inc.; Order Granting Approval

to Proposed Rule Change and Notice

of Filing and Order Granting

Accelerated Approved to Amendment

No. 3 Relating to an Extension and

Expansion of the Pilot for the NASD’s

Rule Permitting Market Makers To

Display Their Actual Quotation Size

October 29, 1997.

I. Background

On April 11, 1997, the National

Association of Securities Dealers, Inc.

(‘‘NASD’’ or ‘‘Association’’) filed with

the Securities and Exchange

Commission (‘‘Commission’’ or ‘‘SEC’’)

a proposed rule change pursuant to

Section 19(b)(1) of the Securities

Exchange Act of 1934 (‘‘Exchange

Act’’),1 and Rule 19b–4 thereunder,2 to

amend NASD Rule 4613(a)(1)(C) by (a)

expanding from 50 to 150 the number of

securities in a pilot program for which

market makers may quote their actual

size by reducing the minimum

quotation size requirement for market

makers in certain securities listed on the

Nasdaq Stock Market (‘‘Nasdaq’’) to one

normal unit of trading (‘‘Actual Size

Rule’’), and (b) extending the pilot

through December 31, 1997.3

On July 10, 1997, the NASD filed

Amendment No. 1 to the proposed rule

change proposing to extend the pilot

through March 27, 1998 and expand it

to 150 stocks.4 On July 17, 1997, the

NASD filed with the Commission

Amendment No. 2, to correct a technical

deficiency in Amendment No. 1.5 The

proposal was noticed for comment on

July 24, 1996.6

On September 15, 1997, the NASD

filed Amendment No. 3,7 proposing to

extend the pilot as previously noted and

to expand the pilot by adding a different

group of 100 securities to those 50

currently subject to the Actual Size Rule

(‘‘First 50’’) than was proposed in

Amendment Nos. 1 and 2. The NASD

believes that this second group of

securities will provide a better basis for

comparison and economic analysis

comparing the Actual Size Rule’s effect

on pilot and non-pilot Nasdaq

securities. In addition, Nasdaq proposes

to replace some of securities in the

initial 50 stock pilot that are no longer

listed on Nasdaq. Amendment No. 3

also proposed extending the pilot

through March 27, 1998.

For the reasons discussed below, the

Commission has determined to approve

the proposed rule change.

II. Proposed Rule Change

The NASD proposes to amend NASD

Rule 4613(a)(1)(C) to allow market

makers to quote their actual size by

reducing the minimum quotation size

requirement for market makers in

certain securities listed on Nasdaq to

one normal unit of trading. As discussed

below, the Actual Size Rule presently

applies to a group of 50 Nasdaq

securities on a pilot basis. The proposed

rule change would expand the pilot

group to 150 stocks and extend the pilot

until March 27, 1998. The text of the

proposed rule change is as follows.

(Additions are italicized; deletions are

bracketed.)

* * * * *

4613. Character of Quotations

(a) Two-Sided quotations

(1) No Change

(A)–(B) No Change

(C) As part of a pilot program

implemented by the Nasdaq Stock

Market, during the period January 20,

1997 through at least [December 31,

1997] March 27, 1998, a registered

market maker in a security listed on the

Nasdaq Stock Market that became

subject to mandatory compliance with

SEC Rule 11Ac1–4 on January 20, 1997

or identified by Nasdaq as being

otherwise subject to the pilot program as

expanded and approved by the

Commission, must display a quotation
Federal Register / Vol. 62, No. 214 / Wednesday, November 5, 1997 / Notices 59933

8 In order to give the public additional time to

comment on the economic analysis of the pilot that

the NASD filed with the Commission on June 3,

1997, the Commission extended the comment

period to July 3, 1997. Securities Exchange Act

Release No. 38720 (June 5, 1997) 62 FR 38156 (June

11, 1997) (SR–NASD–97–26).

9The Commission received comment letters from

numerous broker-dealer firms, some of which are

market makers and others that are order entry firms.

The Commission received comment letters from a

large number of individuals who could be

identified as SOES traders. The Commission also

received comment letters from several

academicians, individual investors, and

professional associations.

10 17 CFR 240.11Ac1–4.

11 17 CFR 240.11Ac1–1.

12See Securities Exchange Act Release No.

37619A (September 6, 1997) 61 FR 48290

(September 12, 1996) (‘‘Order Execution Rules

Adopting Release’’).

13See, e.g., Securities Exchange Act Release No.

38490 (April 9, 1997); Securities Exchange Act

Release No. 38870 (July 24, 1997).

14For example, if a market maker’s quote in stock

ABCD is 10–101⁄4 (1000×1000) and the market

maker receives a customer limit order to buy 200

shares at 101⁄8, the market maker must update its

quote to 101⁄8–101⁄4 (200×1000).

15For example, if a market maker receives a

customer limit order to buy 200 shares of ABCD at

10 when its quote in ABCD is 10–101⁄4 (1000×1000)

and the National Best Bid or Offer (‘‘NBBO’’) for

ABCD is 10–101⁄8, the market maker must update

its quote to 10–101⁄4 (1200×1000).

16There are eight exceptions to the immediate

display requirement of the Limit Order Display

Rule: (1) Customer limit orders executed upon

receipt; (2) limit orders placed by customers who

request that they not be displayed; (3) limit orders

for odd-lots; (4) limit orders of block size (10,000

shares or $200,000); (5) limit orders routed to a

Nasdaq or exchange system for display; (6) limit

orders routed to a qualified electronic

communications network for display; (7) limit

orders routed to another member for display; and

(8) limit orders that are all-or-none orders. See Rule

11Ac1–4(c).

17See Actual Size Rule Approval Order.

18Thus, the Actual Size Rule does not effect a

market maker’s obligation to display the full size of

a customer limit order. If a market maker is required

to display a customer limit order for 200 or more

shares, it must display a quote size reflecting the

size of the customer’s order, absent an exception

from the Limit Order Display Rule.

19 In particular, NASD Rule 4613(a)(2) requires

each market maker in a Nasdaq issue other than

those in the first 50 to enter and maintain two-sided

quotations with a minimum size equal or greater

than the applicable SOES tier size for the security

(e.g., 1000, 500 or 200 shares for Nasdaq National

Market issues and 500 or 100 shares for Nasdaq

SmallCap Market issues (‘‘Mandatory Quote Size

Requirement’’).

size for at least one normal unit of

trading (or a larger multiple thereof)

when it is not displaying a limit order

in compliance with SEC Rule 11Ac1–4,

provided, however, that a registered

market maker may augment its

displayed quotation size to display limit

orders priced at the market maker’s

quotation.

* * * * *

III. Comments 8

The Commission received over 350

comment letters.9 A separate summary

of comments has been prepared and is

available in the public file. The relevant

issues addressed by commenters are

discussed in the appropriate sections of

this order.

IV. Discussion

On August 29, 1996, the Commission

promulgated a new rule, the Limit Order

Display Rule 10 and adopted

amendments to the Quote Rule,11 which

together are designed to enhance the

quality of published quotations for

securities and promote competition and

pricing efficiency in U.S. securities

markets (collectively, the ‘‘Order

Execution Rules’’).12 With respect to

securities included on Nasdaq, the

Order Execution Rules were

implemented according to a phased-in

implementation schedule: 50 Nasdaq

securities became subject to the rules on

June 20, 1997 (‘‘first 50’’), 50 more

securities became subject to the rules on

February 10, 1977 (‘‘second 50’’); and an

additional 50 securities became subject

to the rules on February 24, 1997. The

remaining Nasdaq securities were

phased in on October 13, 1997.13

The SEC’s Limit Order Display Rule

requires the display of customer limit

orders, that: (1) Are priced better than

a market maker’s quote,14 or (2) add to

the size associated with a market

maker’s quote when the market maker is

at the best price in the market.15 By

virtue of the Limit Order Display Rule,

investors now have the ability to

directly advertise their trading interest

to the marketplace, thereby allowing

them to compete with market maker

quotations and affect the size of bid-ask

spreads.16 The Order Execution Rules

also included amendments to the SEC’s

Quote Rule, the most significant of

which requires a market maker to

display in its quote any better priced

orders that it places into an electronic

communications network (‘‘ECN’’) such

as SelectNet or Instinet (‘‘ECN Rule’’).

Alternatively, instead of updating its

quote to reflect better priced orders

entered into an ECN, a market maker

may comply with the display

requirements of the ECN Rule through

the ECN itself, provided the ECN: (1)

Ensures that the best priced orders

entered by market makers into the ECN

are included in the public quotation;

and (2) provides brokers and dealers

access to orders entered by market

makers into the ECN, so that brokers

and dealers who do not subscribe to the

ECN can trade with those orders (‘‘ECN

Display Alternative’’).

In order to facilitate implementation

of the SEC’s Order Execution Rules and

reflect the change in the Nasdaq market

that was to be brought about by the

implementation of these rules, the

Commission approved, on January 10,

1997, a variety of amendments to NASD

Rules pertaining to Nasdaq’s Small

Order Execution System (‘‘SOES’’) and

the SelectNet Service (‘‘SelectNet’’).17 In

particular, one of the NASD Rule

changes approved by the Commission

provides on a temporary basis that

Nasdaq market makers in the first 50

securities subject to the Commission’s

Limit Order Display Rule are only

required to displayed a minimum

quotation size of one normal unit of

trading when quoting solely for their

own proprietary account (i.e., the Actual

Size Rule).18 They can display a greater

quotation size if they so choose (or if

required by the Limit Order Display

Rule). For Nasdaq securities outside of

the first 50, the minimum quotation size

requirements of 1,000, 500, or 200

shares remained the same.19

The NASD submitted the proposal for

the Actual Size Rule because it believed,

and continues to believe, that the

changes in Nasdaq brought about by the

Limit Order Display Rule obviates the

regulatory justification for minimum

quote size requirements because

investors now have the capability to

display their orders on Nasdaq. The

NASD originally imposed the

Mandatory Quote Size Requirements to

ensure an acceptable level of market

liquidity and depth in an environment

where Nasdaq market markers were the

only market participants who could

affect quotation prices. Now that the

Limit Order Display Rule permits

investors to enter orders as part of the

quote, the NASD believes it is

appropriate to treat Nasdaq market

makers in a manner equivalent to

exchange specialists and not subject

them to minimum quote size

requirements when they are not

representing customer orders. In sum,

with the successful implementation of

the SEC’s Order Execution Rules, the

NASD believes that Mandatory Quote

Size Requirements impose unnecessary

regulatory burdens on market makers.

At the same time, the NASD does not

believe that implementation of the

Actual Size Rule in an environment

where limit orders are displayed has or

will compromise the quality of the

Nasdaq market. First, the NASD believes

that display of customer limit orders

enhances the depth, liquidity, and

stability of the market and contributes to

narrower quoted spreads, thereby

mitigating the effects of the loss of

displayed trading interest, if any, by
59934 Federal Register / Vol. 62, No. 214 / Wednesday, November 5, 1997 / Notices

20See Actual Size Approval Order, 62 FR at 2425.

21 Id. 62 FR at 2423.

22 Id. 62 FR at 2424.

23See 62 FR 2415 at 2425.

24On June 3, 1997, the NASD published an

economic analysis entitled ‘‘Effects of the Removal

of Minimum Sizes for Proprietary Quotes in the

Nasdaq Stock Market, Inc.’’ (June Study). On

September 10, 1997, the NASD published a related

study entitled ‘‘Implementation of the SEC Order

Handling Rules’’ (September Study). Both studies

are available to the public at Nasdaq’s World Wide

Web sit at ‘‘http://www.nasdaq.com’’.

25The first 50 securities includes Nasdaq’s top

ten issues by dollar volume plus 40 issues chosen

from Nasdaq’s top 500 issues: 8 ranked between 11

and 100; 8 ranked between 101 and 200; 8 ranked

between 201 and 300; 8 ranked between 301 and

400; 8 ranked between 401 and 500. The second 50

securities include the ten Nasdaq stocks and ranked

between 11 and 20 by dollar volume plus 40 stocks

chosen from Nasdaq’s top 500 stocks in the same

manner explained above. The ten largest Nasdaq

stocks in the first 50 have no comparable peer group

among Nasdaq stocks and the next ten largest

Nasdaq stocks (i.e., Nasdaq stocks ranked 11–20 in

size) included in the second 50 are also not

comparable to the ‘‘bottom 40’’ of either the first 50

or second 50. The Nasdaq stocks ranked 1–20,

therefore, have been excluded from the analysis

comparing the first 50 and the second 50.

Accordingly, the ‘‘first forty’’ stocks are those stocks

that are the ‘‘bottom 40’’ within the first 50 stocks

and the ‘‘second forty’’ stocks are those stocks that

are the ‘‘bottom 40’’ within the second 50 stocks.

26 June Study at 2.

27The remaining 10 stocks in the first tranche

were roughly the top 10 stocks (‘‘First 10’’), and the

remaining 10 from the second tranche were roughly

stocks 11 through 20 (‘‘Second 10’’). Consistent

with the Commission’s request for a ‘‘matched pairs

analysis,’’ the First 10 and Second 10 are excluded

from this analysis, because these groups do not

demonstrate similar trading characteristics and

hence cannot be properly compared. See Actual

Size Approval Order, 62 FR at 2425. Indeed,

inclusion of the First 10 and Second 10 would

likely produce skewed results. The market quality

improvements induced by the Order Handling

Rules, however, are apparent in both the First and

Second 10.

28See also Summary of Comments, Section B.6.

market makers. Second, it also believes

that removing artificial quote size

requirements may lead to narrower

market spreads, thereby reducing

investors’ transaction costs. Third, the

NASD asserts that permitting market

makers to quote in size commensurate

with their own freely-determined

trading interest will enhance the pricing

efficiency of the Nasdaq market and the

independence and competitiveness of

dealers quotations. Fourth, the NASD

suggests that removing quotation size

requirements will allowing greater quote

size changes, thereby increasing the

information content of market maker

quotes by facilitating different quote

sizes from dealers who have a

substantial interest in the stock at a

particular time and those who do not.

Indeed, in its order approving the

Actual Size Rule on a pilot basis, the

Commission noted that it ‘‘preliminary

believes that the proposal will not

adversely affect market quality and

liquidity’’ 20 and that it ‘‘believes there

are substantial reasons * * * to expect

that reducing market makers’

proprietary quotation size requirements

in light of the shift to a more orderdriven market would be beneficial to

investors.’’ 21 In addition, the

Commission stated that, ‘‘based on its

experience with the markets and

discussions with market participants,

[it] believes that decreasing the required

quote size will not result in a reduction

in liquidity that will hurt investors. ’’22

Nevertheless, in light of concerns

raised by commentators opposed to the

Actual Size Rule regarding the potential

adverse impacts of the rule on market

liquidity and volatility, the Commission

originally determined to approve the

rule on a three-month pilot basis to

afford to the Commission and the NASD

an opportunity to gain practical

experience with the rule and evaluate

its effects. The factors identified by the

Commission to be considered in this

evaluation include, among others, the

impact of reduced quotation sizes on

liquidity, volatility and quotation

spreads.23

As detailed below, the NASD has

concluded that implementation of the

SEC’s Order Execution Rules has

significantly improve the quality of the

Nasdaq market by creating a market

structure where customer limit orders

provide liquidity and effectively

compete with market maker quotations.

In this type of environment, the NASD

believes that regulatory necessity for the

Mandatory Quote Size Requirements no

longer exists. Nonetheless, the NASD

determined to extend and broaden the

pilot to gain greater experience with

voluntary quotation size. The NASD is

proposing the pilot be expanded to

include an additional 100 securities and

extended until March 27, 1998.

To evaluate that pilot, the NASD’s

Economic Research Department

conducted an economic analysis of the

pilot’s operation and of the impact of

the Commission’s Order Handling

Rules.24 The analyses thus far indicates

three general findings concerning

implementation of the SEC’s Order

Execution Rules and the Actual Size

Rule: (1) The SEC’s Order Execution

Rules have dramatically improved the

quality of the Nasdaq market,

particularly with respect to the size of

spreads: (2) among those securities

subject to the SEC’s Order Execution

Rules, there is no appreciable difference

in market quality between those

securities subject to the Actual Size

Rule and those securities subject to

Mandatory Quote Size Requirements;25

and (3) implementation of the Actual

Size Rule has not resulted in any

significant diminution of the ability of

investors to receive automated

executions through SOES, SelectNet, or

proprietary systems operated by brokerdealers. Accordingly, as is the case with

100-share minimum quotation size

requirements applicable to exchange

specialists in order-driven markets, the

NASD believes that the Actual Size Rule

has not harmed investors or the quality

of the Nasdaq market.

In the June Study, the NASD found

that pilot and non-pilot stocks

experienced virtually the same

improvements in market quality since

the implementation of the Order

Handling Rules. Specifically, the NASD

found that investors in pilot stocks

continued to have substantial and

reasonable access to market maker

capital through both SOES and market

makers’ proprietary automatic execution

systems.26

A. Implementation of the SEC’s Order

Execution Rules Has Resulted in

Significant Benefits to Investors and

Enhanced the Quality of the Nasdaq

Market

NASD Economic Research evaluated

measures of market quality in four main

areas: spread, volatility, quoted depth,

and liquidity. The Pilot Stocks and the

second tranche of 50 stocks to become

subject to the Order Handling Rules

both include 40 stocks selected from the

first through fifth deciles of the 1,000

most active Nasdaq stocks. Therefore,

those from the Pilot Stocks (‘‘First 40’’)

are reasonable peers of those from the

February 10 tranche (‘‘Second 40’’).27

The NASD believes that, as shown

below, the similar performance of the

First 40 and Second 40 indicates that

the Actual Size Rule did not impair the

markets for these securities.

1. Spreads 28

The NASD looked at mean spreads for

the First and Second 40 and found that

mean spreads declined by about $0.12

for both the First 40 and the Second 40,

or by about 33%. For the First 40, the

mean spread declined from $0.41 to

$0.28, and for the Second 40 the mean

spread declined from $0.36 to $0.24.

The results in the NASD’s study

indicate an equivalent spread effect

across the two groups. These results

provide no statistically significant

evidence of a differential change in

quoted spreads between the First 40 and

Second 40. Therefore, the NASD

believes there is no effect on quoted

spreads associated with removal of the

1,000-Share Quote Size Rule.
Federal Register / Vol. 62, No. 214 / Wednesday, November 5, 1997 / Notices 59935

29See also Summary of Comments, Section B.5.

30 June Study at 31.

31 June Study at 35 and Table B.5 of Appendix B.

32 June Study at 34.

33See also Summary of Comments, Section B.4.

34Normalized effective depth is defined as the

dollar volume required to move the BAM one

percentage point, calculated for BAM moves of the

following percentage movements; all movements,

0.5%, 1%, 1.5%, 2%, 2.5%, and 3%.

35See also Summary of Comments, Section B.9.

36The NASD also found that between August 11

and 29, 1997, SOES access was restricted to 100

shares only 1.2% of the time. That is, only 1.2%

of the trading day was it the case that there was no

market maker at the inside quoting an amount

greater than 100 shares. September Study at 4.

37See June Study at 42–46. For example, for the

First 40, average SOES trade size fell by 15.0% and

by 6.0% for the Second 40. It is important to note,

however, that given that the mean price of stocks

in the First 40 was roughly $35, the average SOES

trade size of 753 shares represents a trade of

approximately $26,000. Compared to most retail

activity, the average SOES trade in the First 40

continues to be quite large. Given that the average

SOES trade size is still large and that SOES

continues to account for a substantial proportion of

Nasdaq dollar volume, it is unlikely that the

decrease in average trade size of SOES executions

has negatively impacted the ability of the SOES

system to provide executions for retail-size orders.

38See also Summary of Comments, Section B. 10.

2. Volatility 29

The NASD looked at the volatility of

the First and Second 40 and found that

volatility slightly increased following

the imposition of the Order Handling

Rules for both the First 40 and the

Second 40. For the First 40, average

volatility rose from 1.16% to 1.25%, an

increase of 7.6%. For the Second 40,

volatility rose from 0.98% to 1.24%. It

also found that the increase in volatility

does not, however, appear to be

attributable to the Order Handling

Rules, because volatility also increased

for other stocks in the top 500 that had

not become subject to the Order

Handling Rules during the sample

period.

On the surface, the results indicate a

general increase in volatility, in

particular for the Second 40 stock

group. In order to correct for stockspecific characteristics such as price,

volume, and interday volatility, the

NASD used a multivariate regression

analysis. The multivariate regression

results show that the differential

increase in volatility for the Second 40

can be attributed to volume, price, and

interday volatility.30 In the presence of

these factors, the differential volatility

effect on the Second 40 is statistically

insignificant. The NASD found that

these results demonstrate that there is

no statistically significant evidence of a

differential change in intraday volatility

between the First 40 and Second 40.

3. Quoted Depth Measures

The NASD examined the impact of

the Actual Size Rule on quoted depth.

First the NASD studied the percentage

change in number of market makers and

the percentage change in number of

market makers at the market maker

inside market. After performing a

regression analysis, it found no

statistically significant difference

between the First 40 and the Second

40.31 For both measures, the marginal

impact of the removal of the 1,000-Share

Quote Size Rule is negligible. The

NASD also studied the distribution of

the sizes of all dealer quote updates. It

found that quote updates for 100 and

1,000 share stocks were similar for the

First 40 and the Second 40.32

Based on this evidence, the NASD

concluded that the changes in quoting

behavior induced by the

implementation of the Order Handling

Rules have been qualitatively similar for

both the First 40 and Second 40.

4. Liquidity 33

The NASD looked at effective depth

in order to measure liquidity. Similar to

the sections on spread, volatility, and

quoted depth measures above, the

change in normalized effective depth 34

after implementation of the Order

Handling Rules was calculated for the

First 40 and Second 40. Effective depth

is calculated for each Bid-Ask Midpoint

(‘‘BAM’’) movement category, and mean

values across all stocks and days in the

sample for each category were

calculated. The NASD applied

multivariate regression analysis and

found that there is no statistically

significant association between the

removal of the 1,000-Share Quote Size

Rule and any change in normalized

effective depth.

After accounting for changes in stock

price, trading volume, and interday

volatility, the NASD found no evidence

of a statistically significant association

between the removal of the regulatory

minimum size for proprietary quotes

and a change in liquidity.

B. Implementation of the Actual Size

Rule Has Not Resulted in any

Diminution in the Ability of Investors To

Receive Automated Executions Through

SOES, SelectNet, or Other Proprietary

Systems Operated by Broker Dealers 35

For some market participants,

Nasdaq’s SOES system is the primary

means they use to obtain executions.

Use of the SOES system has increased

over the past few years. SOES

executions accounted for 8.3% of all

Nasdaq share volume in 1996, up from

5.6% in 1995 and 3.0% in 1993. Much

of the SOES activity is derived from day

traders. The majority of SOES orders are

for 1,000 shares, the maximum tier size

for stocks.

As detailed above, the SOES system

was changed on January 20 to execute

orders based on market maker quoted

size. The NASD examined SOES activity

to determine if the removal of the 1,000-

Share Quote Size Rule diminished the

ability of the SOES system to provide

executions.

First, the NASD examined whether

the incidence of ECNs alone at the

inside market was different for the First

40 and Second 40 stocks. When an ECN

is alone at the inside, SOES is

unavailable. The NASD found that ECNs

were alone at the inside market only

9.2% of the time after implementation

of the Order Handling Rules for the First

40 stocks, and only 9.4% of the time for

the Second 40.36 Second, the NASD

examined how often all market makers

at the inside market were quoting a size

of 100. The NASD found that this

occurred only 1.6% of the time in the

First 40 stocks and only 0.8% of the

time in the Second 40.

Both measures provide evidence from

which the NASD concluded that times

during which SOES is unavailable are

uncommon and that the degree of any

degradation of the effectiveness of SOES

due to the Actual Size Rule is

statistically insignificant. Moreover, the

NASD concluded that only certain

measures of SOES performance (e.g.,

multiple price SOES executions, average

SOES trade size) have experienced any

marginal change between the First 40

and the Second 40.37 To the extent a

marginal difference exists, the NASD

found it to be slight and therefore

concluded that the removal of the 1,000-

Share Quote Size Rule has had no

meaningful effect on the SOES system’s

ability to provide reasonable access to

executions.

C. Response to Electronic Traders

Association (‘‘ETA’’) Study 38

The ETA is an association

representing SOES order entry firms

whose customers use SOES for day

trading. The ETA conducted its own

study of the Actual Size Rule. Its study

found that SOES orders in pilot stocks

are less likely to be executed than for

non-pilot stocks; that the mean time

between entry and execution of a SOES

order is longer for pilot than for nonpilot stocks; and that the mean price

concession is larger for pilot stocks than

for non-pilot stocks.

The NASD examined the ETA study

and found it seriously flawed. The

NASD noted that the ETA study is based

on a small sample of data from three of
59936 Federal Register / Vol. 62, No. 214 / Wednesday, November 5, 1997 / Notices

39September study at 3.

40Some market participants have asserted that the

lack of difference in performance between the First

40 and the Second 40 is attributable to the

operation of several features of SOES. Specifically,

these market participants claim that the SOES AutoRefresh Feature, which refreshes a market maker

quote to the applicable SOES tier size once its quote

has been completely decremented, along with the

‘‘No Decrementation’’ and ‘‘Supplemental Size’’

features of SOES, artificially increase the number of

1000-share quotes in the first 50 securities. The ‘‘No

Decrementation’’ feature of SOES allows a market

maker to provide that its quote shall not be

decremented after the execution of SOES orders. To

use this feature, a market maker’s quote size must

be equal to the applicable SOES tier size. The

‘‘Supplemental Size’’ feature of SOES allows a

market maker to establish a ‘‘supplemental size’’

that is used to automatically replenish a market

maker’s quote once it has been completely

decremented. When a market maker’s quote is

replenished from the supplemental size, it is

replenished to 1000 shares. In order to use this

feature, a market maker must initially enter a quote

size equal to or greater than the applicable SOES

tier size. The NASD notes that market maker’s use

of each of these system features is completely

voluntary and they are available for all Nasdaq

securities. Accordingly, the NASD believes it would

be inaccurate to assert that these SOES features

have obfuscated the impact of the Actual Size Rule.

Id. 62 FR at 19371.

41Ten additional stocks were chosen to make up

for delistings within the first 50 stocks in the pilot

and as reserves in case other pilot stocks delist.

Only domestic common stocks were chosen.

42Actual Size Approval Order, 62 FR 2415.

43As discussed above, ten additional stocks were

chosen to replace those pilot stocks that have

already delisted or that may delist in the future. The

proposal still calls for the pilot to expand from 50

to 150 stocks.

the 425 firms that enter orders through

SOES; the ETA does not distinguish

between SOES orders that were actively

canceled by the order entry firm and

those that were returned to the order

entry firm; and the ETA report does not

account for considerable differences in

the average trading characteristics (e.g.,

price, volume) between pilot and nonpilot stocks. The NASD found that the

ETA study provides ‘‘no basis to

conclude that the Actual Size Rule has

adversely affected the ability of the

SOES system to provide investors with

reasonable access to market maker

capital.’’ 39

D. The Pilot Justifies an Expansion and

Extension of the Actual Size Rule

While some market participants may

maintain that the Actual Size Rule

should be abandoned because it has not

had a demonstrably positive market

impact, the NASD believes, in light of

the pilot experience and its economic

research, that the Rule should be

retained. The NASD believes it

eliminates an unnecessary regulatory

requirement and, moreover, it has not

had any adverse market impacts. In

particular, with respect to the first 50

securities, the NASD believes that

competitive forces in the marketplace,

be they the result of displaying

customer limit orders, ECN quote

display, or market maker competition

for order flow, have driven the Nasdaq

market to perform at least as well, if not

better, than if the artificial 1,000 share

minimum quotation size requirement

was in place.40 As a result, given the

conclusion that the market performs the

same with or without the Actual Size

Rule, the NASD believes it is far

preferable for the protection of investors

and the efficiency of the capital

formation process to promote a

regulatory environment for Nasdaq that

achieves its results through aggressive

competition rather than artificial

regulatory fiat. In sum, in light of the

performance of the first 50 securities,

the NASD believes there is no regulatory

basis to justify the retention of artificial

quotation size requirements for Nasdaq

market makers.

The NASD is proposing to expand the

pilot to 150 stocks in order to provide

a better sample of stocks to use in

studying the effects of the Actual Size

Rule upon the Nasdaq Market. Further,

to address criticism by several

commentators that the group of stocks

making up the pilot (both currently and

as the NASD initially proposed to

expand it) is not an ideal sample of

Nasdaq stocks upon which to base a

decision on the future of the Actual Size

Rule, the NASD altered the group of 100

stocks it is proposing to add to the

current pilot.

The NASD has selected stocks that are

representative of the entire Nasdaq

market by sampling across dollar

volume categories. Within dollar

volume categories, it sought variation

across SOES tier sizes of 1,000 and 500

shares. The NASD then randomly chose

100 stocks.41

V. Conclusion

The Commission approved the Actual

Size Rule on a pilot basis so that the

effects of the rule could be assessed. In

doing so, the Commission stated that it

believed that a reduction in the

quotation size requirement could reduce

the risks that market makers must take,

produce accurate and informative

quotations, and encourage market

makers to maintain competitive prices

even in the changing market conditions

resulting from the Order Execution

Rules.

As discussed above, the NASD has

produced an extensive economic

analysis of the pilot, and several

commentators have provided their own

economic analysis as well. These

economic analyses have proved useful

in assessing the pilot Program’s impact

on the Nasdaq market. Although the

economic studies arrive at conflicting

results on the value of the Actual Size

Rule, the Commission preliminarily

believes that the data indicates that the

pilot has not resulted in harm to the

Nasdaq market. Indeed, as discussed

above, the Actual Size Rule appears to

be a reasonable means to provide market

making obligations that reflect the new

market dynamics produced by the Order

Execution Rules. Nevertheless, as

several commenters noted, the pilot

Program was limited to 50 out of over

5,000 securities. Moreover, the

Commission had decided that it would

be appropriate to gather further data

before reaching a final decision as to

whether or not to extend the Actual Size

Rule to the entire Nasdaq market. The

Commission notes that there has been

some disagreement as to how to

interpret the data the NASD and others

have published concerning the pilot

Program. This is due in part to the

limited nature of the pilot Program and

the need for commenters to extrapolate

data concerning these 50 securities to

the entire Nasdaq market. These

problems can be reduced if the pilot is

expanded as proposed. An extension

and expansion of the pilot will provide

the Commission, the NASD, and market

participants with additional data and

time to study the Order Execution

Rules’ effects on the Nasdaq market.

Based upon the expanded pilot, the

Commission will be in a better position

to evaluate the impact of the Actual Size

Rule upon the Nasdaq market.

The NASD initially proposed to

expand the pilot Program by adding the

100 securities that were next to be

phased-in under the Order Execution

Rules earlier this year. Although the

first 50 securities were chosen to

provide a broad cross section of the

most liquid Nasdaq securities,42 the

NASD filed Amendment No. 3 to select

an additional 110 securities 43 from an

enhanced sample more representative of

the entire Nasdaq market. This was

done in response to a number of the

comment letters which suggested that

the First 50 securities were not

representative of the Nasdaq Market.

Specifically, it was suggested that,

because all 30 of the largest Nasdaq

stocks were subject to the 100 share

minimum, it was impossible to gauge

the Actual Size Rule’s effect on large

Nasdaq stocks, since there were no

sufficiently large non-pilot stocks with

which to compare.

These additional 100 securities were

chosen from those domestic Nasdaq

National Market (‘‘NNM’’) stocks with a
Federal Register / Vol. 62, No. 214 / Wednesday, November 5, 1997 / Notices 59937

44The Commission also has determined to

approve the replacement of those securities in the

pilot that are no longer listed on Nasdaq with others

from the list of securities provided by the NASD.

45 In approving this rule, the Commission notes

that it has considered the proposed rule’s impact on

efficiency, competition, and capital formation. The

proposed rule likely will produce more accurate

and informative quotations and encourage market

makers to maintain competitive prices. It will also

provide the Commission with additional data,

enabling it to evaluate better the impact of the

Actual Size Rule on the Nasdaq market and market

participants. Since the Commission believes that

the data discussed above indicates that the pilot has

not resulted in harm to the Nasdaq market thus far,

the net effect of approving the proposed rule change

will be positive. 15 U.S.C. 78c(f).

46 15 U.S.C. 78s(b)(2).

SOES tier size of either 1,000 or 500

shares that were not included in the

First 50. These stocks were ranked by

average (mean) daily dollar volume over

the first seven months of 1997, and then

divided into deciles, each containing

approximately the same number of

stocks. Eleven stocks were chosen at

random from each decile, for a total of

110 stocks. Ten extra stocks were

chosen to make up for four stocks of the

First 50 that no longer trade on Nasdaq,

and as reserves should any delist in the

interim. This ensures that a total of 150

stocks will be ultimately subject to the

Actual Size Rule is approved. The

chosen stocks will be identified in a fax

or Notice to Members published after

SEC approval of the proposed rule

change.

The Commission believes that the

proposed amendment is consistent with

the Exchange Act because it will

provide for a more representative group

of securities under an expanded Actual

Size Rule pilot. The next 100 stocks

include securities with significantly

different trading volumes, so the NASD

will be better able to assess the impact

of the Actual Size Rule on the full

panoply of Nasdaq stocks. This will

further the evaluation of the Actual Size

Rule and will assist the SEC in its

determination as to whether to expand

the pilot ultimately to all Nasdaq

securities or to end it. In addition,

Amendment No. 3 responds to the

commentators who expressed concern

that an expansion of the pilot to 150

stocks would capture stocks that

account for a large majority of Nasdaq

trading volume and SOES activity, and

thus act as a de facto implementation of

the Actual Size Rule. Regardless of the

validity of this concern, the modified

additional 100 stocks no longer contain

only the next 100 most active stocks.

The Commission requests that the

NASD continue to evaluate the effects of

the reduction in the minimum quotation

size for those Nasdaq stocks included in

the pilot. Specifically, the NASD should

continue its analysis of. (1) The number

and composition of the market makers

in each of the 50 securities, and any

change over time; (2) the average

aggregate dealer and inside spread by

stock over time; (3) the average spread

for each market maker by stock; (4) the

average depth by market maker

(including limit orders), and any change

in the depth over time; (5) the fraction

of volume executed by a market maker

who is at the inside quote per stock; and

(6) a measure of volume required to

move the price of each security one

increment (to determine the overall

liquidity and volatility in the market for

each stock). Finally, the NASD should

compare data for each decile of

securities, focusing particular attention

on relatively active versus inactive

securities that are among the lower tier

of NNM securities, by daily dollar

trading volume.

VI. 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, NW.,

Washington, DC 20549. Copies of the

submission, all subsequent

amendments, all written statements

with respect to Amendment No. 3 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–97–26 and should be

submitted by November 26, 1997.

VII. Commission’s Findings and Order

Granting Accelerated Approval of

Amendment No. 3 to the Proposed Rule

Change

For the reasons discussed above, the

Commission finds that the NASD’s

proposal is consistent with the

Exchange Act and the rules and

regulations thereunder applicable to a

national securities association and has

determined to approve the expansion of

the pilot to 150 Nasdaq securities and to

extend the pilot through March 27,

1998.44

The Commission also is approving

Amendment No. 3 on an accelerated

basis. In Amendment No. 3, the NASD

has addressed criticism by several

commentators who believe that the

current pilot is not well designed to

study effects of the Actual Size Rule.

These commentators believe that the 50

stock pilot is not sufficiently

representative of the entire Nasdaq

Market and cannot form the basis for an

adequate economic study. In particular,

the commenters stated that most of the

20 largest Nasdaq stocks are subject to

Actual Size Rule and that very few

small stocks are subject to rule, and thus

it is impossible to gauge the rule’s effect

on the largest and smallest stocks

without similar groups of nonpilot

stocks to use in comparison.

The Commission finds that the 150

stock pilot the NASD is now proposing

is a reasonable sampling of the Nasdaq

market, calculated to allow the NASD

and others to study the effects of the

Actual Size Rule. The Commission also

believes that approving Amendment No.

3 to the proposed rule change will

provide it with additional data for use

in determining whether to expand the

Actual Size Rule to cover the entire

Nasdaq market or to take another course

of action. The Commission finds good

cause in approving the extension

element of Amendment No. 3 to the

proposed rule change on an accelerated

basis in order to give the NASD

sufficient time to collect data on the

expanded pilot, analyze that data, and

publish a report on its findings. By

allowing the NASD to begin its analysis

quickly so that it may publish its

findings promptly, commentators will

have more time to examine the study

and the Commission will be in a better

position to make a determination on the

future of the Actual Size Rule in a

timely manner. An additional three

months is designed to provide the

Commission and the public time to fully

consider the results of the NASD’s

economic study and is merely a

technical change to prevent a rushed

study and comment period. The

Commission therefore finds good cause

for approving the proposed rule change

prior to the thirtieth day after the date

of publication of notice of filing thereof.

Accordingly, the Commission believes

that the proposed rule change (SR–

NASD–97–26) is consistent with

Sections 15A(b)(6) and (b)(9) of the

Exchange Act 45 and

It is therefore ordered, pursuant to

Section 19(b)(2) of the Exchange Act,46

that the proposed rule change, SR–

NASD–97–26, be and hereby is

approved through March 28, 1998.
59938 Federal Register / Vol. 62, No. 214 / Wednesday, November 5, 1997 / Notices

47 17 CFR 200.30–3(a)(12).

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.47

Jonathan G. Katz,

Secretary.

[FR Doc. 97–29296 Filed 11–4–97; 8:45 am]

BILLING CODE 8010–01–M

SOCIAL SECURITY ADMINISTRATION

Statement of Organization, Functions

and Delegations of Authority

This statement amends part S of the

Statement of the Organization,

Functions and Delegations of Authority

which covers the Social Security

Administration (SSA). Chapter S7

covers the Deputy Commissioner for

Human Resources. Notice is given that

Chapter S7 is being amended

throughout to reflect organizational and

functional changes. Notice is further

given to reflect that Subchapter S7C, the

Office of Labor-Management Relations is

being retitled as the Office of LaborManagement and Employee Relations

(S7C). The changes are as follows:

Section S7.10 The Office of the Deputy

Commissioner, Human Resources—

(Organization)

Retitle:

E. The Office of Labor-Management

Relations (S7C) to the Office of LaborManagement and Employee Relations

(S7C).

Section S7.20 The Office of the Deputy

Commissioner, Human Resources—

(Functions):

Amend to read as follows:

A. The Deputy Commissioner, Human

Resources (DCHR) (S7) is directly

responsible to the Commissioner for

carrying out the ODCHR mission and

providing general supervision to major

components of ODCHR as well as

guidance, support and technical

assistance to the SSA regional personnel

administration operation and policy and

direct service support to the Agency’s

executive personnel activities and other

high level special categories.

C. The Immediate Office of the

Deputy Commissioner, Human

Resources (S7A).

Change to read as follows:

1. Provides the Deputy Commissioner

and the Assistant Deputy Commissioner

with staff assistance on the full range of

their responsibilities.

2. Develops and implements all SSA

policies and activities relating to the

Agency’s executive level personnel

management program.

3. Recruits for and places individuals

in positions in the Senior Executive

Service (SES) in accordance with OPM

regulations.

4. Provides staff support to the

Executive Resources Board in

administering a systematic program to

manage SSA’s executive and

professional resources and ensuring the

appropriate selection of candidates to

participate in official executive

development programs.

5. Provides staff support to the

Performance Review Board in reviewing

performance plans and subsequent

appraisals of career and non-career

executives in SES and employees in

equivalent level positions.

D. The Office of Personnel (OPE)

(S7B).

Delete from the fourth sentence

‘‘executive personnel services.’’

Retitle:

E. The Office of Labor-Management

Relations (S7C) to the Office of LaborManagement and Employee Relations

(S7C).

Retitle:

Existing Subchapter S7C, ‘‘The Office

of Labor-Management Relations’’ (S7C)

to ‘‘The Office of Labor-Management

and Employee Relations’’ (S7C). Change

all references to ‘‘The Office of LaborManagement Relations’’ to ‘‘The Office

of Labor-Management and Employee

Relations’’ and all references to

‘‘OLMR’’ to’’OLMER’’.

Section S7B.00 The Office of

Personnel—(Mission)

Delete from the first sentence

‘‘executive personnel services.’’

Section S7B.20 The Office of

Personnel—(Functions)

D. The Project Management Staff

(S7BH).

Amend as follows:

4. Develops and implements SSAwide program of Personnel security.

Directs personnel security activities

having SSA-wide significance.

5. Designs national policies for the

SSA Drug-Free Workplace Program.

Manages the day-to-day operations of

the Agency’s drug program.

6. Directs the development and

operation of SSA’s Workers’

Compensation services program.

Provides assistance to employees

regarding claims for loss of wages,

settlement awards, notices of injury and

required medical reports.

F. The Center for Personnel

Operations (S7BK).

Delete the following from Item 1,

sentence 1: ‘‘including policies and

guidelines for SSA administration of the

Senior Executive Service (SES).’’

Change to read as follows:

2. Develops and implements SSAwide programs of position classification

and position management within SSA

headquarters. Directs position

classification and position management

activities having SSA-wide significance.

Add a last sentence to Item 8:

Serves as the focal point for

unemployment compensation activities.

Delete Items 10 through 13.

Section S7C.00 The Office of LaborManagement and Employee Relations—

(Mission)

Amend to read as follows:

The Office of Labor-Management and

Employee Relations (OLMER) provides

overall management of an SSA-wide

program of labor-management and

employee relations. The mission

includes the development and

evaluation of the programs and the

formulation of SSA-wide labormanagement relations policy. The office

provides services to SSA components

on labor relations issues and on

employee relations issues relating to

disciplinary and adverse actions and

employee grievances.

Section S7C.20 The Office of LaborManagement and Employee Relations—

(Functions):

Amend to read as follows:

C. The Immediate Office of the

Director, Office of Labor-Management

and Employee Relations (S7C) provides

the Director and the Human Resources

Manager with staff assistance on the full

range of their responsibilities. The

functions of the office include the

following:

1. The formulation and promulgation

of Agency policy, guidance and

direction for exercising management’s

rights and discharging the Agency’s

obligations under labor and employee

relations law, executive orders,

regulation, and negotiated agreements.

The research of policy questions in

these areas for management at various

levels of the organization. Coordinating

with the Office of the General Counsel

(OGC) on matters impacting on law or

requiring legal opinions.

2. The negotiation, implementation

and administration of master

agreements nationwide, which involves

pre-negotiated activities, team

preparation, advisory services and

problem resolution.

3. Negotiating agreements on behalf of

the Agency with unions having

exclusive recognition at the level of the

Agency, advising and assisting

management representatives in

negotiating labor-management