[Federal Register Volume 62, Number 36 (Monday, February 24, 1997)]
[Notices]
[Pages 8289-8291]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-4445]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38294; File No. SR-NASD-97-07]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Temporary Accelerated Approval of Proposed Rule Change by the 
National Association of Securities Dealers, Inc. Relating to Rule 4612, 
Primary Nasdaq Market Maker Standards Through October 1, 1997

February 14, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on January 31, 1997, the 
Nasdaq Stock Market, Inc. (``Nasdaq'') filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
change as described in Items I and II below, which Items have been 
prepared by Nasdaq. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons and to 
grant accelerated approval to the proposal.
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    \1\ 15 U.S.C. Sec. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Pursuant to the provisions of Section 19(b)(1) under the Act, 
Nasdaq, a wholly owned subsidiary of the National Association of 
Securities Dealers, Inc. (``NASD'' or ``Association''), is herewith 
filing a proposed rule change to temporarily suspend the use of the 
Primary Nasdaq Market Maker qualification criteria found in Rule 4612 
(a) and (b) of the Nasdaq Market Maker Requirements of the NASD Rules 
for all Nasdaq National Market securities for the remainder of the 
current pilot period of the Nasdaq Short Sale Rule or until such 
earlier time when new primary market maker qualification criteria can 
be devised and adopted.

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

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

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

    After the first week of trading under the new SEC rules regarding a 
Nasdaq market maker's order handling obligations, i.e., Rule 11Ac1-4 
(the customer limit order display rule) and amended Rule 11Ac1-1 
(amendments to the firm quote rule regarding the display of priced 
orders entered by market makers or specialists into electronic 
communications networks (``ECNs'')),\2\ Nasdaq has re-evaluated its 
existing qualification criteria in the primary market maker standards 
rule, Rule 4612 (a) and (b), in those stocks that are not subject to 
the primary market maker standard suspension approved in SR-NASD-96-
55.\3\ In that rule filing, Nasdaq noted that because of the potential 
changes in quotation and trading activity in Nasdaq securities when the 
new SEC Rules became effective, the existing numerical criteria used to 
qualify a registered market maker as a primary market maker would be 
significantly affected. Because the precise effects on market maker 
quotes and trades were not possible to predict until Nasdaq could 
develop practical experience with new patterns of activity under the 
new rules, Nasdaq believed that it should attempt to minimize the 
possible harmful unintended consequences that could occur by leaving 
the current standards in place. Accordingly, Nasdaq proposed, and the 
SEC approved, that the existing standards would be temporarily 
suspended on the same schedule for the phase in of the SEC Rules 
requirements.
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    \2\ See Securities Exchange Act Release No. 37619A (September 6, 
1996); 61 FR 48290 (September 12, 1996) (Order Handling Rules 
Adopting Release).
    \3\ See Securities Exchange Act Release No. 38175 (January 23, 
1997); 62 FR 3548.
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    However, based upon trading experience in the first week of trading 
under the new SEC and NASD Rules, Nasdaq believes that the primary 
market maker standards should be suspended immediately for all National 
Market securities and all registered market makers in those securities 
should be designated as primary market makers. Nasdaq bases this 
proposed rule change on three factors that were not readily apparent at 
the time it filed SR-NASD-96-55: (1) many market makers have 
voluntarily chosen to display customer limit orders in their quotes 
even though the SEC's Limit Order Display Rule does not yet require it; 
(2) SOES decrementation for all Nasdaq stocks has significantly 
affected market maker ability to meet several of the primary market 
maker standards; and (3) with the inability to meet the existing 
criteria for a larger number of securities, a market maker may be 
prevented from registering as a primary market maker in an initial 
public offering because it fails to meet the 80% primary market maker 
test contained in Rule 4612(g)(2)(B).
    Under existing Rule 4612, a registered Nasdaq Market Maker may be 
deemed to be a Primary Market Maker in National Market securities if 
the market maker meets two of three criteria: (1) the market maker 
maintains the best bid or best offer as shown on Nasdaq no less than 
35% of the time; (2) a market maker maintains a spread no greater than 
102% of the average dealer spread; and (3) no more than 50% of a market 
maker's quotation changes occur without a trade execution. In addition, 
if a registered market maker meets only one of the above criteria, it 
may nevertheless qualify as a primary market maker if the market maker 
accounts for volume at least 1\1/2\ times its proportionate share of 
overall volume in the stock. The review period for meeting any of these 
criteria is one calendar month. Nasdaq notifies a market maker at the 
beginning of the new calendar month if it does not meet the tests, and 
one business day following the notification, Nasdaq withdraws the ``p'' 
designator.
    The changes to market maker quotation and trading activities have 
been dramatic in the first week of trading in the new environment. To 
provide their customers with the greater transparency, many market 
makers have begun to display customer limit orders in all Nasdaq 
securities, not only those subject to the phase-in of the Limit Order 
Display Rule, Rule 11Ac1-4. With the voluntary display of customer 
limit orders in stocks not yet subject to Rule 11Ac1-4, Nasdaq market 
makers are changing their quotes when they are in

[[Page 8290]]

receipt of customer limit orders that improve upon their current 
quotations. Because more dealer quotes are now being driven not merely 
by the market maker's proprietary interests, but also the interests of 
customers that place limit orders with the market maker, Nasdaq 
believes that a market maker's ability to meet the 102% of average 
dealer spread test may be more difficult to meet. For example, because 
a quote of a market maker driven by a customer limit order is 
indistinguishable from that of a quote driven by a customer order, it 
is impossible to tell when market maker quote changes are being driven 
by customer interests that are entered and then subsequently canceled 
without any execution. In addition, the test regarding the percentage 
of time in which the market maker's quote is at the inside will also be 
driven to some extent by customer limit order interest.
    Moreover, the SOES decrementation feature is having a significant 
impact on individual market maker quotations. Under the new SOES rules, 
which apply to all securities, when SOES executes against a quotation, 
whether it is on behalf of a customer or not, Nasdaq's system decreases 
the quotation size. If the quote is decreased to zero, and the market 
maker has the Nasdaq auto-refresh feature turned on, the market maker's 
quote is changed pursuant to that execution, However, because the auto-
refresh moves only one side of the market maker's quote, the market 
maker's quote is spread wider than many market makers want. Therefore, 
market makers then change the quote to a narrower spread. While Nasdaq 
believes that narrower spreads are beneficial for investors overall, in 
this instance, the quote movement without a corresponding trade causes 
the market maker to exceed the 50% quote to trade ratio established in 
the primary market maker standards. If the market maker, on the other 
hand, chooses not to narrow its quote after the auto-refresh, that 
market maker runs the risk that it may not meet the 102% of the average 
spread test. Finally, Nasdaq notes that if a market maker fails to meet 
the standards and falls below the test regarding being a primary market 
maker in 80% or more of the securities for which it is registered as a 
market maker, it will not be allowed to register as a primary market 
maker in an initial public offering, even if it is an underwriter of 
that security and may be required to play an important liquidity 
providing role in that stock's initial trading activity.
    Nasdaq believes that it is in the public investor's best interests 
to temporarily suspend the operation of the primary market maker 
standards that currently exist. If the standards are not suspended, the 
significant shift in the patterns of quotation and executions that 
Nasdaq is beginning to experience is going to cause primary market 
makers operating under the existing standards to lose that status. Loss 
of the designation would mean that market makers without the designator 
would not be permitted to avail themselves of the short sale exemption 
for primary market makers. If a significant number of registered market 
makers were to lose the short sale exemption, or if a single market 
maker that handled a significant portion of the order flow in a 
security were to lose the exemption, liquidity in that particular stock 
could be seriously harmed.
    Therefore, as of February 3, 1997, any registered market maker 
would be able to avail itself of the short sale exemption for qualified 
market makers found in Rule 3350(c)(1). In seeking to temporarily 
suspend the use of the primary market maker qualification criteria, 
Nasdaq believes that the suspension of the criteria is an appropriate 
balance between the need for limitations on the market maker short sale 
exemption and the potential for loss of liquidity and market disruption 
in a period when new patterns and practices of trading are first being 
developed. Nasdaq believes that the period of time in which the new SEC 
Rules are first being implemented may be a period of uncertainty for 
market makers and investors alike and that the prudent course of action 
would be to identify and eliminate as many potential areas for 
increasing that uncertainty as possible. Nasdaq has identified this 
issue as a critical area of uncertainty and believes that the 
suspension of the market maker qualification standards on a temporary 
basis is an appropriate market quality response. This relief will 
enable Nasdaq market makers to better satisfy investor liquidity 
demands and could help to promote pricing efficiency.
    Nasdaq also plans to develop new standards as soon as practicable 
so that Nasdaq can obtain experience with the manner in which the new 
SEC Rules affect market makers. The plan is to analyze the data from 
January and February and discuss the practices among staff and with the 
Quality of Markets Committee.
    Nasdaq believes that the proposed rule change is consistent with 
Section 15A(b)(6) of the Act in that it is designed to prevent 
fraudulent and manipulative acts and facilities transactions in 
securities. In particular, this temporary amendment to the existing 
rule should provide market makers with certainty regarding whether they 
are entitled to an exemption under the rule which should promote market 
efficiency and enhance the orderliness of the market during a 
transition period. It should also help in reducing investor confusion 
at this time and thereby promote efficient and fair markets.

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

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

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

    Written comments were neither solicited nor received.

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

    The Commission has reviewed carefully Nasdaq's proposed rule change 
and believes, for the reasons set forth below, that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to the NASD and, in particular, the 
requirements of Section 15A(b)(6), 15A(b)(9), and 15A(b)(11). In 
addition, the Commission finds that the rule change is consistent with 
the Congressional objectives for the equity markets, set out in Section 
11A of the Act, of achieving more efficient and effective market 
operation, fair competition among brokers and dealers, and economically 
efficient execution of investor orders in the best market. In 
particular, this temporary amendment to the existing rule should avoid 
frustrating the operation of the Order Handling Rules in light of the 
existence of market factors not readily apparent at the time the NASD 
requested more limited relief with respect to the suspension of primary 
market maker standards.\4\ The Commission is approving the rule change 
on a pilot basis through October 1, 1997. During this time, however, 
the Commission expects that, as with the NASD's excess spread rule,\5\ 
the NASD must develop

[[Page 8291]]

new primary market maker standards well before the expiration of the 
pilot.
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    \4\ Id.
    \5\ As with the primary market maker standards, there is also a 
dealer spread test that is part of the NASD's ``excess spread 
rule,'' Rule 4613(d). The Commission recently approved a proposed 
rule change on a pilot basis through July 1, 1997, providing that a 
registered market maker in a security listed on the Nasdaq stock 
market shall be 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 exceeds 150 
percent of the average of all dealer spreads in such issue for the 
month. See Securities Exchange Act Release No. 38180 (January 16, 
1997), 62 FR 3725. Although the Commission approved the proposed 
rule change on a temporary basis to facilitate compliance with the 
Commission's Order Handling Rules, the Commission stated that during 
this time period, the NASD should monitor the effects of the pilot, 
as well as study alternative methods that would enhance market 
making performance while completely fulfilling the NASD's obligation 
regarding the excess spread rule before the August 8, 1997, deadline 
contained in the Commission's Order Instituting Public Proceedings 
Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, 
Making Findings and Imposing Remedial Sanctions, Securities Exchange 
Act Release No. 37538 (August 8, 1996).
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    Nasdaq has requested that the Commission find good cause pursuant 
to Section 19(b)(2) for approving the proposed rule change prior to the 
30th day after publication in the Federal Register. The Commission 
finds good cause for approving the proposed rule change prior to the 
30th day after the date of publication of notice of filing thereof in 
that accelerated approval will accommodate the Order Handling Rules, 
which went into effect January 20, 1997.\6\
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    \6\ The Division of Market Regulation issued an interim no-
action letter to the NASD and Nasdaq with respect to the enforcement 
of the NASD's primary market maker standards during the 
consideration of this proposed rule change. The approval of this 
rule change supersedes that no-action position. See Letter from 
Howard Kramer, Associate Director, Division of Market Regulation, 
SEC, to Eugene A. Lopez, Assistant General Counsel, Nasdaq, dated 
February 3, 1997.
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IV. 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 the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-97-07 and should 
be submitted by March 17, 1997.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\7\ that the proposed rule change be, and hereby is, approved on an 
accelerated basis, effective February 14, 1997 through October 1, 1997.

    \7\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 U.S.C. 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-4445 Filed 2-21-97; 8:45 am]
BILLING CODE 8010-01-M