[Federal Register Volume 62, Number 47 (Tuesday, March 11, 1997)]
[Notices]
[Pages 11245-11247]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-5983]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38354; File No. SR-NASD-97-13)
February 28, 1997.


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 the Elimination of 
the NASD's Excess Spread Rule Applicable to Market Maker Quotations in 
Nasdaq SmallCap Securities

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder, \2\ notice is hereby given 
that on February 24, 1997, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities 
and Exchange Commission (``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the self-regulatory organization. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons and to grant accelerated approval to the proposed rule change.
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    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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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 exclude market 
maker quotations in Nasdaq SmallCap securities from coverage under the 
Rule. As a result, Rule 4613(d) will apply only to quoted spreads by 
registered market makers in Nasdaq National Market securities. The text 
of the proposed rule change is as follows [new text is italicized; 
deleted text is bracketed]:
* * * * *
NASD Rule 4613  Character of Quotations
    (d) Reasonably Competitive Quotations
    A registered market maker in a Nasdaq National Market security 
[listed on The Nasdaq Stock Market] will be withdrawn as a registered 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

[[Page 11246]]

reconsideration shall not operate as a stay of the withdrawal or toll 
the twenty business day period noted in subparagraph (d) above.
    (2)-(3) No change.
* * * * *

II. 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. The NASD has prepared summaries, set forth in Sections 
A, B, and C below, of the most significant aspects of such statements.

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

1. Purpose
    On January 16, 1997, the Securities and Exchange Commission 
(``SEC'' or ``Commission'') approved modifications to NASD Rule 4613(d) 
on a temporary basis through July 1, 1997.\3\ Specifically, Rule 
4613(d), which is commonly known as the NASD's ``excess spread rule,'' 
presently provides that registered market makers in securities listed 
on The Nasdaq Stock Market (``Nasdaq'') shall be precluded from being a 
registered market maker in that 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 (``150% Excess Spread Rule'').\4\
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    \3\ See Securities Exchange Act Release No. 38180 (Jan. 16, 
1997), 62 FR 3725 (Jan. 24, 1997) (order approving File No. SR-NASD-
96-50).
    \4\ Previously, Rule 4613(d) 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 (``125 percent test''), provided, however, 
that the maximum allowable spread shall never be less than \1/4\ of 
a point (``125% Excess Spread Rule'').
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    As noted in the NASD's filing seeking approval of the 150% Excess 
Spread Rule on a temporary basis, the Rule is designed to help 
ameliorate the adverse consequences the 125% Excess Spread Rule may 
have had on the competitiveness and independence of quotations 
displayed on the Nasdaq market.\5\ At the same time, the NASD and 
Nasdaq believe the 150% Excess Spread Rule strikes a reasonable balance 
between the need to eliminate any constraints that the 125% Excess 
Spread Rule may have placed 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, such as affirmative determination 
exemptions and preferential margin treatment.
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    \5\ 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.'' See Appendix to 
Report Pursuant to Section 21(a) of the Securities Exchange Act of 
1934 Regarding the NASD and The Nasdaq Stock Market (``21(a) 
Report'') SEC, Aug. 8, 1996, at p. 98. As a result, the SEC found 
that the excess spread rule creates 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.'' Id. at p. 99 Accordingly, the SEC requested that the NASD 
``modify the rule to eliminate its undesirable effects, or to repeal 
it. Id.
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    Nevertheless, while Nasdaq and the NASD believe the 150% Excess 
Spread Rule will help to ensure that market makers maintain at least a 
minimal level of commitment to their issues, Nasdaq and the NASD 
believe it is prudent to not impose the Rule on a permanent basis until 
there is a substantial basis to conclude that the 150% Excess Spread 
Rule has not contributed to or fostered the same unintended 
consequences created by the former 125% Excess Spread Rule, such as the 
interdependence of market maker quote movements and the exacerbation of 
locked and crossed market situations. Accordingly, the SEC approved the 
NASD's proposal to implement the 150% Excess Spread Rule on a pilot 
basis through July 1, 1997. During the pilot period, Nasdaq and the 
NASD will analyze market maker quotation behavior to determine whether 
the 150% Excess Spread Rule has met its dual objectives of removing 
constraints on market maker quotation movements and ensuring some 
minimal level of commitment by market makers to their issues. 
Throughout the pilot period, Nasdaq and the NASD also will proactively 
explore whether there are other alternative means to achieve these 
objectives without reliance on a quotation-based evaluation 
criteria.\6\
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    \6\ The Commission has 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. 
Release No. 34-38180, supra note 3. 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.'' Id.
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    The NASD and Nasdaq are proposing to exclude market maker 
quotations in Nasdaq SmallCap securities from coverage under NASD Rule 
4613(d). This is because, unlike with Nasdaq National Market 
securities, Nasdaq does not presently calculate and display through the 
Nasdaq system the average spread of all market makers in Nasdaq 
SmallCap securities or a comparison of the size of an individual market 
maker's quoted spread in a Nasdaq SmallCap security relative to the 
average spread of all market makers in Nasdaq SmallCap securities.\7\ 
Thus, Nasdaq does not presently provide market makers in SmallCap 
securities with any indication as to whether they are satisfying the 
requirements of the 150% Excess Spread Rule.
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    \7\ Market makers in Nasdaq National Market securities are able 
to assess whether they are satisfying the 150% Excess Spread Rule on 
a daily basis through use of the ``Primary Market Maker (PMM) 
Window'' of Nasdaq Workstation II. Specifically, while the PMM 
standards are used to determine the eligibility of market makers to 
an exemption from the NASD's short-sale rule, Nasdaq's programs that 
enable market makers to monitor their performance under the 
``average spread'' component of the PMM standards also can be used 
by market makers to evaluate whether they have satisfied the 
requirements of the 150% Excess Spread Rule.
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    Accordingly, given the pilot nature of the 150% Excess Spread Rule 
and the length of time necessary to make system modifications to 
provide market makers in Nasdaq SmallCap securities with the ability to 
assess whether they are satisfying Rule 4613(d), the NASD and Nasdaq 
propose to eliminate market maker quotations in Nasdaq SmallCap 
securities from coverage under the 150% Excess Spread Rule. By 
excluding market maker quotations in Nasdaq SmallCap securities from 
the Rule, the NASD and Nasdaq will not be subjecting market makers in 
these securities to a performance requirement that market makers are 
incapable of monitoring. This is particularly important since failure 
to satisfy the requirement of the Rule results in the loss of 
registered market maker status for a period of 20 business days. In 
addition, for those Nasdaq National Market securities that have trading 
attributes similar to Nasdaq SmallCap securities, elimination of the 
150% Excess Spread Rule for SmallCap securities will create a ``control 
group'' that will afford Nasdaq a better opportunity to evaluate the 
effects of the 150% Excess Spread Rule. The NASD and Nasdaq anticipate, 
however, that market makers in Nasdaq SmallCap securities will be 
subject to the same

[[Page 11247]]

excess spread requirements, if any, as market makers in the Nasdaq 
National Market securities beyond July 1, 1997.
2. Statutory Basis
    The NASD and Nasdaq believe that the proposed rule change is 
consistent with Section 15A(b)(6) of the 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.

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 Act.

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

    No written comments were solicited or received with respect to the 
proposed rule change.

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 the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. Sec. 552, will be available for inspection and copying at 
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-97-13 and should 
be submitted by [insert date 21 days from date of publication].

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

    After careful review, the Commission finds, for the reasons set 
forth below, that the NASD's proposal is consistent with the 
requirements of Section 15A of the Act and the rules and regulations 
thereunder applicable to the NASD and, in particular, Section 
15A(b)(6).
    The Commission believes that it is reasonable for the NASD to 
remove application of the 150% Excess Spread Rule to market maker 
quotations in Nasdaq SmallCap securities because it is difficult for 
market makers to monitor their compliance with that Rule. This stems 
from Nasdaq's inability to calculate and display through the system the 
average spread of all market makers in Nasdaq SmallCap securities or a 
comparison of the size of an individual market maker's quoted spread in 
a Nasdaq SmallCap security relative to the average spread of all market 
makers in Nasdaq SmallCap securities.
    The NASD also points out that application of NASD Rule 4613(d) may 
impose artificial constraints on market makers' quote movements.\8\ 
According to the NASD, market makers may be less apt to adjust their 
quotes in response to market activity for fear that they will violate 
the rule and be subject to mandatory withdrawal for 20 business days. 
The Commission agrees that this is a possibility and prefers to 
eliminate the potential restraint on market maker quote movements to 
foster market maker competition, protect the price discovery process 
and preserve the integrity of quotations in Nasdaq SmallCap securities 
in furtherance of the objectives of Section 15A(b)(6). While the 
Commission approves removal of the applicability of the NASD's excess 
spread rule to market maker quotations in Nasdaq SmallCap securities, 
however, it expects the NASD to develop other means of stimulating and 
measuring sound market making performance for all Nasdaq stocks.
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    \8\ See infra note 7 and accompanying text.
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    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. By accelerating the effectiveness of the proposed 
rule change, market makers in Nasdaq SmallCap securities will not be 
subject to mandatory market maker registration withdrawals for 20 
business days for noncompliance with the 150% Excess Spread Rule.\9\ 
The Commission reiterates that the NASD should 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.\10\
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    \9\ Because the 150% Excess Spread Rule evaluates a market 
maker's spread over a full calendar month, February 1997 was the 
first month in which market maker spreads were evaluated pursuant to 
NASD Rule 4613(d). Accordingly, March 1997 will be the first month 
in which market makers will be subject to the mandatory market maker 
withdrawals for 20 business days for noncompliance with the Rule.
    \10\ See Release 34-38180, supra note 3 and 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 (Aug. 8, 1996).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\11\ that the proposed rule change (SR-NASD-97-13) is approved.

    \11\ 15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-5983 Filed 3-10-97; 8:45 am]
BILLING CODE 8010-01-M