[Federal Register Volume 60, Number 100 (Wednesday, May 24, 1995)]
[Notices]
[Pages 27579-27581]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-12698]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35732; File No. SR-NASD-94-9]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change to Provide Non-
member Viewing Access to SelectNet and that the Transmission of 
Broadcast Orders Through SelectNet be Solely on an Anonymous Basis

May 18, 1995.

I. Introduction

    On January 30, 1995, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities 
and Exchange Commission (``SEC'' or ``Commission'') a proposed rule 
change pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934 (``Act'') \1\ and Rule 19b-4 thereunder.\2\ The NASD seeks to 
amend SelectNet in two ways: (a) to provide real-time access to non-
members to view all ``broadcast'' orders in SelectNet; and (b) to 
provide that the transmission of broadcast orders through SelectNet be 
solely on an anonymous basis.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
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    Notice of the proposed rule change appeared in the Federal Register 
on April 28, 1994 \3\ and March 7, 1995.\4\ The Commission received 
letters from four commenters in response to the NASD's proposal. For 
the reasons discussed below, the Commission is approving the proposed 
rule change.

    \3\ Securities Exchange Act Release No. 33938 (Apr. 20, 1994), 
59 FR 22033 (Apr. 28, 1994) (notice of original proposal and 
Amendment No. 1).
    \4\ Securities Exchange Act Release No. 35428 (Feb. 28, 1995), 
60 FR 12583 (Mar. 7, 1995) (notice of Amendment No. 2).
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II. Background

    Originally referred to as the Order Confirmation Transaction 
Service (``OCT'') and approved by the Commission in January 1988,\5\ 
the NASD developed SelectNet in response to the difficulties 
experienced in the Nasdaq market during the market break of October 
1987. SelectNet is an electronic screen-based order routing system 
allowing market makers and order-entry firms (collectively referred to 
as ``participants'') to negotiate securities transactions in Nasdaq 
securities through computer communications rather than relying on the 
telephone.

    \5\ Securities Exchange Act Release No. 25263 (Jan. 11, 1988), 
53 FR 1430 (Jan. 19, 1988) (order approving SelectNet, previously 
referred to as the Order Confirmation Transaction Service, on a 
temporary, accelerated basis). See also, Securities Exchange Act 
Release No. 25523 (Mar. 28, 1988), 53 FR 10965 (Apr. 4, 1988) (order 
extending temporary approval of SelectNet); Securities Exchange Act 
Release No. 25690 (May 11, 1988), 53 FR 17523 (May 17, 1988) (order 
granting permanent approval of SelectNet).
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    To enter an order in SelectNet, a participant enters the normal 
trade information: security symbol, side (buy or sell), transaction 
size, and price. Participants may enter orders priced at, above or 
below the inside bid or ask and, thus, SelectNet offers the opportunity 
to negotiate for a price superior to the current inside quote. In 
addition, participants may provide that an order or counter-offer will 
be in effect for anywhere from 3 to 99 minutes, specify a day order, or 
indicate whether price or size are negotiable or whether a specific 
minimum quantity is acceptable. Participants may accept, counter, or 
decline a SelectNet order. In the event that a participant elects to 
counter an offer, the service allows negotiations to be conducted 
between the participants by exchanging counter-offers until an 
agreement is reached. Once agreement is reached, the execution is 
``locked-in'' and reported to the tape.
    Through SelectNet, participants may either direct an order to a 
particular market maker in the security, broadcast to all market makers 
in the security, or broadcast to all participants watching a particular 
security (a feature known as ``all call''). The participants then may 
negotiate the terms of the order through counter-offers entered into 
the system. SelectNet's default setting provides anonymity for 
broadcast orders. However, a participant currently entering a broadcast 
order may elect to identify itself. After an anonymous broadcast order 
is executed, each participant to the transaction learns the identity of 
the other. In contrast, directed orders always display to the receiving 
participant the identity of the participant entering the order.

III. Description of the Rule Change

    The NASD seeks to modify SelectNet in two ways. First, it proposes 
to permit non-member viewing access to orders broadcast through 
SelectNet. Second, the NASD proposes to require that broadcast orders 
be entered on an anonymous basis only.
A. Non-member Viewing Access to Broadcast Orders

    Under the NASD's proposal, non-members will be permitted to view on 
a real-time basis all orders broadcast through SelectNet. Specifically, 
non-members will be able to view all unexecuted broadcast SelectNet 
orders, including the security name, the side of the order (buy or 
sell), the quantity available, the order price, the original size of 
the order, the outstanding portion, and the duration of the order (from 
3 to 99 minutes or all day). The NASD will provide this information via 
the Level 2 Nasdaq Workstation service, to which non-members may 
subscribe. In addition, the NASD will provide a data feed of the 
broadcast SelectNet information to data vendors who in turn may provide 
the information to non-members. Under either alternative, dissemination 
of SelectNet information will be provided on a real-time basis.
    Non-members, however, will not be permitted to interact through 
SelectNet with the order or be provided access to orders directed from 
one participant to another. Moreover, because the NASD's proposal will 
restrict all broadcast orders to an anonymous basis, neither members 
nor non-members will be able to determine the identity of the 
participant entering a broadcast order.

B. All Broadcast Orders will be on an Anonymous Basis

    As currently configured, SelectNet allows a participant 
broadcasting an order to elect either to identify itself or to send the 
order anonymously. Under this proposal, however, participants will be 
limited to entering broadcast orders on an anonymous basis.\6\ If two 
firms begin negotiating the terms of a broadcast order, however, the 
participant that entered the order may choose to identify itself to the 
contra side.

    \6\ In contrast, directed orders will continue to identify the 
participant transmitting an order to another participant.
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IV. Comments

    As noted above, the Commission received letters from four 
commenters in response to the proposal. Three of the commenters 
addressed the proposal to provide non-member viewing access, with one 
of these commenters supporting the proposal and the other two opposing 
it; the fourth commenter [[Page 27580]] expressed opposition to the 
proposal to require anonymity for broadcast orders. The NASD responded 
to these comments in Amendment No. 2 \7\ and by a letter dated April 8, 
1995.\8\

    \7\ Securities Exchange Act Release No. 35428 (Feb. 28, 1995), 
60 FR 12583 (Mar. 7, 1995) (notice of Amendment No. 2).
    \8\ Letter from Richard Ketchum, Executive Vice President & 
Chief Operating Officer, NASD, to Jonathan G. Katz, Secretary, SEC 
(Apr. 28, 1995).
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    Commenters responding to the NASD's original proposal criticized it 
because it would have limited non-member viewing access to Nasdaq 
WorkStation Level 2 subscribers.\9\ These commenters argued that the 
NASD should provide this access through a vendor data feed. In 
response, the NASD amended its filing to provide to vendors a separate 
data feed of broadcast orders.\10\

    \9\ Letters from James E. Buck, Senior Vice President and 
Secretary, NYSE (June 2, 1994), Daniel Parker Odell, Assistant 
Secretary, NYSE (Mar. 28, 1995), and Craig S. Tyle, Vice President & 
Senior Counsel, Investment Company Institute (May 19, 1994), to 
Jonathan G. Katz, Secretary, SEC.
    \10\ Securities Exchange Act Release No. 35428 (Feb. 28, 1995), 
60 FR 12583 (Mar. 7, 1995) (notice of Amendment No. 2). In response 
to this amendment, the Investment Company Institute submitted a 
second comment letter, expressing its support for the proposal. 
Letter from Craig S. Tyle, Vice President & Senior Counsel, 
Investment Company Institute, to Jonathan G. Katz, Secretary, SEC 
(Mar. 28, 1995).
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    The NYSE and American Stock Exchange (``Amex'') generally opposed 
the proposal because of their concerns about the broader policy issues 
surrounding SelectNet. Specifically, the NYSE and Amex argue that 
``orders'' entered in SelectNet are actually quotations for purposes of 
the Quote Rule\11\ and, therefore, the NASD should include them for 
dissemination in the calculation of the best bid and offer.\12\ In 
response, the NASD argues that SelectNet orders lack the 
characteristics that trigger an obligation to include an order in the 
calculation of the best bid or offer in a Nasdaq security. 
Specifically, the NASD contends that unlike quotes, SelectNet orders 
are generally limited in duration\13\ and subject to price and size 
negotiation. The NASD concludes that classifying SelectNet orders as 
``indications of interest'' would be more appropriate than treating 
them as bids or offers.\14\ Moreover, the NASD argues that reassessing 
whether market maker orders broadcast through SelectNet should be 
reflected in the market maker's quote would necessarily include a 
similar assessment concerning market maker orders entered in Instinet.

    \11\ 17 CFR 240.11Ac1-1.
    \12\ The NYSE also notes in its comment letters that the 
SelectNet rules are contained in the SelectNet User Guide, but are 
not included in the NASD Manual. See SelectNet User Guide (Nov. 
1990). The NASD has committed to submit to the Commission a package 
of SelectNet rules by the end of 1995. Letter from Richard Ketchum, 
Executive Vice President & Chief Operating Officer, NASD, to 
Jonathan G. Katz, Secretary, SEC (Apr. 28, 1995).
    \13\ The NASD represents that SelectNet orders are usually 
either executed immediately or expire after three minutes. Thus, the 
NASD further argues, SelectNet orders fall within the exception that 
allows the NASD to exclude from the best bid or offer calculation an 
order which is executed immediately. 17 CFR 240.11Ac1-1(b)(1)(ii).
    \14\ Under rules promulgated pursuant to the Act, ``indications 
of interest'' are not considered bids or offers. 17 CFR 240.11Ac1-
1(a)(8).
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    One commenter opposed the NASD's proposal to modify the operation 
of SelectNet to provide that all broadcast orders be entered 
anonymously.\15\ This commenter argued that it identifies itself 
regularly with the hope that market makers will contact it to negotiate 
the order further. This commenter noted that it often wishes to be 
associated with certain buy or sell interest and that, paradoxically, 
the NASD's proposal to provide more information to non-members will 
result in less information to members.

    \15\ Letter from John C. Helmer, President, Caldwell Securities 
Incorporated, to Jonathan G. Katz, Secretary, SEC (Mar. 15, 1994).
    In response, the NASD reiterated the two concerns set forth in its 
original filing as the basis for the proposal. First, the NASD believes 
that orders entered on an anonymous basis will act to maintain the 
incentives for dealers to continue to make markets that provide needed 
liquidity. The depth and liquidity of the Nasdaq market is dependent 
upon the presence of market makers who, among other duties, are 
required to maintain firm, continuous, two-sided quotations and 
participate in automated execution systems.\16\ The NASD is concerned 
about allowing order-entry firms to advertise buy and sell interest 
without having to satisfy these obligations. Specifically, the NASD 
believes that it would be inappropriate to allow a firm to pose as a 
dealer by posting identified positions in SelectNet without registering 
as a market maker. To allow this, the NASD argues, would reduce the 
incentive for firms to undertake market making responsibilities and 
consequently adversely affect market liquidity.

    \16\ 17 CFR 240.11Ac1-1 and NASD Manual, Schedules to the By-
Laws, Schedule D, Sec. 2(a) and (b), (CCH) para. 1819.
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    Second, the NASD is concerned that allowing a participant to 
identify itself provides the opportunity for the participant to 
condition or influence the market in one direction or another. For 
example, in the situation where a particular participant is considered 
a lead market maker or a major institutional block positioner in a 
security, if it were interested in buying shares in the stock, it might 
broadcast a sell order in SelectNet and identify itself. The influence 
associated with the participant's name might trigger a decrease in the 
bid in reaction to the sell interest. This reaction would allow the 
participant to purchase the security at a lower price than would 
otherwise have been the case, simply because it was advertising its 
name, or conditioning the market.\17\

    \17\ Indeed, the Commission and the NASD also have expressed 
concern that other types of market conditioning may violate just and 
equitable principles of trade. See, e.g., NASD Manual, Rules of Fair 
Practice, Art. III, Sec. 6, (CCH) para. 2156 (no member shall offer 
to buy or sell a security unless the member is prepared at the time 
to honor the offer).
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    Finally, the NASD noted that once two firms begin negotiating an 
order, the firm entering the order may choose to identify itself to the 
contra side. Thus, two participants negotiating an order that find the 
need to continue negotiations over the telephone rather than through 
SelectNet may arrange to do so.

V. Discussion

    The Commission believes that the rule change is consistent with the 
requirements of Sections 11A and 15A of the Act and the rules and 
regulations thereunder applicable to the NASD and, therefore, has 
determined to approve the proposal.
    Section 11A sets forth the Congressional goal of achieving more 
efficient and effective market operations and the economically 
efficient execution of transactions through new data processing and 
communications techniques.\18\ Section 11A also expresses the 
Congressional finding that the public interest, the protection of 
investors and the maintenance of fair and orderly markets are enhanced 
by assuring: (a) fair competition among brokers and dealers, and (b) 
the availability to brokers, dealers, and investors of information with 
respect to quotations for and transactions in securities.\19\ Section 
15A requires that the rules of the NASD, among other things, 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 [[Page 27581]] open market, and, in general, to 
protect investors and the public interest.\20\

    \18\ 15 U.S.C. Sec. 78k-1(a)(1)(B).
    \19\ Id. 78k-1(a)(C)(ii) and (iii).
    \20\ Id. 78o-3(b)(6).
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A. Non-member Viewing Access

    In its Market 2000 report,\21\ the Commission's Division of Market 
Regulation (``Division'') expressed concern that the limited 
transparency of SelectNet orders often conceals from the broader market 
the best trading interest in a security and, in turn, impedes 
competition and price discovery.\22\ The Division, therefore, 
recommended that the NASD consider ways to enhance SelectNet 
transparency.\23\ The Commission believes that this proposal is a 
positive response to the Division's recommendation in Market 2000.

    \21\ Market 2000: An Examination of Current Equity Market 
Developments, Division of Market Regulation, United States 
Securities and Exchange Commission (Jan. 1994).
    \22\ Id. at IV-7.
    \23\ Id. at 19 and IV-7.
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    The NASD's proposal to provide non-members viewing access to orders 
broadcast through SelectNet will help achieve more efficient and 
effective market operations by increasing transparency of market 
information. Increased transparency, in turn, will facilitate more 
efficient price discovery and enhance price competition among all 
market participants. This change to SelectNet will allow non-members to 
obtain with relative ease and low cost important pricing information 
about Nasdaq securities. Moreover, investors will be better able to 
assess the overall supply and demand for a particular Nasdaq security 
and, thus, effect transactions in a more cost-effective manner. They 
will now be able to view, although not participate directly in, an 
important system for trading Nasdaq securities.\24\

    \24\ The NASD has represented that SelectNet usage has grown 
from a daily average of 3,000 transactions and 6 million shares in 
the first half of 1991 to over 10,550 transactions and more than 
12.6 million shares in the first quarter of 1995.
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    In response to the NASD's proposal, the NYSE and Amex raised broad 
policy concerns about the operation of SelectNet in the context of the 
Quote Rule. The NYSE and Amex argued that orders broadcast through 
SelectNet constitute quotations for purposes of the Quote Rule and, 
therefore, should be reflected in market maker quotations.
    The Commission believes that this issue reaches beyond the 
broadcast of SelectNet orders to non-members. For example, it raises 
question about whether the widespread dissemination of orders through 
broker-dealer trading systems, such as Instinet, constitute quotations 
for purposes of the Quote Rule. Thus, the Commission believes that this 
issue is beyond the scope of this proposal and that the policy issue 
raised by the NYSE and Amex deserve continued examination. Moreover, 
the Commission believes that this proposal is a meaningful advance in 
the effort to enhance transparency in the Nasdaq market and, therefore, 
should not await further debate of this issue.

B. The Anonymous Display of All Broadcast Orders

    As noted above, the NASD will not identify the origin of SelectNet 
orders when pricing information is made available through Nasdaq or 
vendor facilities. One commenter opposed this feature for the reasons 
described above.
    The Commission currently believes the NASD's proposal incorporating 
anonymity in the display of orders broadcast through SelectNet is 
consistent with the goals of the Act. The Commission believes requiring 
anonymity will promote just and equitable principles of trade by 
removing a mechanism for a participant to induce market movement simply 
by associating its name with a particular order.
    In addition, the Commission finds that the rule change does not 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act. While the imposition of the 
anonymity requirement may alter certain existing trading practices, the 
Commission believes that the proposal furthers the purposes of the Act 
by enhancing SelectNet transparency for non-members. The Commission 
believes that expanded dissemination of SelectNet information will 
better inform public investors regarding the prices at which investors 
and dealers are willing to transact business in a particular security.

VI. Conclusion

    For the reasons stated above, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change SR-NASD-94-9 be, and hereby is, approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\

    \25\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-12698 Filed 5-23-95; 8:45 am]
BILLING CODE 8010-01-M