[Federal Register Volume 66, Number 91 (Thursday, May 10, 2001)]
[Notices]
[Pages 23958-23961]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-11803]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44257; File No. SR-NASD-2001-28]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. To 
Institute an Automated Order Delivery Service on the OTCBB

May 4, 2001.

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\1\ and Rule 19b-4 \2\ thereunder, notice is hereby given that 
on April 12, 2001, the National Association of Securities Dealers, Inc. 
(``NASD''), through its subsidiary, The Nasdaq Stock Market, Inc. 
(``Nasdaq'') 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 Nasdaq. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change from interested persons.
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    \1\ 15 U.S.C. 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

    Nasdaq is proposing to implement an enhancement to the OTC Bulletin 
Board Service (``OTCBB''). Nasdaq proposes to create an automated order 
delivery service (``ODS'') that will enable OTCBB users to communicate 
electronically with one another to negotiate and confirm the execution 
of orders. This communication interface would offer an alternative to 
telephonic communication, which would increase the speed, efficiency, 
and quality of execution in the OTCBB. The proposed ODS would offer 
much of the functionality of the SelectNet service that is used for 
trading of Nasdaq National Market and SmallCap securities. Nasdaq 
states that SelectNet has proven to be a versatile and effective 
trading tool in those segments of the market.
    The principal purpose of this enhancement is to supplement the 
existing capacity of market makers to consummate transactions pursuant 
to applicable trading rules. The ODS would enable member firms to 
communicate and confirm the execution terms of individual transactions 
electronically, just as they do by telephone today. The ODS would 
impose no new trading rules or obligations, but would permit market 
participants to comply more efficiently with existing rules and 
obligations, including best execution and firm quote obligations. 
Additionally, order executions negotiated through the ODS would 
automatically generate transaction reports for OTCBB issues and locked-
in trades for clearance purposes.
    The following paragraphs describe the history of the OTCBB, and 
also outline the major elements of the ODS enhancement.

Development and Operation of the OTCBB

    The OTCBB is a regulated quotation service that displays real-time 
quotes, last-sale prices, and volume information in over-the-counter 
equity securities.\3\ The OTCBB began operating on a pilot basis in 
June 1990 as part of market structure reforms designed to improve 
transparency in the over-the-counter equities market. The system was 
designed to facilitate the widespread publication of quotation and 
last-sale information. Since December 1993, firms have been required to 
report trades in all domestic OTC equity securities through the 
Automated Confirmation Transaction Service (``Act'') within 90 seconds 
of the transaction.
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    \3\ An OTC equity security generally is any equity that is not 
listed or traded on Nasdaq or a national securities exchange. OTCBB 
securities include national, regional, and foreign equity issues, 
warrants, units, American Depository Receipts (``ADRs''), and Direct 
Participation Programs (``DPPs'').
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    Today, the OTCBB provides an electronic quotation medium for 
subscribing members to reflect market making interest in OTCBB-eligible 
securities. The OTCBB currently allows market makers to use an 
authorized Nasdaq Workstation II (``NWII'') to update quotes, query 
positions, register in active stocks, and add or update telephone 
numbers. Market makers may access the service between 7:30 a.m. and 
6:30 p.m. ET and may update quotes in domestic securities, foreign 
securities, and ADRs any time the system is in operation.\4\
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    \4\ Quotes in DPPs may be updated twice daily: once between 8:30 
and 9:30 a.m. ET and again between 12:00 and 12:30 p.m. ET.
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    Subscribing market makers can utilize the OTCBB to enter, update, 
and display their proprietary quotations in individual securities on a 
real-time basis. Such quotation entries may consist of a priced bid 
and/or offer, an unpriced indication of interest (including ``bid 
wanted'' or ``offer wanted'' indications), or a bid/offer accompanied 
by a modifier to reflect unsolicited customer interest. A subscribing 
market maker can also access the proprietary quotations that other 
firms have entered into the OTCBB Service along with highest bid and 
lowest offer (i.e., an inside bid-ask calculation) in any OTCBB-
eligible security with at least two market makers displaying two-aided 
markets. All priced quotes in domestic securities, foreign securities, 
and ADRs are firm; all quotes in DPPs are indicative.
    Additionally, all NASD Level I members with Level \2/3\ service may 
view OTCBB data without paying an additional charge beyond their NWII 
fees. However, only registered market makers are permitted to enter 
quotes and indications of interest.

Access to the ODS

    Upon introduction, the ODS would be available to all NASD member 
firms that have authorized access to Nasdaq Level \2/3\ through NWII 
terminals or through an Applications Programming Interface, and that 
have appropriate clearing arrangements through a registered national 
clearing agency. The ODS would be accessible for negotiation and 
confirmation of transactions in OTCBB issues during normal business 
hours for the OTCBB market (from 7:30 a.m. to 6:30 p.m. ET), although 
quotations would be required to be firm only between 9:30 a.m. and 4 
p.m. During this period, the ODS would be continuously available for 
use by any eligible NASD market maker or order-entry firm. Registered 
OTCBB market makers would be unable to inhibit the receipt of ODS 
messages from other eligible NASD members between 9:30 a.m. and 4 p.m. 
ET, and orders received within a market maker's quoted price and size 
would be considered liability orders. Hence, an NASD member would be 
assured that communication can be established with a market marker 
during all market conditions and that transactions can be consummated 
without reliance on the telephone.

Use of the ODS

    The ODS would provide an alternative medium for retail firms to 
contact market makers and for market makers to contact one another, to 
negotiate trades, and to confirm executions regardless of market 
conditions just as they do by telephone today. The establishment of the 
ODS would not impose any additional obligations beyond those already 
applicable to the market maker and NASD member in connection with 
telephonic transactions, such as the firm quote and best execution 
obligations.
    Nasdaq has established some basic operational requirements for the 
ODS:

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    (i) An order entered through the ODS must be preferenced to a 
market maker in the security.
    (ii) Principal as well as agency orders may be entered through the 
ODS.
    (iii) All orders entered through the ODS must be priced. Therefore, 
it would be impermissible to enter an order only with instructions to 
execute ``at the market'' or ``on the close.''
    (iv) An order entered through the ODS must include the security's 
identifier, price and size (from 100 to 999,900 shares); be designated 
as buy, sell, or sell short; and have a capacity indicator. All orders 
must be in round lots; the system will not accept odd lots.
    (v) Orders entered into the ODS would be in force for a minimum of 
three minutes, unless the entering firm specifies another time in force 
or designates as a day order. The entering firm would be permitted to 
attempt to cancel an order after ten seconds.
    (vi) A market maker receiving an order through the ODS would have 
three minutes to respond with an ``accept'' or ``reject'' message. 
Order recipients can respond with partial acceptance, as long as the 
order is not designated as All-Or-None. If the receiving market maker 
does not act within three minutes (or other time period specified by 
the order entry firm), the order would be automatically timed out and a 
notification of that result sent to the initiating firm.
    (vii) The ODS would send a ``pop-up'' message to a market maker's 
NWII terminal alerting the market maker to the presence of a liability 
order. The market maker would then be obligated to execute the 
liability order up to the size of its quoted price, unless the market 
maker is in the process of executing another limit order at the same 
price.
    (viii) The ODS would prohibit orders from being entered if there is 
no inside market in the security (i.e., there are at least two market 
makers with two-sided quotes).
    (ix) If an incoming buy (sell) order is priced below (above) the 
recipient's quoted bid/offer, or for an amount exceeding the 
recipient's displayed size, the market maker may properly reject it. 
The rejecting market maker can promptly communicate a counter proposal 
for possible acceptance by the initiating firm. This scenario 
illustrates the ability of a market maker to negotiate an execution by 
exchanging messages via the ODS.
    (x) Transmission of an ``accept'' message would automatically 
create and send a ``locked-in'' trade to ACT for comparison and 
clearing. Trades confirmed through the ODS would automatically generate 
a printed confirmation of the execution to both parties.
    (xi) ODS users would have access to the full functionality of ACT 
to enter corrective transactions, including cancel, error, break, no/
was, inhibit, and kill (where appropriate under applicable trade 
reporting rules).
    (xii) Participating market makers would have the capacity to scan 
transactions which they have executed through the ODS during the course 
of a trading day.
    (xiii) The ODS would automatically reject messages involving 
ineligible market makers or initiating member firms.
    As outlined above, the ODS would allow market participants to 
follow a few easy steps to enter, negotiate, and accept orders. To 
enter an order the market participant must choose buy, sell, or sell 
short; enter the share size; enter the security ID; designate a price; 
indicate whether price and/or size are negotiable; and specify the 
duration of the order, including (1) leave the order open for a minimum 
of three minutes, (2) make it a day order, or (3) leave it open until 
after-hours trading has ended. Market participants can respond to an 
order in several ways: accept the order, price improve it, decline it, 
counter the order, accept a portion of the order, or allow the order to 
expire or time out. When an order is countered, negotiations would 
begin and the parties would exchange messages until they produce a full 
or partial execution, they decline the transaction, or the order times 
out.
    After an order is executed, the ODS would automatically confirm it 
to both parties to the transaction; send the trade report through 
Nasdaq for public dissemination; and compare, match, and send the 
locked-in trade to a clearing corporation. All Nasdaq order-entry or 
market maker subscribers would be eligible to participate in the ODS, 
provided that they have a clearing arrangement with an approved 
clearing agent.

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

1. Purpose
    Nasdaq states that trading activity in the OTCBB grew from 41 
million shares and less than 7,000 trades per day in 1995 to 323 
million shares and 53,000 trades per day in 1999. In the first quarter 
of 2000, on average, over 1 billion shares were traded and 205,000 
trades were reported each day. Nasdaq believes that there are many 
reasons for this increase in volume, but chief among them is the wealth 
of OTC information available on the Internet and the growth of online 
trading systems directly accessible to individual investors. The manual 
nature of the OTCBB, where all order delivery, communication, and 
negotiation between two firms regarding an OTCBB trade is done via 
telephone, was a drawback during these periods of explosive volume. 
Nasdaq believes that executions were slower and market participants had 
difficulty keeping abreast of telephone traffic.
    Nasdaq states that the singular purpose of the ODS enhancement is 
to expand the communications facilities available to support the 
continuous, orderly operation of the OTCBB during periods of heavy 
trading, such as those experienced periodically during 2000. The ODS 
would facilitate processing of orders during fast markets, in that it 
would supplement the telephone capacity of market makers to interact 
with one another. It would, however, permit NASD members, from a 
functional standpoint, to continue to conduct business with one another 
by communicating the same basic elements of information that are needed 
to negotiate and confirm executions via telephone. The major difference 
is that electronic messages would substitute for verbal messages.
    Nasdaq states that the ODS would also enable NASD members to 
realize certain efficiencies that are most desirable in periods of 
heavy trading, but unavailable respecting transactions effected via 
telephone. For example, consummation of a transaction through the ODS 
would yield a printed confirmation to both parties to the transaction 
and would obivate the separate entry of a trade report for an execution 
in an OTCBB security. Further, because orders executed through the ODS 
would yield locked-in trades, this feature would help reduce the volume 
of uncompared trades (and

[[Page 23960]]

the attendant allocation of resources needed to resolve them) during 
periods in which overall market volume surges dramatically. Nasdaq 
believes that institution of the ODS would supplement both the 
communications and order processing capabilities of member firms.
    The NASD Regulation Market Regulation Department anticipates that 
the ODS would enable it to surveil more effectively the OTCBB 
marketplace. Nasdaq is committed to maintaining a high level of 
regulation in the OTCBB trading environment. In fact, Nasdaq's market 
surveillance systems and staff would increase the capacity for real-
time monitoring of trading on the OCTBB.
    Nasdaq states that the OTCBB has made significant strides in making 
measurable market improvements in the past three years, including: (1) 
the implementation of the Eligibility Rule, which requires each OTCBB 
issuer to be fully registered with the SEC (or appropriate banking or 
insurance regulator) and be current in its filings,\5\ (2) the 
establishment of limited trading halt authority for OTCBB 
securities,\6\ and, (3) the upcoming launch of a Limit Order Protection 
pilot program, which will prohibit member firms from trading ahead of 
customer limit orders certain OTCBB securities.\7\ Nasdaq believes that 
providing automated access to the OTCBB market would further Nasdaq's 
efforts to make the OTCBB a more efficient and orderly marketplace for 
investors and market participants alike.
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    \5\ See NASD Rules 6530 and 6540.
    \6\ See NASD Rule 6545.
    \7\ See NASD Rule 6541 (implementation pending).
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2. Statutory Basis
    Nasdaq believes that the proposal is consistent with Sections 11A 
and 15A of the Act.\8\ Subsections (A) to (D) of Section 11A(a)(1) \9\ 
articulate the broad findings and policy goals which Congress intended 
to guide the operational enhancement of the nation's securities 
markets. In this context, Congress underscored the importance of 
applying new data processing and communications techniques to assure: 
(1) more efficient and effective market operations; (2) economically 
efficient execution of securities transactions; (3) broad availability 
of information with respect to quotations for and transactions in 
securities; and (4) the optimal execution of investors' orders.\10\ The 
NASD believes that the design and operation features of the ODS 
enhancement comport fully with these Congressional directives.
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    \8\ 15 U.S.C. 78k-1 and 78o-3
    \9\ 15 U.S.C. 78k-1(a)(1)(A) to (D).
    \10\ See 15 U.S.C. 78k-1(a)(1)(C).
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    Nasdaq believes that the proposal is also supported by subsection 
(b)(6) of Section 15A of the Act.\11\ Among other things, that 
provision requires that the NASD's rule-making initiatives be designed: 
(1) to promote just and equitable principles of trade; (2) to foster 
cooperation and coordination with persons engaged in regulating, 
clearing settling, processing information with respect to, and 
facilitating transactions in securities; (3) to perfect the mechanism 
of a free and open market and a national market system; and (4) to 
protect investors and the public interest. As described earlier, the 
ODS would augment the communications and order-handling capacities of 
market makers in OTCBB securities. The NASD views the ODS as an 
essential, auxiliary communications system that would enable market 
makers to conduct business with one another when telephonic 
communications are undesirable due to unusual conditions. Providing 
such a back-up capability promotes continuity in market operations in 
order to service all classes of investors. Nasdaq believes that this 
result is fully consistent with the above-cited portions of Section 
15A(b)(6) of the Act.\12\
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    \11\ See 15 U.S.C. 78o-3(b)(6).
    \12\ Id.
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B. Self-Regulatory Organization's Statement on Burden of Competition

    Nasdaq states that implementation of the ODS would not involve the 
imposition of any competitive burden. Nasdaq believes that this 
conclusion is supported by several factors. First, the ODS involves an 
enhancement of the facilities that support market making in OTCBB 
securities by member firms. This type of enhancement would not alter 
the established terms of access respecting vendors' receipt of market 
information for redistribution to diverse groups of end users. Second, 
the ODS would not pose a competitive burden upon market makers and 
other eligible members. By design, the ODS would be an auxiliary medium 
of communication that eligible firms may employ to conduct business 
when telephonic communication is not desirable. Accordingly, the ODS 
has been structured to accommodate conveyance of the same basic 
elements of information which firms communicate in negotiating and 
executing transactions via the telephone. Third, the ODS enhancement 
would not impose more stringent market-making obligations on 
participating firms. Rather, it would provide an alternative mechanism 
for market participants to conduct their routine business. Fourth, 
firms electing to utilize the ODS would need only to have clearing 
arrangements through a registered clearing agency that uses a 
continuous net settlement system, a requirement that exists today for 
trading of OTCBB securities.
    Nasdaq believes, therefore, that no competitive burden would result 
from the Commission's approval of this filing.

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. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the Nasdaq consents, the Commission will:
    (A) by order approve such proposed rule change; or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. 
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 -2001-28 and 
should be submitted by May 31, 2001.

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For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-11803 Filed 5-9-01; 8:45 am]
BILLING CODE 8010-01-M