[Federal Register Volume 60, Number 236 (Friday, December 8, 1995)]
[Notices]
[Pages 63092-63106]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-29950]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36548; File No. SR-NASD-95-42]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by National Association of Securities Dealers, Inc. Relating to 
NAqcess System and Accompanying Rules of Fair Practice

December 1, 1995.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),<SUP>1 notice is hereby given that on November 9, 1995, the 
National Association of Securities Dealers, Inc. (``NASD'' or 
``Association'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II and III below, which Items have been prepared by the NASD. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Pursuant to Section 19(b)(1) of the Act, attached as Exhibit A is 
the full text of a series of proposed rule changes by the NASD and The 
Nasdaq Stock Market, Inc. (``Nasdaq'') regarding the operation of The 
Nasdaq Stock Market's NAqcess system, a new system that offers 
nationwide limit order protection and price improvement <SUP>2 over the 
dealer quotation of small-sized customer orders. The ``Rules of 
Operation and Procedures for NAqcess'' (``NAqcess Rules'') will replace 
in its entirety the ``Rules of Practice and Procedures for the Small 
Order Execution System'' (``SOES Rules''), which the NASD proposes to 
withdraw simultaneously with the new system becoming operational. The 
NAqcess system rules package attached in Exhibit A is new and 
accordingly has not been italicized. The NASD is also proposing several 
new Interpretations and a new Rule in its Rules of Fair Practice to 
afford individual investors the opportunity to determine whether their 
orders are to be handled in NAqcess and to provide customer limit 
orders held in NAqcess or elsewhere with enhanced price protection 
(Exhibit B). The NASD is also proposing conforming modifications to the 
NASD Manual, including the Rules of Practice and Procedure for the 
Automated Confirmation Transaction Service (``ACT Rules'') and Schedule 
D to the NASD By-Laws (and all other places in the Manual that refer to 
SOES) to delete references to SOES and/or the SOES Rules and to replace 
those references with NAqcess and/or the NAqcess Rules, as appropriate. 
These references may be found in the ACT Rules, Section (c)(2); in 
Schedule D, Part V, Section (1)(f), Section (7)(a), Section (8)(c), and 
Section (9); and Schedule D, Part XI, Section (2)(e)(1).

    \2\ Commission Note: The NASD's use of the term ``price 
improvement'' in this proposal differs from the use of the term in 
recent Commission releases. Specifically, the Commission has used 
the term when referring to the opportunity to receive a price that 
is superior to best bid or offer. See, e.g., 17 CFR 11Ac1-3(a)(2); 
Securities Exchange Act Release No. 34902 (Oct. 27, 1994), 59 FR 
55006 (Nov. 2, 1994) at text accompanying n. 32. The NASD's use of 
the term in this proposal, on the other hand, refers to the 
opportunity to receive a price that is better than the best market 
maker quotation, which may not be the best bid or offer to the 
extent NAqcess limit orders are included. In its recent rule 
proposal concerning the obligations of market makers executing 
customer orders, the Commission asked for comment on whether 
automated systems that include the possibility of the interaction of 
market orders with limit orders should be deemed to satisfy the 
proposal's requirement that market orders be provided with an 
opportunity for price improvement. Securities Exchange Act Release 
No. 36310 (Sept. 29, 1995), 60 FR 52792 (Oct. 10, 1995).
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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 IV 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. Introduction
    The NASD and The Nasdaq Stock Market, Inc. are proposing rules of 
operation and procedure and companion rules for a new service that 
provides investors market-wide price protection of their limit orders, 
the opportunity to obtain price improvement over the dealer quotation 
in buying and selling Nasdaq stocks, and increased access to the Nasdaq 
market. The new facility, to be named NAqcess and operated by The 
Nasdaq Stock Market, will permit significant opportunity for investors 
in Nasdaq securities to enter limit orders inside the Nasdaq dealer 
quotation and enhance the opportunity for such investors to receive 
executions between the best dealer bid and offer without such orders 
interacting with market makers. The limit orders at the top of the 
NAqcess limit order file that are the same as or better than the best 
dealer quotations will be included in the inside market for The Nasdaq 
Stock Market, thereby providing new levels of transparency, increased 
price efficiency, and greater investor protection. Further, the 
companion rule and Interpretations accompanying the new system will 
provide retail customers with enhanced price protection of their limit 
orders, a significant expansion over current limit order protection 
afforded to customers in the Nasdaq market. Finally, NAqcess will 
provide customers that choose to enter market orders into the system 
with the opportunity to obtain price improvement over the dealer 
quotation through interaction with customer limit orders in the NAqcess 
file and will provide a prompt, cost-effective execution at the best 
price available in the market at any particular point in time.
    NAqcess and the accompanying new Rules of Fair Practice provide 
multiple benefits to retail investors that were heretofore unavailable 
to such investors. A key feature of NAqcess that is a significant 
enhancement over current practices in Nasdaq is the ability of 
investors to have limit orders placed in a central file where they can 
interact directly with other customer limit orders and market orders 
entered into the system. Under a proposed new Interpretation to Article 
III, Section 1 of the Rules of Fair Practice, a customer may instruct 
its broker-dealer to enter the customer's limit order or market order 
into NAqcess. Moreover, NAqcess will provide increased transparency of 
the best priced limit orders in NAqcess because Nasdaq will incorporate 
into the Nasdaq inside market limit orders that are priced the same as 
or better than the best dealer bid and offer displayed in Nasdaq, and 
their aggregate sizes in a particular security. This increased 
transparency will enhance the Nasdaq price discovery process. NAqcess 
will match incoming limit and market orders against limit orders 
resident in the 

[[Page 63093]]
NAqcess file so as to permit customer orders to interact directly with 
each other without the participation of a market maker. The interaction 
of customer orders offers such orders an opportunity for price 
improvement over the dealer quotation and increases the likelihood that 
public limit orders will be executed on a more timely basis.
    The companion rules and Interpretations regarding price protection 
in Nasdaq will also significantly enhance the protection of customer 
limit orders whether they are held in NAqcess or stored in a member 
firm's limit order file. Under a newly proposed rule, NASD member 
firms, whether acting as principal or agent, will not be permitted to 
execute an order at a price inferior to any limit order(s) in the 
NAqcess limit order file that the member firm is able to view, without 
satisfying the viewable limit order(s). An ``inferior price'' means an 
execution price that is lower than a buy limit order or higher than a 
sell limit order. In addition, if a member firm holds a customer limit 
order outside of NAqcess, a new Interpretation to Article III, Section 
1 of the Rules of Fair Practice would require the member firm that 
holds the limit order to provide the customer with price protection 
that is equivalent to that which the limit order would have received if 
it had been entered into the NAqcess file. The concept of equivalent 
price protection is further explained below.
    Aside from these major regulatory enhancements that provide for 
major changes in order handling and protection in The Nasdaq Stock 
Market, the NAqcess system itself represents a significant improvement 
over the current methodology for the handling of small investor orders. 
NAqcess, as noted, will permit interaction of small customer limit and 
market orders within the dealer spread and thus permit such orders to 
obtain significant opportunities for price improvement over the dealer 
quotation.
    This new order delivery and execution system will replace SOES, the 
NASD's current system for the handling of small customer orders. 
Because SOES is an automated, quote-based execution system, it does not 
offer the opportunity for price improvement over the dealer quotation 
of small customer orders. Moreover, the proposed NAqcess system 
addresses the queuing concerns that were raised in connection with the 
previously proposed NProve system. NAqcess will distribute non-
directed market orders that can not be immediately matched against 
NAqcess limit orders to available market makers at the inside market as 
the orders are presented. A market maker will provide such order an 
automated execution at the inside if the market maker presented with 
the order does not manually decline the order within a 20-second period 
because the market maker (consistent with SEC Rule 11Ac1-1) <SUP>3 has 
already effected, or is in the process of effecting an execution in the 
security and is in the process of updating its quotation. This approach 
eliminates the single-threaded distribution mechanism proposed in 
Notice To Members 95-20 and permits rapid distribution of orders to 
market makers as the orders are received.<SUP>4

    \3\ 17 CFR 240.11Ac1-1 (1995).
    \4\ The NASD believes that significant queues in excess of those 
currently experienced under SOES today will not occur under the new 
proposal. First, if the limit order file for a security has depth, 
market orders will immediately execute against limit orders without 
any delay. Because each order when received is immediately 
distributed to the next available market maker, the large majority 
of orders will be executed within 20 seconds of distribution. Even 
if an order is declined by a market maker at one price level, an 
event that the NASD believes will not be frequent, the declined 
order will be automatically executed without the possibility of 
rejection immediately upon presentation at the next price level. All 
of these techniques mean that it will be rare for an order not to be 
executed within a 20 to 40-second period after processing.
    For example, assume that five market orders are entered into 
NAqcess at one second apart from each other and there are five 
market makers in the stock at the inside. Each order when received 
will be immediately distributed to the next market maker. Thus, 
order one at second one is distributed immediately to market maker 
one, while order two at second two is sent to market maker two 
immediately, and so on through order five. In most circumstances, 
each market maker will not decline the order within 20 seconds, and 
thus, each order would be executed within 20 seconds of processing. 
If any one of these orders were declined, the order would wait for 
the next available market maker for re-presentation. If that market 
maker remained at the same price level as that when the order was 
originally presented, the order would be subject to a further 20-
second reaction period. In the unlikely event it was declined again, 
the order would be presented again for execution. If that 
presentation occurred at a new price level, it would be immediately 
executed at the new price level.
    If order entry firms enter more orders than there are market 
makers at the inside, the queue for such orders would be the same as 
today in SOES when orders must be queued while waiting for a market 
maker to update its quotation after a SOES execution. Consequently, 
the NASD believes that queuing under this proposal does not 
represent a significant threat to prompt market order execution much 
different from current queuing. It should be noted as well, that 
market orders of eligible size entered into NAqcess are guaranteed 
an execution. Such execution may be effected against a customer 
order or a dealer's quote. Thus, in response to concerns raised in 
some comment letters the NASD received in response to Notice to 
Members 95-20 and 95-60, NAqcess will provide guaranteed executions 
to investors entering eligible market orders. Accordingly, the NASD 
believes that those comment letters from individual investors that 
allege that NAqcess will deprive them of an automatic execution are 
mistaken. Of course, it should be noted that not even in SOES is a 
market order guaranteed an execution at the price observed at the 
time the order was entered. Similarly, under NAqcess no such 
guarantee is extended to an investor.
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    NAqcess and its companion rules represent a significant enhancement 
to the treatment of investor orders in The Nasdaq Stock Market. The 
entire proposal, when taken together with other recent enhancements to 
the Nasdaq trading environment, such as the Limit Order Protection 
Interpretation <SUP>5 and the Short Sale Rule,<SUP>6 demonstrates the 
significant strides that the NASD and The Nasdaq Stock Market have 
taken to provide increased protection of investors while continuing to 
preserve the benefits that its competitive dealer market structure 
currently provides. Individual investors seeking price improvement over 
the dealer quotation will be afforded a transparent mechanism to obtain 
greater opportunities for price improvement over the dealer quotation 
without market maker interaction. Moreover, through the accompanying 
rules, NAqcess will provide such limit orders with increased market-
wide price protection. Individual investors seeking rapid execution of 
small market orders at the best available price will continue to be 
able to obtain executions promptly, while Nasdaq market makers will be 
permitted the opportunity to interact with such orders in a manner 
consistent with SEC rules and in a manner similar to market order 
handling in exchange markets. By permitting market makers to continue 
the operation of their own internal execution systems, the NASD will 
maintain the ability of dealers to provide liquidity and competitive 
mechanisms to handle customer orders.

    \5\ Securities Exchange Act Release Nos. 35751 (May 22, 1995), 
60 FR 27997 (May 26, 1995) and 34279 (June 29, 1994), 59 FR 34883 
(July 7, 1994).
    \6\ Securities Exchange Act Release No. 34277 (June 29, 1994), 
59 FR 34885 (July 7, 1994).
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2. NAqcess Operations
    The proposed NAqcess system will provide the following:
    A. Scope of System. NAqcess will be available for all Nasdaq 
issues. It will completely replace SOES which will operate until the 
effective date for operation of NAqcess and will be discontinued as of 
that date. NAqcess participation will be mandatory for market makers in 
all National Market securities. NAqcess participation for SmallCap 
market makers will be voluntary, as is SOES participation today for 
such market makers.
    B. Order Entry Requirements. Agency orders may be entered into 
NAqcess only by member firms on behalf of customers. ``Customers'' are 
defined to 

[[Page 63094]]
exclude any broker, dealer, person associated with a member, or a 
member of the immediate family of a person associated with a member. 
Because the purpose of the system is to provide small retail customers 
with access to The Nasdaq Stock Market, member firms, with one limited 
exception,<SUP>7 are not permitted to enter proprietary orders.<SUP>8 
As explained in more detail elow, customers may request that 
appropriately sized limit and market orders be entered into NAqcess, 
and if so requested, member firms must honor the customer's 
request.<SUP>9

    \7\ The only exception to the proprietary order prohibition is 
an order designated by a market maker as a ``marker order.'' A 
marker order is a principal order entered by a market maker in a 
transaction that is functionally the equivalent of a riskless 
principal transaction. The firm may place a principal account limit 
order in the NAqcess file, and if an execution is obtained, 
immediately pass along the benefit of such execution to a retail 
customer order it holds in its own file. Because the order is part 
of a principal transaction for the benefit of the retail customer, 
the NASD believes that it is appropriate to permit this limited 
exception to the prohibition of proprietary orders in NAqcess. The 
NASD will require member firms entering such orders to mark their 
order tickets accordingly, and will examine a firm's trading 
activities carefully to determine that such proprietary orders are 
being effected for the purposes of engaging in a riskless principal-
like transaction. Marker orders, however, may not be placed with 
respect to customer limit orders held by the firm that exceed the 
permitted maximum limit order size.
    \8\ Member firms will be permitted, however, to enter so-called 
``takeout'' orders for their own account or on behalf of a customer. 
A takeout order is an order that results in an immediate automatic 
execution of a limit order or orders in the NAqcess limit order file 
at the limit order price(s). There is no size limitation on the 
takeout order. Thus, if the NAqcess file displays limit orders at a 
price with an aggregate size of 15,000 shares, a single takeout 
order of 15,000 shares may be entered and executed. Similarly, a 
firm may enter a takeout order to immediately execute multiple limit 
orders at multiple prices in the NAqcess file. When there are 
multiple limit orders being taken out, each limit order will execute 
at each limit order's price.
    \9\ See infra Section II(A)3.A of this proposal.
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    Customers may request the entry of limit orders up to 1,000 shares 
in National Market and SmallCap issues, except for the Nasdaq 100 
issues, in which case limit orders up to 3,000 shares may be entered. 
This represents a difference from the original proposal <SUP>10 of 
3,000 shares for all National Market issues.<SUP>11 The issue of size 
eligibility for limit orders generated significant comment in response 
to the two Notices.<SUP>12 Many commenters believed that because 
NAqcess is intended to provide small retail customers with limit order 
protection, the initial approach should reflect more closely that the 
average retail order size is well under 1,000 shares. For example, the 
Security Traders Association (``STA'') noted that the experience of STA 
members was that the typical retail customer order size averaged well-
less than 1,000.<SUP>13 It was also noted by commenters that it could 
reduce the potential for investor confusion if NAqcess established a 
standard for limit orders that was consistent with market order size, 
1,000 shares. Commenters also noted that NAqcess could potentially 
significantly impact market maker participation, particularly in less 
active securities. As a result, they suggested that the NAqcess order 
size should be set at lower levels at least until the NASD had 
thoroughly evaluated the impact of the system on market liquidity.

    \10\ NASD Special Notice to Members 95-20 (Mar. 21, 1995).
    \11\ All SmallCap issues have a limit order size of 1,000 
shares.
    \12\ NASD Special Notice to Members 95-20 (Mar. 21, 1995) and 
95-60 (July 27, 1995).
    \13\ See letter from John Giesea, Chairman, and John Watson, 
President, STA (Apr. 28, 1995).
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    While the NASD believes that NAqcess will have overall a positive 
effect on market quality, we believe that it is prudent in this start-
up period to commence NAqcess limit order size eligibility at 1,000 
shares for most securities. However, limit orders up to 3,000 shares 
would be eligible for NAqcess for those securities that comprise the 
Nasdaq 100 Index. The NASD believes that this higher eligibility level 
is appropriate because the securities comprising the Nasdaq 100 have 
high levels of volume, greater market maker participation and 
significant market liquidity and therefore are less likely to be 
adversely impacted by the proposal. Because of the significant changes 
that NAqcess may bring to The Nasdaq Stock Market, the NASD believes 
that it is appropriate to commence the operation of the system with a 
smaller limit order size than originally proposed to permit market 
makers and investors to adjust to the new trading environment. The NASD 
proposes to monitor the limit order size requirement carefully in the 
initial eighteen months of NAqcess operation and may choose to expand 
the eligible size of limit orders, if experience demonstrates such 
expansion to have merit.
    Market orders in National Market issues may be 1,000, 500 or 200 
shares depending upon tier size determination to be made in the same 
manner as done in SOES today.<SUP>14 Similarly, market orders in 
SmallCap issues will be tiered at 500 shares or less as done in SOES 
today.<SUP>15

    \14\ Under SOES Rules, the tier sizes of 1,000, 500 and 200 
shares were determined by reference to the average daily non-block 
volume of a security, among other things. Thus, for example, if an 
issue had an average daily non-block volume of 3,000 or more shares, 
it could qualify for a tier size of 1,000 shares.
    The same concept will apply with respect to NAqcess maximum 
market order sizes, except that the NASD has determined to use a 
slightly higher average daily non-block volume of 6,000 shares. The 
NASD has chosen this higher level because it better reflects trading 
patterns consistent with the increased overall volume in Nasdaq 
securities.
    \15\ The NASD will permit market makers to establish minimum 
exposure limits that are equal to the maximum market order size. In 
addition, NAqcess will contain an automated update feature that will 
automatically change the market maker's quotation by a minimum 
increment set by the market maker after the market maker has 
executed a trade at a price level and has exhausted its minimum 
exposure limit through system executions. The NASD believes that 
these aspects of NAqcess are critical to an effective operation that 
permits a market maker to manage its risk capital, and is consistent 
with the SEC firm quote rule as applied to all other registered 
markets. The minimum exposure limit is set at the same size as the 
minimum quote size in Nasdaq. Under the SEC Firm Quote Rule (Rule 
11Ac1-1(c)), a broker-dealer is entitled to change its quotation 
within a reasonable period of time after it has completed a trade at 
its published price. Accordingly, the NASD believes that these 
aspects of NAqcess are consistent with SEC and NASD rules and 
provide retail investors with the same access to dealer quotations 
as are available in any other registered marketplace.
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    Customers may choose to enter ``marketable limit orders.'' A 
marketable limit order is a limit order that is priced at the time of 
entry at the current inside market or better on the opposite side of 
the market, i.e., a marketable limit order to buy is equal to or higher 
than the current inside offer, while a marketable limit order to sell 
is equal to or lower than the inside bid. For example, if the current 
inside market is 20 bid and 20\1/4\ asked, the entry of limit orders to 
sell priced at 20 or 19\7/8\ would be considered marketable limit 
orders. Marketable limit orders will be treated as market orders. Thus, 
if a firm enters a customer limit order to sell at 20 at the time the 
inside bid is 20, the limit order will be passed over the limit order 
file and if no match occurs, it will be treated as a market order and 
executed as discussed above in the market order handling section. If 
such marketable limit order, however, is greater than 1,000 shares in a 
Nasdaq 100 security, the marketable limit order will be returned to the 
order entry firm for handling outside of NAqcess, without matching 
against the inside market whether the inside consists of a dealer 
quote, limit order(s), or an aggregation thereof.
    Neither a limit order nor a market order may be split up to meet 
the size parameters of NAqcess. The NASD will examine order handling 
practices of 

[[Page 63095]]
order entry firms to determine compliance with this requirement.<SUP>16

    \16\ In this regard, the NASD notes that order entry firms may 
enter agency orders only. The rules continue in effect the 
definition of agency orders as found in the current SOES Rules and 
the new rules carry forward the existing principles regarding the 
aggregation of orders based on a single investment decision entered 
by an order entry firm. Orders entered by an order entry firm within 
any five minute period in accounts controlled by associated person 
or public customers, acting alone or in concert with other 
associated persons or public customers are presumed to be based on a 
single investment decision. In connection with this rule, the NASD 
notes that it will examine carefully the entry of computer-generated 
orders to determine whether such orders are based upon a single 
investment decision.
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    C. Display of Limit Orders. To enhance the transparency of The 
Nasdaq Stock Market and to assist in the price discovery process, the 
NASD will provide for the display of limit orders entered into NAqcess. 
There will be two separate approaches to the display: a consolidated 
inside market display and the Full File Display.
    1. Inside Market Display. In a significant revision to Nasdaq's 
methodology for calculating the inside market for Nasdaq securities, 
The Nasdaq Stock Market will include in the Nasdaq inside market 
NAqcess limit orders, and their aggregate sizes, that are priced the 
same as or better than the best dealer bid and offer.<SUP>17 Thus, in 
Nasdaq the inside market will consist of a single display of the best 
priced quotes or limit orders, as the case may be. The inside market 
will be calculated in the following manner. If the best limit order(s) 
to buy (sell) in NAqcess is (are) better than the best Nasdaq market 
maker bid (offer) displayed in Nasdaq and such limit order(s) is (are) 
100 shares or more, it (they) will be included in the Nasdaq inside 
market and disseminated as the inside bid (offer), together with the 
aggregate size of such order(s) and a unique indicator to denote that 
the inside market is represented by a NAqcess limit order or orders, 
rather than a quotation of a Nasdaq market maker or UTP exchange 
quotation. If there are multiple limit orders at the best price, 
aggregate size will be displayed and execution of such orders will 
occur on a time priority basis as explained below.

    \17\ This is a change from the approach originally proposed in 
Special Notice To Members 95-20 and 95-60. In the original NAqcess 
approach to the display of NAqcess limit orders, the NASD proposed 
to provide two separate displays of prices: the inside dealer 
quotation (i.e., the best-priced bids and offers of Nasdaq market 
makers and UTP exchanges displayed in the Nasdaq market) and the top 
of the NAqcess limit order file (i.e., the best-priced limit orders 
to buy and sell and their aggregate sizes). Such displays would have 
been separate and side-by-side. Under this new proposal, the NASD 
will maintain a Top of the File display on its Nasdaq Workstations, 
as well as include the best priced limit orders to buy and sell in 
the Nasdaq inside market display.
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    If the best-priced NAqcess limit order(s) is (are) equal to the 
inside dealer quotation, the limit order size will be reflected in the 
aggregate size of the quotation. That is, if there is a limit order to 
buy 500 shares at the same price as a 1,000 share dealer bid quotation, 
and both are the best bids reflected in Nasdaq, the aggregated size 
displayed as the best Nasdaq bid will reflect a size of 1,500 shares 
with a special indicator to denote that such size is an aggregation of 
a dealer quote and any limit order(s) at that price. Priority for 
execution will depend upon the general limit order priority rules, 
i.e., if the limit order is received prior to the market maker 
quotation, it will be entitled to priority for execution 
purposes.<SUP>18

    \18\ Rules regarding calculation of the excess spread will not 
include NAqcess limit orders for purposes of determining compliance 
with those Rules. See NASD Manual, Schedules to the By-Laws, 
Schedule D, Part V, Sec. 2(d), CCH para. 1819.
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    The inclusion of NAqcess limit orders in the Nasdaq inside market 
represents a significant enhancement to The Nasdaq Stock Market. 
Consolidation of NAqcess orders into the Nasdaq inside quotation is the 
best means to communicate clearly to all investors in Nasdaq the true 
market for such securities at any particular point in time. The 
consolidation of best-priced limit orders with the best dealer bid and 
offer in Nasdaq provides the best level of transparency and aids in the 
price discovery process.
    Although this represents a change from the original NAqcess 
proposal,<SUP>19 the NASD believes that the display of this 
consolidated information maintains the advantages of a competing dealer 
market while permitting an expansion in information available to 
investors.<SUP>20 The new inside quotation display will clearly 
identify when aggregated customer limit orders are represented in the 
inside market display. Accordingly, market participants will be able to 
ascertain when the inside quotation represents a customer limit order 
and when it represents a market maker whose quotation may signify that 
it is available to effect a significantly larger sized transaction. In 
this way, the NASD believes that transparency of customer orders may be 
enhanced while the integrity of the dealer quotation is preserved.

    \19\ NASD Special Notice to Members 95-60 (July 27, 1995).
    \20\ One commenter specifically noted that a consolidated 
display of the best priced limit orders in the Nasdaq inside market 
was a better approach than maintaining separate displays, especially 
since member best execution obligations would be determined by 
reference to the best prices displayed by Nasdaq, whether such 
prices were dealer quotes or limit orders in NAqcess. See Lehman 
Bros. (Sept. 12, 1995). In addition, several vendors expressed 
technological concerns regarding separate displays. See letters from 
ADP (Aug. 16, 1995) and Telekurs (Aug. 14, 1995).
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    2. Full File Display. The full file display for a particular 
security will be made available on a query basis over Nasdaq 
Workstations only to Nasdaq market makers in that security. The NASD 
believes that, as with other U.S. market centers, display of the entire 
limit order file should be reserved to market makers in a particular 
security to assist in price discovery and to provide the market maker 
with an incentive to provide liquidity by risking its capital. In fact, 
no U.S. exchange registered with the SEC publicly disseminates any 
display (full or partial) of a limit order book maintained by an 
exchange specialist. Because of the accompanying rules described below 
that the NASD has proposed, customer limit orders in the file will be 
protected to a large extent, from inferior executions.
    D. Order Processing. The NAqcess system will provide significant 
improvements over the current SOES system in the way that customer 
limit orders and market orders will be handled. NAqcess will attempt to 
match all incoming orders, limit or market, directed or non-directed, 
against limit orders already resident in NAqcess on a price and time 
priority basis.<SUP>21 If a match is found, the orders will be 
automatically executed against each other without the participation of 
a market maker. For example, assume the current inside market for a 
security is 20-20\1/2\ and customers enter into NAqcess a 1,000 share 
limit order to buy at 20\1/8\ and a 1,000 share limit order to sell at 
20\3/8\. The new inside market will become 20\1/8\-20\3/8\. If a 
customer thereafter enters a 1,000 share limit order to sell at 20\1/
8\, the incoming limit order to sell will match against the 1,000 share 
limit order to buy on the NAqcess file at 20\1/8\ and will be executed 
against that order. If a 

[[Page 63096]]
customer next sends in a market order to buy in NAqcess, the market 
order will match against the limit order to sell at 20\3/8\, rather 
than the dealer offer of 20\1/2\, and thus, the market order will be 
automatically executed immediately at 20\3/8\. In both cases, the 
orders received price improvement over the dealer quotation and 
immediate execution without the participation of a market maker.

    \21\ NAqcess will match only round lots and round lot portions 
of mixed lot orders. Odd lot limit orders will not be matched. Odd 
lots are orders less than 100 shares. Odd lot limit orders will not 
be displayed in the inside quotation; however, odd lot limit orders 
will be displayed in the full file display. If an odd-lot order is 
executable i.e., if it is a market order or an executable limit 
order, it will be automatically executed at the applicable inside 
dealer quotation. If it is a directed order, it is executed against 
the directed market maker. If it is a non-directed order, it will be 
executed automatically without any decline capability against the 
next available market maker at the inside dealer quotation. If the 
odd-lot order is a limit order that is not executable at time of 
entry, it will remain in the file until the inside dealer quotation 
moves to match the odd-lot price.
---------------------------------------------------------------------------

    If, in the scenario set forth above, the second limit order to sell 
is priced at 20 instead of 20\1/8\, the execution price would be 20\1/
8\, the price of the limit order to buy because such order was entered 
into the system earlier than the second limit order to sell.
    The system will only execute such matches when the execution prices 
would be equal to or better than the inside market. Nevertheless, limit 
orders priced away from the inside market, i.e., limit orders to sell 
priced higher than the inside offer and limit orders to buy priced 
lower than the inside bid, will be stored in the NAqcess file. When the 
inside market moves to a price so that the limit order is equal to or 
better than the inside dealer quotation, such limit orders will be 
consolidated into the Nasdaq inside market and the limit order will 
become eligible for matching as described in this section.
    When a limit order in the NAqcess file is priced the same as the 
inside market, the time priority of the limit order compared with the 
best dealer quotation will govern which price interacts first with 
incoming orders in NAqcess. The NASD believes that this approach is a 
well-understood and reasonable means for determining the interaction of 
such orders and provides a further incentive to market makers to 
provide liquidity and narrow spreads.
    If no limit orders reside in the NAqcess file, market orders will 
be immediately assigned and distributed to market makers at the inside 
market. This rapid distribution should minimize the potential for 
queues that the original proposal found in Notice To Members 95-20 
could have caused. After an order is distributed to a market maker, the 
market maker will be permitted a 20-second period within which it may 
decline a non-directed order if such action is consistent with the 
exceptions to the SEC's firm quote rule, Rule 11Ac1-1.<SUP>22 In other 
words, the market maker is permitted to decline the NAqcess order if 
the market maker, immediately before the presentation of the NAqcess 
order: (a) effected or was in the process of effecting a trade, and (b) 
was in the process of updating its quotation to reflect that previous 
transaction. When a NAqcess order is declined by a market maker, the 
declined order is presented to the next available market maker. If that 
market maker is at the same price as the market maker that originally 
declined the order, the second market maker also has a 20-second period 
to react to the order. If the second time the order would be presented, 
the inside market has moved to a different price level, it is 
automatically executed without any decline capability. For example, 
four market makers are at the inside bid of 20. Three market orders to 
sell are entered into NAqcess when there are no limit orders to buy at 
20 or better. Each market order is immediately distributed to one of 
the three market makers. Because the first market maker had completed a 
trade by telephone and was about to change its quotation, the first 
market order is declined by the first market maker. That order is 
redistributed to the fourth market maker still quoting a price of 20. 
The fourth market maker has 20 seconds to interact with the order. If, 
however, there were only three market makers at 20, and all market 
makers had updated their quotations to reflect a price of 19\7/8\, the 
declined order would be immediately executed at 19\7/8\ against the 
first available market maker without any decline capability.

    \22\ While the total time period between order entry and Nasdaq 
receipt of the decline is 20 seconds, the system has been designed 
to provide market makers with a full 15-second period in which to 
react to an order. The rule itself references a 15-second period in 
which the market maker must react. Five seconds of the 20-second 
period is designed to accommodate communications between Nasdaq 
systems and the market maker. Thus, the NASD has purposefully 
designed a 5-second period to accommodate the transmission of 
messages between the NASD host computer and member firm presentation 
devices. This five-second period addresses the potential delays of 
3.75 seconds that may occur in broadcasting a message from the host 
to a workstation, and the .775 seconds that could occur in 
transmitting a decline message from the presentation device to the 
host. (It should be noted that such time periods arise in the 
context of the current configuration of the proposed system. 
Development of alternative methods of processing could increase the 
total time delays.) In examining the potential length of time that a 
message could consume in transmission from the host to the 
presentation device and back again, the NASD determined that market 
makers would be at a significant time disadvantage in that a market 
maker could lose up to 33% of its already limited reaction period. 
In this context, then, the NASD believes that it is appropriate to 
recognize the inherent delays of computer-to-computer data exchange, 
and provide additional time to account for such delays.
---------------------------------------------------------------------------

    The NASD is developing an automated surveillance capability to 
monitor on a real-time basis whether an order was properly declined. 
The NASD believes that this capability is crucial to engendering 
investor confidence in the firmness of Nasdaq market maker quotations 
and should alleviate any concerns regarding ``backing away'' questions. 
The NASD notes that the 15-second decline feature was criticized in the 
context of the N<bullet>Prove proposal.<SUP>23 The NASD believes that 
this proposal to develop a real-time automated surveillance capability 
should alleviate any concerns about the ``decline'' capability. The 
NASD will undertake strong disciplinary measures against any firm that 
displays a pattern and practice of improper order declines.

    \23\ See Securities Exchange Act Release No. 35275 (Jan. 25, 
1995), 60 FR 6327 (Feb. 1, 1995).
---------------------------------------------------------------------------

    Order entry firms have two alternatives in entering NAqcess 
orders--they may direct the order to a particular market maker with 
whom they have established a direct order arrangement, or they may 
enter a non-directed order. In either circumstance, market orders and 
marketable limit orders will first pass over the limit order file to 
obtain a match before execution against a market maker. If an order is 
directed pursuant to a valid agreement between the order entry firm and 
the market maker, the market maker may not decline the order.
    E. Opening Procedures. NAqcess will have special opening procedures 
that are consistent with the opportunities for order matching and price 
improvement over the dealer quotation provided intra-day by NAqcess.
    NAqcess's operating hours are from 9:30 a.m. to 4:00 p.m. (EST). 
However, limit orders may be entered and stored in NAqcess from 4:00 
p.m. to 6:00 p.m. and limit and market orders may be entered from 8:30 
a.m. to 9:28 a.m. At 9:28 a.m., no further orders for opening purposes 
will be accepted.<SUP>24 At 9:30 a.m., Nasdaq will rank all limit 
orders stored as of 9:28 a.m. according to price and time of entry. To 
the extent orders are available, the system will then match the best-
priced sell limit orders against the best-priced buy limit orders in 
the file that are within the best dealer bid and offer as determined at 
9:30 a.m. When all available limit order matches are effected, any 
remaining limit orders within the inside dealer quote at 9:30 a.m. will 
be matched against market orders stored as of 9:28 a.m. and will be 
executed at such limit order prices. Any remaining orders will be 
subject to the normal intra-day, order distribution and execution 
procedures. It should be noted that this opening procedure will not 
create a single, unitary price for all orders in NAqcess. The 
individual 

[[Page 63097]]
prices of each match will be reported. Thus, assuming the dealer 
quotation is 20-20\1/2\, if the file contains two limit orders to buy 
at 20\1/8\, each for 1,000 shares, and there are also three 1,000 share 
limit orders to sell at 20\1/8\, two 1,000 share limit orders to sell 
at 20\1/4\, and 4,000 shares to buy at the market, the system will 
execute as follows: the first two in time priority of the three 1,000 
shares sell limit orders at 20\1/8\ will be matched against the two 
20\1/8\ 1,000 share buy limit orders. The first 3,000 shares to buy at 
the market will be matched against the remaining limit orders to sell, 
with the first market order in time receiving an execution of 20\1/8\ 
and two 1,000 share market orders next in time receiving executions of 
20\1/4\. The remaining 1,000 share market order will be executed 
against the dealer quote according to the normal post-opening execution 
algorithm.

    \24\ Orders entered from 9:28 a.m. to 9:30 a.m. will be stored 
and handled after the opening in line with ordinary matching and 
handling procedures described above.
---------------------------------------------------------------------------

3. Rules of Fair Practice
    The NASD is also proposing in conjunction with NAqcess three major 
changes to the Rules of Fair Practice. Under the proposed new rule and 
Interpretations, the treatment of limit orders will be significantly 
changed to promote price protection of such orders throughout The 
Nasdaq Stock Market. These proposed rule changes provide greatly 
enhanced limit order treatment over current practices. Together with 
existing limit order protections already in place (i.e., the so-called 
``Manning'' rule), the new proposals provide investors placing limit 
orders with significantly enhanced protections against limit order 
trade-throughs throughout The Nasdaq Stock Market.
    A. Customer Order Handling. The NASD is proposing a new 
Interpretation under Article III, Section 1 of the Rules of Fair 
Practice. Under the proposal, if a customer requests that his or her 
order be entered into NAqcess, the member firm must do so. While the 
Interpretation permits a firm to charge for such services and to 
recommend the use of its own execution system, the member is not 
permitted to discriminate against customers that choose NAqcess over an 
internal system by imposing unfair commissions or charges. The proposed 
Interpretation covers both market and limit orders.
    B. Price Protection. The NASD is also proposing a new rule in the 
Rules of Fair Practice that would prohibit a member firm, whether 
acting as a principal or as an agent, from executing any order at a 
price inferior to any limit orders that the firm is able to see in the 
NAqcess limit order file.<SUP>25 An inferior price means an execution 
price that is lower than a buy limit order or higher than a sell limit 
order that a member firm is able to see in the NAqcess limit order 
file. This prohibition means that limit orders in the NAqcess file will 
not be traded through elsewhere in Nasdaq in most circumstances. A 
member firm's activity with respect to protecting NAqcess limit orders 
must be consistent with its best execution obligations to its own 
customers. When a firm acts as principal in filling a NAqcess limit 
order when it is in possession of an executable customer market order 
on the other side of the market, it should pass on the benefit of the 
NAqcess trade to the customer order. If the firm in receipt of the 
market order is acting as agent for its own customer's order, its best 
execution obligation would mean that it should select the appropriate 
market for execution, which could be NAqcess.

    \25\ It should be noted that placement of a customer limit order 
in the NAqcess file does not relieve a member firm of its obligation 
under the Limit Order Protection Interpretation of Article III, 
Section 1 of the Rules of Fair Practice that prohibits a member firm 
from trading ahead of a customer limit order it has been entrusted 
with. Under the so-called ``Manning'' Interpretation, if a member 
firm holding a customer limit order, whether from its own customer 
or as a result of a member-to-member order, places that order into 
NAqcess, the member firm is nevertheless prohibited from trading at 
the same price or at an inferior price to the customer order. Thus, 
while the newly proposed price protection rules speak in terms of 
protecting NAqcess orders from inferior priced transactions, if the 
NAqcess order is the firm's customer's order or a member-to-member 
order it placed in NAqcess, the firm may not trade at the same price 
without protecting that order.
---------------------------------------------------------------------------

    The price protection obligation is related to the ability of the 
firm to view the orders in the limit order file. Thus, under the 
proposal's current configuration, limit orders at the top of the file 
and included in the inside market calculation must be protected by all 
member firms. Under NAqcess system rules, limit orders ranked below the 
top of the file are viewable only by market makers in the particular 
security. Accordingly, market makers in a particular security would be 
obligated to protect all limit orders in that security in the NAqcess 
file from inferior executions that they may engage in.<SUP>26 Thus, if 
a market maker in a security sought to execute a 1,000 share trade at 
20, when the NAqcess file displayed limit orders to buy at 20\1/8\ and 
20\1/4\, the market maker would be required to either execute the limit 
orders first or contemporaneously, depending on the size of the limit 
orders in NAqcess.<SUP>27

    \26\ In today's environment, market makers are involved in 
approximately 83% of all Nasdaq trades. Consequently, it is likely 
that in a large majority of trades when NAqcess is operational, a 
market maker will be involved, and thus, orders away from the top of 
the file typically will be protected as well as the top of the file.
    \27\ The NASD will interpret the price protection rule to not 
apply to member firms that operate passively-priced crossing 
systems, such as POSIT and Instinet's Crossing Network. Generally 
speaking, such systems execute prices at the dealer quotation spread 
midpoint and would not likely trade through a NAqcess order. Members 
that believe that they operate systems that could qualify for this 
exemption should submit a request for exemption to the NASD.
    The proposed rule would apply, however, to ordinary broker-
dealer trading systems such as Instinet's regular trading session. 
Because many such trades could occur at prices that could be 
inferior to limit orders in NAqcess, the NASD believes it 
appropriate that such NASD member firms should protect NAqcess 
customer limit orders as would any other registered broker-dealer 
member firm. Orders placed in SelectNet that trade through NAqcess 
are also subject to the price protection rule.
---------------------------------------------------------------------------

    The NASD believes it important to explain for the purposes of the 
price protection rule and the Interpretation regarding equivalent price 
protection for limit orders held outside of NAqcess, that the 
protectible price that generates a firm's obligation to provide price 
protection is the price reported for last sale reporting purposes. Some 
confusion has occurred regarding limit orders trading at an ``inferior 
price,'' especially in the context of internal sales credits. If the 
execution price reported via ACT for Schedule D transaction reporting 
purposes includes an internal sales credit that will be provided to a 
sales representative at the firm, the price that triggers the member 
firm's obligation to protect a limit order is the reported price. The 
internal sales credit included in the reported price has no effect on 
the obligation to protect the NAqcess limit order.<SUP>28

    \28\ See NASD Special Notices To Members 95-43 (July 27, 1995) 
and 95-67 (Mar. 21, 1995) for a more detailed discussion of the 
proper means for protecting customer limit orders when firms are 
dealing at net prices. The same concepts apply in the context of 
protecting system limit orders.
---------------------------------------------------------------------------

    C. Equivalent Price Protection. As noted earlier, the NASD, to 
encourage competition and to enhance the liquidity of The Nasdaq Stock 
Market, has determined that market makers should continue to be 
permitted to operate their own internal execution systems and to handle 
limit orders outside of NAqcess. However, the NASD also believes it is 
important to provide limit orders held outside of NAqcess with price 
protection substantially equivalent to that which NAqcess orders would 
have. Accordingly, the NASD has proposed an Interpretation to Article 
III, Section 1 of the Rules of Fair Practice 

[[Page 63098]]
that provides substance to the term equivalent price protection.<SUP>29

    \29\ The equivalent price protection Interpretation would not 
apply to continuous trading systems, such as that operated by 
Instinet, because such customers are generally sophisticated and 
have deliberately opted to trade in an alternative trading system. 
Such customers are institutions and broker-dealers that seek other 
advantages in trading in these alternative systems. Because of their 
sophistication, these customers believe they do not need the broker-
dealer operating the system to provide equivalent price protection. 
Accordingly, the NASD will provide an exemption from the 
Interpretation to brokers operating such systems if they seek an 
exemption.
---------------------------------------------------------------------------

    First, a member firm holding a protectible customer limit order 
<SUP>30 outside of NAqcess must provide such order with print 
protection, if any transaction at a price inferior to the customer 
limit order occurs.<SUP>31 Thus, any firm holding a protectible 
customer limit order is required to contemporaneously execute, up to 
the size of the reported transaction, the customer limit order at the 
limit order price if an inferior-priced execution is reported in that 
security. ``Contemporaneously'' means within approximately 60 seconds 
of the trade report. For example, firms A and B each hold 1,000 share 
customer limit orders to buy priced at 20\1/8\. A 1,000 share trade is 
reported at 20. Both firms A and B are obligated to execute their limit 
orders at 20\1/8\ within 60 seconds of the trade report. If the 
triggering trade report had been 500 shares at 20, each firm owed its 
customers executions of at least 500 shares at 20\1/8\.

    \30\ A ``protectible'' order is a customer order of a size that 
would be eligible for entry into NAqcess. Accordingly, the 
Interpretation requirements do not extend to customer limit orders 
that are larger than 1,000 shares (or larger than 3,000 shares for 
Nasdaq 100 securities).
    \31\ A member's obligation to provide print protection will not 
be triggered by a trade report that has a special modifier, such as 
.SLD or otherwise, appended to it. Because such modifiers indicate 
the trade being reported is out of sequence or was executed under 
special conditions, such trade reports should not require an 
execution of a limit order. The NASD will closely monitor member's 
usage of special trade reporting modifiers to ensure that firms to 
not use such modifiers as a vehicle to avoid print protection 
obligations under the new rule.
---------------------------------------------------------------------------

    Next, if the firm holds a protectible customer limit order at a 
price that would match a limit order in the NAqcess file, the firm must 
either execute its limit order or send its limit order to NAqcess for 
matching. ``Matching'' means that the NAqcess limit order is the same 
price or lower than the firm's customer's limit order to buy or higher 
than the limit order to sell.
    The same matching would be required if the firm holds offsetting 
limit orders within its own file. If the firm holds a limit order to 
sell at 20\1/4\ and accepts a limit order to buy at 20\1/4\ or higher, 
the firm must execute the two orders against each other. Finally, if 
the firm holds a limit order that is priced equal to or better than the 
inside market in Nasdaq, and if the firm accepts a customer market 
order for automated execution at the inside market, the firm must first 
match the market order against the limit order before it can execute 
the market order for its own account.
4. NAqcess Proposal--Consistent With Securities Exchange Act
    The proposed NAqcess system and the accompanying proposed rule 
changes in the Rules of Fair Practice propose significant structural 
changes in The Nasdaq Stock Market that greatly benefit investors in 
their handling of limit orders, price improvement over the dealer 
quotation, and rapid execution of orders. It is important to note that 
no previous proposal for a Nasdaq order handling and execution system 
has been so interrelated with such significant changes to rules that 
provide price protection across the Nasdaq market. The two 
developments--a new system with advanced order matching features and 
greater transparency along with the dramatic changes to price 
protection of orders in and outside the system--must be considered as a 
part of a fully integrated approach to the handling of retail customer 
orders. Together, they permit retail investors greater opportunity to 
participate directly in the market through the use of limit orders and 
substantially increase their ability to receive executions between the 
best dealer bid and offer. Further, the NASD believes that the approach 
to changes in The Nasdaq Stock Market proposed in this rule filing 
helps to guarantee investor protection and fairness to all market 
participants, while still allowing the market makers to operate in a 
competitive dealer market. The enhanced price discovery features, the 
transparency of limit orders, and the interaction of limit orders and 
market orders should add to the liquidity, efficiency and immediacy of 
Nasdaq's competing dealer market structure.
    Accordingly, the NASD believes that the proposed rule change is 
consistent with Sections 15A(b)(6), 15A(b)(9), 15A(b)(11) and 
11A(a)(1)(C) of the Act. 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. Section 15A(b)(9) requires 
that rules of an Association not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Act. 
Section 15A(b)(11) requires the NASD to formulate rules governing the 
quality of fair and informative quotations. Section 11A(a)(1)(C) finds 
that it is in the public interest to, among other things, assure 
economically efficient execution of securities transactions. The 
fundamental purpose of NAqcess is to assist investors in achieving 
prompt, efficient executions of their small orders and to provide an 
opportunity for price improvement over the dealer quotation within an 
automated execution environment. The integrity and efficiency of Nasdaq 
for public investors and market-making participants is critical and the 
NASD believes that NAqcess will provide benefits to both 
constituencies. The design of NAqcess is not anti-competitive as it 
treats all non-directed orders uniformly; to the extent that directed 
orders are distinguished, by entering into such arrangements with known 
customers, market makers effectively waive the protections offered by 
the system.
    The new proposals are also fully consistent with the significant 
national market system objectives contained in Section 11A of the Act. 
The NAqcess national limit order facility would advance these 
objectives by offering efficient execution of investors' small orders, 
by maintaining market maker participation through the automated 
delivery of orders with the ability to reject those orders if trades 
have already occurred, and by offering the opportunity for price 
improvement over the dealer quotation to orders both inside and outside 
of the NAqcess system. The system's functionality will more accurately 
reflect market makers' affirmative obligations to provide liquidity to 
the market, without depriving market makers of legitimate exceptions 
from the firmness requirements contained in Rule 11Ac1-1. In sum, the 
NASD believes that the entire proposal set forth herein significantly 
advances the goals of investor protection and greater access to The 
Nasdaq Stock Market.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe that the proposed rule change will result 
in any 

[[Page 63099]]
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 are discussed above.

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 self-regulatory organization 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. In particular, the Commission 
requests general comments concerning the NASD's proposal and whether it 
is consistent with the Act. In addition, the Commission invites 
interested persons to address the following specific issues:
    (1) The Commission recently proposed rules concerning order 
execution obligations.<SUP>32 Among other things, the Commission's 
proposal generally would: (a) require Nasdaq market makers to display 
in their quotations (1) customer limit orders priced better than the 
market maker's current quotation, or (2) the size of a customer limit 
order that equals the current inside bid or offer; and (b) require that 
market makers offer market orders for certain securities an opportunity 
for price improvement over the current national best bid or offer. The 
Commission seeks comment on whether the NASD's proposal is consistent 
with the Commission's proposal and with the goals set forth in the 
Commission's release;

    \32\ Securities Exchange Act Release No. 36310 (Sept. 29, 1995), 
60 FR 52791 (Oct. 10, 1995).
---------------------------------------------------------------------------

    (2) The NASD's proposal would eliminate SOES and does not include 
the immediate automatic execution feature for market orders currently 
available in SOES. In light of historical concern about the 
accessibility of market maker quotations,<SUP>33 the Commission seeks 
comment on the possible effects this change could have on the Nasdaq 
market and retail investors;

    \33\ Division of Market Regulation, SEC, The October 1987 Market 
Break 9-19 (1988).
---------------------------------------------------------------------------

    (3) The SOES Rules provide a market maker a five-minute period 
within which to update its quotation or reestablish its exposure limit 
after its exposure limit has been exhausted. Further, the current 
operation of SOES allows for a market maker to elect to use an 
automated quotation update feature which, generally, changes, by a 
prespecified increment, the market maker's quotation after its SOES 
exposure limit is exhausted. The NASD's NAqcess proposal would continue 
both of these features. In light of the automated quotation update 
feature and the lack of immediate automatic execution that would occur 
under NAqcess, the Commission seeks comment on whether there is a 
continuing need for the five-minute grace period;
    (4) The NASD proposes to modify the methodology for calculating the 
inside Nasdaq market to include both dealer quotations and NAqcess 
limit orders. If a NAqcess limit order equals or improves the best 
market maker quotation, it will be included in the Nasdaq inside market 
and disseminated as the inside quotation, including the aggregate size 
of all orders at that price. Further, the NASD proposes to use a unique 
indicator to denote when the inside market is represented by a NAqcess 
limit order, rather than a dealer or UTP exchange quotation. The 
Commission requests comment on whether using an indicator for a NAqcess 
limit order is appropriate;
    (5) As discussed above in the NASD's proposal, priority of NAqcess 
executions when the best bid or offer consists of both a market maker 
quotation and a NAqcess limit order would be based on time priority. 
For example, if the inside bid consists of two market makers' bids and 
a NAqcess limit order, and the market makers' bids were received before 
the NAqcess limit order, the first two incoming market orders would be 
delivered to the market makers and subject to potential rejection 
within 20 seconds, rather than delivered to the limit order for 
immediate automatic execution. The Commission seeks comment on whether 
limit orders priced equal to the inside dealer quote should be given 
priority over market maker quotations, the implications of such a rule, 
and the relative costs and benefits of such a rule, particularly given 
that orders against market makers are delayed for 20 seconds but are 
executed immediately if matched with NAqcess limit orders;
    (6) The proposal would limit the maximum order size for market 
orders to 1,000 shares (depending on certain trading characteristics of 
the security). For limit orders, the maximum order size would be 1,000 
shares for all securities, except for limit orders in Nasdaq 100 
securities for which the maximum limit order size would be 3,000 
shares. The Commission seeks comment on the appropriate maximum order 
size for NAqcess limit orders, and whether different thresholds should 
be established for different Nasdaq securities. Further, the Commission 
notes that the Commission's recent proposal concerning order execution 
obligations generally would require display of limit orders of 10,000 
shares or less; the Commission requests comment on the interaction 
between this aspect of the Commission's proposal and the NASD's 
proposal;
    (7) The proposed NAqcess rules would limit access to the system to 
agency orders entered by member firms on behalf of public customers. 
Generally, the proposal would exclude: (a) accounts of persons 
associated with any member firm, and (b) the immediate family of any 
person associated with a member. The Commission is interested in 
commenters' views on the appropriateness of these exclusions. 
Specifically, the Commission requests comment on: (a) whether 
proprietary market and limit orders should be allowed or, 
alternatively, whether only proprietary limit orders should be allowed; 
(b) whether orders from the immediate family of members should be 
permitted; and (c) whether orders from non-member broker-dealers (e.g., 
options market makers and UTP specialists) to member broker-dealers 
should be permitted;
    (8) Under the proposal, any firm holding a protectible customer 
limit order would be required to execute contemporaneously (i.e., 
within 60 seconds of the trade report), up to the size of the reported 
transaction, the customer limit order at the limit order price if an 
inferior-priced execution is reported in that security. The Commission 
requests comment on the appropriateness of this time period;
    (9) The NASD's proposal includes Rules of Fair Practice that 
generally would prohibit a member from trading at a price inferior to a 
viewable NAqcess limit order and require that orders held outside of 
NAqcess be provided price protection substantially equivalent to that 
which NAqcess orders would have. 

[[Page 63100]]
Under the proposal, for each security, only market makers in that 
security will be able to see the full limit order file; all other 
members are limited to viewing the top of the file. The Commission 
requests comment on whether there should be an exception to the NASD's 
price protection rule for block trades. In addition, the Commission 
requests comment on whether full file display of the NAqcess limit 
order file should be broadened and, if so, to what extent; and
    (10) The Commission requests comment on whether the NASD's 
proposal, and in particular the amendments to the Rules of Fair 
Practice, would result in any burdens on competition, and if so, the 
extent of such burdens and whether they are necessary and appropriate 
in furtherance of the Act.
    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 in the Commission's Public 
Reference Room. Copies of the filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to the file number SR-NASD-95-42 and should be 
submitted by January 16, 1996.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.<SUP>34

    \34\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Secretary.

Exhibit A--Rules of Operation and Procedures for the NAqcess System

I. Definitions

    The terms used in this Section shall have the same meaning as those 
defined in the Association's By-Laws and Rules of Fair Practice, unless 
otherwise specified.
    A. The term ``NAqcess'' shall mean the limit order and market order 
delivery and execution system owned and operated by The Nasdaq Stock 
Market, Inc. (a wholly owned subsidiary of the National Association of 
Securities Dealers, Inc.).
    B. The term ``NAqcess participant'' shall mean either a market 
maker or order entry firm registered for participation in NAqcess.
    C. The term ``NAqcess eligible security'' shall mean any Nasdaq 
National Market or Nasdaq SmallCap equity security.
    D. The term ``open quote'' shall mean a market maker's quotation 
price and size (up to its designated exposure limit) in an eligible 
security against which orders may be executed through the NAqcess 
system during normal market hours, as specified by the NASD. For the 
purposes of these Rules, a market maker has a ``closed quote'' when its 
exposure limit in NAqcess has been exhausted or it has been deemed 
``closed'' pursuant to Section IV. A. 9 below.
    E. The term ``NAqcess market maker'' shall mean a member of the 
Association that is registered as a Nasdaq market maker pursuant to the 
requirements of Schedule D to the NASD By-Laws and as a market maker in 
one or more NAqcess eligible securities.
    F. The term ``NAqcess order entry firm'' shall mean a member of the 
Association that is registered as an order entry firm for participating 
in NAqcess which permits the firm to enter agency orders of limited 
size for delivery to and execution against NAqcess market makers and 
customer limit orders in NAqcess that are included in the inside 
market.
    G. The term ``agency order'' shall mean an order from a public 
customer that is entered by the NAqcess order entry firm or NAqcess 
market maker on an agency basis.
    An order will not be considered an agency order if it is for any 
account of a person associated with any member firm or any account 
controlled by such an associated person. An order will not be 
considered an agency order if it is for any account of a member of the 
``immediate family'' (as that term is defined in the NASD Free-Riding 
and Withholding Interpretation, Article III, Section 1 of the Rules of 
Fair Practice) of an associated person who has physical access to a 
terminal capable of entering orders into NAqcess.
    H. The term ``directed order'' shall mean an order entered into 
NAqcess and directed to a particular NAqcess market maker or an order 
entered by a NAqcess market maker that is self-directed. Each market 
maker has the ability to select order entry firms from which it will 
accept directed orders.
    I. The term ``non-directed order'' shall mean an order entered into 
NAqcess and not directed to any particular market maker, or a directed 
order that has been directed to a market maker that has not identified 
the order entry firm as one from which it will accept directed orders, 
or a directed order sent to a firm that is not registered as a market 
maker in that security.
    J. The term ``limit order'' shall mean an order entered into 
NAqcess that is a priced order.
    K. The term ``marketable limit order'' shall mean a limit order 
that, at the time it is entered into NAqcess, if it is a limit order to 
buy, is priced at the current inside offer or higher, or if it is a 
limit order to sell, is priced at the inside bid or lower.
    L. The term ``executable limit order'' shall mean a limit order 
that, at the time a limit order, market order, or marketable limit 
order on the opposite side of the market is entered, is either included 
in the inside market or is equal in price to the inside market and has 
time priority over other limit orders or dealer quotations included in 
the inside market.
    M. The term ``marker order'' shall mean a limit order for a market 
maker's principal account that is a part of a contemporaneously 
executed transaction that the firm is engaged in for the benefit of one 
or more customers.
    N. The term ``takeout order'' shall mean an order entered by an 
NASD member firm, acting as principal or as agent, that executes 
against NAqcess limit orders viewable by that firm.
    O. The term ``inside market'' shall mean the best dealer bid, UTP 
exchange bid, or NAqcess limit order(s) to buy and the best dealer 
offer, UTP exchange offer or NAqcess limit order(s) to sell, as the 
case may be, displayed by Nasdaq.
    P. The term ``UTP exchange'' shall mean any registered national 
securities exchange that has unlisted trading privileges in Nasdaq 
securities.
    Q. The term ``matched or crossed file'' shall mean the entry of: 
(1) a bid quotation by a market maker equal to or greater than a limit 
order to sell resident in the NAqcess file in the same security; or (2) 
an offer quotation by a market maker equal to or less than a limit 
order to buy resident in the NAqcess file in the same security.
    R. The term ``maximum market order size'' shall mean the maximum 
size of individual market orders for a NAqcess eligible security that 
may be entered into or executed through NAqcess. The maximum market 
order size for each security shall be advertised in the system and 
published from time to time by the Association. In establishing the 
maximum market order size for each Nasdaq National Market security, the 
Association generally will give 

[[Page 63101]]
consideration to the average daily non-block volume, bid price, and 
number of market makers for each security. Maximum market order size 
for Nasdaq National Market securities shall be 200, 500 or 1,000 
shares, depending upon the trading characteristics of the 
securities.<SUP>1 These sizes may be adjusted on an issue by issue 
basis, depending upon trading characteristics of the issue and other 
relevant factors as determined by the Association. Maximum market order 
size for Nasdaq SmallCap securities shall be 500 shares.

    \1\ The applicable maximum market order size for each Nasdaq 
National Market security is determined generally by the following 
criteria:
    (i) a 1,000 share maximum market order size shall apply to 
Nasdaq National Market securities with an average daily non-block 
volume of 6,000 shares or more a day, a bid price of less than or 
equal to $100, and three or more market makers;
    (ii) a 500 share maximum market order size shall apply to Nasdaq 
National Market securities with an average daily non-block volume of 
2,000 shares or more a day, a bid price of less than or equal to 
$150, and two or more market makers; and
    (iii) a 200 share maximum market order size shall apply to 
Nasdaq National Market securities with an average daily non-block 
volume of less than 2,000 shares a day, a bid price of less than or 
equal to $250, and that have two or more market makers.
---------------------------------------------------------------------------

    S. The term ``maximum limit order size'' shall mean the maximum 
size of a limit order for a security that may be entered into or 
matched through NAqcess. The maximum limit order size for Nasdaq 
National Market securities shall be 1,000 shares for each tier of 
Nasdaq National Market securities, except for the securities that 
comprise the Nasdaq 100 Index,<SUP>2 which shall have a maximum limit 
order size of 3,000 shares. Maximum limit order size for Nasdaq 
SmallCap securities shall be 1,000 shares.

    \2\ The Nasdaq 100 Index is an index comprised of many of the 
largest capitalized issues quoted in the Nasdaq National Market. The 
securities that make up the Nasdaq 100 are changed from time to time 
and The Nasdaq Stock Market publishes notice of such changes as they 
occur.
---------------------------------------------------------------------------

    T. The term ``exposure limit'' shall mean the number of shares of a 
NAqcess eligible security specified by a NAqcess market maker that it 
is willing to have executed for its account by orders entered into 
NAqcess on either side of the market.
    U. The term ``minimum exposure limit'' for a security shall mean an 
exposure limit equal to the maximum market order size for that 
security.
    V. The term ``automated quotation update facility'' shall mean the 
facility in the NAqcess system that allows the system to automatically 
refresh a market maker's quotation in any security that the market 
maker designates when the market maker's exposure limit has been 
exhausted. The facility will update: (1) either the bid or the offer 
side of the quote using a quotation interval designated by the market 
maker, depending upon the side of the market on which the execution has 
occurred and refresh the market maker's exposure limit; or (2) close 
the market maker's quote for five minutes, within which time the market 
maker shall update its quote or be placed in a suspended state for 20 
days.
    W. The term ``Automated Confirmation Transaction service'' 
(``ACT''), for purposes of the NAqcess rules, shall mean the automated 
system owned and operated by The Nasdaq Stock Market, Inc. which 
accommodates trade reporting of transactions executed through NAqcess 
and submits locked-in trades to clearing.

II. NAqcess Participant Registration

    A. All members participating in NAqcess shall register and be 
authorized as NAqcess market makers and/or order entry firms. 
Registration as a NAqcess participant shall be conditioned upon the 
member's initial and continuing compliance with the following 
requirements: (1) membership in a clearing agency registered with the 
Securities and Exchange Commission which maintains facilities through 
which NAqcess compared trades may be settled; or entry into a 
correspondent clearing arrangement with another member that clears 
trades through such clearing agency; (2) registration as a market maker 
(if applicable) in Nasdaq pursuant to Schedule D of the NASD By-Laws 
and compliance with all applicable rules and operating procedures of 
the Association and the Securities and Exchange Commission; (3) 
maintenance of the physical security of the equipment located on the 
premises of the member to prevent the unauthorized entry of orders or 
other data into NAqcess or Nasdaq; and (4) acceptance and settlement of 
each trade for which it is responsible that is executed through the 
facilities of the NAqcess service, or if settlement is to be made 
through another clearing member, guarantee of the acceptance and 
settlement of such identified NAqcess trades by the clearing member on 
the regularly scheduled settlement date.
    B. Upon effectiveness of the member's registration to participate 
in NAqcess, participants may commence activity within NAqcess for entry 
and/or execution of orders, as applicable, and their obligations as 
established in this rule will commence.
    C. Pursuant to Schedule D to the NASD By-Laws, participation as a 
NAqcess market maker is required for any Nasdaq market maker registered 
to make a market in a Nasdaq National Market security. A market maker 
in a Nasdaq SmallCap security may withdraw from and reenter NAqcess at 
any time, and without limitations, during the operating hours of the 
service.
    D. Each NAqcess participant shall be under a continuing obligation 
to inform the Association of noncompliance with any of the registration 
requirements set forth above.

III. Operating Hours of NAqcess

    The operating hours of NAqcess will be the normal market hours 
specified for The Nasdaq Stock Market.

IV. Participant Obligations in NAqcess

A. Market Makers

    1. A NAqcess market maker shall commence participation in NAqcess 
by initially contacting the Market Operation Center to obtain 
authorization for market making in particular Nasdaq securities and 
identifying those terminals on which the NAqcess trade information is 
to be displayed. Thereafter, on-line registration on a security-by-
security basis is permissible, consistent with the requirements of 
Schedule D to the NASD By-Laws.
    2. Participation as a NAqcess market maker obligates the firm, upon 
presentation of a market order or marketable limit order through the 
service, to execute such order as provided in Section V. A. 5. below. 
NAqcess market makers are not permitted to decline orders directed to 
the firm pursuant to a directed order arrangement acknowledged by the 
market maker. The system will transmit to the market maker on the 
Nasdaq Workstation screen and printer, if requested, or through a 
computer interface, as applicable, an execution report generated 
following each execution.
    3. For each NAqcess eligible security in which a market maker is 
registered, the market maker shall enter into NAqcess its exposure 
limit. For a Nasdaq National Market security, that limit shall be any 
amount equal to or larger than the minimum exposure limit for the 
particular security. If no exposure limit is entered for a Nasdaq 
National Market security, the firm's exposure limit will be either the 
default size selected by the particular market maker or the minimum 
exposure limit. ``Default size'' shall mean an exposure limit greater 
than the minimum exposure limit that may be selected by a market maker 
for individual securities or for all securities in which it makes a 
market.
    4. A NAqcess market maker may elect to use the automated quotation 
update 

[[Page 63102]]
facility in one or more securities in which it is registered. The 
facility will update the market maker's quotation automatically by a 
quotation interval designated by the market maker, once its exposure 
limit in the security has been exhausted. The facility will update the 
market maker's quotation in either the bid or the offer side of the 
market by the interval designated and will reestablish the market 
maker's displayed size and either the default size or the minimum 
exposure limit; or the facility will close the market maker quote for 
five minutes.
    5. Matched or crossed file. If a market maker's quotation change 
matches or crosses a limit order residing in the NAqcess limit order 
file, the system will automatically provide a notification to the 
market maker that informs the market maker of its obligation to protect 
all limit orders residing in the NAqcess file that would be affected by 
the quotation change. If the market maker enters the matching or 
crossing quotation change after this notification, limit orders in the 
file for the particular security will be automatically executed against 
the matching or crossing market maker, provided however, that if the 
number of shares in the limit order file that would be matched or 
crossed is greater than five times the maximum market order size for 
that particular security, or if the quotation change matches and 
crosses multiple price levels, the quotation change will be rejected. 
To effect such quotation change, the market maker first must manually 
enter a takeout order for the affected orders in the file prior to re-
entering its quotation update.
    6. The market maker may terminate its obligation by keyboard 
withdrawal from NAqcess at any time. However, the market maker has the 
specific obligation to monitor its status in NAqcess to assure that a 
withdrawal has in fact occurred. Except as otherwise permitted by 
Section 70 of the Uniform Practice Code regarding the Association's 
authority to declare clearly erroneous transactions void, (``UPC 
Section 70''), any transaction occurring prior to the effectiveness of 
the withdrawal may remain the responsibility of the market maker. In 
the case of a Nasdaq SmallCap security, a market maker whose exposure 
limit is exhausted will be deemed to have withdrawn from NAqcess and 
may reenter at any time. In the case of a Nasdaq National Market 
security, a market maker whose exposure limit is exhausted will have a 
closed quote in Nasdaq and NAqcess and will be permitted a standard 
grace period of five minutes within which to take action to restore its 
exposure limit, if the market maker has not authorized use of the 
automated quotation update facility. A market maker that fails to renew 
its exposure limit in a Nasdaq National Market security within the 
allotted time will be deemed to have withdrawn as a market maker. 
Except as provided in subsection 7 below, a market maker that withdraws 
from a Nasdaq National Market security may not re-register in NAqcess 
as a market maker in that security for twenty (20) business days.
    7. Notwithstanding the provisions of subsection 6 above, (i) a 
market maker that obtains an excused withdrawal pursuant to Part V of 
Schedule D to the NASD By-Laws prior to withdrawing from NAqcess may 
reenter NAqcess according to the conditions of its withdrawal; and (ii) 
a market maker that fails to maintain a clearing arrangement with a 
registered clearing agency or with a member of such an agency, and is 
thereby withdrawn from participation in ACT and NAqcess for Nasdaq 
National Market securities, may reenter NAqcess after a clearing 
arrangement has been reestablished and the market maker has complied 
with ACT participant requirements, provided however, that if the 
Association finds that the ACT market maker's failure to maintain a 
clearing arrangement is voluntary, the withdrawal of quotations will be 
considered voluntary and unexcused pursuant to Schedule D and these 
rules.
    8. In the event that a malfunction in the market maker's equipment 
occurs rendering on-line communications with the NAqcess service 
inoperable, the NAqcess market maker is obligated to immediately 
contact the Market Operations Center by telephone to request a closed 
quote status from NAqcess. For Nasdaq securities, such request must be 
made pursuant to the requirements of Part V, Schedule D to the NASD By-
Laws. If the closed quote status is granted, Market Operations 
personnel will enter such status notification into NAqcess from a 
supervisory terminal. Such manual intervention, however, will take a 
certain period of time for completion and, unless otherwise permitted 
by the Association pursuant to its authority under UPC Section 70, the 
NAqcess market maker may continue to be obligated for any transaction 
executed prior to the effectiveness of its closed quote.

B. Order Entry

    1. Only market and limit agency orders may be entered in NAqcess by 
the NAqcess order entry firm through either its Nasdaq Workstation or 
computer interface. The system will transmit to the order entry firm on 
the Nasdaq Workstation screen and printer, if requested, or through a 
computer interface, as applicable, an execution report generated 
following each execution. NAqcess market makers may enter limit agency 
orders in NAqcess for any NAqcess eligible security, but may not enter 
agency market orders or marketable limit orders in securities in which 
they make markets, unless such orders are self-directed. As a limited 
exception to the prohibition of the entry of proprietary orders into 
NAqcess, NAqcess market makers may place marker orders into NAqcess. 
The benefit of any such marker order execution must be passed 
immediately to one or more customer limit orders held by the firm 
placing the marker order. Marker orders may not be placed with respect 
to customer limit orders held by the firm that exceed the maximum limit 
order size permitted by these rules.
    2. NAqcess will accept both market and limit agency orders of 
appropriate size for execution. Agency orders may be directed to a 
specific NAqcess market maker, self-directed by the NAqcess market 
maker, or may be non-directed, thereby resulting in execution against 
the next available NAqcess market maker. If an order is directed to a 
market maker by an order entry firm from which it has not agreed to 
accept direct orders, the order will be executed on a non-directed 
basis.
    3. Only agency orders no larger than the maximum market and limit 
order sizes may be entered by a NAqcess order entry firm into NAqcess 
for execution against an NAqcess market maker or against an executable 
limit order. Orders in excess of the maximum order sizes may not be 
divided into smaller parts for purposes of meeting the size 
requirements for orders entered into NAqcess. All orders based on a 
single investment decision that are entered by a NAqcess order entry 
firm for accounts under the control of associated persons or public 
customers, whether acting alone or in concert with other associated 
persons or public customers, shall be deemed to constitute a single 
order and shall be aggregated for determining compliance with the 
maximum order size limits. Orders entered by the NAqcess order entry 
firm within any five-minute period in accounts controlled by associated 
persons or public customers, acting alone or in concert with other 
associated persons or public customers, shall be presumed to be based 
on a single investment decision. An associated person or customer shall 
be deemed to control an account if the account is his or her personal 
account or an account in 

[[Page 63103]]
which he or she has a beneficial interest; the person exercises 
discretion over the account; the person has been granted a power of 
attorney over the account; or the account is the account of an 
immediate family member as that term is defined in the Board of 
Governors Interpretation on Free-Riding and Withholding, Article III, 
Section 1 of the NASD Rules of Fair Practice.
    4. No order will be considered an agency order from a public 
customer if it is for any account of a person associated with any 
member firm or any account controlled by such an associated person. No 
order will be considered an agency order from a public customer if it 
is for any account of a member of the ``immediate family'' (as that 
term is defined in the NASD Free-Riding and Withholding Interpretation, 
Article III, Section 1 of the Rules of Fair Practice) of an associated 
person who has physical access to a terminal capable of entering orders 
into NAqcess.
    5. No member or person associated with a member shall utilize 
NAqcess for the execution of agency orders in a SmallCap security in 
which the member is a Nasdaq market maker but is not a NAqcess market 
maker.
    6. NAqcess will accept the following types of agency orders during 
normal market hours: (a) day orders; (b) good-till-canceled (``GTC''); 
and (c) good till date (``GTD'').

V. Execution of NAqcess Orders

    A. General Execution Procedures: Orders in Nasdaq equity securities 
entered into NAqcess may be directed or non-directed. Non-directed 
market orders and non-directed marketable limit orders will be 
processed according to the procedures established below. Non-directed 
odd-lot orders that are market orders or marketable limit orders will 
be automatically executed in NAqcess against the next available market 
maker at the inside market and execution reports will be delivered to 
the order entry firm and the market maker.
    1. Entry of Limit Orders: Limit orders may be entered into NAqcess 
by order entry firms and by market makers up to the maximum limit order 
size allowed for a particular security. Limit orders priced away from 
the Nasdaq inside bid or offer (as the case may be) as well as limit 
orders consolidated in the inside market will be stored in the NAqcess 
limit order file. Limit orders in securities priced at $10 or more 
shall be priced in increments of an eighth or more; limit orders in 
securities that are priced at under $10 may be placed in increments of 
a sixteenth or less depending upon the dealer quotation increments 
permitted.
    2. Display of NAqcess Limit Orders: (a) Consolidated Display of 
Limit Orders In Inside Market: If a NAqcess limit order to buy or sell 
for 100 shares or more is better than the best dealer bid or offer, the 
limit order to buy or sell will be displayed in the Nasdaq inside 
market. Such display will contain the limit order price, size (which 
shall be aggregated if two or more limit orders are at the same best 
price) and an indicator to note that the inside market consists of a 
limit order rather than a market maker or UTP exchange quotation. If a 
NAqcess limit order of 100 shares or more is at the same price as the 
best dealer bid or offer, the size displayed in the inside market will 
be an aggregation of any same-priced limit orders and a single dealer 
quote at the best price.
    (b) Full Limit Order File Display: All Nasdaq market makers in a 
particular security may request via Nasdaq Workstations a display of 
all limit orders in such security entered in the NAqcess limit order 
file. Such displays will be available on a query basis only to a 
registered market maker in a particular security.
    3. Execution of Limit Orders: A limit order that matches or crosses 
a limit order on the opposite side of the market will be automatically 
executed against the matching or crossing order when such orders are at 
the inside market or better, and have priority over the dealer 
quotation. The priority rules for limit order interaction shall be that 
orders that are best in price shall be executed against each other 
first. If two or more orders are at the same price on the same side of 
the market, then the order that was received first in time shall be 
accorded priority over other orders at the same price. Limit orders 
that cross each other in price shall be executed at the price of the 
order that entered the file first. A limit order matches a limit order 
on the file when: the limit orders are consolidated in the inside 
market on Nasdaq; are on opposite sides of the market; and are equal in 
price. A limit order crosses a limit order on the file when: both limit 
orders are either consolidated in the inside market or better than the 
inside market; are on opposite sides of the market from each other; and 
the subsequent limit order is at a superior price to the existing limit 
order (i.e., the sell (buy) limit order is priced below (above) a limit 
order to buy (sell)). Execution of limit orders will occur up to the 
size of the initial limit order or the subsequent limit order, 
whichever is smaller, and without the participation of a market maker. 
The unexecuted balance of a limit order is entered into the NAqcess 
file for subsequent matching, unless such balance is less than 100 
shares, in which case the balance is automatically executed against the 
next available market maker, if equal to the inside quotation. If there 
is a limit order at the same price as the best dealer quotation (i.e., 
if a limit order to buy is the same as the best dealer bid, or a limit 
order to sell is the same as the best dealer offer), the order or quote 
that has time priority shall be matched against the incoming limit 
order.
    4. Takeouts of Limit Orders: Any NASD member firm, acting as 
principal or as agent, may enter into NAqcess an order or orders that 
execute(s) any limit order(s) consolidated in the inside market or 
otherwise displayed in the NAqcess limit order file. Such orders shall 
be known as ``takeout'' orders. A takeout order may be for any size up 
to the aggregate amount of shares displayed in the NAqcess limit order 
file at a particular price. Takeout orders must be executed against 
limit orders on the opposite side of the market in order of price and 
time. A firm entering a takeout order for limit orders at multiple 
prices may enter a single takeout order at a price either at or above 
or below the NAqcess limit orders, as the case may be, and each limit 
order will be executed at each such price. Takeout orders do not reduce 
a firm's exposure limit.
    5. Entry and Execution of Market Orders: (a) Market orders up to 
the maximum market order size for NAqcess eligible security may be 
entered into NAqcess. If at the time a market order is entered into 
NAqcess there is a limit order on the opposite side of the market that 
resides in the NAqcess limit order file and is reflected in the inside 
market as the best bid or offer, the incoming market order will be 
automatically executed against the limit order at the limit order price 
without the participation of a market maker. If a market order is not 
fully executed against the limit order file, the balance of such market 
order will be treated as any other market order as set forth in 
subparagraph (b) below, provided that if the balance of the market 
order is odd-lot size, the balance will be automatically executed 
against the next available market maker at the inside quotation. If 
there is a limit order consolidated in the inside market at the same 
price as a dealer bid or offer (i.e., if a limit order to buy is the 
same as the best dealer bid, or a limit order to sell is the same as 
the best dealer offer), the order or quote that has time priority 

[[Page 63104]]
shall be matched against the incoming market order.
    (b) If there is no limit order residing in NAqcess that has been 
consolidated in the inside market on the opposite side of the market 
from the market order, each market order will be assigned to a market 
maker at the inside market and will be executed against the next 
available market maker at the current inside market after a display 
period of 15-seconds. The market maker to which a market order is 
displayed may decline the market order within the 15-second period if 
the market maker has contemporaneously executed another transaction and 
is in the process of updating its quotation pursuant to SEC Rule 11Ac1-
1. If a market order or a marketable limit order is declined by a 
market maker, the order is returned to the system for distribution to 
the next available market maker. If that market maker is at the same 
price level as the first market maker who declined the order, the 
second market maker has 15 seconds to react to the order. If the 
originally declined order is re-presented to a market maker at a price 
level different from its original presentation(s), the order is 
automatically executed at that price level without any market maker 
ability to decline.
    (c) If the NAqcess limit order file does not have any executable 
limit orders at the time a directed market order is entered, directed 
market orders will be automatically executed against the directed order 
market maker without a 15-second decline capability. Directed limit 
orders that are not matched by incoming limit or market orders will be 
automatically executed against the directed order market maker when the 
inside market is changed to match the directed limit order price. 
Directed odd-lot orders (orders of less than 100 shares) that are 
market orders or marketable limit orders also will be automatically 
executed against the directed order market maker. Non-directed odd-lot 
orders that are market orders or marketable limit orders will be 
automatically executed against the next available market maker at the 
current inside market. An odd-lot limit orders that is not executable 
at time of entry will be stored and executed against the best dealer 
bid or offer, as the case may be, when such quotation reaches the limit 
order price.
    6. Entry and Execution of A Marketable Limit Order: Marketable 
limit orders that meet the maximum market order size requirements will 
be accepted and treated as market orders. Marketable limit orders 
greater than the maximum market order size will be returned to the 
order entry firm for handling outside of NAqcess.
    7. NAqcess Opening Procedures: NAqcess will permit the entry of 
limit orders and market orders outside of normal market hours, except 
that market orders will not be accepted between 4:00 and 6:00 p.m. 
Orders entered at such times will not be executed but will be stored 
for matching and execution at the next market opening. NAqcess permits 
the entry of such orders between 4:01 p.m. to 6:00 p.m. and 8:00 a.m. 
to 9:28 a.m. (Orders entered from 9:28 to 9:30 will be stored and 
handled according to normal market procedures after the opening 
procedures are concluded.)
    Matching and execution at the NAqcess opening will occur according 
to the following procedures:
    At 9:28 a.m., NAqcess will stop accepting orders for execution in 
the NAqcess file for opening purposes. At 9:30 a.m., NAqcess will 
commence execution procedures for opening orders in NAqcess by first 
ranking and matching limit orders in NAqcess in sequence of the highest 
price buy order against the lowest price sell order. When all available 
limit orders are matched and executed, market orders on a time priority 
basis will be matched and executed against any remaining limit orders 
in the NAqcess file within the inside quotation at the limit order 
price(s). Any remaining market limit orders will be stored in the 
NAqcess file. Any remaining orders will be subject to normal order 
execution processes.

VI. Clearance and Settlement

    All transactions executed in NAqcess shall be transmitted to the 
National Securities Clearing Corporation to be cleared and settled 
through a registered clearing agency using a continuous net settlement 
system.

VII. Obligation to Honor System Trades

    If a trade reported by a NAqcess participant, or clearing member 
acting on its behalf, is reported by NAqcess to clearing at the close 
of any trading day, or shown by the activity reports generated by 
NAqcess as constituting a side of a NAqcess trade, such NAqcess 
participant, or clearing member acting on its behalf, shall honor such 
trade on the scheduled settlement date.

VIII. Compliance With Procedures and Rules

    Failure of a NAqcess participant or person associated with a 
NAqcess participant to comply with any of the rules or requirements of 
NAqcess may be considered conduct inconsistent with high standards of 
commercial honor and just and equitable principles of trade, in 
violation of Article III, Section 1 of the Rules of Fair Practice. No 
member shall effect a NAqcess transaction for the account of a 
customer, or for its own account, indirectly or through the offices of 
a third party, for the purpose of avoiding the application of these 
rules. Members are precluded from doing indirectly what is directly 
prohibited by these rules. All entries in NAqcess shall be made in 
accordance with the procedures and requirements set forth in the 
NAqcess User Guide. Failure by a NAqcess participant to comply with any 
of the rules or requirements applicable to NAqcess shall subject such 
NAqcess participant to censure, fine, suspension or revocation of its 
registration as a NAqcess market maker and/or order entry firm or any 
other fitting penalty under the Rules of Fair Practice of the 
Association.

IX. Termination of NAqcess Service

    The Association may, upon notice, terminate NAqcess service to a 
participant in the event that a participant fails to abide by any of 
the rules or operating procedures of the NAqcess service or the 
Association, or fails to pay promptly for services rendered.

Exhibit B--Interpretations Related to Member Firm Responsibilities 
Regarding Orders in NAqcess

    In its efforts to maximize the protection of investors and to 
enhance the quality of the marketplace, the NASD and The Nasdaq Stock 
Market, Inc. have developed a nationwide limit order protection, price 
improvement, and market order handling facility of The Nasdaq Stock 
Market. This nationwide facility is herein referred to as ``NAqcess''.
    The NASD Board of Governors is issuing these Interpretations to the 
Rules of Fair Practice to provide: (1) Customers the right to have 
their orders entered and protected in NAqcess; and (2) member firm 
provision of equivalent protection for limit orders held in a member 
firm's proprietary limit order system. These Interpretations are based 
upon a member firm's obligation to provide best execution to customer 
orders under Article III, Section 1 of the Rules of Fair Practice and a 
member firm's obligations in dealing with customers as principal or 
agent to buy and sell at fair prices and charge reasonable commissions 
or service charges under Article III, Section 4 of the Rules of Fair 
Practice. Accordingly, it shall be deemed a violation of Article 

[[Page 63105]]
III, Section 1 of the Rules of Fair Practice for a member or a person 
associated with a member to violate the following provisions:

1. Member Firm Obligation Regarding Investors' Directions on Order 
Handling

    NAqcess will provide individual investors with significant 
opportunities to achieve limit order protection and price improvement. 
The NASD recognizes that member firms operating as market makers also 
operate trading systems which offer significant protection and 
execution opportunities for customer limit orders. Accordingly, nothing 
herein is intended to limit a member's ability to recommend use of its 
own or another member firm's proprietary system for handling limit and 
market orders where equivalent protection is afforded. In light of the 
significant benefits offered to customers by the NAqcess system, 
however, members must abide by the directions of its customers who 
request that the firm enter their orders in NAqcess.
    Further, nothing in this Interpretation requires a member firm to 
accept any or all customer limit orders. Member firms accepting limit 
orders that are placed in NAqcess or otherwise may charge fair and 
reasonable commissions, commission equivalents, or service charges for 
such handling, provided that such commissions, commission equivalents, 
or service charges do not violate Article III, Section 4 of the Rules 
of Fair Practice. In no event, however, shall a member impose any fee 
or charge that effectively operates as a disincentive to the entry of 
orders in the nationwide facility and thereby interferes with the 
investor's ability to choose order handling alternatives.

2. Equivalent Protection for Orders Held Outside of NAqcess

    As a further adjunct to a member firm's best execution obligations, 
the NASD Board of Governors has interpreted Article III, Section 1 of 
the Rules of Fair Practice to require member firms that do not enter 
customer limit orders into NAqcess, but hold such protectible orders in 
their own proprietary system, to provide such orders with price 
protection at least equivalent in substance to that which the order 
would have received had the order been entered into NAqcess. For the 
purposes of this Interpretation, a ``protectible limit order'' shall 
mean a limit order that meets the maximum limit-order size criteria as 
set forth in the Rules of Operation and Procedure for NAqcess at 
Section I.S. For the purposes of this Interpretation, equivalent price 
protection shall mean:

A. Print Protection

    If a transaction in a Nasdaq security is reported via the Automated 
Confirmation Transaction Service (``ACT'') at a price inferior to the 
price of customer limit order(s) that the firm is holding (i.e., if the 
reported price is a price lower than a buy limit order or higher than a 
sell limit order being held by the firm), the firm holding the limit 
order(s) is required on a contemporaneous basis to execute the limit 
order(s) at the limit price(s) up to the size of the reported 
transaction.

B. Matching Limit Orders

    If the firm holds a customer buy (sell) limit order in its 
proprietary limit order file and that limit order matches a sell (buy) 
limit order in NAqcess, the firm holding the limit order must either 
provide its customer with an immediate execution at the limit order 
price or must immediately direct the order to NAqcess. A limit order 
held by a firm would match a limit order in NAqcess when the limit 
order in NAqcess is at the same price or is priced lower than the 
firm's customer's limit order to buy or higher than the firm's customer 
limit order to sell (``offsetting limit orders'').

C. Matching Limit Order Interaction Within A Firm's File

    If the firm holds two or more offsetting customer limit orders 
within its own proprietary file, the firm must execute the offsetting 
limit orders.

D. Interaction Between Limit and Market Orders Held Within A Firm's 
File

    While holding a customer limit order that is priced equal to or 
better than the best bid or offer in the security disseminated in 
Nasdaq, if a firm accepts customer market orders for automated 
execution against the best bid or offer in the security disseminated in 
Nasdaq, the firm, pursuant to its obligation set forth in the 
Interpretation to the Rules of Fair Practice, Article III, Section 1, 
(the so-called ``Manning Interpretation''), must first permit the 
market orders to execute against any applicable limit orders it holds 
before the firm may execute the market orders for its own account.

E. Examples of Equivalent Protection

    The NASD Board of Governors has provided the following examples to 
further explain a member firm's equivalent protection obligation for 
orders held outside of NAqcess:
    Print Protection The best dealer bid and offer in Nasdaq (``the 
inside price'') is 20 bid-20\1/4\ offer. Firm ABCD holds a customer 
limit order of 1,000 shares to buy at 20\1/8\ in its own proprietary 
file. Firm MNOP reports a transaction in the subject security via ACT, 
disseminating a price of 20\1/16\ for 500 shares. Contemporaneous with 
the dissemination of the trade report, firm ABCD is required to provide 
an execution of its customer limit order for at least 500 shares at 
20\1/8\.
    Matching Limit Orders The inside price is 20 bid-20\1/4\ offer. 
NAqcess is displaying a 1,000 share customer limit order to buy at 
20\1/8\ for customer X. Firm ABCD thereafter receives from customer Y a 
1,000 share limit order to sell at 20\1/8\ that the firm ABCD retains 
for handling outside of NAqcess. Upon receipt of the limit order, firm 
ABCD must execute customer Y's limit order for 1,000 shares at 20\1/8\.
    Matching Limit Order Interaction Within A Firm's File. The inside 
price is the same as above. Firm ABCD holds a customer limit order to 
buy 1,000 shares at 20\1/8\. Firm ABCD thereafter receives a customer 
limit order to sell 1,000 shares at 20\1/8\. Firm ABCD must match the 
orders and execute the trade.
    Interaction Between Limit and Market Orders Held Within A Firm's 
File. The inside price is the same as above. Firm ABCD holds a customer 
limit order to buy 1,000 shares at 20\1/8\. Firm ABCD thereafter 
receives a customer market order to sell 1,000 shares. Firm ABCD must 
match the two orders and execute the trade at 20\1/8\. Similarly, if 
the limit order to buy were priced at 20, the firm would have to 
execute the market order against the limit order at 20.

Price Protection for NAqcess Limit Orders, Rules of Fair Practice, 
Article III, Section [XX]

    No member firm shall execute an order as principal or as agent at a 
price inferior to any limit order(s) viewable in NAqcess to the member 
firm, provided however, that a member firm executing a transaction that 
is larger than the limit order(s) viewable in NAqcess at an inferior 
price must contemporaneously satisfy the limit order(s) viewable in 
NAqcess. An ``inferior price'' means an execution price that is lower 
than a buy limit order or higher than a sell limit order that is 
viewable in NAqcess. The term ``limit orders viewable in NAqcess'' 
shall mean those orders that the member firm is able to view either as 
consolidated in the Nasdaq inside market or as reflected in the Full 
Limit Order File Display as the firm is 

[[Page 63106]]
authorized to view under the Rules of Operation and Procedure.

[FR Doc. 95-29950 Filed 12-7-95; 8:45 am]
BILLING CODE 8010-01-P