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[Federal Register Volume 61, Number 96 (Thursday, May 16, 1996)]
[Notices]
[Pages 24845-24846]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-12234]

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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37190; File No. SR-NASD-96-11]

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by National Association of Securities Dealers, Inc. Relating to 
Amendments to the Primary Maker Standards

May 9, 1996.
    On March 27, 1996, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association'') filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') a proposed rule change 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder.\2\ The rule change amends the 
Primary Market Maker (``PMM'') Standards rule be deleting a provision 
of the rule that allows a market maker to qualify as a PMM in a 
security by registering in that security and refraining from quoting 
that security for five days.\3\
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    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ NASD Manual, Rules of Fair Practice, Art. III, Sec. 49 (CCH) 
para. 2200I.
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    Notice of the proposed rule change, together with the substance of 
the proposal, was provided by issuance of a Commission release 
(Securities Exchange Act Release No. 37062, April 2, 1996) and by 
publication in the Federal Register (61 FR 15885, April 9, 1996). No 
comment letters were received. This order approves the proposed rule 
change.
    On June 29, 1994, the Commission approved on a pilot basis the 
NASD's short sale rule governing short sales in Nasdaq National Market 
(``NNM'') securities (``Short Sale Rule'').\4\
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    \4\ See Securities Exchange Act Release No. 34277 (June 29, 
1994), 59 FR 34885 (July 7, 1994) (approving, inter alia, Article 
III, Section 48 to the NASD Rules of Fair Practice). The pilot has 
been approved to continue through August 3, 1996. See Securities 
Exchange Act Release No. 36532 (Nov. 30, 1995), 60 FR 62519 (Dec. 6, 
1995).
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    The Short Sale Rule prohibits member firms from effecting short 
sales \5\ at or below the current inside bid as disseminated by the 
Nasdaq system whenever that bid is lower than the previous inside 
bid.\6\
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    \5\ A short sale is a sale of a security which the seller does 
not own or any sale which is consummated by the delivery of a 
security borrowed by, or for the account of, the seller. To 
determine whether a sale is a short sale members must adhere to the 
definition of a ``short sale'' contained in SEC Rule 3b-3, which 
rule is incorporated into Nasdaq's short sale rule by Article III, 
Section 48(l)(1) of the NASD Rules of Fair Practice.
    \6\ Nasdaq calculates the inside bid and the best bid from all 
market makers in the security (including bids on behalf of exchanges 
trading Nasdaq securities on an unlisted trading privileges basis), 
and disseminates symbols to denote whether the current inside bid is 
an ``up bid'' or a ``down bid.'' Specifically, an ``up bid'' is 
denoted by a green ``up'' arrow symbol and a ``down bid'' is denoted 
by a red ``down'' arrow. Accordingly, absent an exemption from the 
rule, a member can not effect a short sale at or below the inside 
bid in a security in its proprietary account or an account of a 
customer if there is a red arrow next to the security's symbol on 
the screen. In order to effect a ``legal'' short sale on a down bid, 
the short sale must be executed at a price at least a \1/16\th of a 
point above the current inside bid. Conversely, if the security's 
symbol has a green ``up'' arrow next to it, members can effect short 
sales in the security without any restrictions. The rule is in 
effect during normal domestic market hours (9:30 a.m. to 4:00 p.m.; 
Eastern Time).
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    The short sale rule provides an exemption to so-called 
``qualified'' Nasdaq market makers (``market maker exemption'') to 
ensure that the rule does not constrain market making activities that 
provide liquidity and continuity to the market.\7\ The market maker 
exemption is limited to transactions made in connection with bona fide 
market making activity. A market maker that does not satisfy the 
requirements for a qualified market maker can remain a market maker but 
cannot rely upon the market maker exemption when effecting short sales 
of a NNM security.
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    \7\ Article III, Section 48(c)(1).
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    A ''qualified'' Nasdaq market maker is currently defined to be a 
market maker that satisfies the criteria for a PMM found in Section 49 
of the NASD Rules of Fair Practice.\8\ A market maker may qualify as a 
PMM if it satisfies at least two of the following four criteria: (1) 
the market maker must be at the best bid or best offer as shown on the 
Nasdaq system no less than 35 percent of the time; (2) the market maker 
must maintain a spread no greater than 102 percent of the average 
dealer spread; (3) no more than 50 percent of the market maker's 
quotation updates may occur without being accompanied by a trade 
execution of at least one unit of trading; or (4) the market maker 
executes 1\1/2\ times its ``proportionate'' volume in the stock.\9\ A 
market maker also may qualify as a PMM in a security by registering in 
the security and refraining from quoting the security for five days 
(``five-day quotation delay rule''). A ``P'' indicator is displayed 
next to the market maker identification of a market maker that 
qualifies as a PMM.
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    \8\ Before the PMM standards went into effect, a ``qualified 
market maker'' was defined to be a market maker that had entered 
quotations in the relevant security on an uninterrupted basis for 
the preceding 20 business days, the so-called ``20-day test.''
    \9\ For example, if there are 10 market makers in a stock, each 
dealer's proportionate share volume would be 10 percent; therefore, 
1\1/2\ times proportionate share volume would mean 15 percent of 
overall volume.
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    Market makers are reviewed each month to determine whether they 
have satisfied the PMM performance standards. If a PMM has not 
satisfied the threshold standards after a particular review period, its 
PMM designation is removed commencing on the next business day 
following notice of failure to comply with the standards. A market 
maker that loses its PMM designation may requalify for PMM designation 
by satisfying the threshold standards for the next review period.

[[Page 24846]]

    A market maker may register as a market maker in a NNM security and 
become a PMM immediately if it is a PMM in at least 80% of the 
securities in which it makes a market. If a market maker does not meet 
the 80% threshold, it can either comply with the five-day quotation 
delay rule or it can register in the security as a regular Nasdaq 
market maker, enter quotes immediately, and satisfy the qualification 
criteria for the next review period.
    The NASD stated in its filing that the five-day quotation delay 
rule originally was intended to ensure that market makers were not 
registering in a security to take advantage of momentary short-selling 
opportunities. However, the NASD expressed concern in its filing that 
market making affiliates of the same firm are able to use the five-day 
quotation delay rule to circumvent the application of the PMM standards 
by ``swapping'' lists of stocks in which they make a market and 
alternatively receive PMM designation without ever meeting the 
quantitative PMM standards. The NASD also expressed concern in its 
filing that market makers are able to use the five-day quotation delay 
rule to inflate the percentage of stocks in which they are a PMM above 
the 80 percent level, thereby entitling them to PMM status for all NNM 
securities in which they register during the next month. In both 
instances, the five-day quotation delay rule would allow a market maker 
to become a PMM for reasons wholly unrelated to the quality of its 
market-making.\10\ Therefore, the NASD has proposed to amend the 
Primary Market Maker (``PMM'') Standards rule by deleting the five-day 
quotation delay rule.
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    \10\ The NASD stated in its filing that few market makers have 
utilized the five-day quotation delay rule to become PMMs.
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    The Commission finds that the rule change is consistent with the 
provisions of section 15A(b)(6) of the Act. The rule change is designed 
to prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, 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 
by ensuring that market makers qualify for PMM status only if they have 
met certain performance standards. The rule change also is reasonably 
designed to ensure that a market maker's short sale transactions are 
made in connection with bona fide market making activity.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change SR-NASD-96-11 be, and hereby is, 
approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-12234 Filed 5-15-96; 8:45 am]
BILLING CODE 8010-01-M
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