35284 Federal Register / Vol. 61, No. 130 / Friday, July 5, 1996 / Notices

8See Amendment No. 2, supra note 4.

9The pilot expires at 3:10 p.m. central time on

July 26, 1996. Any request for an extension of the

pilot period or request for permanent approval of

the system would have to be submitted to the

Commission pursuant to Section 19(b)(2) of the Act.

10 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2See Securities Exchange Act Release No. 33377

(December 23, 1993), 58 FR 69419 (December 30,

1993) (‘‘Interim SOES Rules Approval Order’’).

3See Securities Exchange Act Release No. 36795

(January 31, 1996), 61 FR 4504 (February 6, 1996)

(‘‘Interim SOES Rules Extension Order’’).

CBOE desires to implement the

automatic system on a permanent basis

for all classes of equity options, CBOE

will make a subsequent filing to this

effect under Section 19(b)(2) of the Act.

CBOE believes that the

implementation of a pilot test of a

system that, if successful, would permit

the continued availability of CBOE’s

automatic execution system for public

customer orders during the period when

options are traded after the close of

trading in the primary markets for

underlying stocks and would assure that

these orders are executed at fair prices

in the event of significant news

announcements, is in the interest of

promoting just and equitable principles

of trade and protecting investors and the

public interest, and thus is consistent

with the objectives of Section 6(b)(5) of

the Act.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

CBOE does not believe that the

proposed rule change will impose any

burden on competition.

C. Self-Regulatory Organization’s

Statement on the Proposed Rule Change

Received from Members, Participants or

Others

No written comments were solicited

or received with respect to the proposed

rule change.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

The Exchange has requested that the

proposed rule change be given

accelerated effectiveness pursuant to

Section 19(b)(2) of the Act. The

Commission finds that the proposed

rule change is consistent with the

requirements of the Act and the rules

and regulations thereunder applicable to

a national securities exchange, and, in

particular the requirements of Section

6(b)(5) thereunder.

The Commission believes that the

Exchange’s proposal provides a

reasonable method of testing a system to

address pending news announcements

after the close of trading in the primary

market for the underlying securities.8

The Commission notes that the test will

be limited to news announcements after

the close of trading in the primary

market for the underlying stock, while

continuing to (1) ensure prompt

execution of customer orders in the

particular class subject to a news

announcement by rerouting such orders

to a PAR workstation and (2) make

RAES executions available in classes of

options not subject to news

announcements during the time when

options continue to be traded after the

close of trading in the primary market

for underlying stocks.

As noted, the CBOE intends to

evaluate the pilot in several respects to

determine if it wants to implement the

system on a permanent basis.9 The

CBOE will provide the Commission

with the analysis of the pilot.

The Commission finds good cause for

approving this proposed rule change, as

amended, on an accelerated basis prior

to the thirtieth day after the date of

publication of notice thereof in the

Federal Register. Specifically, the

Commission believes that accelerated

approval of the proposal, as amended, is

appropriate because it is to be

implemented for a limited 30-day

period which will provide CBOE with

the time to test the effectiveness of the

system.

Accordingly, the Commission believes

that it is consistent with Section 6(b)(5)

of the Act to approve the proposed rule

change, as amended, on an accelerated

basis.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views and

arguments concerning the foregoing and

Amendment Nos. 1 and 2. Persons

making written submissions should file

six copies thereof with the Secretary,

Securities and Exchange Commission,

450 Fifth Street, N.W., Washington, DC

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. 552, will be

available for inspection and copying in

the Commission’s Public Reference

Section, 450 Fifth Street, N.W.,

Washington, DC 20549. Copies of such

filing will also be available for

inspection and copying at the principal

office of CBOE. All submissions should

refer to File No. SR–CBOE–96–37 and

should be submitted by July 26, 1996.

V. Conclusion

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act, that the

proposed rule change (File No. SR–

CBOE–96–37), as amended, is hereby

approved for a 30-day pilot period, on

an accelerated basis.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.10

Jonathan G. Katz,

Secretary.

[FR Doc. 96–17149 Filed 7–3–96; 8:45 am]

BILLING CODE 8010–01–M

[Release No. 34–37377; File No. SR–NASD–

96–22]

Self-Regulatory Organizations; Notice

of Proposed Rule Change by the

National Association of Securities

Dealers, Inc. Relating to an Extension

of the SOES Minimum Exposure Limit

Rule and the SOES Automated

Quotation Update Feature Until

January 31, 1997

June 27, 1996.

Pursuant to section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’),1 notice is hereby given that on

June 10, 1996, the National Association

of Securities Dealers, Inc. (‘‘NASD’’ or

‘‘Association’’) filed with the Securities

and Exchange Commission

(‘‘Commission’’ or ‘‘SEC’’) 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.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

The NASD proposes to extend, until

January 31, 1997, the effectiveness of

certain rules governing the operation of

the Nasdaq Stock Market, Inc.’s

(‘‘Nasdaq’’) Small Order Execution

System (‘‘SOES’’). Specifically, these

SOES rules, which were previously

approved by the Commission on a pilot

basis on December 23, 19932 and

recently extended through July 31,

1996,3 provide for: (1) a reduction in the

minimum exposure limit for

unpreferenced SOES orders from five

times the maximum order size to two

times the maximum order size, and for

the elimination of exposure limits for

preference orders (‘‘SOES Minimum

Exposure Limit Rule’’); and (2)
Federal Register / Vol. 61, No. 130 / Friday, July 5, 1996 / Notices 35285

4As first approved by the Commission on

December 23, 1993, the Interim SOES Rules has

four components: (1) the SOES Minimum Exposure;

(2) the Automated Quotation Update; (3) a

reduction in the maximum size order eligible for

executive through SOES from 1,000 shares to 500

shares (‘‘SOES Maximum Order Size’’); and (4) the

prohibition of short sales through SOES. The SOES

Maximum Order Size Rule lapsed effective March

28, 1995 and the rule prohibiting the execution of

short sales through SOES lapsed effective January

26, 1995.

5See Interim SOES Rules Approval Order, supra

note 2.

6See Interim SOES Rules Extension Order, supra

note 3, and Securities Exchange Act Release Nos.

35275 (January 25, 1995), 60 FR 6327 (February 1,

1995); 35535 (March 27, 1995), 60 FR 16690 (March

31, 1995); and 36311 (September 29, 1995), 60 FR

52438 (October 6, 1995) (‘‘October 1995 Extension

Order’’).

7 Interim SOES Rules Approval Order, supra note

2, 58 FR at 69423.

8 Id.

9 Id. at 69424–25.

10 Id.

implementation of an automated

function for updating market maker

quotations when the market maker’s

exposure limit has been exhausted

(‘‘SOES Automated Quotation Update

Feature’’). These rules are part of a set

of SOES rules approved by the SEC on

a pilot basis known as the Interim SOES

Rules.4

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

The Commission originally approved

the SOES Minimum Exposure Limit

Rule and the SOES Automated

Quotation Update Feature on a one-year

pilot basis in December 1993, along

with two other SOES rules which have

since lapsed.5 Since December 1993, the

SEC has approved four NASD proposals

to extend the effectiveness of the rules,

with the most recent approval extending

the rules through July 31, 1996.6 With

this filing the NASD proposes to further

extend the effectiveness of the SOES

Minimum Exposure Limit Rule and the

SOES Automated Quotation Update

Feature until January 31, 1997, so that

the rules can continue on an

uninterrupted basis until the SEC has

had an opportunity to consider Nasdaq’s

proposed NAqcess system.

As described in more detail below,

because the NASD believes

implementation of the SOES Minimum

Exposure Limit Rule and the SOES

Automated Quotation Update Feature

have been associated with positive

developments in the markets for Nasdaq

securities and clearly have not had any

negative effects on market quality, the

NASD believes it is appropriate and

consistent with the maintenance of fair

and orderly markets and the protection

of investors for the Commission to

approve a further limited extension of

the effectiveness of these rules. The

NASD believes the SOES Minimum

Exposure Limit Rule and the SOES

Automated Quotation Update Feature

reflect a reasoned approach by the

NASD to address the adverse effects on

market liquidity attributable to active

intra-day trading activity through SOES,

while at the same time not

compromising the ability of small, retail

investors to receive immediate

executions through SOES. Specifically,

these rules are designed to address

concern that concentrated, aggressive

use of SOES by a growing number of

order entry firms has resulted in

increased volatility in quotations and

transaction prices, wider spreads, and

the loss of liquidity for individual and

institutional investor orders.

The NASD believes that the same

arguments and justifications made by

the NASD in support of approval of the

SOES Minimum Exposure Limit Rule

and the SOES Automated Quotation

Update Feature and four extensions of

these rules are just as compelling today

as they were when the SEC relied on

them to initially approve these rules. In

sum, the NASD continues to believe that

concentrated bursts of SOES activity by

active order-entry firms contribute to

increased short-term volatility, wider

spreads, and less market liquidity on

Nasdaq and that the SOES Minimum

Exposure Limit Rule and the SOES

Automated Quotation Update Feature

are an effective means to minimize these

adverse market impacts. In addition,

given the increased utilization of SOES

since the SOES Maximum Order Size

Rule lapsed at the end of March 1995,

the NASD believes it is even more

imperative that the SOES Minimum

Exposure Limit Rule and the SOES

Automated Quotation Update Feature

remain in effect to help to ensure the

integrity of the Nasdaq market and

prevent waves of SOES orders from a

handful of SOES order-entry firms from

degrading market liquidity and

contributing to excessive short-term

market volatility.

The NASD notes that the SEC made

specific findings in the Interim SOES

Rules Approval Order that the SOES

Minimum Exposure Limit Rule and the

SOES Automated Quotation Update

Feature were consistent with the Act. In

particular, the SEC stated in its approval

order that:

a. Because the benefits for market quality

of restricting SOES usage outweigh any

potential decrease in pricing efficiency, the

Commission concludes that the net effect of

the proposal is to remove impediments to the

mechanism of a free and open market and a

national market system, and to protect

investors and the public interest, and that the

proposed rule changes are designed to

produce accurate quotations, consistent with

Sections 15A(b)(6) and 15A(b)(11) of the Act.

In addition, the Commission concludes that

the benefits of the proposal in terms of

preserving market quality and preserving the

operational efficiencies of SOES for the

processing of small size retail orders

outweigh any potential burden on

competition or costs to customers or brokerdealers affected adversely by the proposal.

Thus, the Commission concludes that the

proposal is consistent with Section 15A(b)(9)

of the Act in that it does not impose a burden

on competition which is not necessary or

appropriate in furtherance of the purposes of

the Act.7

b. The Commission also concludes that the

proposal advances the objectives of Section

11A of the Act. Section 11A provides that it

is in the public interest and appropriate for

the protection of investors and the

maintenance of fair and orderly markets to

assure economically effective execution of

securities transactions, fair competition

among market participants, and the

practically of brokers executing orders in the

best market. The Commission concludes that

the proposal furthers these objectives by

preserving the operational efficiencies of

SOES for the processing of small orders from

retail investors.8

c. The Commission believes that it is

appropriate to restrict trading practices

through SOES that impose excessive risks

and costs on market makers and jeopardize

market quality, and which do not provide

significant contributions to liquidity or

pricing efficiency. * * * The Commission

believes that it is more important to ensure

that investors seeking to establish or

liquidate an inventory position have ready

access to a liquid Nasdaq market and SOES

than to protect the ability of customers to use

SOES for intra-day trading strategies.9

d. The Commission believes that there are

increased costs associated with active intraday trading activity through SOES that

undermine Nasdaq market quality. * * *

Active intra-day trading activity through

SOES can also contribute to instability in the

market.10

e. In addition, these waves of executions

can make it difficult to maintain orderly

markets. Given the increased volatility
35286 Federal Register / Vol. 61, No. 130 / Friday, July 5, 1996 / Notices

11 Id. at 69425–26.

12 Id.

13 Id.

14 Id. at 69429.

15See letter from Gene Finn, Vice President &

Chief Economist, NASD, to Katherine England,

Assistant Director, National Market System & OTC

Regulation, SEC, dated October 24, 1994 (letter

submitted in connection with the

NADD’S)N•PROVE filing, SR–NASD–94–13).

16The Association Between the Interim SOES

Rules and Nasdaq Market Quality, Fear Furbush, Ph

D.

17 Interim SOES Rules Approval Order , Supra

note 2, 59 FR at 69429.

18Some press reports have attributed the recent

decline in spreads for Nasdaq stocks to the

publication, on May 26 and 27, 1994, of newspaper

articles in The Wall Street Journal, The Los Angeles

Times and other publications reporting the results

of an economic study conducted by two

academicians that illustrated the lack of odd-eighth

quotes for active Nasdaq stocks. Contrary to these

press reports, this study shows that spreads had

indeed narrowed before publication of these articles

(from April 28 to May 12), stabilized at these

narrower levels from mid-May until June 23, and

declined again from June 23 to July 18.

19See NASD Department of Economic Research:

Impact of SOES Active Trading Firms on Nasdaq

Market Quality (May 12, 1993) (‘‘May 1993 SOES

Study’’). See also Securities Exchange Act Release

No. 32313 (May 17, 1993), 58 FR 29647 (publication

of the study for comment).

associated with these waves of intra-day

trading activity, market makers are subject to

increased risks that concentrated waves of

orders will cause the market to move away.

As a result, individual market makers may be

unwilling to narrow the current spread and

commit additional capital to the market by

raising the bid or lowering the offer. When

market makers commit less capital and quote

less competitive markets, prices can be

expected to deteriorate more rapidly.

Accordingly, the Commission believes that it

is appropriate for the NASD to take measured

steps to redress the economic incentives for

frequent intra-day trading inherent in SOES

to prevent SOES activity from having a

negative effect on market prices and

volatility.11

f. The Commission does not believe the

intra-day trading strategies through SOES

contribute significantly to market efficiency

in the sense of causing prices to reflect

information more accurately.12

g. The Commission has evaluated each of

the proposed modifications to SOES, and

concludes that each of the modifications

reduces the adverse effects of active trading

through SOES and better enables market

makers to manage risk while maintaining

continuous participation in SOES. In

addition, the Commission does not believe

that any of the modifications will have a

significant negative effect on market quality.

To the extent that any of the modifications

may result in a potential loss of liquidity for

small investor orders, the Commission

believes that these reductions are marginal

and are outweighed by the benefits of

preserving market maker participation in

SOES and increasing the quality of

executions for public and institutional orders

as a result of the modifications.13

h. The Commission * * * has determined

that the instant modifications to SOES

further the objectives of investor protection

and fair and orderly markets, and that these

goals, on balance, outweigh any marginal

effects on liquidity for small retail orders,

and any anti-competitive effects on order

entry firms and their customers. The

Commission concludes that the ability of

active traders to place trades through a

system designed for retail investors can

impair market efficiency and jeopardize the

level of market making capital devoted to

Nasdaq issues. The Commission believes that

the rule change is an appropriate response to

active trading through SOES, and that the

modifications will reduce the effects of

concentrated intra-day SOES activity on the

market.14

The NASD believes these significant

statutory findings by the SEC regarding

the SOES Minimum Exposure Limit

Rule and the SOES Automated

Quotation Update Feature and the SEC’s

assessment of the likely benefits to the

marketplace that would result from the

rules have been confirmed and

substantiated by econometric studies on

the effectiveness of the Interim SOES

Rule conducted by the NASD’s

Economic Research Development15 and

an independent economist

commissioned by the NASD.16 When

the SEC approved the Interim SOES

Rules, it stated that ‘‘[a]ny further action

the NASD seeks with respect to SOES—

extension of these modifications upon

expiration, or introduction of other

changes—will require independent

consideration under Section 19 of the

Act.’’ 17 In addition, the SEC stated that,

should the NASD desire to extend these

SOES changes or modify SOES, the

Commission would expect ‘‘the NASD

to monitor the quality of its markets and

assess the effects of the approved SOES

changes on market quality for Nasdaq

securities.’’ Also, if feasible, the SEC

instructed the NASD to provide a

quantitative and statistical assessment

of the effects of the SOES changes on

market quality; or, if an assessment is

not feasible, the SEC stated that the

NASD should provide a reasoned

explanation supporting that

determination.

In sum, the NASD’s study found that:

• Since the SOES changes went into

effect in January 1994, the statistical

evidence indicated that when average

daily volume, stock price, and stock

price volatility are held constant

through regression techniques, quoted

percentage spreads in Nasdaq securities

experienced a decline in the immediate

period following implementation of the

changes and have continued to decline

since then. The statistical evidence also

showed that the narrowing of quoted

percentage spreads became more

pronounced and robust the longer the

Interim SOES Rules were in effect. In

particular, quoted spreads in cents per

share for the 500 largest Nasdaq

National Market (‘‘NNM’’) securities

experienced a sharp decline from April

28 to May 12 and from June 23 to July

18.18

• With the exception of a brief,

market-wide period of volatility

experienced by stocks traded on

Nasdaq, the New York Stock Exchange,

and the American Stock Exchange

during the Spring, the volatility of

Nasdaq securities appears to be

unchanged in the period following

implementation of the changes; and

• A smaller percentage of Nasdaq

stocks experienced extreme relative

price volatility after implementation of

the rules and that these modifications,

in turn, suggest a reduction in relative

volatilities since the rules were put into

effect.

The Furbush Study found that there

was a statistically significant

improvement in effective spreads for the

top 100 Nasdaq stocks (based on dollar

volume) during the three month period

following implementation of the rules.

Moreover, the study also found that the

most significant improvement in

effective spreads for the top 100 stocks

occurred for trade sizes between 501

and 1,000 shares, precisely the level that

was made ineligible for SOES trading by

the Interim SOES Rules. In addition, the

study found that the average number of

market makers for the top ten Nasdaqlisted stocks increased from 44.3 to 46.0,

or 3.8 percent, and from 30.2 to 30.9 for

the top 100 stocks, or 2.3 percent.

Although correlation does not

necessarily imply causation, as noted by

the SEC when it approved the Interim

SOES Rules and extensions of the

Interim SOES Rules, the NASD believes

that positive market developments

clearly have been associated with

implementation of the Interim SOES

Rules.

The NASD also believes that these

studies of the effectiveness of the

Interim SOES Rules lend credence to

another NASD study that was submitted

to the SEC in support of approval of the

Interim SOES Rules.19 In the May 1993

SOES Study, the NASD found that

concentrated waves of orders entered

into SOES by active order-entry firms

resulted in discernible degradation to

the quality of the Nasdaq market.

Specifically, the study found, among

other things, that: (1) Bursts of orders

entered into SOES by active order entry

firms frequently result in a decline in

the bid price and a widening of the bidask spread; (2) that there is a significant
Federal Register / Vol. 61, No. 130 / Friday, July 5, 1996 / Notices 35287

20See letter from Richard G. Ketchum, Executive

Vice President & Chief Operating Officer, NASD, to

Brandon Becker, Director, Division of Market

Regulation, SEC, dated August 1, 1995.

21The NASD believes that elimination of the ban

against short sales through SOES did not have a

dramatic negative market effect because the NASD’s

short sale rule was approved during the time that

the ban was in effect.

22See Monitoring Report of Exhaustion of SOES

Exposure Limits and the Usage of Nasdaq

Automated Quotation Update Feature, NASD

Economic Research Department, December 18,

1995.

23October 1995 Extension Order, supra note 6, 60

FR at 52439, n. 12 (‘‘December 1995 Monitoring

Report’’).

24The highest number of exposure limits

exhausted on any day during this period was 119

on November 21, 1995 and the lowest number was

47 on October 4, 1995.

25The report also found that SOES orders can

experience brief execution delays in isolated

instances, as one order took as long as 87 seconds

to be executed. While the NASD could not readily

identify the reasons for these infrequent execution

delays, the NASD believes these delays are likely

the result of two factors. First, consistent with the

NASD’s short-sale rule, short sales entered into

SOES cannot be executed on down bids. Second,

waves of SOES orders transmitted by active SOES

order-entry firms cause queues to develop in the

processing of SOES orders, which, in turn, causes

execution delays.

positive relationship between increases

in spreads and volume attributable to

active order-entry firms as it related to

total SOES volume per security; and (3)

activity by active order-entry firms

resulted in higher price volatility and

less liquidity—higher price changes are

associated with high active trading firm

volume, even after controlling for

normal price fluctuations.

The NASD also believes market

activity since the SOES Maximum Order

Size Rule lapsed on March 28, 1995,

provides further support for the

effectiveness of the SOES Minimum

Exposure Limit Rule and the SOES

Automated Quotation Update Feature

and the NASD’s economic rationale for

these rules. In particular, an analysis

prepared by the NASD’s Economic

Research Department clearly illustrates

that there has been a dramatic increase

in SOES volume since the SOES

Maximum Order Size Rule lapsed and

that many market maker positions have

been abandoned. These two phenomena

appear to be linked. Those Nasdaq

stocks that have experienced the

greatest decline in the number of market

makers are the ones that have

experienced the greatest increase in

SOES volume since the rule lapsed.20

The NASD believes these figures

indicate that the relaxation of one of the

Interim SOES Rules may have

contributed to some of the adverse

market developments that the NASD

was seeking to avoid through

implementation of the Interim SOES

Rules (e.g., degradation in market maker

participation and market liquidity).21

Accordingly, the NASD believes that

any further relaxation of the Interim

SOES Rules by permitting the SOES

Minimum Exposure Limit Rule or the

SOES Automated Quotation Update

Feature to lapse would further harm the

Nasdaq market. In light of the

significance of these figures and their

indicated adverse ramifications upon

the Nasdaq market, the NASD also

believes that SEC reconsideration of its

position with respect to the entry of

1,000-share orders into SOES is

warranted.

The NASD also has prepared another

report that the NASD believes illustrates

that the SOES Minimum Exposure Limit

Rule and the SOES Automated

Quotation Update Feature have had no

adverse impact on the market for

Nasdaq securities.22 This report was in

response to the Commission’s request in

the Interim SOES Rules Extension Order

that the NASD:

monitor the extent to which exposure limits

are exhausted, the extent to which the

automated quotation update feature is used,

and the effects these two aspects have on

liquidity. Moreover, the Commission expects

the NASD to consider the possibility of

enhancements to eliminate the potential for

delayed and/or inferior executions.23

In sum, the December 1995 Monitoring

Report found that it is a very infrequent

occurrence for a market maker to have

its exposure limit exhausted in a NNM

security. In particular, from the period

October 2, 1995 to November 22, 1995,

there were, on average, 83 instances per

day where a market maker’s exposure

limit in NNM securities was

exhausted.24 Thus, given the fact that

there was an average of 44,062 market

making positions in NNM securities and

3,932 NNM securities trading per day

during this time period, the impact of

these individual exposure limit

exhaustions on the availability of SOES

to investors throughout the trading day

was infinitesimal. Each market making

position experienced .0019 exposure

limit exhaustions per day over this time

period and each NNM security

experienced .0211 exhaustions per day.

Moreover, while Nasdaq could not

readily determine the extent to which

the exposure limit exhaustions occurred

simultaneously in the same security,

given the stark infrequency with which

the exposure limit exhaustions

occurred, the NASD believes it is

extremely improbable that a NNM

security would experience a situation

where the SOES exposure limits for all

market makers in that stock were

exhausted at the same time. Indeed, this

conclusion is borne out by the

extremely short time-span in which

SOES orders are executed. Specifically,

the report shows that, on average, SOES

orders are executed 1.62 seconds after

entry and that 98.5 percent of all SOES

orders are executed within three

seconds.25

The report also showed that SOES

exposure limit exhaustions tend to

cluster in active NNM securities with

high numbers of market makers. This

further illustrates the extremely low

probability that all market makers in the

same security would ever have their

exposure limits exhausted

simultaneously. Lastly, examining one

trading day, the report shows that active

SOES order entry firms accounted for 92

percent of the exposure limit

exhaustion, as might be expected given

that these firms account for 89 percent

of SOES dollar volume. Accordingly,

the NASD and Nasdaq believe that the

SOES Minimum Exposure Limit Rule

has had a very negligible, if any, impact

on the availability of SOES to small,

retail investors.

The report also found that the

Automated Quotation Update Feature

appears to be used extensively by some

market making firms. Specifically, the

report shows that the quote update

feature is sued by 126 market makers for

10,646 market making positions. Thus,

this feature is currently being used by

26 percent of the market makers and for

24 percent of all market making

positions. In addition the report showed

that, on average, 3,394 quotations a day

were generated by the quote update

feature from October 2, 1995 to

November 21, 1995. Accordingly, the

NASD and Nasdaq believe that the

Automated Update Feature has

effectively served its intended purpose

of helping to maintain continuous

quotations in Nasdaq, minimize ‘‘closed

quote’’ conditions, and avoid unexcused

market maker withdrawals, thereby

promoting market liquidity.

Accordingly, the NASD believes the

Commission should properly view these

two SOES rules as strictures that are

highly correlated with improvements in

market liquidity, not as rules that have

had or could have a damaging effect on

liquidity. The NASD and Nasdaq also

believe the monitoring report illustrates

that implementation of the Automated

Quotation Update Feature and the SOES

Minimum Exposure Limit Rule have not

diminished the significant benefits

provided to investors through the

automatic execution capabilities of

SOES. Simply put, these two SOES

rules have in no way altered the

operation of SOES as an automatic
35288 Federal Register / Vol. 61, No. 130 / Friday, July 5, 1996 / Notices

26 Interim SOES Rules Extension Order, supra

note 3, 61 FR at 4505.

27 Id. (footnotes omitted).

28Even if the Commission concludes that the

SOES Minimum Exposure Limit Rule and the SOES

Automated Quotation Update Feature have had no

impact on market quality, the NASD believes the

Commission’s approval of New York Stock

Exchange (‘‘NYSE’’) Rule 80A on a permanent basis

illustrates that the Commission would still have a

sufficient basis to approve an extension of the rules

for a four-month period. In particular, the SEC’s

discussion of the statutory basis for approval of

NYSE Rule 80A focused in large part on the fact

that Rule 80A did not have any adverse impacts on

market quality on the NYSE and that, as a result,

the NYSE should be given the latitude to take

reasonable steps to address excessive volatility in

its marketplace. See Securities Exchange Act

Release No. 29854 (October 24, 1994), 56 FR 55963

(October 30, 1994). Accordingly, the NASD believes

the SEC should afford the NASD the same

regulatory flexibility that it afforded the NYSE to

implement rules reasonably designed to enhance

the quality of Nasdaq and minimize the effects of

potential disruptive trading practice.

29 Interim SOES Rules Extension Order, supra

note 3, 61 FR at 4506.

execution system that affords small,

retail investors immediate execution at

the inside market. However, as noted in

the NASD’s proposed NAqcess filing,

the NASD believes the limit order

processing capabilities and order

execution algorithm of SOES could be

significantly improved upon for the

benefit of small investors and the

market place as a whole.

Moreover, in the Interim SOES Rules

Extension Order, an order approving a

proposal identical to the NASD’s instant

proposal, the SEC found that the

continued effectiveness of the SOES

Minimum Exposure Limit Rule

‘‘provides customers fair access to the

Nasdaq market and reasonable

assurance of timely executions.’’ 26 With

respect to the SOES Automated

Quotation Update Feature, the SEC also

stated that it believes ‘‘that extending

the automated update function is

consistent with the Act and, in

particular, the Firm Quote Rule. The

update function provides market makers

the opportunity to update their

quotations automatically after

executions through SOES; under the

Commission’s Firm Quote Rule, market

makers are entitled to update their

quotations following an execution and

prior to accepting a second order at their

published quotes.’’ 27

Therefore, in light of the above-cited

statutory findings made by the SEC

when it first approved the SOES

Minimum Exposure Limit Rule and the

SOES Automated Quotation Update

Feature and extensions of these rules,

coupled with the NASD’s findings that

these rules have been associated with

positive market developments in terms

of lower spreads on Nasdaq and fewer

stocks with extreme relative price

volatility, the NASD believes it would

be consistent with the Act for the

Commission to extend the effectiveness

of the SOES Minimum Exposure Limit

Rule and the SOES Automated

Quotation Update Feature for an

additional six-month period. Moreover,

even if the Commission is unwilling to

find positive significance in the NASD’s

statistical analyses, at the very least,

these studies indicate that the market

has not been harmed by implementation

of these rules.28 Indeed, the Commission

clearly stated in the Interim SOES Rules

Extension Order that the SOES

Minimum Exposure Limit Rule and the

SOES Automated Quotation Update

Feature have not had a detrimental

effect on the Nasdaq market: ‘‘the

Commission * * * continues to believe

that the data submitted by the NASD

demonstrates * * * [no] serious

deterioration in the quality of the

Nasdaq market subsequent to the

adoption of the January 1994, January

1995, March 1995, and September 1995

Amended SOES Rules.’’ 29

The NASD believes that the proposed

rule change is consistent with Sections

15A9b)(6), 15A(b)(9), 15A(b)(11) and

11A(a)(1)(C) of the Act. Among other

things, Section 15A(b)(6) requires that

the rules of a national securities

association be designed to prevent

fraudulent and manipulative acts and

practices, to promote just and equitable

principles of trade, to foster cooperation

and coordination with persons engaged

in regulating, clearing, settling,

processing information with respect to,

and facilitating transactions in

securities, to remove impediments to

and perfect the mechanism of a free and

open market and a national market

system and in general to protect

investors and the public interest.

Specifically, the NASD is proposing to

extend the effectiveness of the SOES

Minimum Exposure Limit Rule and the

SOES Automated Quotation Update

Feature until January 31, 1997 because

of concerns tat concentrated, aggressive

use of SOES by a growing number of

order entry firms has resulted in

increased volatility in quotations and

transaction prices, wider spreads, and

the loss of liquidity for individual and

institutional investor orders, all to the

detriment of public investors and the

public interest. The NASD believes the

SOES Minimum Exposure Limit Rule

and the SOES Automated Quotation

Update Feature have operated to rectify

this situation while continuing to

provide an effective opportunity for the

prompt, reliable execution of small

orders received from the investing

public. Accordingly, in order to protect

investors and the public interest, the

NASD believes the SEC should approve

an additional six-month extension of the

SOES Minimum Exposure Limit Rule

and the SOES Automated Quotation

Update Feature through January 31,

1997, so that small investors’ orders will

continue to receive the fair and efficient

executions that SOES was designed to

provide.

Section 15A(b)(9) provides that the

rules of the Association may not impose

any burden on competition not

necessary or appropriate in furtherance

of the purposes of the Act. The SOES

Minimum Exposure Limit Rule and the

SOES Automated Quotation Update

Feature apply across the board and do

not target any particular user or

participant, as all dealers may set their

exposure limits at two times the tier size

and all dealers may elect to utilize the

automated quote update feature.

Accordingly, the NASD believes that

these rule changes are not anticompetitive, as they are uniform in

application and they seek to preserve

the ability of SOES to provide fair and

efficient automated executions for small

investor orders, while preserving market

maker participation in SOES and market

liquidity.

Section 15A(b)(11) empowers the

NASD to adopt rules governing the form

and content of quotations relating to

securities in the Nasdaq market. Such

rules must be designed to produce fair

and informative quotations, prevent

fictitious and misleading quotations,

and promote orderly procedures for

collecting and distributing quotations.

The NASD is seeking to continue the

effectiveness of SOES Minimum

Exposure Limit Rule and the SOES

Automated Quotation Update Feature so

that SOES activity may not result in

misleading quotations in the Nasdaq

market. Market makers place quotes in

the Nasdaq system and these quotes

comprise the inside market and define

the execution parameters of SOES.

When volatility in the SOES

environment causes market makers to

widen spreads or to change quotes in

anticipation of waves of SOES orders,

quotes in the Nasdaq market become

more volatile and may be misleading to

the investing public. Accordingly,

absent continuation of the SOES

Minimum Exposure Limit Rule and the

SOES Automated Quotation Update

Feature, the quotations published by

Nasdaq may not reflect the true market

in a security and, as a result, there may

be short-term volatility and loss of

liquidity in Nasdaq securities, to the

detriment of the investing pubic.

Further, the continuation of the

automated refresh feature will ensure
Federal Register / Vol. 61, No. 130 / Friday, July 5, 1996 / Notices 35289

30 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1) (1988).

2Letter from J. Keith Kessel, Compliance Officer,

SCCP, to Peter R. Geraghty, Senior Counsel,

Commission (May 8, 1996). The amendment also

requested permanent approval of SCCP’s CNS

guarantee procedures.

3The proposals, along with a similar proposal

submitted by the Midwest Clearing Corporation

(‘‘MCC’’), were originally approved on a temporary

basis in 1989. For a complete discussion of these

proposals, refer to Securities Exchange Act Release

Nos. 27192 (August 29, 1989), 54 FR 37010

(approving File Nos. SR–NSCC–87–04, SR–MCC–

87–03, and SR–SCCP–87–03 until December 31,

1990). In addition, the Commission has temporarily

extended the respective proposals on six previous

occasions in Securities Exchange Act Release Nos.

28728 (December 31, 1990), 56 FR 717 (approving

File Nos. SR–NSCC–90–25, SR–MCC–90–08, and

SR–SCCP–90–03 until June 30, 1991); 29388 (June

28, 1992), 56 FR 30951 (approving File Nos. SR–

NSCC–91–06, SR–MCC–91–03, and SR–SCCP–91–

03 through June 30, 1992); 30879 (July 1, 1992), 57

FR 30279 (approving File Nos. SR–NSCC–92–04,

SR–MCC–92–07, and SR–SCCP–92–02 through June

30, 1993); 32547 (June 29, 1993), 58 FR 36491

(approving File Nos. SR–NSCC–93–04, SR–MCC–

93–02, and SR–SCCP–93–02 through June 30,

1994); and 33996 (June 27, 1994), 59 FR 33996

(approving File Nos. SR–NSCC–94–09, SR–MCC–

94–06, and SR–SCCP–94–02 through June 30,

1995); and 35916 (June 28, 1995), 60 FR 35575 (July

10, 1995) (approving File Nos. SR–NSCC–95–04,

SR–MCC–95–02, and SR–SCCP–95–03). On January

5, 1996, MCC withdrew from the securities

clearance business. Securities Exchange Act Release

No. 36684 (January 5, 1996), 61 FR 1195 (order

approving File No. SR–MCC–95–04).

that a market maker’s quotation is

updated after an exposure limit is

exhausted. Uninterrupted use of this

function will maintain continuous

quotations in Nasdaq as market makers

exhausting their exposure limits in

SOES will not be subject to a ‘‘closed

quote’’ condition or an unexcused

withdrawal from the market.

Finally, the NASD believes that the

proposed rule change is consistent with

significant national market system

objectives contained in Section

11A(a)(1)(C) of the Act. This provision

states it is in the public interest and

appropriate for the protection of

investors and the maintenance of fair

and orderly markets to assure, among

other things: (i) Economically efficient

execution of securities transactions; (ii)

fair competition among brokers and

dealers; and (iii) the practicality of

brokers executing investor orders in the

best market. Specifically, the SOES

Minimum Exposure Limit Rule and the

SOES Automated Quotation Update

Feature advance each of these objectives

by preserving the operational

efficiencies of SOES for the processing

of small investors’ orders, by

maintaining current levels of market

maker participation through reduced

financial exposure from unpreferenced

orders, and by reducing price volatility

and the widening of market makers’

spreads in response to the practices of

order entry firms active in SOES.

In addition, for the same reasons

provided by the SEC when it approved

the Interim SOES Rules that are cited

above in the text accompanying

footnotes 6 through 13, 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.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

The NASD believes that the proposed

rule change will not result in any

burden on competition that is not

necessary or appropriate in furtherance

of the purposes of the Act.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

Comments were neither solicited nor

received.

III. Date of effectiveness of the Proposed

Rule Change and Timing for

Commission Action

Within 35 days of the date of

publication of this notice in the Federal

Register or within such longer period (i)

as the Commission may designate up to

90 days of such date if it finds such

longer period to be appropriate and

publishes its reasons for so finding or

(ii) as to which the NASD 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.

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. 552, will be

available for inspection and copying in

the Commission’s Public Reference

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the NASD. All

submissions should refer to File

Number SR–NASD–96–22 and should

be submitted by July 26, 1996.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.30

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96–17144 Filed 7–3–96; 8:45 am]

BILLING CODE 8010–01–M

[Release No. 34–37381; File Nos. SR–

NSCC–96–09; SR–SCCP–96–02]

Self-Regulatory Organizations;

National Securities Clearing

Corporation; Stock Clearing

Corporation of Philadelphia; Notice of

Filing and Order Granting Permanent

Approval on an Accelerated Basis of

Proposed Rule Changes Relating to

the Guarantee of Trades in Continuous

Net Settlement Systems

June 28, 1996.

Pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’),1 notice is hereby given that the

National Securities Clearing Corporation

(‘‘NSCC’’) and Stock Clearing

Corporation of Philadelphia (‘‘SCCP’’)

(collectively referred to as ‘‘Clearing

Corporations’’) filed with the Securities

and Exchange Commission

(‘‘Commission’’) on April 3, 1996, and

May 8, 1996, respectively, the proposed

rule changes as described in Items I and

II below, which items have been

prepared primarily by the Clearing

Corporations. On May 8, 1996, SCCP

filed an amendment to the proposed

rule change to remove from

consideration certain proposed

amendments to its clearing fund

calculations.2 The proposals seek

permanent approval of rule changes

relating to the guarantee of trades in the

Clearing Corporations’ continuous net

settlement (‘‘CNS’’) systems. The

Commission is publishing this notice

and order to solicit comments on the

proposed rule changes from interested

persons and to grant accelerated

permanent approval of the proposed

rule changes.

I. Self-Regulatory Organizations’

Statement of the Terms of Substance of

the Proposed Rule Changes

The proposals seek permanent

approval of proposed rule changes to

which the Commission has granted

temporary approval.3 The proposals

authorize the Clearing Corporations to

guarantee at an earlier time the

settlement of participant trades in their

CNS systems. In addition, NSCC’s