May 7, 1998
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Re: SR-NASD-98-21 (NASDAQ Proposed Actual Size Rule)
Dear Mr. Katz:
Credit Suisse First Boston Corporation ("CSFB") appreciates the opportunity to comment on the above-referenced National Association of Securities Dealers rule proposal to permanently permit market makers to quote their actual size (i.e.100 shares) by reducing the minimum quotation size requirement for market makers in all securities listed on the Nasdaq Stock Market ("Nasdaq") to one normal unit of trading ("Actual Size Rule"). CSFB believes that this proposal is critical to and desirous for the Nasdaq Market in that it affords market makers the ability to manage their quote not only by changing the price but the size of their quote as well, and CSFB strongly encourages the Commission to expand the rule to apply to all Nasdaq securities. Adoption of the Actual Size Rule is in the public interest, and will further the purposes of the Securities Exchange Act of 1934 (the "Act") by removing unnecessary competitive burdens, and also assuring the economically efficient execution of securities transactions, and the availability to brokers, dealers and investors of information with respect to quotations for and transactions in securities.
In order to facilitate implementation of the Commissionís Order Handling Rules and reflect the order driven nature of the Nasdaq market that was to be brought about by the implementation of these rules, the Commission approved, on January 10, 1997, a variety of amendments to NASD Rules pertaining to Nasdaqís Small Order Execution System ("SOES") and the SelectNet Service ("SelectNet"). In particular, one of the NASD Rule changes approved by the Commission provided on a temporary basis that Nasdaq market makers in the first fifty securities subject to the Commissionís Limit Order Display Rule are required to display a minimum quotation size of one normal unit of trading when quoting solely for their own proprietary account. This Actual Size Rule pilot was subsequently extended by the Commission. On October 29, 1997, the Commission approved the NASD proposal to expand the Actual Size Rule to include 150 stocks to provide for a test sample more representative of the entire Nasdaq market.
The Actual Size Rule Removes Unnecessary Barriers to Competition
In view of the fact that the limit order display rule permits investors to directly impact quoted prices, the historical reasons for the adoption of the mandatory quote size requirement no longer exists. CSFB notes that the original reason for the adoption of the mandatory quote size requirements was to ensure an acceptable level of market liquidity and depth in a trading environment where market makers were the only market participants who could impact quotation prices. CSFB believes it is now appropriate to allow Nasdaq market makers to operate in a manner consistent with other primary markets and not subject them to minimum quote size requirements when they are not representing customer orders. Indeed, we note that no other primary market in the US mandates minimum quote size requirements that are larger than 100 shares for its market makers and specialists. Consequently, the proposal, if adopted, would remove unnecessary competitive burdens by leveling the playing field between primary markets in the U.S. In addition, a lowering of the minimum quote size to 100 shares would remove an unnecessary barrier to entry by making it less capital intensive for broker-dealers to function as market makers in Nasdaq stocks.
The Actual Size Rule Enhances Pricing Efficiency
Permitting market makers to quote in size commensurate with their own freely determined trading interest should enhance the pricing efficiency of the Nasdaq Market and the independence and competitiveness of dealer quotations. We believe that the removal of minimum sizes will allow market makers to commit capital more freely and therefore make price discovery, i.e. the marketís process of putting a value on a stock, more efficient. Ultimately, increased competition among market makers, lowering of the barriers to entry, and enhanced price discovery will benefit the investing public.
The adoption of the SECís Order Handling Rule has rendered obsolete the rationale for the current Quote Size requirements. The Order Handling Rules allow investors to directly affect the price and the size of Nasdaq quotes. Consequently, the old regulatory requirement to show a minimum quote size that matched the SOES tier size is irrelevant and should be eliminated. Moreover, empirical analysis of data thus far available, as discussed below, demonstrates that the removal of the regulatory minimum has not degraded market quality, and has in fact resulted in less market volatility.
For example, a recent study conducted by the NASD at the Commissionís request examined the effects of the removal of the 1,000-Share Quote Size Rule on the quality of the Nasdaq Market. In particular, the study compared the market quality of those stocks that were subject to the actual size pilot with the next tranche of stocks that were subject to the Order Handling Rules and the 1000-Share Quote Minimum ("non-pilot stocks"). The rigorous analysis of this study clearly reveals that pilot and non-pilot stocks have experienced virtually the same improvements in market quality since implementation of the Order Handling Rules. In addition, the NASD study clearly states that it found no evidence to conclude that the market quality of the pilot stocks has been affected as a result of the elimination of the 1,000 share minimum. Moreover, the NASD study confirms that investors in pilot stocks continue to have substantial and reasonable access to market maker capital through both SOES and market makersí proprietary automatic execution systems. In short, the weight of the available, reliable evidence clearly supports the Commissionís initial decision to adopt the Actual Size Rule, and presents a compelling argument for permanently adopting and expanding that rule.
In addition, the NASD, at the Commissionís request, conducted an additional study of the effects of the Actual Size Rule, as expanded by the Commission in October 1997 (the "January 1998 Study"). The study compared the performance of stocks that had joined the ranks of stocks subject to the Actual Size Rule versus stocks that were subject to minimum size rules. The January 1998 Study once again confirmed that the Actual Size Rule has had no material effect on spreads, volatility, market depth or liquidity in Nasdaq securities. In short, the empirical evidence clearly points to an inescapable conclusion - the Actual Size Rule has had no material effect on the quality of the Nasdaq market. It is clear from these statements and studies that differences in spread sizes do not offer a reasonable basis for the Commission to adopt a larger and thus more punitive minimum quote requirement for Nasdaq market makers.
The Actual Size Rule Has Not Harmed SOES Accessibility
The implementation of the Actual Size Rule has not diminished the availability of investors to receive automated execution through SOES. This finding is supported by the June 1997 study showing that SOES access was restricted to 100 shares only 1% of the time. This means that on average, only on 1% of the trading days in question was it the case that there was no market maker at the inside quoting an amount greater than 100 shares. In addition, the June 1997 revealed that since the implementation of the Order Handling Rules, the SOES and SelectNet Dollar volume for the pilot stocks have increased. The January 1998 study confirmed again that the effect on SOES executions of the Actual Size Rule on the additional 103 stocks that were added to the test pilot has been minimal. In fact, 98.5 % of SOES orders in the additional 103 stocks were fully executed after these stocks became subject to the Actual Size Rule. Indeed, the average size of a SOES trade in the additional 103 stocks fell by only 18 shares after the expansion of the pilot program. These statistics clearly refute any suggestion that adoption of the Actual Size Rule has resulted in diminished SOES executions.
CSFB fully supports this expansion proposal and believes that the available evidence greatly supports expansion of the pilot program to include all Nasdaq securities. Such action would be beneficial to all market participants, including market makers, issuers, and especially investors.
Should you have any questions or wish to discuss this matter further, kindly contact the undersigned or Mr. Gautam S. Gujral.
Raymond J. Dorado
Director and Counsel
Legal and Compliance Department
cc: The Honorable Arthur Levitt, Chairman
The Honorable Norman S. Johnson, Commissioner
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Laura S. Unger, Commissioner
The Honorable Paul Carey, Commissioner
Dr. Richard R. Lindsey, Director, Division of Market Regulation
Robert L. D. Colby, Deputy Director, Division of Market Regulation
Katherine England, Assistant Director, Division of Market Regulation
Richard C. Strasser, Assistant Director, Division of Market Regulation
Jeffrey Schwartz, Special Counsel, Division of Market Regulation
Stephen R. Greene, Global General Counsel, Credit Suisse First Boston
Joseph T. McLaughlin, General Counsel for the Americas, Credit Suisse First Boston