Mr. Jonathan G. Katz
The U.S. Securities and Exchange Commission
450 5th Street N.W.
Washington, D.C. 20549
Re: Release No. 34-39760; File No. SR-NASD-98-21
(Proposed Expansion of NASD Rule 4613(a)(1)(C)
"Actual Size Rule"
Dear Mr. Katz:
TD Securities (USA) Inc. ("TD Securities"), a registered broker-dealer and NYSE and NASD member, is writing to comment on the above-referenced proposal to expand NASD Rule 4613(a)(1)(C) to all Nasdaq stocks on a permanent basis.
For the reasons set forth below, TD Securities strongly agrees that NASD Rule 4613(a)(1)(C) should be expanded to cover all Nasdaq stocks.
I. Expansion of the "Actual Size Rule" is Consistent with Commission Rule 11Acl-4 - the "Display Rule" and the Commissions View of the Nasdaq Market.
In its release adopting Rule 11Ac1-4 under the Securities Exchange Act of 1934, the Securities and Exchange Commission ("Commission") stated that it "believes that customer orders are the ultimate source of liquidity to the markets, and that adoption of a rule that improves the handling of such orders will have the effect of enhancing market liquidity". [ See Securities Exchange Act Release No. 37619 (August 29, 1996), adopting Rules 11Ac1-4 and 11Ac1-1 ("Adopting Release") at p. 49-50.]
The adoption of the Display Rule occurred after years of Commission analysis and study of the dealer market. The Display Rule can be viewed as a manifestation of the Commission belief that overlaying certain auction market principles (e.g., order transparency) on the dealer market will result in improved executions of customer orders. Not suprisingly, the Commission realized that the Display Rule "could lead to a re-evaluation by some market makers of the services they want to provide". [ Id at 49.] Specifically, the concern regarding re-evaluation focused on the issue of whether the Display Rule would remove an incentive for a market maker to provide liquidity in a market place when it was required to reflect customer limit orders in its quotations, thus resulting in fewer opportunities to "make the spread". The Commission ultimately believes that whatever decisions a market maker makes requiring capital commitment, greater transparency through increased exposure of customer orders results in a more efficient market. [ In fact, in Exchange Act Release No. 34884 (April 17, 1998) (the "ATS Proposing Release"), the Commission proposed rulemaking designed to increase transparency by requiring certain additional order flows to be made part of the present market. Under proposed Rule 301(b)(3), an alternative trading system that displays subscriber orders to more than one person would be required to disseminate in the public quotation system the best priced orders in a security if that system accounted for more than 10 percent of the average daily share volume for that security over a specific period of time.]
Consistent with this belief, the Commission approved the NASD proposed rule change to allow a pilot program for the reduction of the market maker minimum quotation size. [ See Exchange Act Release No. 38156 (January 10, 1997) establishing a 3-month pilot for 50 Nasdaq stocks. The pilot was later extended and expanded to 150 Nasdaq stocks (see Nasdaq Head Trader Alert # 1997-77 October 31, 1997).] In the approving release, the Commission noted that in an increasingly order driven market the "role of a market maker in providing liquidity changes dramatically". Further, it notes that neither the Exchange Act nor Commission rules require a quote size greater than 100 shares. [ Id. (1997 SEC LEXIS 58) at 62.] In fact, no such requirement exists for exchange specialists, the primary and often sole "market maker" of the auction market.
In the year that the Nasdaq market has been subject to the Display Rule and significant changes in its structure, statistics from the SEC and NASD seem to strongly support the Commissions thesis that increased transparency improves market efficiencies as evidenced by narrower spreads and better customer executions. Accordingly, in light of this evidence and as would be consistent with prior Commission rulemaking and current proposals, we support expanding the Actual Size Rule to all Nasdaq stocks.
II. Expanding the "Actual Size Rule" Should Increase Market Competition and Benefit the Entire Nasdaq Market.
By eliminating the 1000 share "hurdle" a market maker faces when it chooses to commit capital, expanding the Actual Size Rule should result in additional competition for order flow. In addition to customer orders as being the basis for liquidity, market makers would now have greater flexibility in committing capital and providing liquidity. It would be cheaper to commit capital. Market makers, in order to be competitive, would likely pass these costs on to the market in the form of improved executions and narrower spreads. This would be particularly helpful for smaller market makers whose firms may have a niche in a particular industry or industries. These firms may be active in investment banking and research and may earnestly want to provide liquidity for their issuer clients. A market with no arbitrary size requirement truly would provide a playing field where these firms can compete for orderflow with all firms based on size and price. Expanding the Actual Size Rule should significantly benefit not only these firms but also their issuer clients. Many of these issuers would be considered smaller cap issuers whose markets may not be as liquid as the more well known larger cap issuers. Market makers sponsorship historically has helped provide liquidity and the market foundation for those issuers to attract further capital and grow.
Thank you for the opportunity to comment. If you have any questions, please contact the
undersigned at (212) 827-7606.
Elliot Levine, Esq.
Vice President & Director