April 29, 1998
Jonathan G. Katz, Secretary
United States Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549
(also via e-mail to: email@example.com).
Re: Release No. 34-39819; File No. SR-NASD 98-26
Proposed Change to the Definition of Primary Market Maker,
and Extension of Short Sale Pilot
Dear Mr. Katz:
CREDIT SUISSE FIRST BOSTON CORPORATION ("CSFB") appreciates the opportunity to comment on the above referenced National Association of Securities Dealers, Inc. ("NASD") proposal to amend the NASD Rule 4612 Primary Nasdaq Market Maker ("PMM") standards on a test pilot basis beginning May 1, 1998, for all Nasdaq National Market ("NNM") securities. In addition the NASD has requested that the Commission allow, on an accelerated basis, the continued suspension of the PMM standards until May 1, 1998, and the extension of the Short Sale Rule until November 1, 1998. In essence, the NASD has asked that the Commission approve a major restructuring of the Nasdaq market without affording the public sufficient time to understand, comment or test the proposed changes. CSFB respectfully submits that the Commission not approve, on a test or permanent basis, the changes to the PMM designation sought by the NASD until industry participants, who will be most affected by the changes, have had sufficient opportunity to review and reflect upon the proposed amendments.
The NASD Has Failed to Show the Need for Expediting a Rule Proposal with Major Market Impact
The NASD proposal was published for public comment in the Federal Register on April 6. Assuming the unlikely event of same day delivery of the Federal Register, NASD members around the country would be afforded 18 business days before implementation of the proposed PMM pilot. While the proposed Rule change would assure that no market maker would loose its current market maker standard until July 6, 1998, CSFB submits that even this two month "grace period" is remarkably insufficient, and not supported by any demonstrable rationale for the aggressive implementation schedule sought by the NASD. This short time period is troublesome in light of the fact that the Commission is being asked to approve a proposal that is likely to cause market makers economic and property loss without adherence to the due process requirements of law and its own rules. The NASD proposal itself states that it expects that "the number of market makers qualifying for PMM status will be reduced significantly from the levels under previous PMM standards." [ 63 Fed. Reg. 16847 (April 6, 1998).] Since CSFB agrees with the NASDs forecast of upheaval in the Nasdaq market, CSFB requests that the NASD and the Commission afford a considerably longer time period during which all market participants can gather and review data and perform the necessary analysis to determine the potential impact of the proposed rule.
More Data Should Be Compiled Before Embarking Upon a Far Reaching Pilot Program
Indeed, one stated purpose of the rule proposal is to gather data to determine the effect of the revised PMM standards on the Short Sale rule. In arguing for an extension of the Short Sale Rule, the NASD states that such extension "is necessary to allow the NASD and the Nasdaq to study the effects of the revised PMMs and the soon-to-be-filed amendments to the Short Sale Rule, and to study the interaction between the revised PMM standards and the Short Sale Rule." [ Id. at 16847-848.] While we understand and support the extension of the Short Sale Rule for the time being, we believe that the proposed changes to the PMM standards are premature and that it would be prudent for the NASD to first gather data and conduct a comprehensive analysis of the interaction between the proposed PMM standards and the Short Sale Rule before proposing major revisions to the PMM standards. To do it in the proposed reverse order of effecting a change in order to study its effects at the real expense of market makers not only is unfair, but also shows a lack of concern for market impact by seeking to perform a little understood experiment on one of the nations premier securities markets.
The Language of the Rule Is Difficult to Comprehend and Apply
The proposed NASD rule language is hyper-technical, and our general observation is that it is less than clear to those individuals within our firm who would have to determine our future status for each NNM security in which we currently make a market. We also understand that some other market makers who have had an opportunity to reflect on the proposed rule have also experienced difficulties in determining their status in working with the proposed calculations. This confusion is understandable because the proposed NASD rule and the multiple footnotes needed to explain essential, yet perplexing, phrases used in the rule are in stark contrast to the Commissions Plain English initiative.
For example, as stated in the Release, the NASD proposes to change the PMM definition to include in the determination of whether a market maker is a PMM, the concept of "Net Liquidity Ratio" ("NLR"). NLR is not defined in the language of the rule, but rather requires a lengthy explanation in a footnote. [ "The Net Liquidity Ratio ("NLR") formula accords credit for liquidity contribution: (1) in an "up market" by accumulating all sales, irrespective of price; and (2) in a "down market" by accumulating all purchases, irrespective of price. These trades are then divided by total shares traded in both up and down markets, excluding volume during neutral periods, sales at the inside offer during down markets, and purchases at the inside bid during up markets. In addition to excluding from the denominator of the NLR sales at the inside offer during down markets and purchases at the inside bid during up markets, these sales and purchases are excluded from the numerator of the NLR. The result is expressed as a ratio with a potential value between zero and one." 63 Fed. Reg. 16842. ] Similarly, a PMM calculation appears to take into account the market makers "proportionate volume" which will be determined by:
"dividing the market makers total proprietary share-volume in a stock by all market maker proprietary share-volume for that stock; and then multiplying the ratio by the total number of registered market makers in that stock."
In the alternative, the PMM calculation can take into consideration the market makers proportionate share of proprietary trades or so called "proportionate trades" to be determined by:
"dividing the market makers total number of proprietary trades in a stock by the total number of proprietary trades by all market makers in that stock; and then multiplying that ratio by the total number of registered market makers in that stock".
We believe the language of the proposed rule is confusing, and would benefit from revision. Moreover, the NASD has failed to give an adequate explanation of why it proposed the particular formulas listed in the Release over others. The arbitrariness of the particular formula selections is reinforced by an examination of the proposed thresholds required to be met under the above formulas. For example, the NASD states that the initial NLR threshold shall be set at 0.67 [ 63 Fed. Reg. 16482.] without offering any explanation for its choice, or explaining the technical or mathematical analysis that would serve as the logical underpinning for its determination. The entire rule proposal should be revised to be more easily understandable by the marketplace, and the reasoning behind the adoption of the formulas should be explained in a manner other than the cursory recitations of portions of the Exchange Act.
CSFB appreciates the opportunity to provide its views on this important industry matter. We support the goals of a revised approach to the Short Sale Rule and could support a revised PMM proposal after having an opportunity commensurate with its importance to independently review the impact of the proposed rule. We respectfully submit, however, that the current proposals would benefit from further revisions. As such, we request that the Commission continue the operation of the current suspension of the PMM standards of Rule 4612 or reinstate the operation of that Rule, and continue to allow all current PMMs to avail themselves of the PMM exemption to the Short Sale Rule. CSFB believes that current market conditions warrant and demand a more thorough compilation and analysis of market data, and a full discussion of available alternatives before adopting any permanent or interim changes. The Commissions own experience with, for example, the Bulletin Board illustrates that pilots once begun are very difficult, if not impossible, to restrict to the originally proposed time periods. Should you have any questions or wish to discuss this matter further, kindly contact the undersigned or Mr. Gautam S. Gujral (212-325-5291).
Very truly yours,
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;
Richard C. Strasser, Assistant Director, 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