June 22, 2001
Richard Romano, Chair
Re: Request for Exemption from Rule 11Ac1-5
Dear Mr. Romano and Mr. Sherr:
In your letter dated April 23, 2001 ("Letter") on behalf of the NASD Small Firms Advisory Board, you requested that the Commission issue an exemption from Rule 11Ac1-5 ("Rule") under the Securities Exchange Act of 1934 ("Exchange Act") for small Nasdaq market makers. This letter responds to your request.
Adopted in November 2000,1 the Rule generally requires a "market center" (as defined in the Rule) that trades national market system securities to make available to the public monthly electronic reports that include uniform statistical measures of execution quality. The Adopting Release established a three-stage phase-in of compliance with the Rule. The first phase-in date was April 2, 2001, on which the Rule was to apply to the 1000 NYSE securities, 1000 Nasdaq securities, and 200 Amex securities with the highest average daily share volume for the quarter ending December 31, 2000. This initial compliance date for the Rule was moved back by one month until May 1, 2001.2 On April 12, 2001, the Commission granted a temporary exemption, until July 31, 2001, from the reporting requirements of the Rule for all orders in securities that are qualified for inclusion in the National Market tier of Nasdaq.3 The first monthly reports (for August 2001) that must include Nasdaq securities must be made available to the public by the end of September 2001. The final phase-in date is October 1, 2001, on which the Rule is scheduled to apply to all national market system securities.
In the Letter, you request an exemption from the Rule for all small Nasdaq market makers. You assert that most small firms do not have the resources to collect the necessary data elements and perform the complex calculations required by the Rule on their own. Although outside vendors are available to provide this service, you represent that retaining such a vendor would be a significant cost to small firms. In addition, the Letter expresses concern that the significant additional compliance costs could cause many small firms to cease acting as market makers. Because many small firms make markets in thinly traded Nasdaq stocks that are national market system securities, you believe that their dropping out of the market could have a detrimental affect on the liquidity in these securities, and that the harm to investors from the loss of liquidity could outweigh the benefits from enhanced transparency.
On the basis of your representations and the facts presented, the Commission, by the Division pursuant to delegated authority,4 is granting the following two exemptions from the Rule, one for very inactively traded securities and one for small market centers that do not focus their business on the most actively traded securities.
The Commission finds that the two exemptions are necessary or appropriate in the public interest, and are consistent with the protection of investors. First, the exemption for very inactively traded national market system securities is consistent with the Commission's exclusion from the Rule of Nasdaq SmallCap securities and Over-the-Counter Bulletin Board securities. In the Adopting Release, the Commission found that, given the relatively light dollar amount of trading in these securities, the value of statistical measures of trading might not justify the costs to produce the information.5
Second, small market centers often may be significant sources of liquidity in the securities of small and medium companies, but have fewer transactions than large market centers over which to distribute the cost of generating the monthly execution quality reports. The Commission therefore is concerned that the costs of compliance for small market centers, as well as the potential costs if small market centers ceased supplying liquidity, potentially could outweigh the benefits of their monthly reports. If a small market center chooses, however, to focus a significant part of its business on the most actively traded securities, it should compete on the same terms as larger market centers that trade those securities. In addition, a broker-dealer that routes orders to a market center that does not generate monthly execution quality reports continues to have a duty to monitor the quality of executions received to obtain the best execution of those orders.
The exemptions granted in this letter is subject to modification or revocation at any time if the Commission determines that such action is necessary or appropriate in the public interest or otherwise in furtherance of the purposes of the Exchange Act. If you have questions, please do not hesitate to contact me.
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.
Annette L. Nazareth