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SECURITIES AND EXCHANGE COMMISSION
Release No. 34-36548; File No. SR-NASD-95-42
December 1, 1995
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by National Association of Securities Dealers, Inc.
Relating to NAqcess System and Accompanying Rules of Fair
Practice
Pursuant to Section 19(b)(1) of the Securities Exchange Act
of 1934 ("Act"),-[1]- notice is hereby given that on November 9,
1995, the National Association of Securities Dealers, Inc.
("NASD" or "Association") filed with the Securities and Exchange
Commission ("SEC" or "Commission") 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
Pursuant to Section 19(b)(1) of the Act, attached as Exhibit
A is the full text of a series of proposed rule changes by the
NASD and The Nasdaq Stock Market, Inc. ("Nasdaq") regarding the
operation of The Nasdaq Stock Market's NAqcess system, a new
system that offers nationwide limit order protection and price
improvement-[2]- over the dealer quotation of small-sized
customer orders. The "Rules of Operation and Procedures for
NAqcess" ("NAqcess Rules") will replace in its entirety the
"Rules of Practice and Procedures for the Small Order Execution
System" ("SOES Rules"), which the NASD proposes to withdraw
simultaneously with the new system becoming operational. The
NAqcess system rules package attached in Exhibit A is new and
accordingly has not been italicized. The NASD is also proposing
several new Interpretations and a new Rule in its Rules of Fair
Practice to afford individual investors the opportunity to
determine whether their orders are to be handled in NAqcess and
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-[1]- 15 U.S.C. 78s(b)(1) (1988).
-[2]- Commission Note: The NASD's use of the term "price
improvement" in this proposal differs from the use of
the term in recent Commission releases. Specifically,
the Commission has used the term when referring to the
opportunity to receive a price that is superior to best
bid or offer. See, e.g., 17 CFR 11Ac1-3(a)(2);
Securities Exchange Act Release No. 34902 (Oct. 27,
1994), 59 FR 55006 (Nov. 2, 1994) at text accompanying
n. 32. The NASD's use of the term in this proposal, on
the other hand, refers to the opportunity to receive a
price that is better than the best market maker
quotation, which may not be the best bid or offer to
the extent NAqcess limit orders are included. In its
recent rule proposal concerning the obligations of
market makers executing customer orders, the Commission
asked for comment on whether automated systems that
include the possibility of the interaction of market
orders with limit orders should be deemed to satisfy
the proposal's requirement that market orders be
provided with an opportunity for price improvement.
Securities Exchange Act Release No. 36310 (Sept. 29,
1995), 60 FR 52792 (Oct. 10, 1995).
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to provide customer limit orders held in NAqcess or elsewhere
with enhanced price protection (Exhibit B). The NASD is also
proposing conforming modifications to the NASD Manual, including
the Rules of Practice and Procedure for the Automated
Confirmation Transaction Service ("ACT Rules") and Schedule D to
the NASD By-Laws (and all other places in the Manual that refer
to SOES) to delete references to SOES and/or the SOES Rules and
to replace those references with NAqcess and/or the NAqcess
Rules, as appropriate. These references may be found in the ACT
Rules, Section (c)(2); in Schedule D, Part V, Section (1)(f),
Section (7)(a), Section (8)(c), and Section (9); and Schedule D,
Part XI, Section (2)(e)(1).
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
1. Introduction
The NASD and The Nasdaq Stock Market, Inc. are proposing
rules of operation and procedure and companion rules for a new
service that provides investors market-wide price protection of
their limit orders, the opportunity to obtain price improvement
over the dealer quotation in buying and selling Nasdaq stocks,
and increased access to the Nasdaq market. The new facility, to
be named NAqcess and operated by The Nasdaq Stock Market, will
permit significant opportunity for investors in Nasdaq securities
to enter limit orders inside the Nasdaq dealer quotation and
enhance the opportunity for such investors to receive executions
between the best dealer bid and offer without such orders
interacting with market makers. The limit orders at the top of
the NAqcess limit order file that are the same as or better than
the best dealer quotations will be included in the inside market
for The Nasdaq Stock Market, thereby providing new levels of
transparency, increased price efficiency, and greater investor
protection. Further, the companion rule and Interpretations
accompanying the new system will provide retail customers with
enhanced price protection of their limit orders, a significant
expansion over current limit order protection afforded to
customers in the Nasdaq market. Finally, NAqcess will provide
customers that choose to enter market orders into the system with
the opportunity to obtain price improvement over the dealer
quotation through interaction with customer limit orders in the
NAqcess file and will provide a prompt, cost-effective execution
at the best price available in the market at any particular point
in time.
NAqcess and the accompanying new Rules of Fair Practice
provide multiple benefits to retail investors that were
heretofore unavailable to such investors. A key feature of
NAqcess that is a significant enhancement over current practices
in Nasdaq is the ability of investors to have limit orders placed
in a central file where they can interact directly with other
customer limit orders and market orders entered into the system.
Under a proposed new Interpretation to Article III, Section 1 of
the Rules of Fair Practice, a customer may instruct its broker-
dealer to enter the customer's limit order or market order into
NAqcess. Moreover, NAqcess will provide increased transparency
of the best priced limit orders in NAqcess because Nasdaq will
incorporate into the Nasdaq inside market limit orders that are
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priced the same as or better than the best dealer bid and offer
displayed in Nasdaq, and their aggregate sizes in a particular
security. This increased transparency will enhance the Nasdaq
price discovery process. NAqcess will match incoming limit and
market orders against limit orders resident in the NAqcess file
so as to permit customer orders to interact directly with each
other without the participation of a market maker. The
interaction of customer orders offers such orders an opportunity
for price improvement over the dealer quotation and increases the
likelihood that public limit orders will be executed on a more
timely basis.
The companion rules and Interpretations regarding price
protection in Nasdaq will also significantly enhance the
protection of customer limit orders whether they are held in
NAqcess or stored in a member firm's limit order file. Under a
newly proposed rule, NASD member firms, whether acting as
principal or agent, will not be permitted to execute an order at
a price inferior to any limit order(s) in the NAqcess limit order
file that the member firm is able to view, without satisfying the
viewable limit order(s). An "inferior price" means an execution
price that is lower than a buy limit order or higher than a sell
limit order. In addition, if a member firm holds a customer
limit order outside of NAqcess, a new Interpretation to Article
III, Section 1 of the Rules of Fair Practice would require the
member firm that holds the limit order to provide the customer
with price protection that is equivalent to that which the limit
order would have received if it had been entered into the NAqcess
file. The concept of equivalent price protection is further
explained below.
Aside from these major regulatory enhancements that provide
for major changes in order handling and protection in The Nasdaq
Stock Market, the NAqcess system itself represents a significant
improvement over the current methodology for the handling of
small investor orders. NAqcess, as noted, will permit
interaction of small customer limit and market orders within the
dealer spread and thus permit such orders to obtain significant
opportunities for price improvement over the dealer quotation.
This new order delivery and execution system will replace
SOES, the NASD's current system for the handling of small
customer orders. Because SOES is an automated, quote-based
execution system, it does not offer the opportunity for price
improvement over the dealer quotation of small customer orders.
Moreover, the proposed NAqcess system addresses the queuing
concerns that were raised in connection with the previously
proposed N Prove system. NAqcess will distribute non-directed
market orders that can not be immediately matched against NAqcess
limit orders to available market makers at the inside market as
the orders are presented. A market maker will provide such order
an automated execution at the inside if the market maker
presented with the order does not manually decline the order
within a 20-second period because the market maker (consistent
with SEC Rule 11Ac1-1)-[3]- has already effected, or is in the
process of effecting an execution in the security and is in the
process of updating its quotation. This approach eliminates the
single-threaded distribution mechanism proposed in Notice To
Members 95-20 and permits rapid distribution of orders to market
makers as the orders are received.-[4]-
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-[3]- 17 CFR 240.11Ac1-1 (1995).
-[4]- The NASD believes that significant queues in excess of
those currently experienced under SOES today will not
(continued...)
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NAqcess and its companion rules represent a significant
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-[4]-(...continued)
occur under the new proposal. First, if the limit
order file for a security has depth, market orders will
immediately execute against limit orders without any
delay. Because each order when received is immediately
distributed to the next available market maker, the
large majority of orders will be executed within 20
seconds of distribution. Even if an order is declined
by a market maker at one price level, an event that the
NASD believes will not be frequent, the declined order
will be automatically executed without the possibility
of rejection immediately upon presentation at the next
price level. All of these techniques mean that it will
be rare for an order not to be executed within a 20 to
40-second period after processing.
For example, assume that five market orders are entered
into NAqcess at one second apart from each other and
there are five market makers in the stock at the
inside. Each order when received will be immediately
distributed to the next market maker. Thus, order one
at second one is distributed immediately to market
maker one, while order two at second two is sent to
market maker two immediately, and so on through order
five. In most circumstances, each market maker will
not decline the order within 20 seconds, and thus, each
order would be executed within 20 seconds of
processing. If any one of these orders were declined,
the order would wait for the next available market
maker for re-presentation. If that market maker
remained at the same price level as that when the order
was originally presented, the order would be subject to
a further 20-second reaction period. In the unlikely
event it was declined again, the order would be
presented again for execution. If that presentation
occurred at a new price level, it would be immediately
executed at the new price level.
If order entry firms enter more orders than there are
market makers at the inside, the queue for such orders
would be the same as today in SOES when orders must be
queued while waiting for a market maker to update its
quotation after a SOES execution. Consequently, the
NASD believes that queuing under this proposal does not
represent a significant threat to prompt market order
execution much different from current queuing. It
should be noted as well, that market orders of eligible
size entered into NAqcess are guaranteed an execution.
Such execution may be effected against a customer order
or a dealer's quote. Thus, in response to concerns
raised in some comment letters the NASD received in
response to Notice to Members 95-20 and 95-60, NAqcess
will provide guaranteed executions to investors
entering eligible market orders. Accordingly, the NASD
believes that those comment letters from individual
investors that allege that NAqcess will deprive them of
an automatic execution are mistaken. Of course, it
should be noted that not even in SOES is a market order
guaranteed an execution at the price observed at the
time the order was entered. Similarly, under NAqcess
no such guarantee is extended to an investor.
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enhancement to the treatment of investor orders in The Nasdaq
Stock Market. The entire proposal, when taken together with
other recent enhancements to the Nasdaq trading environment, such
as the Limit Order Protection Interpretation-[5]- and the Short
Sale Rule,-[6]- demonstrates the significant strides that the
NASD and The Nasdaq Stock Market have taken to provide increased
protection of investors while continuing to preserve the benefits
that its competitive dealer market structure currently provides.
Individual investors seeking price improvement over the dealer
quotation will be afforded a transparent mechanism to obtain
greater opportunities for price improvement over the dealer
quotation without market maker interaction. Moreover, through
the accompanying rules, NAqcess will provide such limit orders
with increased market-wide price protection. Individual
investors seeking rapid execution of small market orders at the
best available price will continue to be able to obtain
executions promptly, while Nasdaq market makers will be permitted
the opportunity to interact with such orders in a manner
consistent with SEC rules and in a manner similar to market order
handling in exchange markets. By permitting market makers to
continue the operation of their own internal execution systems,
the NASD will maintain the ability of dealers to provide
liquidity and competitive mechanisms to handle customer orders.
2. NAqcess Operations
The proposed NAqcess system will provide the following:
A. Scope of System. NAqcess will be available for
all Nasdaq issues. It will completely replace SOES which will
operate until the effective date for operation of NAqcess and
will be discontinued as of that date. NAqcess participation will
be mandatory for market makers in all National Market securities.
NAqcess participation for SmallCap market makers will be
voluntary, as is SOES participation today for such market makers.
B. Order Entry Requirements. Agency orders may be
entered into NAqcess only by member firms on behalf of customers.
"Customers" are defined to exclude any broker, dealer, person
associated with a member, or a member of the immediate family of
a person associated with a member. Because the purpose of the
system is to provide small retail customers with access to The
Nasdaq Stock Market, member firms, with one limited
exception,-[7]- are not permitted to enter proprietary
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-[5]- Securities Exchange Act Release Nos. 35751 (May 22,
1995), 60 FR 27997 (May 26, 1995) and 34279 (June 29,
1994), 59 FR 34883 (July 7, 1994).
-[6]- Securities Exchange Act Release No. 34277 (June 29,
1994), 59 FR 34885 (July 7, 1994).
-[7]- The only exception to the proprietary order prohibition
is an order designated by a market maker as a "marker
order." A marker order is a principal order entered by
a market maker in a transaction that is functionally
the equivalent of a riskless principal transaction.
The firm may place a principal account limit order in
the NAqcess file, and if an execution is obtained,
immediately pass along the benefit of such execution to
a retail customer order it holds in its own file.
Because the order is part of a principal transaction
for the benefit of the retail customer, the NASD
believes that it is appropriate to permit this limited
exception to the prohibition of proprietary orders in
NAqcess. The NASD will require member firms entering
(continued...)
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orders.-[8]- As explained in more detail elow, customers may
request that appropriately sized limit and market orders be
entered into NAqcess, and if so requested, member firms must
honor the customer's request.-[9]-
Customers may request the entry of limit orders up to 1,000
shares in National Market and SmallCap issues, except for the
Nasdaq 100 issues, in which case limit orders up to 3,000 shares
may be entered. This represents a difference from the original
proposal-[10]- of 3,000 shares for all National Market
issues.-[11]- The issue of size eligibility for limit orders
generated significant comment in response to the two
Notices.-[12]- Many commenters believed that because NAqcess is
intended to provide small retail customers with limit order
protection, the initial approach should reflect more closely that
the average retail order size is well under 1,000 shares. For
example, the Security Traders Association ("STA") noted that the
experience of STA members was that the typical retail customer
order size averaged well-less than 1,000.-[13]- It was also
noted by commenters that it could reduce the potential for
investor confusion if NAqcess established a standard for limit
orders that was consistent with market order size, 1,000 shares.
Commenters also noted that NAqcess could potentially
significantly impact market maker participation, particularly in
less active securities. As a result, they suggested that the
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-[7]-(...continued)
such orders to mark their order tickets accordingly,
and will examine a firm's trading activities carefully
to determine that such proprietary orders are being
effected for the purposes of engaging in a riskless
principal-like transaction. Marker orders, however,
may not be placed with respect to customer limit orders
held by the firm that exceed the permitted maximum
limit order size.
-[8]- Member firms will be permitted, however, to enter so-
called "takeout" orders for their own account or on
behalf of a customer. A takeout order is an order that
results in an immediate automatic execution of a limit
order or orders in the NAqcess limit order file at the
limit order price(s). There is no size limitation on
the takeout order. Thus, if the NAqcess file displays
limit orders at a price with an aggregate size of
15,000 shares, a single takeout order of 15,000 shares
may be entered and executed. Similarly, a firm may
enter a takeout order to immediately execute multiple
limit orders at multiple prices in the NAqcess file.
When there are multiple limit orders being taken out,
each limit order will execute at each limit order's
price.
-[9]- See infra Section II(A)3.A of this proposal.
-[10]- NASD Special Notice to Members 95-20 (Mar. 21, 1995).
-[11]- All SmallCap issues have a limit order size of 1,000
shares.
-[12]- NASD Special Notice to Members 95-20 (Mar. 21, 1995)
and 95-60 (July 27, 1995).
-[13]- See letter from John Giesea, Chairman, and John Watson,
President, STA (Apr. 28, 1995).
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NAqcess order size should be set at lower levels at least until
the NASD had thoroughly evaluated the impact of the system on
market liquidity.
While the NASD believes that NAqcess will have overall a
positive effect on market quality, we believe that it is prudent
in this start-up period to commence NAqcess limit order size
eligibility at 1,000 shares for most securities. However, limit
orders up to 3,000 shares would be eligible for NAqcess for those
securities that comprise the Nasdaq 100 Index. The NASD believes
that this higher eligibility level is appropriate because the
securities comprising the Nasdaq 100 have high levels of volume,
greater market maker participation and significant market
liquidity and therefore are less likely to be adversely impacted
by the proposal. Because of the significant changes that NAqcess
may bring to The Nasdaq Stock Market, the NASD believes that it
is appropriate to commence the operation of the system with a
smaller limit order size than originally proposed to permit
market makers and investors to adjust to the new trading
environment. The NASD proposes to monitor the limit order size
requirement carefully in the initial eighteen months of NAqcess
operation and may choose to expand the eligible size of limit
orders, if experience demonstrates such expansion to have merit.
Market orders in National Market issues may be 1,000, 500 or
200 shares depending upon tier size determination to be made in
the same manner as done in SOES today.-[14]- Similarly, market
orders in SmallCap issues will be tiered at 500 shares or less as
done in SOES today.-[15]-
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-[14]- Under SOES Rules, the tier sizes of 1,000, 500 and 200
shares were determined by reference to the average
daily non-block volume of a security, among other
things. Thus, for example, if an issue had an average
daily non-block volume of 3,000 or more shares, it
could qualify for a tier size of 1,000 shares.
The same concept will apply with respect to NAqcess
maximum market order sizes, except that the NASD has
determined to use a slightly higher average daily non-
block volume of 6,000 shares. The NASD has chosen this
higher level because it better reflects trading
patterns consistent with the increased overall volume
in Nasdaq securities.
-[15]- The NASD will permit market makers to establish minimum
exposure limits that are equal to the maximum market
order size. In addition, NAqcess will contain an
automated update feature that will automatically change
the market maker's quotation by a minimum increment set
by the market maker after the market maker has executed
a trade at a price level and has exhausted its minimum
exposure limit through system executions. The NASD
believes that these aspects of NAqcess are critical to
an effective operation that permits a market maker to
manage its risk capital, and is consistent with the SEC
firm quote rule as applied to all other registered
markets. The minimum exposure limit is set at the same
size as the minimum quote size in Nasdaq. Under the
SEC Firm Quote Rule (Rule 11Ac1-1(c)), a broker-dealer
is entitled to change its quotation within a reasonable
period of time after it has completed a trade at its
published price. Accordingly, the NASD believes that
these aspects of NAqcess are consistent with SEC and
(continued...)
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Customers may choose to enter "marketable limit orders." A
marketable limit order is a limit order that is priced at the
time of entry at the current inside market or better on the
opposite side of the market, i.e., a marketable limit order to
buy is equal to or higher than the current inside offer, while a
marketable limit order to sell is equal to or lower than the
inside bid. For example, if the current inside market is 20 bid
and 20 1/4 asked, the entry of limit orders to sell priced at 20
or 19 7/8 would be considered marketable limit orders.
Marketable limit orders will be treated as market orders. Thus,
if a firm enters a customer limit order to sell at 20 at the time
the inside bid is 20, the limit order will be passed over the
limit order file and if no match occurs, it will be treated as a
market order and executed as discussed above in the market order
handling section. If such marketable limit order, however, is
greater than 1,000 shares in a Nasdaq 100 security, the
marketable limit order will be returned to the order entry firm
for handling outside of NAqcess, without matching against the
inside market whether the inside consists of a dealer quote,
limit order(s), or an aggregation thereof.
Neither a limit order nor a market order may be split up to
meet the size parameters of NAqcess. The NASD will examine order
handling practices of order entry firms to determine compliance
with this requirement.-[16]-
C. Display of Limit Orders. To enhance the
transparency of The Nasdaq Stock Market and to assist in the
price discovery process, the NASD will provide for the display of
limit orders entered into NAqcess. There will be two separate
approaches to the display: a consolidated inside market display
and the Full File Display.
1. Inside Market Display. In a significant
revision to Nasdaq's methodology for calculating the inside
market for Nasdaq securities, The Nasdaq Stock Market will
include in the Nasdaq inside market NAqcess limit orders, and
their aggregate sizes, that are priced the same as or better than
the best dealer bid and offer.-[17]- Thus, in Nasdaq the inside
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-[15]-(...continued)
NASD rules and provide retail investors with the same
access to dealer quotations as are available in any
other registered marketplace.
-[16]- In this regard, the NASD notes that order entry firms
may enter agency orders only. The rules continue in
effect the definition of agency orders as found in the
current SOES Rules and the new rules carry forward the
existing principles regarding the aggregation of orders
based on a single investment decision entered by an
order entry firm. Orders entered by an order entry
firm within any five minute period in accounts
controlled by associated person or public customers,
acting alone or in concert with other associated
persons or public customers are presumed to be based on
a single investment decision. In connection with this
rule, the NASD notes that it will examine carefully the
entry of computer-generated orders to determine whether
such orders are based upon a single investment
decision.
-[17]- This is a change from the approach originally proposed
in Special Notice To Members 95-20 and 95-60. In the
original NAqcess approach to the display of NAqcess
(continued...)
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market will consist of a single display of the best priced quotes
or limit orders, as the case may be. The inside market will be
calculated in the following manner. If the best limit order(s)
to buy (sell) in NAqcess is (are) better than the best Nasdaq
market maker bid (offer) displayed in Nasdaq and such limit
order(s) is (are) 100 shares or more, it (they) will be included
in the Nasdaq inside market and disseminated as the inside bid
(offer), together with the aggregate size of such order(s) and a
unique indicator to denote that the inside market is represented
by a NAqcess limit order or orders, rather than a quotation of a
Nasdaq market maker or UTP exchange quotation. If there are
multiple limit orders at the best price, aggregate size will be
displayed and execution of such orders will occur on a time
priority basis as explained below.
If the best-priced NAqcess limit order(s) is (are) equal to
the inside dealer quotation, the limit order size will be
reflected in the aggregate size of the quotation. That is, if
there is a limit order to buy 500 shares at the same price as a
1,000 share dealer bid quotation, and both are the best bids
reflected in Nasdaq, the aggregated size displayed as the best
Nasdaq bid will reflect a size of 1,500 shares with a special
indicator to denote that such size is an aggregation of a dealer
quote and any limit order(s) at that price. Priority for
execution will depend upon the general limit order priority
rules, i.e., if the limit order is received prior to the market
maker quotation, it will be entitled to priority for execution
purposes.-[18]-
The inclusion of NAqcess limit orders in the Nasdaq inside
market represents a significant enhancement to The Nasdaq Stock
Market. Consolidation of NAqcess orders into the Nasdaq inside
quotation is the best means to communicate clearly to all
investors in Nasdaq the true market for such securities at any
particular point in time. The consolidation of best-priced limit
orders with the best dealer bid and offer in Nasdaq provides the
best level of transparency and aids in the price discovery
process.
Although this represents a change from the original NAqcess
proposal,-[19]- the NASD believes that the display of this
consolidated information maintains the advantages of a competing
dealer market while permitting an expansion in information
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-[17]-(...continued)
limit orders, the NASD proposed to provide two separate
displays of prices: the inside dealer quotation (i.e.,
the best-priced bids and offers of Nasdaq market makers
and UTP exchanges displayed in the Nasdaq market) and
the top of the NAqcess limit order file (i.e., the
best-priced limit orders to buy and sell and their
aggregate sizes). Such displays would have been
separate and side-by-side. Under this new proposal,
the NASD will maintain a Top of the File display on its
Nasdaq Workstations, as well as include the best priced
limit orders to buy and sell in the Nasdaq inside
market display.
-[18]- Rules regarding calculation of the excess spread will
not include NAqcess limit orders for purposes of
determining compliance with those Rules. See NASD
Manual, Schedules to the By-Laws, Schedule D, Part V,
Sec. 2(d), CCH 1819.
-[19]- NASD Special Notice to Members 95-60 (July 27, 1995).
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available to investors.-[20]- The new inside quotation display
will clearly identify when aggregated customer limit orders are
represented in the inside market display. Accordingly, market
participants will be able to ascertain when the inside quotation
represents a customer limit order and when it represents a market
maker whose quotation may signify that it is available to effect
a significantly larger sized transaction. In this way, the NASD
believes that transparency of customer orders may be enhanced
while the integrity of the dealer quotation is preserved.
2. Full File Display. The full file display for
a particular security will be made available on a query basis
over Nasdaq Workstations only to Nasdaq market makers in that
security. The NASD believes that, as with other U.S. market
centers, display of the entire limit order file should be
reserved to market makers in a particular security to assist in
price discovery and to provide the market maker with an incentive
to provide liquidity by risking its capital. In fact, no U.S.
exchange registered with the SEC publicly disseminates any
display (full or partial) of a limit order book maintained by an
exchange specialist. Because of the accompanying rules described
below that the NASD has proposed, customer limit orders in the
file will be protected to a large extent, from inferior
executions.
D. Order Processing. The NAqcess system will provide
significant improvements over the current SOES system in the way
that customer limit orders and market orders will be handled.
NAqcess will attempt to match all incoming orders, limit or
market, directed or non-directed, against limit orders already
resident in NAqcess on a price and time priority basis.-[21]- If
a match is found, the orders will be automatically executed
against each other without the participation of a market maker.
For example, assume the current inside market for a security is
20 - 20 1/2 and customers enter into NAqcess a 1,000 share limit
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-[20]- One commenter specifically noted that a consolidated
display of the best priced limit orders in the Nasdaq
inside market was a better approach than maintaining
separate displays, especially since member best
execution obligations would be determined by reference
to the best prices displayed by Nasdaq, whether such
prices were dealer quotes or limit orders in NAqcess.
See Lehman Bros. (Sept. 12, 1995). In addition,
several vendors expressed technological concerns
regarding separate displays. See letters from ADP
(Aug. 16, 1995) and Telekurs (Aug. 14, 1995).
-[21]- NAqcess will match only round lots and round lot
portions of mixed lot orders. Odd lot limit orders
will not be matched. Odd lots are orders less than 100
shares. Odd lot limit orders will not be displayed in
the inside quotation; however, odd lot limit orders
will be displayed in the full file display. If an odd-
lot order is executable i.e., if it is a market order
or an executable limit order, it will be automatically
executed at the applicable inside dealer quotation. If
it is a directed order, it is executed against the
directed market maker. If it is a non-directed order,
it will be executed automatically without any decline
capability against the next available market maker at
the inside dealer quotation. If the odd-lot order is a
limit order that is not executable at time of entry, it
will remain in the file until the inside dealer
quotation moves to match the odd-lot price.
-------------------- BEGINNING OF PAGE #11 -------------------
order to buy at 20 1/8 and a 1,000 share limit order to sell at
20 3/8. The new inside market will become 20 1/8 - 20 3/8. If a
customer thereafter enters a 1,000 share limit order to sell at
20 1/8, the incoming limit order to sell will match against the
1,000 share limit order to buy on the NAqcess file at 20 1/8 and
will be executed against that order. If a customer next sends in
a market order to buy in NAqcess, the market order will match
against the limit order to sell at 20 3/8, rather than the dealer
offer of 20 1/2, and thus, the market order will be automatically
executed immediately at 20 3/8. In both cases, the orders
received price improvement over the dealer quotation and
immediate execution without the participation of a market maker.
If, in the scenario set forth above, the second limit order
to sell is priced at 20 instead of 20 1/8, the execution price
would be 20 1/8, the price of the limit order to buy because such
order was entered into the system earlier than the second limit
order to sell.
The system will only execute such matches when the execution
prices would be equal to or better than the inside market.
Nevertheless, limit orders priced away from the inside market,
i.e., limit orders to sell priced higher than the inside offer
and limit orders to buy priced lower than the inside bid, will be
stored in the NAqcess file. When the inside market moves to a
price so that the limit order is equal to or better than the
inside dealer quotation, such limit orders will be consolidated
into the Nasdaq inside market and the limit order will become
eligible for matching as described in this section.
When a limit order in the NAqcess file is priced the same as
the inside market, the time priority of the limit order compared
with the best dealer quotation will govern which price interacts
first with incoming orders in NAqcess. The NASD believes that
this approach is a well-understood and reasonable means for
determining the interaction of such orders and provides a further
incentive to market makers to provide liquidity and narrow
spreads.
If no limit orders reside in the NAqcess file, market orders
will be immediately assigned and distributed to market makers at
the inside market. This rapid distribution should minimize the
potential for queues that the original proposal found in Notice
To Members 95-20 could have caused. After an order is
distributed to a market maker, the market maker will be permitted
a 20-second period within which it may decline a non-directed
order if such action is consistent with the exceptions to the
SEC's firm quote rule, Rule 11Ac1-1.-[22]- In other words, the
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[22]- While the total time period between order entry and
Nasdaq receipt of the decline is 20 seconds, the system
has been designed to provide market makers with a full
15-second period in which to react to an order. The
rule itself references a 15-second period in which the
market maker must react. Five seconds of the 20-
second period is designed to accommodate communications
between Nasdaq systems and the market maker. Thus, the
NASD has purposefully designed a 5-second period to
accommodate the transmission of messages between the
NASD host computer and member firm presentation
devices. This five-second period addresses the
potential delays of 3.75 seconds that may occur in
broadcasting a message from the host to a workstation,
and the .775 seconds that could occur in transmitting a
decline message from the presentation device to the
host. (It should be noted that such time periods arise
(continued...)
-------------------- BEGINNING OF PAGE #12 -------------------
market maker is permitted to decline the NAqcess order if the
market maker, immediately before the presentation of the NAqcess
order: (a) effected or was in the process of effecting a trade,
and (b) was in the process of updating its quotation to reflect
that previous transaction. When a NAqcess order is declined by a
market maker, the declined order is presented to the next
available market maker. If that market maker is at the same
price as the market maker that originally declined the order, the
second market maker also has a 20-second period to react to the
order. If the second time the order would be presented, the
inside market has moved to a different price level, it is
automatically executed without any decline capability. For
example, four market makers are at the inside bid of 20. Three
market orders to sell are entered into NAqcess when there are no
limit orders to buy at 20 or better. Each market order is
immediately distributed to one of the three market makers.
Because the first market maker had completed a trade by telephone
and was about to change its quotation, the first market order is
declined by the first market maker. That order is redistributed
to the fourth market maker still quoting a price of 20. The
fourth market maker has 20 seconds to interact with the order.
If, however, there were only three market makers at 20, and all
market makers had updated their quotations to reflect a price of
19 7/8, the declined order would be immediately executed at 19
7/8 against the first available market maker without any decline
capability.
The NASD is developing an automated surveillance capability
to monitor on a real-time basis whether an order was properly
declined. The NASD believes that this capability is crucial to
engendering investor confidence in the firmness of Nasdaq market
maker quotations and should alleviate any concerns regarding
"backing away" questions. The NASD notes that the 15-second
decline feature was criticized in the context of the N Prove
proposal.-[23]- The NASD believes that this proposal to develop
a real-time automated surveillance capability should alleviate
any concerns about the "decline" capability. The NASD will
undertake strong disciplinary measures against any firm that
displays a pattern and practice of improper order declines.
Order entry firms have two alternatives in entering NAqcess
orders -- they may direct the order to a particular market maker
with whom they have established a direct order arrangement, or
they may enter a non-directed order. In either circumstance,
market orders and marketable limit orders will first pass over
the limit order file to obtain a match before execution against a
market maker. If an order is directed pursuant to a valid
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[22]-(...continued)
in the context of the current configuration of the
proposed system. Development of alternative methods of
processing could increase the total time delays.) In
examining the potential length of time that a message
could consume in transmission from the host to the
presentation device and back again, the NASD determined
that market makers would be at a significant time
disadvantage in that a market maker could lose up to
33% of its already limited reaction period. In this
context, then, the NASD believes that it is appropriate
to recognize the inherent delays of computer-to-
computer data exchange, and provide additional time to
account for such delays.
-[23]- See Securities Exchange Act Release No. 35275 (Jan. 25,
1995), 60 FR 6327 (Feb. 1, 1995).
-------------------- BEGINNING OF PAGE #13 -------------------
agreement between the order entry firm and the market maker, the
market maker may not decline the order.
E. Opening Procedures. NAqcess will have special
opening procedures that are consistent with the opportunities for
order matching and price improvement over the dealer quotation
provided intra-day by NAqcess.
NAqcess's operating hours are from 9:30 a.m. to 4:00 p.m.
(EST). However, limit orders may be entered and stored in
NAqcess from 4:00 p.m. to 6:00 p.m. and limit and market orders
may be entered from 8:30 a.m. to 9:28 a.m. At 9:28 a.m., no
further orders for opening purposes will be accepted.-[24]- At
9:30 a.m., Nasdaq will rank all limit orders stored as of 9:28
a.m. according to price and time of entry. To the extent orders
are available, the system will then match the best-priced sell
limit orders against the best-priced buy limit orders in the file
that are within the best dealer bid and offer as determined at
9:30 a.m. When all available limit order matches are effected,
any remaining limit orders within the inside dealer quote at 9:30
a.m. will be matched against market orders stored as of 9:28 a.m.
and will be executed at such limit order prices. Any remaining
orders will be subject to the normal intra-day, order
distribution and execution procedures. It should be noted that
this opening procedure will not create a single, unitary price
for all orders in NAqcess. The individual prices of each match
will be reported. Thus, assuming the dealer quotation is 20 - 20
1/2, if the file contains two limit orders to buy at 20 1/8, each
for 1,000 shares, and there are also three 1,000 share limit
orders to sell at 20 1/8, two 1,000 share limit orders to sell at
20 1/4, and 4,000 shares to buy at the market, the system will
execute as follows: the first two in time priority of the three
1,000 shares sell limit orders at 20 1/8 will be matched against
the two 20 1/8 1,000 share buy limit orders. The first 3,000
shares to buy at the market will be matched against the remaining
limit orders to sell, with the first market order in time
receiving an execution of 20 1/8 and two 1,000 share market
orders next in time receiving executions of 20 1/4. The
remaining 1,000 share market order will be executed against the
dealer quote according to the normal post-opening execution
algorithm.
3. Rules of Fair Practice
The NASD is also proposing in conjunction with NAqcess three
major changes to the Rules of Fair Practice. Under the proposed
new rule and Interpretations, the treatment of limit orders will
be significantly changed to promote price protection of such
orders throughout The Nasdaq Stock Market. These proposed rule
changes provide greatly enhanced limit order treatment over
current practices. Together with existing limit order
protections already in place (i.e., the so-called "Manning"
rule), the new proposals provide investors placing limit orders
with significantly enhanced protections against limit order
trade-throughs throughout The Nasdaq Stock Market.
A. Customer Order Handling. The NASD is proposing a
new Interpretation under Article III, Section 1 of the Rules of
Fair Practice. Under the proposal, if a customer requests that
his or her order be entered into NAqcess, the member firm must do
so. While the Interpretation permits a firm to charge for such
services and to recommend the use of its own execution system,
the member is not permitted to discriminate against customers
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[24]- Orders entered from 9:28 a.m. to 9:30 a.m. will be
stored and handled after the opening in line with
ordinary matching and handling procedures described
above.
-------------------- BEGINNING OF PAGE #14 -------------------
that choose NAqcess over an internal system by imposing unfair
commissions or charges. The proposed Interpretation covers both
market and limit orders.
B. Price Protection. The NASD is also proposing a
new rule in the Rules of Fair Practice that would prohibit a
member firm, whether acting as a principal or as an agent, from
executing any order at a price inferior to any limit orders that
the firm is able to see in the NAqcess limit order file.-[25]-
An inferior price means an execution price that is lower than a
buy limit order or higher than a sell limit order that a member
firm is able to see in the NAqcess limit order file. This
prohibition means that limit orders in the NAqcess file will not
be traded through elsewhere in Nasdaq in most circumstances. A
member firm's activity with respect to protecting NAqcess limit
orders must be consistent with its best execution obligations to
its own customers. When a firm acts as principal in filling a
NAqcess limit order when it is in possession of an executable
customer market order on the other side of the market, it should
pass on the benefit of the NAqcess trade to the customer order.
If the firm in receipt of the market order is acting as agent for
its own customer's order, its best execution obligation would
mean that it should select the appropriate market for execution,
which could be NAqcess.
The price protection obligation is related to the ability of
the firm to view the orders in the limit order file. Thus, under
the proposal's current configuration, limit orders at the top of
the file and included in the inside market calculation must be
protected by all member firms. Under NAqcess system rules, limit
orders ranked below the top of the file are viewable only by
market makers in the particular security. Accordingly, market
makers in a particular security would be obligated to protect all
limit orders in that security in the NAqcess file from inferior
executions that they may engage in.-[26]- Thus, if a market
maker in a security sought to execute a 1,000 share trade at 20,
when the NAqcess file displayed limit orders to buy at 20 1/8 and
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[25]- It should be noted that placement of a customer limit
order in the NAqcess file does not relieve a member
firm of its obligation under the Limit Order Protection
Interpretation of Article III, Section 1 of the Rules
of Fair Practice that prohibits a member firm from
trading ahead of a customer limit order it has been
entrusted with. Under the so-called "Manning"
Interpretation, if a member firm holding a customer
limit order, whether from its own customer or as a
result of a member-to-member order, places that order
into NAqcess, the member firm is nevertheless
prohibited from trading at the same price or at an
inferior price to the customer order. Thus, while the
newly proposed price protection rules speak in terms of
protecting NAqcess orders from inferior priced
transactions, if the NAqcess order is the firm's
customer's order or a member-to-member order it placed
in NAqcess, the firm may not trade at the same price
without protecting that order.
-[26]- In today's environment, market makers are involved in
approximately 83% of all Nasdaq trades. Consequently,
it is likely that in a large majority of trades when
NAqcess is operational, a market maker will be
involved, and thus, orders away from the top of the
file typically will be protected as well as the top of
the file.
-------------------- BEGINNING OF PAGE #15 -------------------
20 1/4, the market maker would be required to either execute the
limit orders first or contemporaneously, depending on the size of
the limit orders in NAqcess.-[27]-
The NASD believes it important to explain for the purposes
of the price protection rule and the Interpretation regarding
equivalent price protection for limit orders held outside of
NAqcess, that the protectible price that generates a firm's
obligation to provide price protection is the price reported for
last sale reporting purposes. Some confusion has occurred
regarding limit orders trading at an "inferior price," especially
in the context of internal sales credits. If the execution price
reported via ACT for Schedule D transaction reporting purposes
includes an internal sales credit that will be provided to a
sales representative at the firm, the price that triggers the
member firm's obligation to protect a limit order is the reported
price. The internal sales credit included in the reported price
has no effect on the obligation to protect the NAqcess limit
order.-[28]-
C. Equivalent Price Protection. As noted earlier,
the NASD, to encourage competition and to enhance the liquidity
of The Nasdaq Stock Market, has determined that market makers
should continue to be permitted to operate their own internal
execution systems and to handle limit orders outside of NAqcess.
However, the NASD also believes it is important to provide limit
orders held outside of NAqcess with price protection
substantially equivalent to that which NAqcess orders would have.
Accordingly, the NASD has proposed an Interpretation to Article
III, Section 1 of the Rules of Fair Practice that provides
substance to the term equivalent price protection.-[29]-
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[27]- The NASD will interpret the price protection rule to
not apply to member firms that operate passively -
priced crossing systems, such as POSIT and Instinet's
Crossing Network. Generally speaking, such systems
execute prices at the dealer quotation spread midpoint
and would not likely trade through a NAqcess order.
Members that believe that they operate systems that
could qualify for this exemption should submit a
request for exemption to the NASD.
The proposed rule would apply, however, to ordinary
broker-dealer trading systems such as Instinet's
regular trading session. Because many such trades
could occur at prices that could be inferior to limit
orders in NAqcess, the NASD believes it appropriate
that such NASD member firms should protect NAqcess
customer limit orders as would any other registered
broker-dealer member firm. Orders placed in SelectNet
that trade through NAqcess are also subject to the
price protection rule.
-[28]- See NASD Special Notices To Members 95-43 (July 27,
1995) and 95-67 (Mar. 21, 1995) for a more detailed
discussion of the proper means for protecting customer
limit orders when firms are dealing at net prices. The
same concepts apply in the context of protecting system
limit orders.
-[29]- The equivalent price protection Interpretation would
not apply to continuous trading systems, such as that
operated by Instinet, because such customers are
generally sophisticated and have deliberately opted to
(continued...)
-------------------- BEGINNING OF PAGE #16 -------------------
First, a member firm holding a protectible customer limit
order-[30]- outside of NAqcess must provide such order with print
protection, if any transaction at a price inferior to the
customer limit order occurs.-[31]- Thus, any firm holding a
protectible customer limit order is required to contemporaneously
execute, up to the size of the reported transaction, the customer
limit order at the limit order price if an inferior-priced
execution is reported in that security. "Contemporaneously"
means within approximately 60 seconds of the trade report. For
example, firms A and B each hold 1,000 share customer limit
orders to buy priced at 20 1/8. A 1,000 share trade is reported
at 20. Both firms A and B are obligated to execute their limit
orders at 20 1/8 within 60 seconds of the trade report. If the
triggering trade report had been 500 shares at 20, each firm owed
its customers executions of at least 500 shares at 20 1/8.
Next, if the firm holds a protectible customer limit order
at a price that would match a limit order in the NAqcess file,
the firm must either execute its limit order or send its limit
order to NAqcess for matching. "Matching" means that the NAqcess
limit order is the same price or lower than the firm's customer's
limit order to buy or higher than the limit order to sell.
The same matching would be required if the firm holds
offsetting limit orders within its own file. If the firm holds a
limit order to sell at 20 1/4 and accepts a limit order to buy at
20 1/4 or higher, the firm must execute the two orders against
each other. Finally, if the firm holds a limit order that is
priced equal to or better than the inside market in Nasdaq, and
if the firm accepts a customer market order for automated
execution at the inside market, the firm must first match the
market order against the limit order before it can execute the
market order for its own account.
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[29]-(...continued)
trade in an alternative trading system. Such customers
are institutions and broker-dealers that seek other
advantages in trading in these alternative systems.
Because of their sophistication, these customers
believe they do not need the broker-dealer operating
the system to provide equivalent price protection.
Accordingly, the NASD will provide an exemption from
the Interpretation to brokers operating such systems if
they seek an exemption.
-[30]- A "protectible" order is a customer order of a size
that would be eligible for entry into NAqcess.
Accordingly, the Interpretation requirements do not
extend to customer limit orders that are larger than
1,000 shares (or larger than 3,000 shares for Nasdaq
100 securities).
-[31]- A member's obligation to provide print protection will
not be triggered by a trade report that has a special
modifier, such as .SLD or otherwise, appended to it.
Because such modifiers indicate the trade being
reported is out of sequence or was executed under
special conditions, such trade reports should not
require an execution of a limit order. The NASD will
closely monitor member's usage of special trade
reporting modifiers to ensure that firms to not use
such modifiers as a vehicle to avoid print protection
obligations under the new rule.
-------------------- BEGINNING OF PAGE #17 -------------------
4. NAqcess Proposal - Consistent With Securities Exchange
Act
The proposed NAqcess system and the accompanying proposed
rule changes in the Rules of Fair Practice propose significant
structural changes in The Nasdaq Stock Market that greatly
benefit investors in their handling of limit orders, price
improvement over the dealer quotation, and rapid execution of
orders. It is important to note that no previous proposal for a
Nasdaq order handling and execution system has been so
interrelated with such significant changes to rules that provide
price protection across the Nasdaq market. The two developments
- a new system with advanced order matching features and greater
transparency along with the dramatic changes to price protection
of orders in and outside the system - must be considered as a
part of a fully integrated approach to the handling of retail
customer orders. Together, they permit retail investors greater
opportunity to participate directly in the market through the use
of limit orders and substantially increase their ability to
receive executions between the best dealer bid and offer.
Further, the NASD believes that the approach to changes in The
Nasdaq Stock Market proposed in this rule filing helps to
guarantee investor protection and fairness to all market
participants, while still allowing the market makers to operate
in a competitive dealer market. The enhanced price discovery
features, the transparency of limit orders, and the interaction
of limit orders and market orders should add to the liquidity,
efficiency and immediacy of Nasdaq's competing dealer market
structure.
Accordingly, 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. 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. Section 15A(b)(9) requires that rules of an
Association not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Act. Section
15A(b)(11) requires the NASD to formulate rules governing the
quality of fair and informative quotations. Section 11A(a)(1)(C)
finds that it is in the public interest to, among other things,
assure economically efficient execution of securities
transactions. The fundamental purpose of NAqcess is to assist
investors in achieving prompt, efficient executions of their
small orders and to provide an opportunity for price improvement
over the dealer quotation within an automated execution
environment. The integrity and efficiency of Nasdaq for public
investors and market-making participants is critical and the NASD
believes that NAqcess will provide benefits to both
constituencies. The design of NAqcess is not anti-competitive as
it treats all non-directed orders uniformly; to the extent that
directed orders are distinguished, by entering into such
arrangements with known customers, market makers effectively
waive the protections offered by the system.
The new proposals are also fully consistent with the
significant national market system objectives contained in
Section 11A of the Act. The NAqcess national limit order
facility would advance these objectives by offering efficient
execution of investors' small orders, by maintaining market maker
participation through the automated delivery of orders with the
-------------------- BEGINNING OF PAGE #18 -------------------
ability to reject those orders if trades have already occurred,
and by offering the opportunity for price improvement over the
dealer quotation to orders both inside and outside of the NAqcess
system. The system's functionality will more accurately reflect
market makers' affirmative obligations to provide liquidity to
the market, without depriving market makers of legitimate
exceptions from the firmness requirements contained in Rule
11Ac1-1. In sum, the NASD believes that the entire proposal set
forth herein significantly advances the goals of investor
protection and greater access to The Nasdaq Stock Market.
(B) Self-Regulatory Organization's Statement on Burden on
Competition
The NASD does not believe that the proposed rule change will
result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act, as
amended.
(C) Self-Regulatory Organization's Statement on Comments on
the Proposed Rule Change Received from Members,
Participants, or Others
Written comments are discussed above.
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 self-regulatory
organization 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. In particular,
the Commission requests general comments concerning the NASD's
proposal and whether it is consistent with the Act. In addition,
the Commission invites interested persons to address the
following specific issues:
(1) The Commission recently proposed rules concerning order
execution obligations.-[32]- Among other things, the
Commission's proposal generally would: (a) require Nasdaq market
makers to display in their quotations (1) customer limit orders
priced better than the market maker's current quotation, or (2)
the size of a customer limit order that equals the current inside
bid or offer; and (b) require that market makers offer market
orders for certain securities an opportunity for price
improvement over the current national best bid or offer. The
Commission seeks comment on whether the NASD's proposal is
consistent with the Commission's proposal and with the goals set
forth in the Commission's release;
(2) The NASD's proposal would eliminate SOES and does not
include the immediate automatic execution feature for market
orders currently available in SOES. In light of historical
concern about the accessibility of market maker quotations,-
[33]-
the Commission seeks comment on the possible effects this change
could have on the Nasdaq market and retail investors;
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[32]- Securities Exchange Act Release No. 36310 (Sept. 29,
1995), 60 FR 52791 (Oct. 10, 1995).
-[33]- Division of Market Regulation, SEC, The October 1987
Market Break 9-19 (1988).
-------------------- BEGINNING OF PAGE #19 -------------------
(3) The SOES Rules provide a market maker a five-minute
period within which to update its quotation or reestablish its
exposure limit after its exposure limit has been exhausted.
Further, the current operation of SOES allows for a market maker
to elect to use an automated quotation update feature which,
generally, changes, by a prespecified increment, the market
maker's quotation after its SOES exposure limit is exhausted.
The NASD's NAqcess proposal would continue both of these
features. In light of the automated quotation update feature and
the lack of immediate automatic execution that would occur under
NAqcess, the Commission seeks comment on whether there is a
continuing need for the five-minute grace period;
(4) The NASD proposes to modify the methodology for
calculating the inside Nasdaq market to include both dealer
quotations and NAqcess limit orders. If a NAqcess limit order
equals or improves the best market maker quotation, it will be
included in the Nasdaq inside market and disseminated as the
inside quotation, including the aggregate size of all orders at
that price. Further, the NASD proposes to use a unique indicator
to denote when the inside market is represented by a NAqcess
limit order, rather than a dealer or UTP exchange quotation. The
Commission requests comment on whether using an indicator for a
NAqcess limit order is appropriate;
(5) As discussed above in the NASD's proposal, priority of
NAqcess executions when the best bid or offer consists of both a
market maker quotation and a NAqcess limit order would be based
on time priority. For example, if the inside bid consists of two
market makers' bids and a NAqcess limit order, and the market
makers' bids were received before the NAqcess limit order, the
first two incoming market orders would be delivered to the market
makers and subject to potential rejection within 20 seconds,
rather than delivered to the limit order for immediate automatic
execution. The Commission seeks comment on whether limit orders
priced equal to the inside dealer quote should be given priority
over market maker quotations, the implications of such a rule,
and the relative costs and benefits of such a rule, particularly
given that orders against market makers are delayed for 20
seconds but are executed immediately if matched with NAqcess
limit orders;
(6) The proposal would limit the maximum order size for
market orders to 1,000 shares (depending on certain trading
characteristics of the security). For limit orders, the maximum
order size would be 1,000 shares for all securities, except for
limit orders in Nasdaq 100 securities for which the maximum limit
order size would be 3,000 shares. The Commission seeks comment
on the appropriate maximum order size for NAqcess limit orders,
and whether different thresholds should be established for
different Nasdaq securities. Further, the Commission notes that
the Commission's recent proposal concerning order execution
obligations generally would require display of limit orders of
10,000 shares or less; the Commission requests comment on the
interaction between this aspect of the Commission's proposal and
the NASD's proposal;
(7) The proposed NAqcess rules would limit access to the
system to agency orders entered by member firms on behalf of
public customers. Generally, the proposal would exclude: (a)
accounts of persons associated with any member firm, and (b) the
immediate family of any person associated with a member. The
Commission is interested in commenters' views on the
appropriateness of these exclusions. Specifically, the
Commission requests comment on: (a) whether proprietary market
and limit orders should be allowed or, alternatively, whether
only proprietary limit orders should be allowed; (b) whether
orders from the immediate family of members should be permitted;
-------------------- BEGINNING OF PAGE #20 -------------------
and (c) whether orders from non-member broker-dealers (e.g.,
options market makers and UTP specialists) to member broker-
dealers should be permitted;
(8) Under the proposal, any firm holding a protectible
customer limit order would be required to execute
contemporaneously (i.e., within 60 seconds of the trade report),
up to the size of the reported transaction, the customer limit
order at the limit order price if an inferior-priced execution is
reported in that security. The Commission requests comment on
the appropriateness of this time period;
(9) The NASD's proposal includes Rules of Fair Practice
that generally would prohibit a member from trading at a price
inferior to a viewable NAqcess limit order and require that
orders held outside of NAqcess be provided price protection
substantially equivalent to that which NAqcess orders would have.
Under the proposal, for each security, only market makers in that
security will be able to see the full limit order file; all other
members are limited to viewing the top of the file. The
Commission requests comment on whether there should be an
exception to the NASD's price protection rule for block trades.
In addition, the Commission requests comment on whether full file
display of the NAqcess limit order file should be broadened and,
if so, to what extent; and
(10) The Commission requests comment on whether the NASD's
proposal, and in particular the amendments to the Rules of Fair
Practice, would result in any burdens on competition, and if so,
the extent of such burdens and whether they are necessary and
appropriate in furtherance of the Act.
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. Section 552, will be available
for inspection and copying in the Commission's Public Reference
Room. Copies of the filing will also be available for inspection
and copying at the principal office of the NASD. All submissions
should refer to the file number SR-NASD-95-42 and should be
submitted by January 16, 1996.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.-[34]-
Jonathan G. Katz
Secretary
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[34]- 17 CFR 200.30-3(a)(12).
-------------------- BEGINNING OF PAGE #21 -------------------
EXHIBIT A
RULES OF OPERATION AND PROCEDURES
FOR THE NAQCESS SYSTEM
I. DEFINITIONS
The terms used in this Section shall have the same meaning
as those defined in the Association's By-Laws and Rules of Fair
Practice, unless otherwise specified.
A. The term "NAqcess" shall mean the limit order and
market order delivery and execution system owned and operated by
The Nasdaq Stock Market, Inc. (a wholly owned subsidiary of the
National Association of Securities Dealers, Inc.).
B. The term "NAqcess participant" shall mean either a
market maker or order entry firm registered for participation in
NAqcess.
C. The term "NAqcess eligible security" shall mean any
Nasdaq National Market or Nasdaq SmallCap equity security.
D. The term "open quote" shall mean a market maker's
quotation price and size (up to its designated exposure limit) in
an eligible security against which orders may be executed through
the NAqcess system during normal market hours, as specified by
the NASD. For the purposes of these Rules, a market maker has a
"closed quote" when its exposure limit in NAqcess has been
exhausted or it has been deemed "closed" pursuant to Section IV.
A. 9 below.
E. The term "NAqcess market maker" shall mean a member of
the Association that is registered as a Nasdaq market maker
pursuant to the requirements of Schedule D to the NASD By-Laws
and as a market maker in one or more NAqcess eligible securities.
F. The term "NAqcess order entry firm" shall mean a member
of the Association that is registered as an order entry firm for
participating in NAqcess which permits the firm to enter agency
orders of limited size for delivery to and execution against
NAqcess market makers and customer limit orders in NAqcess that
are included in the inside market.
G. The term "agency order" shall mean an order from a
public customer that is entered by the NAqcess order entry firm
or NAqcess market maker on an agency basis.
An order will not be considered an agency order if it is for
any account of a person associated with any member firm or any
account controlled by such an associated person. An order will
not be considered an agency order if it is for any account of a
member of the "immediate family" (as that term is defined in the
NASD Free-Riding and Withholding Interpretation, Article III,
Section 1 of the Rules of Fair Practice) of an associated person
who has physical access to a terminal capable of entering orders
into NAqcess.
H. The term "directed order" shall mean an order entered
into NAqcess and directed to a particular NAqcess market maker or
an order entered by a NAqcess market maker that is self-directed.
Each market maker has the ability to select order entry firms
from which it will accept directed orders.
I. The term "non-directed order" shall mean an order
entered into NAqcess and not directed to any particular market
maker, or a directed order that has been directed to a market
maker that has not identified the order entry firm as one from
which it will accept directed orders, or a directed order sent to
a firm that is not registered as a market maker in that security.
J. The term "limit order" shall mean an order entered into
NAqcess that is a priced order.
K. The term "marketable limit order" shall mean a limit
order that, at the time it is entered into NAqcess, if it is a
-------------------- BEGINNING OF PAGE #22 -------------------
limit order to buy, is priced at the current inside offer or
higher, or if it is a limit order to sell, is priced at the
inside bid or lower.
L. The term "executable limit order" shall mean a limit
order that, at the time a limit order, market order, or
marketable limit order on the opposite side of the market is
entered, is either included in the inside market or is equal in
price to the inside market and has time priority over other limit
orders or dealer quotations included in the inside market.
M. The term "marker order" shall mean a limit order for a
market maker's principal account that is a part of a
contemporaneously executed transaction that the firm is engaged
in for the benefit of one or more customers.
N. The term "takeout order" shall mean an order entered by
an NASD member firm, acting as principal or as agent, that
executes against NAqcess limit orders viewable by that firm.
O. The term "inside market" shall mean the best dealer
bid, UTP exchange bid, or NAqcess limit order(s) to buy and the
best dealer offer, UTP exchange offer or NAqcess limit order(s)
to sell, as the case may be, displayed by Nasdaq.
P. The term "UTP exchange" shall mean any registered
national securities exchange that has unlisted trading privileges
in Nasdaq securities.
Q. The term "matched or crossed file" shall mean the entry
of: (1) a bid quotation by a market maker equal to or greater
than a limit order to sell resident in the NAqcess file in the
same security; or (2) an offer quotation by a market maker equal
to or less than a limit order to buy resident in the NAqcess file
in the same security.
R. The term "maximum market order size" shall mean the
maximum size of individual market orders for a NAqcess eligible
security that may be entered into or executed through NAqcess.
The maximum market order size for each security shall be
advertised in the system and published from time to time by the
Association. In establishing the maximum market order size for
each Nasdaq National Market security, the Association generally
will give consideration to the average daily non-block volume,
bid price, and number of market makers for each security.
Maximum market order size for Nasdaq National Market securities
shall be 200, 500 or 1,000 shares, depending upon the trading
characteristics of the securities.-[35]- These sizes may be
adjusted on an issue by issue basis, depending upon trading
characteristics of the issue and other relevant factors as
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[35]- The applicable maximum market order size for each
Nasdaq National Market security is determined generally
by the following criteria:
i) a 1,000 share maximum market order size shall apply to
Nasdaq National Market securities with an average daily
non-block volume of 6,000 shares or more a day, a bid
price of less than or equal to $100, and three or more
market makers;
ii) a 500 share maximum market order size shall apply to
Nasdaq National Market securities with an average daily
non-block volume of 2,000 shares or more a day, a bid
price of less than or equal to $150, and two or more
market makers; and
iii) a 200 share maximum market order size shall apply to
Nasdaq National Market securities with an average daily
non-block volume of less than 2,000 shares a day, a bid
price of less than or equal to $250, and that have two
or more market makers.
-------------------- BEGINNING OF PAGE #23 -------------------
determined by the Association. Maximum market order size for
Nasdaq SmallCap securities shall be 500 shares.
S. The term "maximum limit order size" shall mean the
maximum size of a limit order for a security that may be entered
into or matched through NAqcess. The maximum limit order size
for Nasdaq National Market securities shall be 1,000 shares for
each tier of Nasdaq National Market securities, except for the
securities that comprise the Nasdaq 100 Index,-[36]- which shall
have a maximum limit order size of 3,000 shares. Maximum limit
order size for Nasdaq SmallCap securities shall be 1,000 shares.
T. The term "exposure limit" shall mean the number of
shares of a NAqcess eligible security specified by a NAqcess
market maker that it is willing to have executed for its account
by orders entered into NAqcess on either side of the market.
U. The term "minimum exposure limit" for a security shall
mean an exposure limit equal to the maximum market order size
for that security.
V. The term "automated quotation update facility" shall
mean the facility in the NAqcess system that allows the system to
automatically refresh a market maker's quotation in any security
that the market maker designates when the market maker's exposure
limit has been exhausted. The facility will update: (1) either
the bid or the offer side of the quote using a quotation interval
designated by the market maker, depending upon the side of the
market on which the execution has occurred and refresh the market
maker's exposure limit; or (2) close the market maker's quote for
five minutes, within which time the market maker shall update its
quote or be placed in a suspended state for 20 days.
W. The term "Automated Confirmation Transaction service"
("ACT"), for purposes of the NAqcess rules, shall mean the
automated system owned and operated by The Nasdaq Stock Market,
Inc. which accommodates trade reporting of transactions executed
through NAqcess and submits locked-in trades to clearing.
II. NAQCESS PARTICIPANT REGISTRATION
A. All members participating in NAqcess shall register and
be authorized as NAqcess market makers and/or order entry firms.
Registration as a NAqcess participant shall be conditioned upon
the member's initial and continuing compliance with the following
requirements: (1) membership in a clearing agency registered with
the Securities and Exchange Commission which maintains facilities
through which NAqcess compared trades may be settled; or entry
into a correspondent clearing arrangement with another member
that clears trades through such clearing agency; (2) registration
as a market maker (if applicable) in Nasdaq pursuant to Schedule
D of the NASD By-Laws and compliance with all applicable rules
and operating procedures of the Association and the Securities
and Exchange Commission; (3) maintenance of the physical security
of the equipment located on the premises of the member to prevent
the unauthorized entry of orders or other data into NAqcess or
Nasdaq; and (4) acceptance and settlement of each trade for which
it is responsible that is executed through the facilities of the
NAqcess service, or if settlement is to be made through another
clearing member, guarantee of the acceptance and settlement of
such identified NAqcess trades by the clearing member on the
regularly scheduled settlement date.
--------- FOOTNOTES ---------
--------- FOOTNOTES ---------
-[36]- The Nasdaq 100 Index is an index comprised of many of
the largest capitalized issues quoted in the Nasdaq
National Market. The securities that make up the
Nasdaq 100 are changed from time to time and The Nasdaq
Stock Market publishes notice of such changes as they
occur.
-------------------- BEGINNING OF PAGE #24 -------------------
B. Upon effectiveness of the member's registration to
participate in NAqcess, participants may commence activity within
NAqcess for entry and/or execution of orders, as applicable, and
their obligations as established in this rule will commence.
C. Pursuant to Schedule D to the NASD By-Laws,
participation as a NAqcess market maker is required for any
Nasdaq market maker registered to make a market in a Nasdaq
National Market security. A market maker in a Nasdaq SmallCap
security may withdraw from and reenter NAqcess at any time, and
without limitations, during the operating hours of the service.
D. Each NAqcess participant shall be under a continuing
obligation to inform the Association of noncompliance with any of
the registration requirements set forth above.
III. OPERATING HOURS OF NAQCESS
The operating hours of NAqcess will be the normal market
hours specified for The Nasdaq Stock Market.
IV. PARTICIPANT OBLIGATIONS IN NAQCESS
A. Market Makers
1. A NAqcess market maker shall commence
participation in NAqcess by initially contacting the Market
Operation Center to obtain authorization for market making in
particular Nasdaq securities and identifying those terminals on
which the NAqcess trade information is to be displayed.
Thereafter, on-line registration on a security-by-security basis
is permissible, consistent with the requirements of Schedule D to
the NASD By-Laws.
2. Participation as a NAqcess market maker obligates
the firm, upon presentation of a market order or marketable limit
order through the service, to execute such order as provided in
Section V. A. 5. below. NAqcess market makers are not permitted
to decline orders directed to the firm pursuant to a directed
order arrangement acknowledged by the market maker.
The system will transmit to the market maker on the
Nasdaq Workstation screen and printer, if requested, or through a
computer interface, as applicable, an execution report generated
following each execution.
3. For each NAqcess eligible security in which a
market maker is registered, the market maker shall enter into
NAqcess its exposure limit. For a Nasdaq National Market
security, that limit shall be any amount equal to or larger than
the minimum exposure limit for the particular security. If no
exposure limit is entered for a Nasdaq National Market security,
the firm's exposure limit will be either the default size
selected by the particular market maker or the minimum exposure
limit. "Default size" shall mean an exposure limit greater than
the minimum exposure limit that may be selected by a market maker
for individual securities or for all securities in which it makes
a market.
4. A NAqcess market maker may elect to use the
automated quotation update facility in one or more securities in
which it is registered. The facility will update the market
maker's quotation automatically by a quotation interval
designated by the market maker, once its exposure limit in the
security has been exhausted. The facility will update the market
maker's quotation in either the bid or the offer side of the
market by the interval designated and will reestablish the market
maker's displayed size and either the default size or the minimum
exposure limit; or the facility will close the market maker quote
for five minutes.
5. Matched or crossed file. If a market maker's
quotation change matches or crosses a limit order residing in the
NAqcess limit order file, the system will automatically provide a
notification to the market maker that informs the market maker of
its obligation to protect all limit orders residing in the
-------------------- BEGINNING OF PAGE #25 -------------------
NAqcess file that would be affected by the quotation change. If
the market maker enters the matching or crossing quotation change
after this notification, limit orders in the file for the
particular security will be automatically executed against the
matching or crossing market maker, provided however, that if the
number of shares in the limit order file that would be matched or
crossed is greater than five times the maximum market order size
for that particular security, or if the quotation change matches
and crosses multiple price levels, the quotation change will be
rejected. To effect such quotation change, the market maker
first must manually enter a takeout order for the affected orders
in the file prior to re-entering its quotation update.
6. The market maker may terminate its obligation by
keyboard withdrawal from NAqcess at any time. However, the
market maker has the specific obligation to monitor its status in
NAqcess to assure that a withdrawal has in fact occurred. Except
as otherwise permitted by Section 70 of the Uniform Practice Code
regarding the Association's authority to declare clearly
erroneous transactions void, ("UPC Section 70"), any transaction
occurring prior to the effectiveness of the withdrawal may remain
the responsibility of the market maker. In the case of a Nasdaq
SmallCap security, a market maker whose exposure limit is
exhausted will be deemed to have withdrawn from NAqcess and may
reenter at any time. In the case of a Nasdaq National Market
security, a market maker whose exposure limit is exhausted will
have a closed quote in Nasdaq and NAqcess and will be permitted a
standard grace period of five minutes within which to take action
to restore its exposure limit, if the market maker has not
authorized use of the automated quotation update facility. A
market maker that fails to renew its exposure limit in a Nasdaq
National Market security within the allotted time will be deemed
to have withdrawn as a market maker. Except as provided in
subsection 7 below, a market maker that withdraws from a Nasdaq
National Market security may not re-register in NAqcess as a
market maker in that security for twenty (20) business days.
7. Notwithstanding the provisions of subsection 6
above, (i) a market maker that obtains an excused withdrawal
pursuant to Part V of Schedule D to the NASD By-Laws prior to
withdrawing from NAqcess may reenter NAqcess according to the
conditions of its withdrawal; and (ii) a market maker that fails
to maintain a clearing arrangement with a registered clearing
agency or with a member of such an agency, and is thereby
withdrawn from participation in ACT and NAqcess for Nasdaq
National Market securities, may reenter NAqcess after a clearing
arrangement has been reestablished and the market maker has
complied with ACT participant requirements, provided however,
that if the Association finds that the ACT market maker's failure
to maintain a clearing arrangement is voluntary, the withdrawal
of quotations will be considered voluntary and unexcused pursuant
to Schedule D and these rules.
8. In the event that a malfunction in the market
maker's equipment occurs rendering on-line communications with
the NAqcess service inoperable, the NAqcess market maker is
obligated to immediately contact the Market Operations Center by
telephone to request a closed quote status from NAqcess. For
Nasdaq securities, such request must be made pursuant to the
requirements of Part V, Schedule D to the NASD By-Laws. If the
closed quote status is granted, Market Operations personnel will
enter such status notification into NAqcess from a supervisory
terminal. Such manual intervention, however, will take a certain
period of time for completion and, unless otherwise permitted by
the Association pursuant to its authority under UPC Section 70,
the NAqcess market maker may continue to be obligated for any
-------------------- BEGINNING OF PAGE #26 -------------------
transaction executed prior to the effectiveness of its closed
quote.
B. Order Entry
1. Only market and limit agency orders may be entered
in NAqcess by the NAqcess order entry firm through either its
Nasdaq Workstation or computer interface. The system will
transmit to the order entry firm on the Nasdaq Workstation screen
and printer, if requested, or through a computer interface, as
applicable, an execution report generated following each
execution. NAqcess market makers may enter limit agency orders
in NAqcess for any NAqcess eligible security, but may not enter
agency market orders or marketable limit orders in securities in
which they make markets, unless such orders are self-directed.
As a limited exception to the prohibition of the entry of
proprietary orders into NAqcess, NAqcess market makers may place
marker orders into NAqcess. The benefit of any such marker order
execution must be passed immediately to one or more customer
limit orders held by the firm placing the marker order. Marker
orders may not be placed with respect to customer limit orders
held by the firm that exceed the maximum limit order size
permitted by these rules.
2. NAqcess will accept both market and limit agency
orders of appropriate size for execution. Agency orders may be
directed to a specific NAqcess market maker, self-directed by the
NAqcess market maker, or may be non-directed, thereby resulting
in execution against the next available NAqcess market maker. If
an order is directed to a market maker by an order entry firm
from which it has not agreed to accept direct orders, the order
will be executed on a non-directed basis.
3. Only agency orders no larger than the maximum
market and limit order sizes may be entered by a NAqcess order
entry firm into NAqcess for execution against an NAqcess market
maker or against an executable limit order. Orders in excess of
the maximum order sizes may not be divided into smaller parts for
purposes of meeting the size requirements for orders entered into
NAqcess. All orders based on a single investment decision that
are entered by a NAqcess order entry firm for accounts under the
control of associated persons or public customers, whether acting
alone or in concert with other associated persons or public
customers, shall be deemed to constitute a single order and shall
be aggregated for determining compliance with the maximum order
size limits. Orders entered by the NAqcess order entry firm
within any five-minute period in accounts controlled by
associated persons or public customers, acting alone or in
concert with other associated persons or public customers, shall
be presumed to be based on a single investment decision. An
associated person or customer shall be deemed to control an
account if the account is his or her personal account or an
account in which he or she has a beneficial interest; the person
exercises discretion over the account; the person has been
granted a power of attorney over the account; or the account is
the account of an immediate family member as that term is defined
in the Board of Governors Interpretation on Free-Riding and
Withholding, Article III, Section 1 of the NASD Rules of Fair
Practice.
4. No order will be considered an agency order from a
public customer if it is for any account of a person associated
with any member firm or any account controlled by such an
associated person. No order will be considered an agency order
from a public customer if it is for any account of a member of
the "immediate family" (as that term is defined in the NASD Free-
Riding and Withholding Interpretation, Article III, Section 1 of
the Rules of Fair Practice) of an associated person who has
-------------------- BEGINNING OF PAGE #27 -------------------
physical access to a terminal capable of entering orders into
NAqcess.
5. No member or person associated with a member shall
utilize NAqcess for the execution of agency orders in a SmallCap
security in which the member is a Nasdaq market maker but is not
a NAqcess market maker.
6. NAqcess will accept the following types of agency
orders during normal market hours: (a) day orders; (b) good-
till-canceled ("GTC"); and (c) good till date ("GTD").
V. EXECUTION OF NAQCESS ORDERS
A. General Execution Procedures: Orders in Nasdaq equity
securities entered into NAqcess may be directed or non-directed.
Non-directed market orders and non-directed marketable limit
orders will be processed according to the procedures established
below. Non-directed odd-lot orders that are market orders or
marketable limit orders will be automatically executed in NAqcess
against the next available market maker at the inside market and
execution reports will be delivered to the order entry firm and
the market maker.
1. Entry of Limit Orders: Limit orders may be
entered into NAqcess by order entry firms and by market makers up
to the maximum limit order size allowed for a particular
security. Limit orders priced away from the Nasdaq inside bid
or offer (as the case may be) as well as limit orders
consolidated in the inside market will be stored in the NAqcess
limit order file. Limit orders in securities priced at $10 or
more shall be priced in increments of an eighth or more; limit
orders in securities that are priced at under $10 may be placed
in increments of a sixteenth or less depending upon the dealer
quotation increments permitted.
2. Display of NAqcess Limit Orders: (a)
Consolidated Display of Limit Orders In Inside Market: If a
NAqcess limit order to buy or sell for 100 shares or more is
better than the best dealer bid or offer, the limit order to buy
or sell will be displayed in the Nasdaq inside market. Such
display will contain the limit order price, size (which shall be
aggregated if two or more limit orders are at the same best
price) and an indicator to note that the inside market consists
of a limit order rather than a market maker or UTP exchange
quotation. If a NAqcess limit order of 100 shares or more is at
the same price as the best dealer bid or offer, the size
displayed in the inside market will be an aggregation of any
same-priced limit orders and a single dealer quote at the best
price.
(b) Full Limit Order File Display: All Nasdaq
market makers in a particular security may request via Nasdaq
Workstations a display of all limit orders in such security
entered in the NAqcess limit order file. Such displays will be
available on a query basis only to a registered market maker in a
particular security.
3. Execution of Limit Orders: A limit order that
matches or crosses a limit order on the opposite side of the
market will be automatically executed against the matching or
crossing order when such orders are at the inside market or
better, and have priority over the dealer quotation. The
priority rules for limit order interaction shall be that orders
that are best in price shall be executed against each other
first. If two or more orders are at the same price on the same
side of the market, then the order that was received first in
time shall be accorded priority over other orders at the same
price. Limit orders that cross each other in price shall be
executed at the price of the order that entered the file first.
A limit order matches a limit order on the file when: the limit
orders are consolidated in the inside market on Nasdaq; are on
-------------------- BEGINNING OF PAGE #28 -------------------
opposite sides of the market; and are equal in price. A limit
order crosses a limit order on the file when: both limit orders
are either consolidated in the inside market or better than the
inside market; are on opposite sides of the market from each
other; and the subsequent limit order is at a superior price to
the existing limit order (i.e., the sell (buy) limit order is
priced below (above) a limit order to buy (sell)). Execution of
limit orders will occur up to the size of the initial limit order
or the subsequent limit order, whichever is smaller, and without
the participation of a market maker. The unexecuted balance of
a limit order is entered into the NAqcess file for subsequent
matching, unless such balance is less than 100 shares, in which
case the balance is automatically executed against the next
available market maker, if equal to the inside quotation. If
there is a limit order at the same price as the best dealer
quotation (i.e., if a limit order to buy is the same as the best
dealer bid, or a limit order to sell is the same as the best
dealer offer), the order or quote that has time priority shall be
matched against the incoming limit order.
4. Takeouts of Limit Orders: Any NASD member firm,
acting as principal or as agent, may enter into NAqcess an order
or orders that execute(s) any limit order(s) consolidated in the
inside market or otherwise displayed in the NAqcess limit order
file. Such orders shall be known as "takeout" orders. A takeout
order may be for any size up to the aggregate amount of shares
displayed in the NAqcess limit order file at a particular price.
Takeout orders must be executed against limit orders on the
opposite side of the market in order of price and time. A firm
entering a takeout order for limit orders at multiple prices may
enter a single takeout order at a price either at or above or
below the NAqcess limit orders, as the case may be, and each
limit order will be executed at each such price. Takeout orders
do not reduce a firm's exposure limit.
5. Entry and Execution of Market Orders: (a)
Market orders up to the maximum market order size for NAqcess
eligible security may be entered into NAqcess. If at the time a
market order is entered into NAqcess there is a limit order on
the opposite side of the market that resides in the NAqcess limit
order file and is reflected in the inside market as the best bid
or offer, the incoming market order will be automatically
executed against the limit order at the limit order price without
the participation of a market maker. If a market order is not
fully executed against the limit order file, the balance of such
market order will be treated as any other market order as set
forth in subparagraph (b) below, provided that if the balance of
the market order is odd-lot size, the balance will be
automatically executed against the next available market maker at
the inside quotation. If there is a limit order consolidated in
the inside market at the same price as a dealer bid or offer
(i.e., if a limit order to buy is the same as the best dealer
bid, or a limit order to sell is the same as the best dealer
offer), the order or quote that has time priority shall be
matched against the incoming market order.
(b) If there is no limit order residing in
NAqcess that has been consolidated in the inside market on the
opposite side of the market from the market order, each market
order will be assigned to a market maker at the inside market and
will be executed against the next available market maker at the
current inside market after a display period of 15-seconds. The
market maker to which a market order is displayed may decline the
market order within the 15-second period if the market maker has
contemporaneously executed another transaction and is in the
process of updating its quotation pursuant to SEC Rule 11Ac1-1.
If a market order or a marketable limit order is declined by a
-------------------- BEGINNING OF PAGE #29 -------------------
market maker, the order is returned to the system for
distribution to the next available market maker. If that market
maker is at the same price level as the first market maker who
declined the order, the second market maker has 15 seconds to
react to the order. If the originally declined order is re-
presented to a market maker at a price level different from its
original presentation(s), the order is automatically executed at
that price level without any market maker ability to decline.
(c) If the NAqcess limit order file does not have
any executable limit orders at the time a directed market order
is entered, directed market orders will be automatically executed
against the directed order market maker without a 15-second
decline capability. Directed limit orders that are not matched
by incoming limit or market orders will be automatically executed
against the directed order market maker when the inside market is
changed to match the directed limit order price. Directed odd-
lot orders (orders of less than 100 shares) that are market
orders or marketable limit orders also will be automatically
executed against the directed order market maker. Non-directed
odd-lot orders that are market orders or marketable limit orders
will be automatically executed against the next available market
maker at the current inside market. An odd-lot limit orders that
is not executable at time of entry will be stored and executed
against the best dealer bid or offer, as the case may be, when
such quotation reaches the limit order price.
6. Entry and Execution of A Marketable Limit Order:
Marketable limit orders that meet the maximum market order size
requirements will be accepted and treated as market orders.
Marketable limit orders greater than the maximum market order
size will be returned to the order entry firm for handling
outside of NAqcess.
7. NAqcess Opening Procedures: NAqcess will permit
the entry of limit orders and market orders outside of normal
market hours, except that market orders will not be accepted
between 4:00 and 6:00 p.m. Orders entered at such times will not
be executed but will be stored for matching and execution at the
next market opening. NAqcess permits the entry of such orders
between 4:01 p.m. to 6:00 p.m. and 8:00 a.m. to 9:28 a.m. (Orders
entered from 9:28 to 9:30 will be stored and handled according to
normal market procedures after the opening procedures are
concluded.)
Matching and execution at the NAqcess opening will
occur according to the following procedures:
At 9:28 a.m., NAqcess will stop accepting orders for
execution in the NAqcess file for opening purposes. At 9:30
a.m., NAqcess will commence execution procedures for opening
orders in NAqcess by first ranking and matching limit orders in
NAqcess in sequence of the highest price buy order against the
lowest price sell order. When all available limit orders are
matched and executed, market orders on a time priority basis will
be matched and executed against any remaining limit orders in the
NAqcess file within the inside quotation at the limit order
price(s). Any remaining market limit orders will be stored in
the NAqcess file. Any remaining orders will be subject to normal
order execution processes.
VI. CLEARANCE AND SETTLEMENT
All transactions executed in NAqcess shall be transmitted to
the National Securities Clearing Corporation to be cleared and
settled through a registered clearing agency using a continuous
net settlement system.
VII. OBLIGATION TO HONOR SYSTEM TRADES
If a trade reported by a NAqcess participant, or clearing
member acting on its behalf, is reported by NAqcess to clearing
at the close of any trading day, or shown by the activity reports
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generated by NAqcess as constituting a side of a NAqcess trade,
such NAqcess participant, or clearing member acting on its
behalf, shall honor such trade on the scheduled settlement date.
VIII. COMPLIANCE WITH PROCEDURES AND RULES
Failure of a NAqcess participant or person associated with a
NAqcess participant to comply with any of the rules or
requirements of NAqcess may be considered conduct inconsistent
with high standards of commercial honor and just and equitable
principles of trade, in violation of Article III, Section 1 of
the Rules of Fair Practice. No member shall effect a NAqcess
transaction for the account of a customer, or for its own
account, indirectly or through the offices of a third party, for
the purpose of avoiding the application of these rules. Members
are precluded from doing indirectly what is directly prohibited
by these rules. All entries in NAqcess shall be made in
accordance with the procedures and requirements set forth in the
NAqcess User Guide. Failure by a NAqcess participant to comply
with any of the rules or requirements applicable to NAqcess shall
subject such NAqcess participant to censure, fine, suspension or
revocation of its registration as a NAqcess market maker and/or
order entry firm or any other fitting penalty under the Rules of
Fair Practice of the Association.
IX. TERMINATION OF NAQCESS SERVICE
The Association may, upon notice, terminate NAqcess service
to a participant in the event that a participant fails to abide
by any of the rules or operating procedures of the NAqcess
service or the Association, or fails to pay promptly for services
rendered.
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EXHIBIT B
Interpretations Related To Member Firm
Responsibilities Regarding Orders In NAqcess
In its efforts to maximize the protection of investors and
to enhance the quality of the marketplace, the NASD and The
Nasdaq Stock Market, Inc. have developed a nationwide limit order
protection, price improvement, and market order handling facility
of The Nasdaq Stock Market. This nationwide facility is herein
referred to as "NAqcess".
The NASD Board of Governors is issuing these Interpretations
to the Rules of Fair Practice to provide: (1) customers the
right to have their orders entered and protected in NAqcess; and
(2) member firm provision of equivalent protection for limit
orders held in a member firm s proprietary limit order system.
These Interpretations are based upon a member firm s obligation
to provide best execution to customer orders under Article III,
Section 1 of the Rules of Fair Practice and a member firm s
obligations in dealing with customers as principal or agent to
buy and sell at fair prices and charge reasonable commissions or
service charges under Article III, Section 4 of the Rules of Fair
Practice. Accordingly, it shall be deemed a violation of Article
III, Section 1 of the Rules of Fair Practice for a member or a
person associated with a member to violate the following
provisions:
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1. Member Firm Obligation Regarding Investors Directions On
Order Handling
NAqcess will provide individual investors with significant
opportunities to achieve limit order protection and price
improvement. The NASD recognizes that member firms operating as
market makers also operate trading systems which offer
significant protection and execution opportunities for customer
limit orders. Accordingly, nothing herein is intended to limit a
member's ability to recommend use of its own or another member
firm's proprietary system for handling limit and market orders
where equivalent protection is afforded. In light of the
significant benefits offered to customers by the NAqcess system,
however, members must abide by the directions of its customers
who request that the firm enter their orders in NAqcess.
Further, nothing in this Interpretation requires a member
firm to accept any or all customer limit orders. Member firms
accepting limit orders that are placed in NAqcess or otherwise
may charge fair and reasonable commissions, commission-
equivalents, or service charges for such handling, provided that
such commissions, commission-equivalents, or service charges do
not violate Article III, Section 4 of the Rules of Fair Practice.
In no event, however, shall a member impose any fee or charge
that effectively operates as a disincentive to the entry of
orders in the nationwide facility and thereby interferes with the
investor's ability to choose order handling alternatives.
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2. Equivalent Protection for Orders Held Outside of NAqcess
As a further adjunct to a member firm s best execution
obligations, the NASD Board of Governors has interpreted Article
III, Section 1 of the Rules of Fair Practice to require member
firms that do not enter customer limit orders into NAqcess, but
hold such protectible orders in their own proprietary system, to
provide such orders with price protection at least equivalent in
substance to that which the order would have received had the
order been entered into NAqcess. For the purposes of this
Interpretation, a "protectible limit order" shall mean a limit
order that meets the maximum limit-order size criteria as set
forth in the Rules of Operation and Procedure for NAqcess at
Section I.S. For the purposes of this Interpretation, equivalent
price protection shall mean:
A. Print Protection
If a transaction in a Nasdaq security is reported via
the Automated Confirmation Transaction Service ("ACT") at a
price inferior to the price of customer limit order(s) that
the firm is holding (i.e., if the reported price is a price
lower than a buy limit order or higher than a sell limit
order being held by the firm), the firm holding the limit
order(s) is required on a contemporaneous basis to execute
the limit order(s) at the limit price(s) up to the size of
the reported transaction.
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B. Matching Limit Orders
If the firm holds a customer buy (sell) limit order in
its proprietary limit order file and that limit order
matches a sell (buy) limit order in NAqcess, the firm
holding the limit order must either provide its customer
with an immediate execution at the limit order price or must
immediately direct the order to NAqcess. A limit order held
by a firm would match a limit order in NAqcess when the
limit order in NAqcess is at the same price or is priced
lower than the firm s customer s limit order to buy or
higher than the firm s customer limit order to sell
("offsetting limit orders").
C. Matching Limit Order Interaction Within A Firm's File
If the firm holds two or more offsetting customer limit
orders within its own proprietary file, the firm must
execute the offsetting limit orders.
D. Interaction Between Limit and Market Orders Held Within
A Firm's File
While holding a customer limit order that is priced
equal to or better than the best bid or offer in the
security disseminated in Nasdaq, if a firm accepts customer
market orders for automated execution against the best bid
or offer in the security disseminated in Nasdaq, the firm,
pursuant to its obligation set forth in the Interpretation
to the Rules of Fair Practice, Article III, Section 1, (the
so-called "Manning Interpretation"), must first permit the
market orders to execute against any applicable limit orders
it holds before the firm may execute the market orders for
its own account.
E. Examples of Equivalent Protection
The NASD Board of Governors has provided the following
examples to further explain a member firm's equivalent
protection obligation for orders held outside of NAqcess:
Print Protection The best dealer bid and offer in
Nasdaq ( the inside price ) is 20 bid - 20 1/4 offer.
Firm ABCD holds a customer limit order of 1,000 shares
to buy at 20 1/8 in its own proprietary file. Firm
MNOP reports a transaction in the subject security via
ACT, disseminating a price of 20 1/16 for 500 shares.
Contemporaneous with the dissemination of the trade
report, firm ABCD is required to provide an execution
of its customer limit order for at least 500 shares at
20 1/8.
Matching Limit Orders The inside price is 20 bid - 20
1/4 offer. NAqcess is displaying a 1,000 share
customer limit order to buy at 20 1/8 for customer X.
Firm ABCD thereafter receives from customer Y a 1,000
share limit order to sell at 20 1/8 that the firm ABCD
retains for handling outside of NAqcess. Upon receipt
of the limit order, firm ABCD must execute customer Y s
limit order for 1,000 shares at 20 1/8.
Matching Limit Order Interaction Within A Firm's File
The inside price is the same as above. Firm ABCD holds
a customer limit order to buy 1,000 shares at 20 1/8.
Firm ABCD thereafter receives a customer limit order to
sell 1,000 shares at 20 1/8. Firm ABCD must match the
orders and execute the trade.
Interaction Between Limit and Market Orders Held Within
A Firm's File The inside price is the same as above.
Firm ABCD holds a customer limit order to buy 1,000
shares at 20 1/8. Firm ABCD thereafter receives a
customer market order to sell 1,000 shares. Firm ABCD
must match the two orders and execute the trade at 20
1/8. Similarly, if the limit order to buy were priced
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at 20, the firm would have to execute the market order
against the limit order at 20.
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Price Protection for NAqcess Limit Orders
Rules of Fair Practice, Article III, Section [XX]
No member firm shall execute an order as principal or as
agent at a price inferior to any limit order(s) viewable in
NAqcess to the member firm, provided however, that a member firm
executing a transaction that is larger than the limit order(s)
viewable in NAqcess at an inferior price must contemporaneously
satisfy the limit order(s) viewable in NAqcess. An "inferior
price" means an execution price that is lower than a buy limit
order or higher than a sell limit order that is viewable in
NAqcess. The term "limit orders viewable in NAqcess" shall mean
those orders that the member firm is able to view either as
consolidated in the Nasdaq inside market or as reflected in the
Full Limit Order File Display as the firm is authorized to view
under the Rules of Operation and Procedure.