# Self-Regulatory Organizations; Order Approving Proposed Rule Changes by the National Association of Securities Dealers, Inc. and Amendment Nos. 1, 2, 3, 4, 5, 6, 7 and 8 Thereto and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 9 Relating to the Establishment of the Nasdaq Order Display Facility and Order Collector Facility and Modifications of the Nasdaq Trading Platform > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A01-2381 ## Record - **Collection:** Federal Register - **Document type:** Notice - **Published:** January 26, 2001 - **Citation:** 66 FR 8020 ## Text SECURITIES AND EXCHANGE COMMISSION [Release No. 34-43863; File No. SR-NASD-99-53] Self-Regulatory Organizations; Order Approving Proposed Rule Changes by the National Association of Securities Dealers, Inc. and Amendment Nos. 1, 2, 3, 4, 5, 6, 7 and 8 Thereto and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 9 Relating to the Establishment of the Nasdaq Order Display Facility and Order Collector Facility and Modifications of the Nasdaq Trading Platform January 19, 2001. Table of Contents I. Introduction II. Executive Summary A. Background of the Nasdaq System B. Overview of the SuperMontage Proposal 1. Quote/Order Collection 2. Display of Quotes/Orders 3. Execution Services C. Summary of Conclusions 1. Execution Procedures and Quote/Order Priority 2. Inherent Conflicts of NASD Roles III. Description of the Proposal A. Nasdaq Order Display Facility 1. Enhanced Display of Trading Interest 2. Size MMID and Summary Scan 3. Reserve Size B. Order Collector Facility 1. Entry of Quotes/Orders 2. Order Execution and Delivery C. Non-Directed Orders 1. Quote Decrementation of Non-Directed Orders 2. Quote Refresh and Revised SOESed-Out-of-the Box Procedures D. Order Execution Algorithms E. Directed Orders F. Locked/Crossed Markets G. UTP Exchange Participation H. ECN Participation I. Odd-Lot Processing J. Nasdaq SmallCap K. System Roll Out IV. Summary of Comments V. Discussion A. Nasdaq Order Display Facility 1. Non-Attributable Quotes and Other Factors 2. Reserve Size B. Order Collector Facility 1. Order Entry and Access 2. Non-Marketable Limit Orders C. Quote Refresh and Revised SOESed-Out-of-the-Box Procedures D. Order Execution Algorithms 1. Matching Against a Participant's Own Quote/Order at the BBO 2. Preferenced Orders 3. ECNs a. Order Execution Algorithms b. Time Restrictions on the Order Delivery Feature c. ECN's Automatic Execution Function 4. UTP Exchange Priority 5. Five-Second Interval Delay E. Directed Orders F. Locked/Crossed Markets G. UTP Exchange Participation as Automatic Execution Participants H. Odd-Lot Processing I. Issues Relating to Competition 1. Centralization 2. Other Issues Relating to Competition 3. Nasdaq as an Exclusive Securities Information Processor 4. Commission's Conclusion on Competition Issues J. Technology Issues K. Impact on Competition, Efficiency and Capital Formation VI. Amendment No. 9 VII. Solicitation of Comments VIII. Conclusion I. Introduction On October 1, 1999, the National Association of Securities Dealers, Inc. (“NASD” or “Association”), through its wholly-owned subsidiary, the Nasdaq Stock Market, Inc. (“Nasdaq”), filed with the Securities and Exchange Commission (“SEC” or “Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act” or “Exchange Act”), 1 and Rule 19b-4 thereunder, 2 proposed rule changes to establish the Nasdaq Order Display Facility (“NODF”) and the Order Collector Facility (“OCF”) and to modify its primary trading platform, the Nasdaq National Market System (“NNMS”), collectively referred to as the SuperMontage proposal. On October 26 and October 29, 1999, respectively, Nasdaq filed Amendment Nos. 1 and 2 to the proposal. 3 The SuperMontage proposal and Amendment Nos. 1 and 2 were published for comment in the Federal Register on December 6, 1999. 4 On March 16, 2000, Nasdaq filed Amendment No. 3 to the proposal. 5 On March 23, 2000, Nasdaq filed Amendment No. 4 to the proposal, 6 which was published for comment in the Federal Register on March 30, 2000. 7 On May 19, 2000, Nasdaq filed Amendment No. 5 to the proposal; 8 on June 7, 2000, Nasdaq filed Amendment No. 6; 9 and on August 8, 2000, Nasdaq filed Amendment No. 7. 10 Amendment Nos. 5, 6 and 7 were published for comment on August 15, 2000. 11 On October 23, 2000, the NASD filed Amendment No. 8, 12 which was published for comment on November 15, 2000. 13 On January 9, 2001, the NASD filed Amendment No. 9. 14 The Commission received 104 comments regarding the proposal. 15 The Commission is approving the SuperMontage proposal, as amended, and is soliciting comments on Amendment No. 9 from interested persons. 16 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b-4. 3 See letters from Thomas P. Moran, Assistant General Counsel, Office of the General Counsel, Nasdaq, to Richard Strasser, Assistant Director, Division of Market Regulation (“Division”), Commission, dated October 26, 1999 (“Amendment No. 1”); and from John F. Malitzis, Assistant General Counsel, Office of the General Counsel, Nasdaq, to Richard Strasser, Assistant Director, Division, Commission, dated October 29, 1999 (“Amendment No. 2”). 4 See Securities Exchange Act Release No. 42166 (November 22, 1999), 64 FR 68125 (December 6, 1999) (“December 6, 1999 notice”). 5 See letter from Richard G. Ketchum, President, NASD, to Belinda Blaine, Associate Director, Division, Commission, dated March 15, 2000 (“Amendment No. 3”). In Amendment No. 3, the NASD responded to comment letters and submitted substantive, clarifying, and technical amendments to the proposal. Other than the response to the comment letters, Amendment No. 3 was repeated in Amendment No. 4, which was published for comment in the Federal Register . 6 See letter from Richard G. Ketchum, President, NASD, to Belinda Blaine, Associate Director, Division, Commission, dated March 23, 2000 (“Amendment No. 4”). Among other things, in Amendment No. 4, the following aspects of the proposal were changed: (1) the order execution priorities of the system as they apply to electronic communications networks (“ECNs”), reserve size orders, and unlisted trading privilege exchanges (“UTP Exchanges”); (2) the five-second delay between price levels; and (3) the way odd-lots are processed. 7 See Securities Exchange Act Release No. 42573 (March 23, 2000), 65 FR 16981 (March 30, 2000). 8 See letter from Richard G. Ketchum, President, NASD, to Belinda Blaine, Associate Director, Division, Commission, dated May 16, 2000 (“Amendment No. 5”). Among other things, in Amendment No. 5, the NASD responded to comment letters received by the Commission in response to Amendment No. 4, submitted technical amendments to the proposed rule language, and provided a description of how the proposal would be implemented. 9 See letter from Richard G. Ketchum, President, NASD, to Belinda Blaine, Associate Director, Division, Commission, dated July 6, 2000 (“Amendment No. 6”). Generally, in Amendment No. 6, the NASD stated that it intends to implement the SuperMontage only after the planned conversion to decimals takes place. It also confirmed that it will allow market participants ample opportunity to prepare and test their internal systems before the start-up of the SuperMontage. The NASD further amended the SuperMontage proposal to provide reciprocity for UTP Exchanges that provide automatic executions against their quotes/orders. Also, the NASD clarified the order routing process and quote update feature for UTP Exchanges that take order delivery. 10 See letter from Richard G. Ketchum, President, NASD, to Annette Nazareth, Director, Division, Commission, dated August 7, 2000 (“Amendment No. 7”). Among other things, in Amendment No. 7, the NASD responded to comment letters sent to the Commission by Bloomberg Tradebook, LLC and Instinet Corporation. As discussed below, the NASD amended the Order Execution Algorithm to provide that Nasdaq will rank orders from ECNs that charge a separate access fee on parity with orders from market makers and ECNs that do not charge a separate fee if the ECN notifies the NASD that the order offers price improvement that exceeds the access fee. Also, Nasdaq revised the directed order processing rules so that ECNs and market makers can elect to receive Liability Orders through the directed order process of the system. 11 See Securities Exchange Act Release No. 43133 (August 10, 2000), 65 FR 49842 (August 15, 2000). 12 See letter from Richard G. Ketchum, President, Nasdaq, to Belinda Blaine, Associate Director, Division, Commission, dated October 20, 2000 (“Amendment No. 8”). Generally, in Amendment No. 8, the NASD revised its Order Execution Algorithm to allow market participants that enter non-directed orders to interact with quotes/orders in the SuperMontage based on price/time priority, price/size/time priority, and price/time priority taking into account ECN access fees; created a new class of orders called preferenced orders; created a new data vendor data feed called NQDS Prime; clarified that SuperMontage will identify parties enering orders; modified the time priority feature to preserve time priority when quotes are increased in size; modified the response time frames for order-delivery ECNs and UTP Exchanges; modified the SuperMontage so that all non-directed orders entered by order-entry firms are designated as “immediate or cancel” orders; and revised the definition of agency orders for UTP Exchanges. Amendment No. 8 also contained a summary, Exhibit 3, that incorporated and reconciled the original rule proposal and the subsequent proposed amendments. 13 See Securities Exchange Act Release No. 43514 (November 3, 2000), 65 FR 69084 (November 15, 2000). 14 See letter from Richard G. Ketchup, President, Nasdaq, to Robert L.D. Colby, Deputy Director, Division, Commission, dated January 8, 2001 (“Amendment No. 9”). In Amendment No. 9, the NASD withdrew Alternative A, regarding preferenced orders with no price restrictions, made a technical correction to its rule text to conform the definition of a preferenced order with the rule text describing the processing of such orders, and represented that Nasdaq will not use data received through the Order Audit Trail System (“OATS”) to gain an unfair competitive advantage over other market participants, including another self-regulatory organization (“SRO”) or broker/dealer (market maker or ECN). 15 A summary of the comment letters received by the Commission is available for public inspection in the Commission's Public Reference Room. 16 In addition, the Commission notes that the NASD withdrew a proposed rule change relating to an Integrated Order Delivery and Execution System (“IODES”) on March 16, 2000 (SR-NASD-98-17). II. Executive Summary A. Background of the Nasdaq System The Nasdaq System originated 30 years ago for the purpose of collecting and displaying quotations posted by individual dealers in the over-the-counter market regulated by the NASD, which sponsored the system. Nasdaq's quotation management system currently collects and displays quotations of registered market makers and ECNs that are members of the NASD (collectively, “Nasdaq Quoting Market Participants”). By agreement, Nasdaq also collects and displays quotations in Nasdaq securities from UTP Exchanges. 17 17 As of the date of this Order, the Chicago Stock Exchange (“CHX”) is the only active UTP Exchange. The existing quotation management system permits each Nasdaq Quoting Market Participant and UTP Exchange to enter a single quotation into the system at any one time. This single quotation may reflect the Nasdaq Quoting Market Participant's or UTP Exchange's proprietary trading interest or customer limit orders handled by that participant, or both. 18 The quotations of Nasdaq Quoting Market Participants and UTP Exchanges are displayed on a quotation montage (arranged by price and time) that can be viewed on a Nasdaq screen, and are disseminated to vendors for further redistribution to broker-dealers and other subscribers. 18 NASD Rule 4613 requires a registered market maker to submit a two-sided quote (both bid and offer) that represents its proprietary trading interest and/or customer limit orders handled by the market maker. NASD Rule 4623 requires an ECN to submit the prices and sizes of orders at the highest buy price and lowest sell price entered into the ECN by market makers (and, in some cases, other subscribers). By agreement, UTP Exchanges must submit a two-sided quote that represents their market's best quote. Other Nasdaq systems facilitate a Nasdaq participant's ability to interact with the quotations of Nasdaq Quoting Market Participants and UTP Exchanges. In 1984, Nasdaq introduced the Small Order Execution System (“SOES”), which allows Nasdaq participants to execute small orders automatically against the quotation of a market maker at the best bid or offer (“BBO”). 19 Nasdaq's SelectNet system, introduced in 1988, allows Nasdaq participants to route orders to a particular market maker or ECN. 20 Although SelectNet is an order delivery service, rather than an execution service, a SelectNet order presented to a market maker or ECN at its displayed quotation obligates the market maker or ECN to execute the order at the price and size of its quote consistent with the Commission's Firm Quote Rule. 21 The SOES and SelectNet systems currently are not integrated, so that it is possible for a market maker to receive a SelectNet order that it is obligated to execute and a SOES execution against the same quote, creating a double liability exposure. 22 19 SOES was initially approved on a temporary basis in Securities Exchange Act Release No. 21567 (December 14, 1984), 50 FR 1662 (December 27, 1984). It was granted permanent approval in 1985. See Securities Exchange Act Release No. 21743 (February 12, 1985), 50 FR 7432 (February 22, 1985). 20 See Securities Exchange Act Release No. 25263 (January 11, 1988), 53 FR 1430 (January 19, 1988). See also Securities Exchange Act Release No. 25690 (May 11, 1988), 53 FR 17523 (May 17, 1988) (order granting permanent approval of SelectNet). 21 See Exchange Act Rule 11Ac1-1, 17 CFR 240.11Ac1-1. 22 On January 14, 2000, the Commission approved an NASD rule change that allows Nasdaq to integrate the two systems to prevent most double liability situations. To date, the NASD has not implemented this change. See Securities Exchange Act Release No. 42344 (January 14, 2000), 65 FR 3987 (January 14, 2000), 65 FR 3987 (January 25, 2000) (“NNMS Order”). Nasdaq's SOES and SelectNet systems supplement the separate order execution services offered by market makers, ECNs, and UTP Exchanges, but do not supplant those services. In fact, the large majority of orders are executed outside Nasdaq's order delivery and execution services through direct links—by telephone, dedicated line, or other means—among order entry firms, market makers, ECNs, and UTP Exchanges. In recent years, changes in technology and market structure have placed increasing demands on, and created new challenges for, Nasdaq's systems. For example, while Nasdaq's existing quotation management system displays the best bid and offer of a Nasdaq Quoting Market Participant or UTP Exchange, many market participants are interested in seeing more of a Nasdaq Quoting Market Participant's or UTP Exchange's trading interest outside its best bid and offer. In addition, the entry of ECNs and UTP Exchanges trading Nasdaq securities has increased competition among execution service providers, including Nasdaq. The changing competitive environment has been accompanied by changes in Nasdaq's structure and ownership. The NASD's ownership of Nasdaq was reduced to 60% on a fully diluted basis by a private placement sale of shares and warrants on June 28, 2000 and was further reduced to 40.6% by a second private placement just completed. The warrants are exercisable over a four year period beginning June 28, 2002. Under the terms of the sale, the voting rights for NASD shares underlying warrants will shift to the warrant holders upon registration of Nasdaq as an exchange. Nasdaq filed an application for registration with the Commission on November 9, 2000. 23 23 The Commission intends to give expeditious consideration to Nasdaq's application for registration and to similar applications from other markets, consistent with statutory requirements, in order to further competition and innovation among securities markets. Subsequently, the NASD Board adopted a resolution stating its intent to divest itself of all remaining shares of Nasdaq not subject to outstanding warrants by June 30, 2002, subject to existing contractual and legal arrangements and to the reasonable judgment of NASD management that market conditions permit. 23 The NASD also has undertaken that during any interim period it intends to vote its shares in Nasdaq on any matter in proportion to the votes of all other shareholders. 24 See letter from Joan C. Conley, Corporate Secretary, NASD, to Robert Colby, Deputy Director, Division, dated January 18, 2001. The Commission has considered the SuperMontage proposal in the context of increased demand for information about trading interest, increasing competition among execution service providers, and changes in Nasdaq's ownership structure. The Exchange Act requires the Commission to approve the proposed rule changes if it finds that the changes are consistent with the requirements of the Exchange Act applicable to the NASD. In this context, including Nasdaq's demutualization, application for registration as an exchange, and impending full separation of the NASD and Nasdaq, and for the reasons discussed in this release, the Commission finds that the proposed rule changes are consistent with the requirements of the Exchange Act applicable to the NASD and therefore approves the proposed rule changes. B. Overview of the SuperMontage Proposal The SuperMontage proposal is designed to modify Nasdaq's systems in three principal areas: (1) Quote/order collection; (2) quote/order display; and (3) execution services. 1. Quote/Order Collection SuperMontage will partially eliminate the distinction between quotes and orders and expand the ability of Nasdaq Quoting Market Participants and UTP Exchanges to represent quotes/orders in the Nasdaq market. It will permit, but not require, Nasdaq Quoting Market Participants and UTP Exchanges to enter multiple quotes/orders at the same price or at different prices. 25 In addition, SuperMontage will allow Nasdaq Quoting Market Participants to enter quotes/orders on a non-attributable basis ( i.e. , anonymously), although market makers will be obligated to maintain a two-sided attributable quote/order consistent with Commission and NASD rules. UTP Exchanges will not be permitted to enter principal quotes on a non-attributable basis, but may enter agency quotes/orders on a non-attributable basis. 25 UTP Exchanges may only enter a single principal quote/order. See Proposed NASD Rule 4710(f). For Nasdaq Quoting Market Participants and UTP Exchanges that choose to enter multiple quotes/orders, SuperMontage will aggregate their best-priced attributable quotes/orders on each side of the market to create the Nasdaq Quoting Market Participant's or UTP Exchange's displayed quote, while maintaining the separate identity, price, and time of entry of each quote/order. Alternatively, a Nasdaq Quoting Market Participant or UTP Exchange may choose to maintain only its required quotation, and not enter additional quotes/orders. 2. Display of Quotes/Orders To the extent Nasdaq Quoting Market Participants and UTP Exchanges use the quote/order collection system to represent more quotes and orders than they currently are able to represent, SuperMontage will show more information than the current quotation montage. SuperMontage will display the additional information in two ways. First, the best-priced non-attributable quotes/orders from all participants will be aggregated and displayed in the quotation montage as one buy and one sell price, each under the generic name “SIZE”, along with the best-priced attributable quotes/orders of each Nasdaq Quoting Market Participant and UTP Exchange. Second, and more significantly, SuperMontage will aggregate all quotes/orders (attributable and non-attributable) at each price level, and display the three best prices with associated aggregate size on each side of the market through the NODF. This information will be distributed to market data vendors so that they can provide an equivalent display service to their customers. In addition, the NASD will make available to market data vendors individual attributable quotes/orders displayed in the three best price levels in the NODF. Thus, to the extent Nasdaq Quoting Market Participants and UTP Exchanges voluntarily enter their “near the market” quotes/orders, investors and market professionals will be able to see the aggregate of this interest at three price levels in widely available displays. 3. Execution Services SuperMontage will replace Nasdaq's current SOES and SelectNet services with two new processes: a directed order process and a non-directed order process. Nasdaq participants that wish to use either of these processes to interact with the quotes/orders of Nasdaq Quoting Market Participants and UTP Exchanges may enter orders into the same order collection facility used by Nasdaq Quoting Market Participants and UTP Exchanges to enter quotes/orders. The directed order process will be functionally similar to the current SelectNet service in that it will allow a Nasdaq participant to direct an order to a particular Nasdaq Quoting Market Participant or UTP Exchange. As in SelectNet, a directed order can match a posted quote/order of the recipient (a Liability Order) or not match any quote/order of the recipient (a non-Liability Order). 26 To avoid creating a risk of double liability, no Nasdaq Quoting Market Participant or UTP Exchange is required to receive directed Liability Orders through the OCF, but may elect to do so. 26 Non-liability orders are usually used to probe for undisplayed interest or to begin a negotiation. The non-directed order process will be the default execution process for marketable orders entered by a Nasdaq participant into Nasdaq's order collection facility. A marketable order entered into the non-directed order process will be matched with the highest ranked quotes/orders of Nasdaq Quoting Market Participants and UTP Exchanges on the opposite side of the market, and either will be executed automatically or delivered (on a liability basis) to the matched Nasdaq Quoting Participants and UTP Exchanges, depending upon how such participants participate in the non-directed order process. 27 27 Registered market makers must accept automatic executions (a sthey do currently under SOES). UTP Exchanges and ECNs may elect to accept automatic executions or delivery of the order. The ranking of Nasdaq Quoting Market Participant and UTP Exchange quotes/orders in the non-directed order process will be established pursuant to one of three order execution algorithms: price/time priority, price/size/time priority, or price/time priority that account for ECN fees. The Nasdaq participant entering a non-directed order may select the algorithm used for executing its order, but the system will default to the price/time priority algorithm if none is selected. Within each algorithm, a non-directed order entered by a Nasdaq participant that is also a Nasdaq Quoting Market Participant will be matched first against its own quote/order on the other side of the market, provided that its quote/order is at the BBO. In addition, a Nasdaq participant entering a non-directed order will be permitted to “preference” the order to a particular Nasdaq Quoting Market Participant or UTP Exchange, if that participant's quote/order is at the BBO. Nasdaq participants are not required to use either the directed or non-directed order processes to execute their orders but may choose, instead, systematically or on an order-by-order basis, to continue to use other methods such as telephone access or direct connections to market makers, ECNs, and UTP Exchanges. Any Nasdaq member is free to offer a competing execution service, and may even use the Nasdaq service as one of its options. C. Summary Conclusions The SuperMontage proposal generated significant controversy. Throughout a series of comment periods and revisions, commenters maintained that various aspects of the proposal were unfair or anti-competitive, and that the proposal as a whole fell short of the standards that ought to be required of National Market System facilities. Many issues were resolved through the process of public comment and response. For example, under the original proposal Nasdaq Quoting Market Participants would have transmitted to Nasdaq multiple quotes/orders at the same price or at different prices, and Nasdaq would have aggregated the best priced orders on either side of the market to produce the participant's required quotation, which would then be distributed by Nasdaq, in its capacity as an exclusive processor for the OTC market. In addition, Nasdaq would have distributed the aggregate amount of buying and selling interest at the three best price levels on either side of the market. Some commenters objected that the proposal in this form meant that Nasdaq alone would know the details of any quotes/orders not incorporated into participant quotations, and that it would be unfair for Nasdaq to keep such information to itself. In response, Nasdaq agreed to disseminate the details of all attributable quotes/orders in the three best price levels on either side of the market via a new information service, in addition to the aggregate amounts of interest at those prices. The result will be that all quote/order details will be generally available at the best price levels, except those quotes/orders that are submitted on an anonymous basis (non-attributable quotes/orders). The Commission believes that this additional information will be valuable to competitors that may offer execution services complementary to, or in competition with, Nasdaq's SuperMontage services, and that Nasdaq's proposal appropriately resolves the issue. Several other issues have been dealt with in similar fashion. All of these are described at length in the Discussion section below. The remaining issues, which remain controversial, generally fall in two groups: (1) Disagreements about the appropriate priority and protections afforded to quotes/orders represented in SuperMontage under the applicable execution procedures, and (2) questions concerning the conflicts inherent in NASD's multiple roles as SRO and default regulator for the OTC market, and as the principal owner of Nasdaq, which will be the operator of SuperMontage. These issues have been carefully weighed by the Commission and are described individually and in detail in the Discussion section below. A more general description and overview of the Commission's analysis and reasoning follow: 1. Execution Procedures and Quote/Order Priority Following Amendment No. 7, the proposed execution procedures involved a single execution algorithm for non-directed orders (without any preferencing), and the directed order process. Preferencing through the non-directed order process had not yet been proposed. The single execution algorithm applicable to non-directed orders was based on price/time priority, but gave lower priority to quotes/orders of an ECN that charges a separate fee for accessing its quotes/orders, and last priority to the principal quotes of UTP Exchange specialists. 28 Some ECNs and others objected to the treatment of quotes/orders involving payment of a separate fee, arguing among other things that many market participants preferred to deal with ECNs, even if they charged fees, because statistically the price improvement provided by certain ECNs exceeded the cost of their fees. Some also maintained that only displayed prices should be considered in assigning priority because any associated fees would be paid by brokers and not by customers. Still others argued that Nasdaq should not assign any priorities to quotes/orders but should only provide a means to access displayed quotes and leave the choice of priorities to participants. 28 ECNs that charge fees were permitted to indicate on any individual quote/order that the quote/order would provide price improvement exceeding the applicable fee, and such quote/orders would be given parity with quotes/orders that did not require payment of a separate fee. In response to these arguments and others, the NASD in Amendment No. 8 proposed to offer participants much greater control of the execution process by creating two additional execution algorithms using price/time and price/size/time priorities respectively, ignoring any separate fees, and by creating the ability to send preferenced orders to any Nasdaq Quoting Market Participant or UTP Exchange at the discretion of the entering firm. This response was satisfactory to some earlier commenters that had sought greater control of the execution process, but not to certain ECNs that had wanted the execution process to ignore access fees. Moreover, the new approach embodied in Amendment No. 8 brought new objections from some commenters that it would be a step backward in achieving price/time priority that would encourage price competition. The Commission believes that the competing interests of Nasdaq participants with respect to some of the issues of priority are essentially irreconcilable. For example, there is no way to simultaneously satisfy both those ECNs that want their orders executed and fees assessed when their orders have time priority at the displayed price, and other participants that want to avoid paying such fees when they can receive a better net price from other orders that do not have time priority. The Commission recognizes that there is merit to both sides of the discussion, but it believes that price priority ordinarily must take precedence over time priority. Because a quote that involves payment of a separate fee is, all other things equal, inferior to a quote at the same displayed price that does not involve payment of a fee, the Commission believes that it is reasonable to allow market participants to choose a method of execution that gives lower priority to quotes that require payment of a fee. It is true that price improvement may sometimes exceed the value of the required fee, but the fee is certain while price improvement is uncertain. The Commission believes that market participants are best able to exercise judgment in such cases. The Commission shares the view expressed by some commenters that price/time priority tends to encourage price competition. The Commission notes, however, that although price priority is generally followed in the Nasdaq market, there is at present virtually no time priority across market centers. The proposal, in its present form, provides for more time priority than currently exists in the market, and may to that extent encourage more price competition. Moreover, for the reasons outlined above, a displayed price does not always represent the actual price to a participant and, indeed, the actual price is often not the same for all participants that might execute against a particular quote. 29 The Commission does not believe that it is appropriate to require strict time priority based on such prices. 29 Several ECNs have variable access fees that are differnt for subscribers and non-subscribers, and may depend on other factors, such as the volume of business. For these reasons, the Commission finds that the combination of choices offered in the current proposal is both fair to participants and reasonably designed to promote competition. 2. Inherent Conflicts of NASD Roles Many commenters raised issues that relate in one way or another to the multiple roles that the NASD has as an SRO and, through Nasdaq, as an exclusive processor of market information and as an operator of trading facilities. The Commission notes that conflicting roles are inherent in the self-regulatory model. Indeed, the Act specifically recognizes that SROs will act not only as regulators, but also as operators of markets, and exclusive processors of information derived from those markets. The Act authorizes the Commission to oversee SRO functions to address the inherent conflicts, and to ensure, among other things, that SROs do not abuse their regulatory powers, 30 and when acting as exclusive processors, make available market information in a non-discriminatory, fair, and reasonable fashion. Thus, the Commission's role is to reach a fair and appropriate balance of the conflicts inherent in the SRO structure, not to eliminate those conflicts. 30 See discussion at Sectio V.I.2, infra , regarding limitations on the NASD's ability to use its regulatory authority to preference or prejudice another market or market participants. Prior to Amendment No. 8, many objections were raised that SuperMontage, as then proposed, would become a centralized, monopolistic execution system. The gist of these arguments was that because NASD is the default regulator for the OTC market, 31 any market maker or ECN that wished to do business in Nasdaq securities must make its quotes available for execution through SuperMontage. Thus, SuperMontage would be, by the effect of NASD and Commission rules, the only execution system through which substantially all displayed trading interest could be reached. The only exception would have been any UTP Exchanges that chose not to participate in SuperMontage. 31 Any broker-dealer that does business with the public and is not a member of a registered national seucrities exchange must be a member of the NASD. See 15 U.S.C. 78 o (b)(8). In response to these concerns, the NASD has agreed to provide an alternative quotation and transaction reporting facility for NASD members, including alternative trading systems (“ATSs”), ECNs, and market makers. In effect, this facility makes participation in SuperMontage voluntary. This facility will permit NASD members to comply with their obligations under Commission and NASD rules (including Rule 11Ac1-1(c)(5) and Regulation ATS) without participating in the Nasdaq execution facility. The facility will identify through the central processor the identity of the NASD member that is the source of each quote. 32 The facility also will provide a market neutral linkage to the Nasdaq and other marketplaces, but not an execution service. NASD represents that the facility will be available upon the implementation of SuperMontage by Nasdaq. The Commission believes that this undertaking by NASD, in conjunction with other terms applicable to the NASD's interaction with the SuperMontage, 33 provides an appropriate balance of NASD's role as regulator of the OTC market and its role (through Nasdaq) as operator of an execution service in a competitive market. 32 See Rule 11Ac1-1(b)(1)(iii); 17 CFR 240.11Ac1-1(b)(1)(iii). 33 See discussion at Sections V.I.2 and 3, infra. Some commenters also argued that automatic execution against market makers would give the SuperMontage an unfair advantage in attracting order flow, and make it difficult for others to offer competitive execution services. It appears that inherent in this argument is the view that Nasdaq should not be permitted to require its registered market makers to accept automatic executions, or that Nasdaq should not be permitted to operate a market itself, but should be restricted to providing connections among market makers and ECNs. Although the Commission is sensitive to the need to ensure that competition is fair, it cannot accept the view that Nasdaq should not be allowed to operate a market in which its registered market makers are required to accept automatic executions, particularly when participation in that market is voluntary. The Commission notes that compulsory automatic executions have been a feature of the Nasdaq market since at least 1988. 34 The “SuperSOES” proposal approved in January 2000 further expanded the scope of automatic execution against market maker quotes. The Commission therefore finds that the requirement that registered market makers in Nasdaq accept automatic executions against their published quotes is not a new feature of the SuperMontage and that it remains an appropriate feature of a system designed to provide economically efficient executions to investors within a fair and orderly market. 34 SOES was initially developed in 1984, and market maker participation was made mandatory in 1988. Some commenters argued that Nasdaq's role as the exclusive processor of information for Nasdaq-listed securities will give SuperMontage an unfair advantage. On close examination, these criticisms pertained less to the operation of SuperMontage than to the requirement that market makers and ECNs quote through Nasdaq, as the sole consolidator of market data for Nasdaq securities. To address this issue, the NASD has agreed to provide an alternative quote and trade reporting mechanism, while Nasdaq has said that it is willing to confer with the other markets about establishing a separate central processor for information on Nasdaq securities under the UTP Plan. 35 Nevertheless, the Commission believes that the current UTP plan must be revised to provide for a fair competitive environment in the future for all market centers trading in Nasdaq securities. 36 The Commission believes that these undertakings, which are discussed in detail below, appropriately address the concerns about an advantage to Nasdaq arising from its role as the exclusive processor for Nasdaq securities. 35 See letter from Frank Zarb, Chairman and CEO, Nasdaq, to Senator Phil Gramm, dated October 24, 2000. 36 The UTP Plan is the Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation and Dissemination of Quotation and Transaction Information for Exchange-Listed Nasdaq/National Market System Securities Traded on Exchanges on an Unlisted Trading Privileges Basis. See also , discussion at Section V.I.3, infra, regarding the need to revise the UTP Plan. Finally, the Commission believes that Nasdaq, as well as the traditional exchanges, must have the flexibility to alter their existing services and to create new services in response to changes in the marketplace. Congress instructed the Commission to seek to “enhance competition and to allow economic forces, interacting with a fair regulatory field, to arrive at appropriate variation in practices and services.” 37 The Commission believes that the SuperMontage proposal is consistent with these goals. 37 See S. Rep. No. 94-75, 94th Cong., 1st Sess. 7 (1975) at p. 8. (“Senate Report”). III. Description of the Proposal The SuperMontage proposal will enhance Nasdaq's quotation montage by adding a new display facility for trading interest, the NODF, and establishing a new system for collecting quotes/orders, the OCF. This proposal also will modify Nasdaq's primary trading platform, the NNMS, as approved on January 14, 2000. 38 38 See NNMS Order supra note 22. A. Nasdaq Order Display Facility Today, the Nasdaq screen, commonly referred to as the Nasdaq Workstation II (“NWII”), is split into two primary display components. The top portion of the NWII contains, among other things: (1) the Market Minder Window, which allows market participants to monitor price activity (inside bid/offer and last sale) of selected stocks; and (2) the Dynamic Quote Window, which shows for a particular stock the inside bid and offer, the last sale, change in price from previous close, daily high and low, volume, and the short sale arrow indicator. The bottom portion of the NWII contains the Nasdaq Quotation Montage. The Nasdaq Quotation Montage shows for a particular stock two columns (one for bids, one for offers), under which is listed the market maker identification (“MMID”) for each registered market maker, ECN, and UTP Exchange in the stock, and the corresponding quote (price and size). Nasdaq ranks the bids and offers along with the corresponding MMID in price/time priority. Accordingly, the market participant at the best bid who is first in time appears first in the montage, the market participant at the best bid (or the next best bid) who is next in time is ranked second, and so on. Market makers that choose to participate in Nasdaq are required to submit a two-sided principal quote, 39 which may reflect customer limit orders held by the market maker. ECNs, to qualify under the Order Handling Rules, must submit the prices and sizes of orders at the highest buy price and lowest sell price entered into the ECN by market makers. 40 UTP Exchanges that have an interface with Nasdaq are required under the UTP Plan to submit to Nasdaq a two-sided quote, which represents the exchange's best quote in the stock at issue. 39 See NASD Rule 4613. While a market maker's quoted price and size is attributed to the market maker by the corresponding MMID, this may not represent the market maker's best price if the market maker has placed a better-priced order with an ECN that complies with the display alternative under SEC Rules 11Ac1-1(c)(5) and 11Ac1-4. See 17 CFR 240.11Ac1-1(c)(5) and 17 CFR 240.11Ac1-4. 40 See NASD Rule 4623. ECNs also may be required to submit the prices and sizes of orders at the highest buy price and lowest sell price entered into the ECN by all subscribers to comply with Regulation ATS. 1. Enhanced Display of Trading Interest Under the proposal, Nasdaq will retain the bottom portion of the NWII, the Nasdaq Quotation Montage, which displays market maker, ECN and UTP Exchange attributable quotes ranked in price/time priority. Nasdaq proposes to add the NODF, which will be displayed in the top portion of the NWII. The NODF will display the three best price levels in Nasdaq on both the bid and offer side of the market. These displayed price levels will include, for the first time in the Nasdaq market, anonymous (or non-attributable) quotes/orders in addition to the attributable quotes/orders of market makers, ECNs, and UTP Exchanges. Each price level will be updated and will display the aggregate size of displayed trading interest (attributable and non-attributable, as explained below). In addition to displaying the aggregate size of displayed trading interest at the three best price levels, Nasdaq will create and make available a new vendor data feed called NQDS Prime. NQDS Prime will provide, on a real-time basis, all individual attributable quote/order information at the three best price levels displayed in the NODF. 41 41 See Amendment No. 8, supra note 12. The NASD has stated that if Nasdaq should display more than three price levels in the NODF, it will provide expanded price level information through NQDS Prime. Nasdaq will assess a separate, additional vendor data fee for quote/order information away from the inside. The NASD will seek approval for the fee from the Commission in a separate filing. Nasdaq Quoting Market Participants will be required to designate a quote/order as attributable or non-attributable 42 and will be able to indicate a reserve size for the quote/order. 43 If a quote/order is designated as attributable, the price and size of the quote/order will be displayed next to the Nasdaq Quoting Market Participant or UTP Exchange's MMID in the Nasdaq Quotation Montage if it is the Nasdaq Quoting Market Participant or UTP Exchange's best-priced attributable quote/order. Attributable quotes/orders will be displayed in the NODF as part of the aggregate trading interest when the price of the quote/order is within the best three price levels (on either side of the market) in Nasdaq. 42 According to the NASD, both attributable and non-attributable quotes/orders are considered “displayed orders” because they are displayed in the Nasdaq system. 43 UTP Exchanges will only be permitted to display principal quotes/orders on an attributable basis and agency quotes/orders on a non-attributable basis. See Proposed NASD Rule 4710(f). Further, UTP Exchanges will not be permitted to indicate a reserve size. See Proposed NASD Rule 4701(dd). If a quote/order is designated as non-attributable, it will be displayed in the NODF as part of the aggregate trading interest when it is within the best three price levels. That quote/order will not, however, be displayed in the Nasdaq Quotation Montage next to the Nasdaq Quoting Market Participant's or UTP Exchange's MMID but instead may be displayed in a special “SIZE MMID,” which is described in greater detail below, representing the aggregate size of the best priced non-attributable bids or offers. Pursuant to NASD Rule 4613, market makers will continue to be required to publish a two-sided quote that is attributed to their MMID in the Nasdaq Quotation Montage. 2. SIZE MMID and Summary Scan A SIZE MMID, representing the aggregate displayed size of the best-priced non-attributable bids or offers, will be shown in the Nasdaq Quotation Montage along with the other MMIDs for the Nasdaq Quoting Market Participants and UTP Exchanges displaying attributable size. The bid side and the offer side of the market each will have one SIZE MMID. 44 44 Nasdaq Level 1 Service provides the inside bid/offer quotations and identifies the market center at the best bid/best offer according to the Nasdaq UTP Plan. See NASD Rule 7010 and Nasdaq UTP Plan, Section VI, Paragraph C, Subparagraph 1. The National Quotation Data Service, or NQDS, provides individual market maker quotes, Level 1 Service, and last sale information. See id . According to the NASD, the SIZE MMID will be used in determining the best bid/best offer and corresponding market center for purposes of Level 1 and UTP. The SuperMontage also will include a “Summary Scan” function. The Summary Scan will be a query-only function that will provide a snapshot of the total displayed size (attributable and non-attributable) for all levels below the three price levels in the NODF. The Summary Scan will anonymously display the aggregate interest (attributable and non-attributable) at each price level on both sides of the market, but will not be dynamically updated. 3. Reserve Size Nasdaq Quoting Market Participants will be able to use reserve size. According to the NASD, reserve size will work in virtually the same manner as approved in the NNMS Order. 45 A Nasdaq Quoting Market Participant will be required to display (either as attributable or non-attributable) 1,000 shares in order to use reserve size. Reserve size will replenish displayed size (attributable or non-attributable) by at least 1,000 shares once displayed size is decremented to zero. Reserve size, along with displayed (both attributable and non-attributable) size, will be accessible through Nasdaq's trading platform, the NNMS. Reserve size, however, will not be displayed in either the NODF or the Nasdaq Quotation Montage. As described further below in the Order Execution Algorithms section of this Order, reserve size generally will be accessed after all displayed size at a given price in the Nasdaq market is exhausted. 46 45 See NNMS Order, supra note 22. Nasdaq also filed a proposal with the Commission that will permit the separate display of customer orders by market makers in Nasdaq through a market maker agency identification symbol. See Securities Exchange Act Release No. 41128 (March 2, 1999), 64 FR 12198 (March 11, 1999) (notice of filing of SR-NASD-99-09) (“Agency Quote Proposal”). The Commission subsequently extended the comment period for the Agency Quote Proposal. See Securities Exchange Act Release No. 41243 (April 1, 1999), 64 FR 17428 (April 9, 1999). The Agency Quote Proposal currently is pending with the Commission. If the Commission approves the Agency Quote Proposal, a market maker's Agency Quote could also have reserve size. 46 See Amendment No. 4, supra note 6. The displayed size of UTP principal quotes/orders will be executed after the reserve size of other participants has been accessed. B. Order Collector Facility Nasdaq proposes to establish an OCF as part of the SuperMontage that will: (1) transmit to Nasdaq multiple quotes/orders at one price or quotes/orders at multiple price levels entered by Nasdaq Quoting Market Participants and UTP Exchanges; 47 (2) accept orders to access quotes/orders displayed (as either attributable or non-attributable) in both the NODF and the Nasdaq Quotation Montage; and (3) unify Nasdaq's delivery of Liability Orders to Nasdaq Quoting Market Participants and UTP Exchanges, 48 which should minimize the potential for dual liability. 47 A UTP Exchange could only transmit a single bid quote/order or single offer quote/order for principal quotes/orders, but could send multiple quotes/orders for agency quotes/orders. See Proposed NASD Rule 4710(f). 48 Under the proposed rule change, a Liability Order is an order that Nasdaq believes gives rise to liability under the Firm Quote Rule, Exchange Act Rule 11Ac1-1, for a Nasdaq Quoting Market Participant or UTP Exchange. See 17 CFR 240-11Ac1-1. 1. Entry of Quotes/Orders Nasdaq proposes to allow Nasdaq Quoting Market Participants and UTP Exchanges to transmit multiple quotes/orders and quotes/orders at multiple price levels (subject to restrictions on a UTP Exchange's ability to send multiple quotes/orders for principal quotes/orders), which the system will manage and display in the SuperMontage consistent with a quote/order's parameters. Nasdaq will time stamp each quote/order upon receipt, and the time stamp will be used in determining the ranking of the quote/order for execution purposes. If a size increment is received from a Nasdaq Quoting Market Participant for an existing quote/order at a given price, the system will maintain the original time stamp for the original quantity and assign a separate time stamp for the augmentation, thus protecting the time priority of the originally-entered quantity. Subsequent decreases in size will be deducted from individually stamped components in reverse time priority. Once a displayed size is diminished to zero, however, the quote/order will no longer retain priority, although it may have a feature that automatically refreshes size. 49 49 See Amendment No. 8, supra note 12. In addition, a Nasdaq Quoting Market Participant will designate a quote/order as either attributable or non-attributable, and could designate a reserve size. 50 As noted above, for attributable quotes/orders, the prices and sizes of a Nasdaq Quoting Market Participant's or UTP Exchange's best-priced attributable quotes/orders on both the bid and offer side will be aggregated and displayed in the Nasdaq Quotation Montage under the participant's MMID, and also will be included in aggregate trading interest displayed in the NODF if the quotes/orders fall within the three best price levels (on either side of the market) in Nasdaq. For non-attributable quotes/orders, Nasdaq will display the aggregate size of such quotes/orders in the NODF when the quotes/orders fall within the three best price levels (on either side of the market) in Nasdaq. In addition, the best-priced non-attributable quotes/orders from all Nasdaq Quoting Market Participants and UTP Exchanges will be aggregated and displayed next to the SIZE MMID in the Nasdaq Quotation Montage. 50 Under the proposal, UTP Exchanges cannot use the reserve size function, but may submit multiple non-attributable quotes representing agency interest. The proposal will not require Nasdaq Quoting Market Participants and UTP Exchanges to post multiple quotes/orders at multiple price levels. A market maker could continue to send only its best bid/best offer to Nasdaq, and an ECN could continue to send Nasdaq only its top of the book. In addition, UTP Exchanges may elect to provide only their best quotes for display in the Nasdaq Quoting Montage. 51 51 See Amendment No. 8, supra note. 2. Order Execution and Delivery Even under NNMS ( i.e. , the SOES and SelectNet integration), the SOES and SelectNet systems continue to operate on separate platforms, and from the end-user's perspective there are still two separate systems. 52 In order to further integrate the systems and minimize the potential for market maker dual liability, Nasdaq proposes to route all Liability and non-Liability Orders in the Nasdaq system through the OCF portion of the SuperMontage. 52 See NNMS Order, supra note 22. To access quotes/orders through the OCF, order entry firms, market makers, ECNs, and UTP Exchanges may enter either a directed or non-directed (including preferenced) order into the OCF. 53 The order can be up to 999,999 shares (there will be a separate odd-lot process), and must indicate whether it is a buy, sell, sell short, or sell short exempt order. 54 The order must be a priced or market order. Non-directed orders entered by order-entry firms will be designated as immediate or cancel orders. Orders entered by Nasdaq Quoting Market Participants or UTP Exchanges may be designated as immediate or cancel. 55 53 See discussion in Section V.E., infra , for a description of the directed order process. 54 Although Nasdaq eliminated the rule limiting the size of orders that may be entered into the NNMS, the system in the short term will only be able to deliver an execution up to 9,900 shares. However, if a market participant enters an order into the system that is eligible for automatic execution and exceeds the system size limit of 9,900, the OCF will break the order up into multiples of 9,900 shares. See NMMS Order, supra note 22. 55 See Amendment No. 8, supra note 12. Nasdaq will affix the MMID of the sender to all delivered orders. Further, preferenced orders and non-directed orders that are executed against a market maker or other market participant that participates in the automatic execution functionality of the system will result in an execution report being sent to each party to the trade immediately upon execution that identifies all counterparties to the trade. This is true whether a non-directed order is executed against an attributable quote/order or a non-attributable quote/order. 56 56 See Amendment No. 8, supra note 12. The NASD represents that the SuperMontage improves the current SelectNet order cancellation process for ECNs and other participants that take order delivery. Today, a firm entering an order into SelectNet can cancel the order after 10 seconds regardless of the order's status— i.e. , regardless of whether the market participant that received the order is attempting to execute the order. In SuperMontage, an order that is in delivery to an ECN or UTP Exchange cannot be canceled. Thus, if a market participant requests to cancel an order that has been delivered to an ECN or UTP Exchange, the system will hold the cancel request until the ECN or UTP Exchange has completed interacting with the delivered order ( i.e. , once the ECN or UTP Exchange executes, partially executes, or declines the order) or fails to respond within the allowable time. For example, if an order is delivered to an ECN and the entering market participant requests to cancel, the system will hold the cancel request. If the ECN declines or partially executes the order, the cancel request will be honored, thus canceling the original order (or the unexecuted balance of the original order for partially-executed orders). 57 57 See Amendment No. 7, supra note 10. C. Non-Directed Orders Under the proposal, a market participant will be able to immediately access the best prices in Nasdaq by entering a non-directed order into the OCF. A non-directed order is an order that the market participant does not route to a particular Nasdaq Quoting Market Participant or UTP Exchange, or a preferenced order (as further described below). A non-directed order must be a market order or a marketable limit order. 58 Upon receipt of a non-directed order that is not a preferenced order, the OCF will ascertain the next Nasdaq Quoting Market Participant or UTP Exchange in the queue due to receive an order pursuant to one of three Order Execution Algorithms and deliver either an execution or a Liability Order, depending on how the Nasdaq Quoting Market Participant or UTP Exchange participates in Nasdaq. 59 However, as described below in the Order Execution Algorithms section of this Order, a Nasdaq Quoting Market Participant's non-directed orders first will be matched against its own quotes/orders if the participant is at the Nasdaq BBO. 58 Because non-directed orders entered by order-entry firms will be designated as “immediate or cancel” orders, if a marketable limit order becomes non-marketable after entry into the system, Nasdaq will return the order (or the unexecuted portion thereof) to the entering party. See Amendment No. 8, supra note 12. If an order is a sell short that is not exempt from NASD Rule 3350 and the market moves from an up-bid to a down-bid after the order has been entered but before delivery or execution, the system will return the order to the participant who entered it. Sell-short exempt orders ( i.e. , those entered by primary market makers) may be entered into the system for execution. 59 Under the proposal, market makers will continue to be required to take automatic executions via the NNMS; however, ECNs and UTP Exchanges will have the option to participate in either the system's automatic execution or order delivery functions. A new type of non-directed order called a “preferenced order” also can be entered into the non-directed order process, and will be considered a Liability Order. The market participant entering the preferenced order must designate the particular Nasdaq Quoting Market Participant or UTP Exchange against which the order is to be executed or delivered. When a preferenced order is next to be executed within the non-directed order queue it will be delivered to the designated party as an order or as an execution depending on how the party participates in Nasdaq. The SuperMontage will execute against (or deliver an order in an amount up to) both the displayed and reserve size of the preferenced Nasdaq Quoting Market Participant or UTP Exchange, but only if it is at the BBO. Any unexecuted portion will be returned to the entering market participant. 60 60 See Amendment No. 8, supra note 12. 1. Quote Decrementation of Non-Directed Orders For Nasdaq Quoting Market Participants and UTP Exchanges accepting automatic executions, the SuperMontage will deliver an execution up to the size displayed by the participant, then to other displayed orders at that price, and then to the participant's reserve size (if any). 61 The SuperMontage will automatically decrement the aggregate quote in the NODF by the size of the delivered execution, and decrement the Nasdaq Quoting Market Participant's or UTP Exchange's quote/order in the Nasdaq Quotation Montage if the quote/order is attributable. Displayed (attributable or non-attributable) size will be replenished from reserve size for Nasdaq Quoting Market Participants accepting automatic executions if the participant's displayed size has been decremented to zero and the participant has reserve size. If an ECN accepts automatic executions and its attributable quotes/orders and reserve sizes are exhausted without the ECN updating or transmitting another attributable quote/order to Nasdaq, Nasdaq will zero out the side of the quote that is exhausted. If both sides of the ECN's quote are reduced to zero without the ECN updating or transmitting another attributable quote/order, the ECN will be placed into an excused withdrawal state until the ECN transmits a revised attributable quote/order to Nasdaq. However, Nasdaq will continue to access any non-attributable quotes/orders in NNMS while the ECN is in an excused withdrawal state. 61 UTP Exchanges cannot use the reserve size feature. For Nasdaq Quoting Market Participants and UTP Exchanges not participating in automatic executions ( i.e., order delivery ECNs and UTP Exchanges), Nasdaq will deliver a Liability Order. Nasdaq will automatically decrement the participant's quote by the size of the delivered order and the remaining quote, if not decremented to zero, will retain its priority in the queue. 62 62 For example, assume there are three market participants at the inside bid of $20 and ECN1, ranked first for execution purposes, is displaying 1,000 shares at $20 on the bid side of the market, with 5,000 in reserve. Further assume that five market sell orders are entered into the system for the following amounts: (1) 100 shares; (2) 100 shares; (3) 100 shares; (4) 100 shares; (5) 700 shares. These market sell orders will be processed as follows. The first 100-share order will be delivered to ECN1, reducing its displayed size to 900. The second, third and fourth orders also will be delivered to ECN1, further reducing its displayed size to 600. When the fifth order is delivered to ECN1, its displayed size will be reduced to zero and the remaining 100 shares will access the displayed size of the next market participant in the queue at $20. See Amendment No. 7, supra note 10. Nasdaq will not wait for an order to be processed before routing another order to an ECN. See Amendment No. 8, supra note 12. If an order delivery ECN or UTP Exchange declines or partially fills an order, or fails to respond in any manner within thirty seconds of order delivery, Nasdaq will immediately re-route the order (or unexecuted portion thereof) to the next Nasdaq Quoting Market Participant or UTP Exchange in the queue. 63 In addition, in the case of an order delivery ECN that has declined or partially filled an order without immediately transmitting a revised quote/order or that has failed to respond within 30 seconds, Nasdaq will zero out the ECN's quotes/orders at that price level on that side of the market. In the case of an order delivery UTP Exchange that has declined or partially filled an order without immediately transmitting a revised quote/order or that has failed to respond within 30 seconds, Nasdaq will move the side of the UTP Exchange's quote/order, to which the declined or partially filled order was delivered, to the lowest bid or highest offer in Nasdaq for 100 shares. 64 63 See Amendment No. 8, supra note 12. 64 See Amendment No. 8, supra note 12. Nasdaq also will apply a shorter uniform turn-around standard of a maximum of 5 seconds to order delivery ECNs. The purpose is to establish a general standard (as opposed to an order-by-order standard) that measures whether an ECN is providing an automated response in a time period that ensures market quality. Thus, Nasdaq proposes to monitor an ECN's order turnaround time based on information received from the ECN's Nasdaq Service Display Platform (“SDP”). Nasdaq will use SDPs linked to each ECN to assign a time-stamp for when an order is delivered to the ECN. Nasdaq also will capture the time-stamp via the SDP of when the ECN sends a response to the delivered order. Nasdaq will then calculate and monitor, on a real-time basis, the difference between the two time stamps and determine whether the ECN is meeting the 5 second maximum order-response standard. On an ongoing basis, Nasdaq will monitor ECN response times and provide each ECN with its own order responsiveness time statistics, which will not be made public. If an ECN regularly fails to meet the 5 second response time over a number of orders, Nasdaq will place that ECN's quote in a closed quote state. The closed quote state will be lifted when the ECN can certify that it can meet the 5 second response time requirement. 65 65 See Amendment No. 8, supra note 12. 2. Quote Refresh and Revised SOESed-Out-of-the-Box Procedures As noted previously, market makers are required to maintain a two-sided, attributable principal quote in Nasdaq at all times. To assist with this requirement, market makers will be able to use the Quote Refresh (“QR”) function. 66 QR allows a market maker to designate a refresh size (with a default refresh size of 1,000 shares) and price ( e.g., a tick amount away from the price of its decremented quote) to which it wishes to refresh if its quoted size is decremented to zero. If a market maker is using QR but has an attributable quote/order in the system that is priced at or better than the quote that will be created by the QR, Nasdaq will display the better-priced or equally-priced attributable quote/order that is already in the system, not the QR-produced quote. If a market maker is not using QR and the market maker has given Nasdaq multiple attributable quotes/orders, Nasdaq will display the market maker's next best-priced attributable quote/order when its best-priced attributable quote/order is decremented to zero. 66 See NNMS Order, supra note 22. If a market maker's quote/order is decremented to zero and the market maker does not update its principal quote via QR, transmit a revised attributable quote/order to Nasdaq, or have another attributable quote/order in the system, Nasdaq will place the market maker's quote (both sides) in a closed state for three minutes. At the end of that time, if the market maker did not voluntarily update or withdraw its quote from the market, Nasdaq will refresh the market maker's quote/order to its normal unit of trading (generally 100 shares) at the lowest bid and highest offer currently being displayed in that security and reopen the market maker's quote. 67 67 See discussion of current SOESed-out-of-the-Box procedure at Section V.C., infra and Proposed Amended NASD Rule 4613(a). D. Order Execution Algorithms 68 68 The Order Execution Algorithm was substantially modified by Amendment Nos. 4, 6, 7, and 8 to the proposal. See supra notes 6, 9, 10, and 12. The OCF will execute non-directed orders, other than preferenced orders, against Nasdaq Quoting Market Participant's and UTP Exchange's quotes/orders based on price/time priority unless the market participant chooses to override this default algorithm and select one of the alternative algorithms made available by the OCF. These alternative algorithms are: (1) price/size/time priority; and (2) price/time priority that accounts for ECN quote access fees. In the price/time algorithm, non-directed orders other than preferenced orders will be executed (within each price level) as follows: displayed quotes/orders of market makers, ECNs, and non-attributable agency interest of UTP Exchanges, in time priority; (2) reserve size of market makers and ECNs, in time priority; and (3) principal quotes of UTP Exchanges, in time priority. 69 69 According to the NASD, similar to the Intermarket Trading System (“ITS”), the SuperMontage will generally attempt to probe and sweep the Nasdaq market before sending an order to another market center. See, e.g., Section 8(a)(v) of the ITS Plan. In the alternative order execution algorithm based on price/size/time priority, non-directed orders other than preferenced orders will be processed (within each price level) as follows: (1) Displayed quotes/orders of market makers, ECNs, and non-attributable agency interest of UTP Exchanges, in size/time priority; (2) reserve size of market makers and ECNs, in size/time priority, with size priority based on the size of the related displayed quote/order; and (3) principal quotes of UTP Exchanges, in size/time priority. As a third choice, market participants will be able to indicate that their order should be executed in a manner that accounts for an ECN's separate quote access fee. 70 Under this option, non-directed orders other than preferenced orders will be executed (within each price level) as follows: (1) Displayed quotes/orders of market makers, ECNs that do not charge a separate quote access fee, and non-attributable agency interest of UTP Exchanges, as well as quotes/orders of ECNs that charge a separate quote access fee where the ECN indicates that the price improvement offered by the quote/order is equal to or exceeds the quote access fee, in time priority; (2) displayed quotes/orders of ECNs that charge a separate quote access fee to non-subscribers that do not indicate that the price improvement offered by the specific quote/order is equal to or exceeds the access fee, in time priority; 71 (3) reserve size of market makers and ECNs that do not charge a separate quote access fee to non-subscribers, as well as reserve size of quotes/orders from ECNs that charge a separate quote access fee to non-subscribers where the ECN entering such quote/order has indicated that the price improvement offered by the specific quote/order is equal to or exceeds the quote access fee, in time priority; (4) reserve size of ECNs that charge a separate quote access fee to non-subscribers that do not indicate that the price improvement offered by the specific quote/order is equal to or exceeds the quote access fee, in time priority; and (5) the principal interest of UTP Exchanges, in time priority. 70 The algorithm is similar to the algorithm proposed in Amendment No. 7. See Amendment No. 7, supra note 10. 71 In Amendment No. 6, supra note 9, the NASD represented that if, in a decimals environment, ECNs changed the manner in which they charge fees to reflect their fees in their published quote, these ECN quotes will be given the same priority for non-directed orders as market makers and non-attributable agency quotes of UTP Exchanges. Each of these algorithms will make an exception for non-directed, non-preferenced orders entered by a Nasdaq Quoting Market Participant when that Nasdaq Quoting Market Participant's quote/order is at the inside market. In that case, the SuperMontage will first attempt to match orders entered by the Nasdaq Quoting Market Participant against its own quote/order if the Nasdaq Quoting Market Participant is at the BBO. Finally, market participants may preference an order to a Nasdaq Quoting Market Participant or UTP Exchange at the BBO, as described above. In all three algorithms, there will be a five-second interval delay in certain instances before an order moves to the next price level. As a general rule, where an order might be partially filled at one price level but the remaining shares of the order will not be filled in full within the next two minimum trading increments ( i.e., price ticks) away, there will be a five-second interval delay or pause before the order moves to the next price level. At any point after a delay, if the remainder of the order can be entirely filled within the next two price ticks away, there will be no further delays and the order will be filled completely. Thus, a large market order moving through many price levels could pause for five seconds before every price move except for the last two. 72 72 Orders will be processed in time sequence. Thus, if an order is in interval delay because it meets the above parameters, orders that are behind the interval-delay order will be held in the queue. To reduce these interval delays, a market participant will be able to designate an individual order as a “Sweep Order.” A Sweep Order will trade through all interest ( i.e., displayed and reserve interest) at the three price levels being displayed in the NODF at the time of entry, without pausing five seconds between each displayed price. If the order is not executed in full at the third price level, the order will pause for five seconds between each subsequent price level. 73 73 For example, assume that at 10:00:01 a.m., the inside market in Stock G is $104.55 to $104.60, and the following quotes/orders are being displayed in the system on the bid side of the market: MMA $104.55—1,000 (total, including reserve), MMB $104.50—2,000 (total, including reserve), ECN1 $104.45—9,000 (total, including reserve), MMC $104.45—10,000 (total, including reserve). At 10:00:02 a.m., Institution Q enters a 10,000 share market sell order (through a market maker), which is designated as a Sweep Order. Since the order will be filled in full by the interest that is at the three price levels being displayed in Nasdaq, Institution Q's order is filled in full with no time delay between prices. If at 10:00:02 a.m., while the Sweep Order is executing against the quotes/orders in Nasdaq, an internal subscriber of ECN1 (an automatic execution ECN) wishes to execute against the $104.45 for 9,000 shares being displayed in Nasdaq, before filling the subscriber's order, ECN1 could send a request to cancel the order to Nasdaq. If Nasdaq had already executed against the 9,000 shares, ECN1 would send a message to its customer declining the execution because the Sweep Order had filled the quote/order. If Nasdaq had not executed against the 9,000 shares, ECN1's request to cancel would be granted, the internal execution could occur, and the remainder of Institution Q's order would be executed against MMC. See Amendment No. 5, supra note 8. E. Directed Orders A directed order is one that is routed by the market participant entering the order to a specific Nasdaq Quoting Market Participant or UTP Exchange. Unless the participant to which a directed order is being sent has agreed to accept directed orders that are Liability Orders, a directed order must be a non-Liability Order, and as such, must be designated as: (1) All-or-None (“AON”) with a size at least one unit of trading greater than the size of the attributable quote/order of the market participant to which the order is directed; or (2) a Minimum Acceptable Quantity order (“MAQ”) with a MAQ value of at least one unit of trading greater than the size of the attributable quote/order of the participant to which the order is directed. If a Nasdaq Quoting Market Participant or UTP Exchange is at the inside or is displaying (attributable or non-attributable) interest in the NODF and receives a directed non-Liability Order that it wants to fill, to avoid double execution, it may request to cancel its displayed quote/order in Nasdaq before it fills the non-Liability Order. Nasdaq will not decrement a quote/order upon the delivery of a directed non-Liability Order. Nasdaq Quoting Market Participants and UTP Exchanges also can elect to receive directed orders that are Liability Orders ( i.e., orders that when delivered to market participants' quotes/orders impose an obligation to respond in a manner consistent with the Commission's Firm Quote Rule). 74 If a market participant chooses to accept directed Liability Orders, Nasdaq will append an indicator to the Nasdaq Quoting Market Participant's or UTP Exchange's MMID, showing that the market participant is available to receive directed Liability Orders. 74 See Exchange Act Rule 11Ac1-1, 17 CFR 240.11Ac1-1. F. Locked/Crossed Markets A locked market occurs when a market participant's bid equals the lowest offer of another market participant. A crossed market occurs when a market participant's bid exceeds the lowest offer of another market participant. Under the NASD's proposal, if a Nasdaq Quoting Market Participant or UTP Exchange enters a quote/order that will lock or cross the market, the SuperMontage will not display the quote/order, but instead will reformat the quote/order as a marketable limit order and enter it into the SuperMontage as a non-directed order for execution. 75 The reformatted order will be routed to the displayed quote/order (attributable or non-attributable) next in the queue that will be locked or crossed, and the order will be executed at the price of the displayed quote/order. Once the lock or cross is cleared, if the Nasdaq Quoting Market Participant's or UTP Exchange's quote/order that would have locked or crossed the market has not been completely filled, the SuperMontage will reformat the order again and display it (consistent with the parameters of the quote/order) as a quote/order on behalf of the entering Nasdaq Quoting Market Participant or UTP Exchange. It should be noted, however, that a market participant will receive a system warning (as it does today) if it attempts to send a quote/order that will lock or cross the market. To complete the order entry, the participant will be required to override the system warning. This override will help market participants avoid automatic executions resulting from inadvertent locking or crossing quotes/orders by not overriding the system warning. 76 75 See Proposed NASD Rule 4710(b)(3). 76 See Amendment No. 7, supra note 10. If the market is locked or crossed at 9:30 a.m., Nasdaq will clear out the locked or crossed quotes by executing the oldest bid (offer) against the oldest offer (bid) which it is marketable against, at the price of the oldest quote/order. Nasdaq then will begin processing non-directed orders that are in the queue. 77 77 According to the NASD, prior to the opening, Nasdaq will process “trade-or-move” messages in accordance with NASD Rule 4613, as amended by File Nos. SR-NASD-99-23 and SR-NASD-00-18. See Securities Exchange Act Release Nos. 42400 (February 7, 2000), 65 FR 7407 (February 14, 2000); and 42896 (June 2, 2000), 65 FR 36747 (June 9, 2000). G. UTP Exchange Participation Under the proposal, UTP Exchanges will be able to enter orders into the SuperMontage. Orders from UTP Exchanges that offer automatic execution reciprocity to Nasdaq will receive automatic execution against Nasdaq Quoting Market Participants that take automatic executions. 78 Participating UTP Exchanges that do not offer automatic execution reciprocity to Nasdaq will have their orders delivered to the next Nasdaq Quoting Market Participant in the queue according to their choice of the Order Execution Algorithms. 79 Otherwise, UTP Exchanges will be able to use the directed 80 and non-directed order processes of SuperMontage in the same way as Nasdaq Quoting Market Participants. Also, UTP Exchanges will be able to enter multiple non-attributable quotes/orders representing agency interest. UTP Exchanges, however, will only be able to submit a single, two-sided attributable quote, and will not be able to use reserve size or QR. 78 See Amendment Nos. 4 and 6, supra notes 6 and 9. 79 See Amendment No. 6, supra note 9. As a result, market makers may have to develop separate systems to accept order delivery from UTP Exchanges. 80 See Proposed NASD Rule 4710(f). As discussed above, pursuant to the Order Execution Algorithms, non-attributable agency interest of UTP Exchanges generally will be executed on parity with displayed quotes/orders (attributable and non-attributable) of market makers and ECNs. 81 The principal interest of UTP Exchanges will be last in priority under the Order Execution Algorithms, and will be executed after the system does a complete sweep of the agency interest of UTP Exchanges and the displayed and reserve size of all Nasdaq Quoting Market Participants. 81 See Amendment Nos. 4 and 8, supra notes 6 and 12. H. ECN Participation As discussed above, ECNs that are NASD members will have the choice of participating in order delivery or automatic execution. Regardless of the method of participation, these ECNs will have full access to the SuperMontage for order entry and order delivery. Specifically, ECNs that are NASD members will be able to designate quotes/orders as attributable or non-attributable, and will be able to transmit multiple quotes/orders at the same price or at multiple prices. All ECNs will be able to use the SuperMontage's reserve size feature for quotes/orders. ECN participation in Nasdaq will continue to be governed by rule and private contract. I. Odd-Lot Processing 82 82 The system's odd-lot processing function was substantially modified by Amendment No. 4 to the proposal. See Amendment No. 4, supra note 6. The SuperMontage will accept and execute orders for less than one normal unit of trading ( i.e., odd-lot orders). The SuperMontage will provide a separate mechanism for processing and executing odd-lot orders including: (1) An “odd-lot exposure limit” for market makers; (2) an interval delay between odd-lot executions against the same market maker; and (3) an odd-lot order entry limitation of one order per second, per firm. Odd-lot orders will be processed in a round-robin fashion against market makers with an available exposure limit and will be executed at the BBO, even if the market makers are not at the inside. A market maker can set its exposure limit, on a security-by-security basis, from 0 to 999,999 shares. The SuperMontage will not execute an odd-lot order against a market maker unless the market maker has a sufficient exposure limit to fill the odd-lot order. When a market maker's odd-lot exposure limit is reduced to zero, it will be taken out of the odd-lot rotation unless and until the market maker sets a new exposure limit. If no market maker has an odd-lot exposure limit, the SuperMontage will suspend the processing of odd-lots until an exposure limit is refreshed. Odd-lot executions will decrement the exposure limit (but not the quote/order sizes displayed in the Nasdaq Quotation Montage or NODF) by the size of the odd-lot order. To ensure continuity of price, if a mixed-lot is entered into the system, the odd-lot portion will be executed against the next market maker in the rotation at the round-lot portion price once the round-lot portion has been executed. The odd-lot processing mechanism also will provide a maximum five-second interval delay between executions against the same market maker in the same security. A market maker will be able to adjust its interval-delay time down ( i.e., down to 0-4 seconds), so that it may receive odd-lot executions more frequently than five seconds apart. Thus, after an odd-lot has been executed against a market maker with an available exposure limit, there will be at most a five-second interval delay before the market maker will be subject to another odd-lot execution. During the five-second (or less) interval delay, the market maker could adjust its odd-lot exposure limit up or down. Finally, the system will be programmed to accept odd-lot orders at a rate no faster than one order per second from any single participant. J. Nasdaq SmallCap Nasdaq proposes to use the SuperMontage for all Nasdaq securities, including SmallCap securities. Nasdaq proposes to delete the current SOES rules excluding SmallCap securities from the NNMS. K. System Roll Out 83 83 Nasdaq described its proposed system roll out in Amendment No. 5 to the proposal. See Amendment No. 5, supra note 8. Nasdaq intends to implement the SuperMontage as soon as practicable after decimal pricing is fully implemented in Nasdaq. 84 Nasdaq plans to give market participants and vendors at least 90 days notification of changes in system specifications. At the time of such notification, market participants will be given new specifications in order to begin analyzing the system changes. Nasdaq has represented that its staff will work throughout this period with market participants to address any system and specification-related questions and issues. 84 See Amendment No. 6, supra note 9. At least 60 days prior to system implementation, Nasdaq plans to give participants notice of specific testing dates and of the availability of a testing environment. In addition, at least 30 days prior to system implementation, Nasdaq plans to make available a testing environment in which firms may begin testing their software and hardware (if applicable). Finally, Nasdaq plans to hold at least two full-day, mock trading sessions on a weekend. This will allow market participants to train their personnel on the new system and to participate in a real-time trading environment. Nasdaq plans to phase-in Nasdaq securities similar to the way the SEC's Order Handling Rules were introduced. Specifically, Nasdaq intends to initially implement the system for a limited number of securities ( e.g., 100) representing a cross-section of Nasdaq-listed stocks. On a regular basis thereafter, Nasdaq will add 100 new stocks until the system is implemented for all Nasdaq-listed securities. Nasdaq will select a cross section of stocks to be included in each group of 100 securities to be rolled out during a particular week. The purpose of the system roll out is to give Nasdaq and its members the opportunity to observe and gain experience with the new system, and to give Nasdaq the opportunity to make any adjustments to the system (subject to approval by the Commission), if necessary. Nasdaq intends to work closely with the Commission during the roll-out phase to ensure a smooth transition to the new system. IV. Summary of Comments The Commission received 21 comment letters in response to the December 6, 1999 notice. 85 Ten commenters supported 86 and five commenters opposed 87 the proposal to establish the SuperMontage. Six commenters did not clearly state a position on the proposal. 88 Of the commenters who supported the proposal, all expressed reservations regarding certain aspects of the proposal. 89 85 See December 6, 1999 notice, supra note 4, and Comment Summary for a complete description of these comments. The Commission notes that several commenters addressed the NNMS, which was pending at the time that the NASD submitted this proposed rule change. The Commission is not addressing these comments because the Commission has already approved the NNMS. See NNMS Order, supra note 22. The Commission also notes that several commenters raised issues with respect to the Agency Quote proposal currently pending before the Commission. The Commission will address those comments when it considers the Agency Quote proposal. If the Agency Quote proposal is not approved by the Commission, Nasdaq has represented that it will file conforming rule changes to eliminate references to Agency Quotes in its rule text. See Amendment No. 3, note 8, supra note 5. At least one commenter also questioned the application of the proposal with respect to the IODES proposal. Nasdaq, however, has withdrawn this proposal. See supra note 16. Other comments not directly related to the SuperMontage are also not addressed in this Order. 86 See Electronic Traders Association Letter (“ETA” Letter); Investment Company Institute Letter (“ICI” Letter); Security Traders Association Letter (“STA” Letter); Security Traders Association of New York, Inc. Letter (“STANY” Letter); Merrill Lynch Letter; Chicago Stock Exchange Letter (“CHX” Letter); Morgan Stanley Dean Witter Letter (“MSDW” Letter); Goldman Sachs Letter; Nasdaq Institutional Advisory Council Letter (“ITAC” Letter); and ITG Letter. 87 See Bloomberg Letter; Automated Trading Desk Letter (“ATD” Letter); Instinet Letter; Island Letter (Initially, Island did not explicitly approve of or oppose the proposed rule change. Island recommended that the Commission delay consideration of the proposed rule “until such time as the Nasdaq market is restructured to ensure fair competition between Nasdaq and ECNs or until such time as the Commission has permitted ECNs such as Island to become registered national securities exchanges.” However, in its comment letter responding to Amendment No. 4, Island expressed its opposition to the proposal); and NexTrade Letter. 88 See BNY ESI & Co. Letter (“BNY” Letter); Bancorp Letter; Heartland Letter (Heartland believed that the proposed rule change should not be approved until the SOES/SelectNet Integration is used and tested); American Century Investment Management Letter (“ACIM” Letter); Salomon Smith Barney Letter; and Mount Pleasant Brokerage Services Letter (“MPBS” Letter). 89 See ETA Letter; ICI Letter; STA Letter; STANY Letter; Merrill Lynch Letter; MSDW Letter; ITAC Letter; CHX Letter; Goldman Sachs Letter; and ITG Letter. In response to the comment letters, the NASD and Nasdaq made several amendments to the proposal. These proposed changes were published for comment in the Federal Register on March 30, 2000 as Amendment No. 4. 90 The Commission received 31 comment letters from a total of 27 commenters in response to Amendment No. 4. 91 Of these 27 commenters, 20 generally supported the proposal, 92 while five opposed the proposal, including the proposed changes. 93 Two commenters expressed neither support nor opposition to the proposal. 94 Of those commenters who expressed support for the proposal, three expressed reservations about certain aspects of the proposal. 95 90 See Securities Exchange Act Release No. 42573, supra note. 91 See Instinet Letter; ICI Letter; Bloomberg Letter; CHX Letter; Joseph J. Burrello, Principal and Manager of Nasdaq Trading, William Blair & Company, Larry Elmore, Partner and Manager of Equity Trading, J.C. Bradford & Co., Dennis A. Green, Senior Vice President and Manager of Nasdaq Trading, Legg Mason Wood Walker, Inc., Jack Hughes, First Vice President and Manager of Equity Trading, Janney Montgomery Scott, LLC, Robert Krohn, Managing Director of Nasdaq Trading, McDonald Investments, Inc., Greg Lemaster, Manager of Nasdaq Trading, Stifel, Nicolaus & Company, Inc., James R. Miller, Manager of Nasdaq Trading, Robert W. Baird & Company, Inc., Bobby Olsen, Vice President and Manager of Nasdaq Trading, Advest, Inc., Gerard Yurasits, Senior Nasdaq Trader, First Albany Corporation, Hedi H. Reynolds, Managing Director of Nasdaq Trading, Morgan, Keegan & Company, Inc., William Cahill, Managing Director of Nasdaq Trading, Robinson Humphrey Letter (“Traders” Letter); Island Letter; Archipelago Letter; Granite Financial Letter; Security Investment Company Letters; Charles Schwab Letter (addressed to Senator Phil Gramm); Telemet Letter; Congressman Drier Letter; Congressman Pallone Letter; Congressman Dingell Letter; Congresswoman Morella Letter; Congressman Stupak Letter; Congresswoman Wilson Letter; Congressman Radanovich Letter; Congressman Towns Letter; Congressman McInnis Letter; Congressman Thomas Letter; Spears, Leeds & Kellogg Letter (addressed to Senator Phil Gramm); First Union Letter (addressed to Alfred R. Berkeley, President, the Nasdaq Stock Market); Seidel Letter (“Seidel” Letter); Thurston, Springer, Miller, Herd & Titak Letter (“Titak” Letter); Philadelphia Corporation for Investment Services Letter (“Philadelphia Corp.” Letter)(address to Senator Arlen Spector); and Robert Bannon Letter (“Bannon” Letter). The Commission notes that commenters did not limit their discussion to the topics addressed in Amendment No. 4. Rather, many commenters discussed the proposal in its entirety. These commenters are listed as responding to Amendment No. 4 because their letters were dated after Amendment No. 4 was published. 92 See ICI Letter; CHX Letter; Traders Letter; Charles Schwab Letter; Congressman Drier Letter; Congressman Pallone Letter; Congresswoman Morella Letter; Congressman Stupak Letter; Congresswoman Wilson Letter; Congressman Towns Letter; Congressman McInnis Letter; Congressman Thomas Letter; Congressman Radanovich Letter; Titak Letter; Philadelphia Corp. Letter; Spears, Leeds & Kellogg Letter; First Union Letter; Security Investment Company Letters; Seidel Letter; and Bannon Letter. 93 See Instinet Letter; Bloomberg Letter; Archipelago Letter; Granite Financial Letter; and Island Letter. 94 See Congressman Dingell Letter; and Telemet Letter. 95 See ICI Letter; Traders Letter; and Bannon Letter. In response to these comments, the NASD and Nasdaq made additional revisions to the proposal. The proposed changes were published in the Federal Register as Amendment Nos. 5, 6, and 7 on August 15, 2000. 96 The Commission received 28 comment letters in response to these Amendments. 97 Twelve expressed support for the proposal, 98 while 13 continued to oppose it. 99 Three commenters supported the general concept of the SuperMontage, but expressed concerns about specific provisions contained in the proposal, or did not clearly state a position on the proposal. 100 96 See Securities Exchange Release No. 43133, supra note 11. 97 The Commission notes that commenters did not limit their discussion to the topics addressed in Amendment Nos. 5, 6, and 7. Rather, many commenters discussed the proposal in its entirety. These commenters are listed as responding to Amendment Nos. 5, 6 and 7 because their letters were dated after Amendment No. 7 was published. 98 See Senator Schumer Letter; Congressman Ehrlich Letter; Congressman Shays Letter; Congressman Fossella Letter; Starbucks Coffee Letter (“Starbucks” Letter)(addressed to Congresswoman Jennifer Dunn); STA Letter; Association of Publicly Traded Companies Letter (“APTC” Letter); American Shareholder's Association Letter (“ASA” Letter); Consumer Federation of America Letter (“CFA” Letter); Wendell Garrett Letter (“Garrett” Letter) (addressed to Congressman John Shadegg and Senator Jon Kyl); O'Connor Letter; and Jeffries Letter. 99 See Philadelphia Stock Exchange Letter (“Phlx” Letter); ACIM Letter; Instinet Letter; Bloomberg Letter; BRUT Letter; Harold Bradley Letter (“Bradley” Letter); Archipelago Letter; NexTrade Letter; Seema Aurora Letter (“Aurora” Letter); Island Letter; Renaissance Letter; Leon Letter; and Kupfer Letter. 100 See T. Rowe Price Associates, Inc. Letter (“TRPC” Letter); Gramm Letter; and Scudder Kemper Investments Letter (“Scudder Kemper” Letter). In response to these comments, the NASD and Nasdaq made several additional changes to the proposed rule change. The proposed changes were published in the Federal Register as Amendment No. 8 on November 15, 2000. 101 The Commission received 24 comment letters in response to Amendment No. 8. One commenter expressed support for the proposal, 102 while 6 continued to oppose it. 103 Eight commenters supported the general concept of the SuperMontage, but expressed concerns about specific provisions contained in the proposal. 104 Nine commenters, while objecting to certain aspects of the proposal, did not clearly state a position on the proposal as a whole. 105 101 See Securities Exchange Act Release No. 43514, supra note 13. 102 See Bloomberg Letter. 103 See Instinet Letter (Instinet also submitted a letter addressing changes to be made by Amendment No. 8 prior to the Commission's receipt of the Amendment. This letter has also been incorporated); Archipelago Letter; Letter from American Century Investment Management, Inc., Janus Capital Corporation, Neptune Capital Management LLC, State Farm Mutual Automobile Insurance Company, Alex Brown Investment Management, LP, Boston Company, Wachovia Bank, NA, State Street Research & Management Co., Banc One Investment Advisors Corporation, West Highland Capital, Inc., Fidelity Trust Company, GMG/Seneca Capital Management, Westchester Capital Management, Inc., Becker Capital Management, Inc., Greenville Capital Management, Inc., Friess Associates of Delaware, Inc., C.E. Unterberg, Tobin Advisors, LP, Kepmen Capital, Schroder Investment Management Ltd., Foreign & Colonial Management, Ltd., RAS Asset Management SGR, Scudder Investor Services, Inc., New York State Common Retirement Fund, Dreyfus Fund, Virginia Retirement System, Pennsylvania School Employee Retirement Systems, Harris Associates Securities, LP, Columbia Partners, LLC Investment Management, Caterpillar Investment Management, Ltd., Nicholas Applegate Capital Management, Inc., Symphony Asset Management, Monetta Financial Services, Inc., Buckingham Capital Management, Sedacca Capital Management, Inc., Robeco Group NV, Montag & Caldwell, Gemini Management Partners, LLC, Abu Dhabi Investment Authority, BT&T Asset Management AG, Jacobs Levy Equity Management, Inc., Newton Investment Management Ltd., Berliner Freiverkehrs (Aktien) AG, Compass Capital Ltd., SAC Capital, Standish, Ayer & Wood, Minnesota Power and Light Co., Frontier Capital Management, Sage Asset Management, LLC, Target Holdings Corporation, Lincoln Partners, Apex Capital, LLC, Twin Capital Management, Kanaly Trust Company, Rothschild Bank AG, Sanpaolo IMI Asset Management SGR, Banque Paribas Luxembourg, Golden Capital Management, Investment Adviser, Inc., R.H. Capital Associates, Quaker Capital Management, Eagle and Dominion Asset Management Ltd., Bank Invest, Morley Fund Management, Provident Investment Counsel, Gruber & McBaine Capital Management, Dupont Capital Management, Masters Capital Investments, LLC, Sawgrass Asset Management, LLC, Kaintuck Capital Management, LP, HighMark Capital Management, Inc., Atticus Holdings, LLC, Credit Agricole Indosuez Cheuvreux, Royce & Associates, Inc., OrbiMed Advisors LLC, Cordillera Asset Management, Inc., Fisher Investments, Inc., Ohio Valley Management, Inc., Loews Corporation, National City Investment Company, Zak Capital, Inc., Ocean Park Capital Management, LLC, Tattersall Advisory Group, Peninsula Capital Management, Westway Capital, LLC, Munder Capital Management, Kadem Capital, LLC, Phoenix Zweig Advisers, Fuller & Thaler Asset Management, Chicago Equity Partners, LLC, Amerindo Advisers, Ltd., Group Aesop Capital Partners, LLC, Wilen Management Corporation, Ballentine Capital Management, Inc., Summit Capital Management LLC, Sirach Capital Management LLC, Cadwell and Orkin, Wentworth, Hauser & Violich, Inc., Matrix Asset Advisors, Inc., George Weiss Associates (“Investment Companies Letter”)(addressed to Senator Phil Gramm); CFA Letter; Office of the Comptroller, State of New York (“NY” Letter) (stating that SuperMontage could ideally increase information, but may provide unfair advantages to market makers); and Adriaanse Letter (“Adriaanse Letter”). 104 See Security Investment Company Letter; ICI Letter; STA Letter; Pershing Trading Company, L.P. (“Pershing” Letter); ACIM Letter; Cincinnati Stock Exchange (“CSE” Letter); Scudder Kemper Letter; and Vanguard Letter. 105 See Island Letter; BRUT Letter; Ryley Letter; CHX Letter; Suss Letter (“Suss Letter”); Silverman Letter (“Silverman Letter”); Erfort Letter (“Erfort Letter”); Birmingham Letter (“Birmingham Letter”) and aLV Letter (“aLV Letter”) (urging Commission to re-think passing the SuperMontage in its current form). V. Discussion After carefully considering the comments, the Commission finds, for the reasons discussed below, that the SuperMontage proposal is consistent with the requirements of the Act and the rules and regulations thereunder applicable to the NASD. In particular, the Commission finds that the proposal is consistent with the requirements of Sections 15A(b)(6), (9), and (11), and 11A(a)(1)(C) of the Act. 106 Section 15A(b)(6) 107 requires that the rules of a registered 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 the rules of an association not impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. 108 Section 15A(b)(11) 109 requires that the rules of an association be designed to produce fair and informative quotations, prevent fictitious or misleading quotations, and to promote orderly procedures for collecting, distributing, and publishing quotations. And finally, in Section 11A(a)(1)(C), 110 Congress found that it is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure: (1) The economically efficient execution of securities transactions; (2) fair competition among brokers and dealers; (3) the availability to brokers, dealers, and investors of information with respect to quotations and transactions in securities; (4) the practicability of brokers executing investors' orders in the best market; and (5) an opportunity for investors' orders to be executed without the participation of a dealer. 106 15 U.S.C. 78 o -3(b)(6), (9), and (11), and 15 U.S.C. 78k-1(a)(1)(C). 107 15 U.S.C. 78 o -3(b)(6). 108 15 U.S.C. 78 o -3(b)(9). 109 15 U.S.C. 78 o -3(b)(11). 110 15 U.S.C. 78k-1(a)(1)(C). As discussed more fully below, the Commission finds that the proposed changes are in the public interest and are designed to assure the economically efficient execution of securities transactions by increasing the availability of pre-trade information in Nasdaq securities, as well as the opportunity for the orders of market makers, public customers, and order entry firms to interact. Several commenters believed that the proposal will improve the Nasdaq market by either providing more information to investors, promoting greater efficiency in executions, or increasing overall market transparency. 111 The ICI, for example, stated that “creating a system that provides investors with greater access to priced orders and allows them to execute against those orders will greatly enhance the quality of the Nasdaq market.” 112 MSDW stated that the “ability to enter multiple proprietary/agency quotes/orders at multiple price levels will greatly assist market makers in managing their limit orders.” 113 TRPA stated that “the SuperMontage concept furthers the goals of unifying the markets and providing a means for orders to interact with one another, while allowing for continuing innovation.” 114 The Commission agrees with these commenters that there is good reason to conclude that the SuperMontage, by providing for the enhanced display of trading interest in Nasdaq securities and by expanding the availability of automatic execution, will facilitate the price discovery process and promote quote competition among Nasdaq Quoting Market Participants and UTP Exchanges, thus helping to ensure the best execution of customer orders. 111 See ETA Letter; Merrill Lynch Letter; Goldman Sachs Letter; MSDW Letter; STA Letter; STANY Letter; ITAC Letter; ICI Letter; Bannon Letter; Bancorp Letter; Charles Schwab Letter; Congressman Drier Letter; Congressman Pallone Letter; Congresswoman Morella Letter; Congressman Stupak Letter; Congresswoman Wilson Letter; Congressman Towns Letter; Congressman McInnis Letter; Congressman Thomas Letter; Spear, Leeds & Kellogg Letter; First Union Letter; Seidel Letter; Security Investment Company Letters; ITG Letter; APTC Letter; Jeffries Letter; Senator Schumer Letter; Congressman Radanovich Letter; Congressman Shays Letter; Congressman Fossella Letter; Titak Letter; ASA Letter; Starbucks Letter; Philadelphia Corp. Letter; Garrett Letter; NY Letter; and Congressman Ehrlich Letter. 112 See ICI Letter. 113 See MSDW Letter. 114 See TRPA Letter. In addition, by introducing features to: (1) Assist market makers with the management of their quotes/orders; (2) reduce instances of double liability for market makers; and (3) encourage the entry of larger sized quotations and orders by market makers and ECNs, the proposal likely will add liquidity to the market and help assure the economically efficient execution of transactions in Nasdaq securities. The proposed changes thus should enhance the efficiency and increase the depth and liquidity of the market for Nasdaq securities, to the benefit of all investors. A. Nasdaq Order Display Facility The NODF will increase the availability of information about quotations by displaying the three best price levels in Nasdaq on both the bid and offer side of the market to supplement the Nasdaq Quotation Montage. Each price level will be updated and will display aggregate trading interest at that price level. Several commenters stated this aspect of the proposal will result in more information to investors, promote greater efficiency in executions, promote liquidity, increase market transparency, and reduce market fragmentation. 115 For example, several commenters believed that the proposal will provide a better overall picture of the market's depth by enabling market participants to display (and accept) multiple levels of priced orders. 116 In addition, one commenter believed that the enhanced display of trading interest will promote investor protection by decreasing trade-throughs ( i.e., trades at prices worse than those available for a security) and giving market participants more options for meeting best execution, firm quote, and limit order display obligations. 117 Another commenter stated that the proposal will help improve the current state of fragmented trading in Nasdaq securities, and offer an improved execution system over SOES and SelectNet. 118 A third commenter believed that the NODF “will offer an enhanced means for market participants to gauge trading interest at the Nasdaq inside market and prices near the inside market.” 119 115 See ETA Letter; Merrill Lynch Letter; Goldman Sachs Letter; STA Letter; STANY Letter; ITAC Letter; ICI Letter; Bannon Letter; Bancorp Letter; MSDW Letter; Charles Schwab Letter; Congressman Drier Letter; Congressman Pallone Letter; Congresswoman Morella Letter; Congressman Stupak Letter; Congresswoman Wilson Letter; Congressman Towns Letter; Congressman McInnis Letter; Congressman Thomas Letter; Spears, Leeds & Kellogg Letter; First Union Letter; Seidel Letter; Security Investment Company Letters; ITG Letter; APTC Letter; Senator Schumer Letter; Congressman Radanovich Letter; Congressman Shays Letter; Congressman Fossella Letter; Titak Letter; ASA Letter; Starbucks Letter; Philadelphia Corp. Letter; Jeffries Letter; Garrett Letter; NY Letter; and Congressman Ehrlich Letter. 116 See ITAC Letter; Congressman Fossella Letter; APTC Letter; and Charles Schwab Letter; see also Bannon Letter and Island Letter. 117 See ITAC Letter. 118 See Bannon Letter; see also Senator Schumer Letter. 119 See MSDW Letter. Two commenters, however, questioned the need for the NODF. 120 One of these commenters believed that fragmentation was no longer a problem in the Nasdaq market. 121 Further, this commenter argued that if the NASD was concerned about the fragmentation and transparency of pre-trade information, the NASD should allow market participants to display all of their bids and offers under their MMID. 122 Another commenter argued that the NODF would create a false perception of liquidity in Nasdaq because orders below a market participant's top of book will not be attributed to the firm representing the order. 123 This commenter believed, as a result, that liquidity will appear to reside in Nasdaq, rather than with the broker/dealer that represents the liquidity in Nasdaq. 124 120 See Bloomberg Letter and NexTrade Letter. 121 See Bloomberg Letter. 122 See Bloomberg Letter. 123 See Archipelago Letter. 124 See Archipelago Letter. One commenter also believed that the NODF was unnecessary because ECNs and market makers have created their own limit order books, and that the proposed NODF will not provide any additional capability to the market. 125 Another commenter believed that the SuperMontage proposal did not provide complete transparency because of its anonymous display and reserve size features. 126 This commenter urged the Commission to review this issue to ensure that large players do not receive an unfair trading advantage that is not available to small investors. 127 Two commenters also suggested that the NODF should display the five best price levels in Nasdaq on both the bid and offer side of the market to allow investors to better gauge the market 128 and to constrain volatility. 129 Another commenter believed that Nasdaq should display information for individual market makers and ECNs up to three price levels. 130 125 See NexTrade Letter. 126 See CFA Letter. 127 See CFA Letter. 128 See ICI Letter and ACIM Letter; see also ITAC Letter. 129 See ACIM Letter. 130 See Bloomberg Letter. The Commission finds that the NODF, as part of the SuperMontage, is consistent with Sections 15A(b)(6) and 15A(b)(11) of the Act 131 in that, among other things, it is designed to facilitate transactions in securities and to produce fair and informative quotations. Further, the Commission finds that the order aggregation characteristics of the proposed rule change are consistent with Sections 11A(a)(1)(B) and 11A(a)(1)(C) of the Act. 132 In particular, in Section 11A(a)(1)(B), Congress found that new data processing and communications techniques create the opportunity for more efficient and effective market operations. 133 131 15 U.S.C. 78 o -3(b)(6), (b)(11). 132 15 U.S.C. 78k-1(a)(1)(B)-(a)(1)(C). 133 15 U.S.C. 78k-1(a)(1)(B). The Commission believes that the NODF has the potential to facilitate securities transactions by enhancing the display of trading interest. Currently, when Nasdaq receives a quote, it cannot discern whether that quote represents a single order or multiple orders at one price. Nasdaq Quoting Market Participants and UTP Exchanges can send Nasdaq only a single, two-sided quote. In contrast, under the proposal, Nasdaq Quoting Market Participants and UTP Exchanges generally will have the ability to transmit multiple orders at multiple price levels for display at their discretion. 134 In addition, the NODF has two other features designed to enhance the display of trading interest—the size of displayed interest will be aggregated at the best three price levels on both sides of the market and the Summary Scan function will show the total displayed size (attributable and non-attributable) for all levels below the first three price levels. With the implementation of decimals, market participants will need to view and access greater depth. At a penny quotation increment, for example, a best offer of $20 for 100 shares may be less meaningful than a second best offer at $20.01 for 1,000 shares. As discussed in more detail below, because the NODF is designed to enhance the display of trading interest among participants, it should facilitate trading in a decimals environment. 135 While the Commission agrees with certain commenters that display of depth beyond three levels may be necessary once the markets move to decimals, the Commission understands that Nasdaq will consider expanding the number of levels as it further develops the system. 134 UTP Exchanges will be permitted only to send a single bid and a single offer for principal orders/quotes, but may submit multiple agency quotes/orders. See Proposed NASD Rule 4710(f). 135 As discussed in Section III.K, supra, the SuperMontage will not be implemented until after decimals in the Spring of 2001. In a recent study, SRI Consulting found that with smaller minimum pricing increments, liquidity may be dispersed as limit orders are spread over smaller price intervals. See SRI Consulting, Assessing the Impact on Message Traffic of Trading Equities and Option in Decimal Increments (Executive Summary at p. 31) (April 16, 1999). Therefore, market participants may want to see more price levels away from the BBO. With respect to concerns that Nasdaq should display even greater information, the Commission believes that Nasdaq's proposed NQDS Prime, which will provide on a real-time basis, all individual attributable quote and order information at the three best price levels displayed in the NODF, 136 will help to address these concerns. NQDS Prime will enhance the display of trading interest and provide market participants greater information in making order-routing decisions. The Commission believes that this will provide investors with more options since market participants will be able to use this information to access liquidity through Nasdaq or non-Nasdaq systems (such as proprietary links). 136 See Amendment No. 8, supra 12. At least one commenter supported the addition of NQDS Prime. See STA Letter. 1. Non-Attributable Quotes and Other Features Under the proposed rule change, a SIZE MMID, representing the aggregate size of the best-priced non-attributable bids or offers, will be displayed in the Nasdaq Quotation Montage along with the other MMIDs for the Nasdaq Quoting Market Participants and UTP Exchanges displaying attributable size. The Commission received several comment letters addressing this display feature in response to the December 6, 1999 notice. 137 One commenter believed that there is a risk that non-attributable proprietary orders will be susceptible to manipulation because a market maker could post a small bid under its own MMID and post a larger sell order anonymously. 138 Another commenter argued that because Nasdaq Quoting Market Participants and UTP Exchanges can display quotes/orders anonymously under the proposed rule change, a “moral hazard” might be created. 139 The commenter expressed concern that participants with weaker credit might “hide behind unattributable quotations in times of market stress.” 140 Further, this commenter noted that because the solvency of a participant's counterparty may be unknown, investor confidence could be threatened. 141 This commenter also opined that the anonymous display feature will deny viewers the opportunity to access secondary or tertiary quotations directly. 142 In addition, one commenter believed that order entry firms could use the feature to access ECNs without paying an access fee. 143 137 See December 6, 1999 notice, supra note 4. 138 See ATD Letter. 139 See Bloomberg Letter. 140 See Bloomberg Letter. 141 See Bloomberg Letter. 142 See Bloomberg Letter. 143 See Bloomberg Letter. Another commenter pointed out that the NASD has not revealed how it proposes to provide participants with transaction reports. 144 This commenter stated that the counterparty to a transaction should be disclosed at the time an order is executed, not at the end of the trade day. 145 This commenter explained that disclosure of a counterparty's identity at the time of execution is critical in order for a market participant to monitor its intraday credit risk exposure. 146 144 See Island Letter. 145 See Island Letter. 146 See Island Letter. In response to some of the issues raised by commenters, the NASD has committed to assist market participants in their efforts to manage operational and credit risk. 147 Nasdaq will affix the MMID of the sender to all directed orders, delivered non-directed orders, and delivered preferenced orders. Further, preferenced orders and non-directed orders that are executed against a market maker or other market participant that participates in the automatic execution functionality of the system will result in an execution report immediately upon execution that identifies all of the parties to the trade. This is true if a non-directed order is executed against an attributable order or a non-attributable order. 148 147 See Amendment No. 8, supra note 12. 148 See Amendment No. 8, supra note 12. Two commenters believed that these features will allow ECNs to deny access to their quotes through SuperMontage to non-subscribing firms that do not pay their fees. 149 One of these commenters believed that “[s]anctioning the denial of quote access through SuperMontage also conflicts with [b]est [e]xecution, as a firm who has been denied access may be unable to hit the inside bid or offer.” 150 149 See STA Letter and Pershing Letter. 150 See STA Letter. As an initial matter, the Commission notes that market makers currently can enter multiple quotes/orders by submitting a quote/order to Nasdaq and orders to multiple ECNs. Under the Commission's Order Handling Rules, 151 a market maker can place a better-priced order with an ECN anonymously without updating its quote to reflect the better-priced order, as long as the ECN displays the order in the public market. Other market participants also may submit orders to ECNs and have their orders traded on an anonymous basis. As a result, market participants trading with ECN quotes currently are subject to a certain level of uncertainty regarding their ultimate counterparty. The SuperMontage proposal merely provides market makers with the ability to display multiple quotes in Nasdaq on an attributable and non-attributable basis, which is consistent with the ability of market makers and other market participants to display orders on ECNs today. 151 See 17 CFR 240.11Ac1-1(c)(5). The Commission believes that the use of non-attributable quotes ( i.e. , SIZE MMID) in the SuperMontage has the potential to promote the display of greater market interest and encourage greater transparency in the Nasdaq market. The ability to display non-attributed market interest may encourage certain market participants to submit larger quotes/orders, particularly institutions wishing to minimize the market impact of their orders. Furthermore, the Commission believes that the NASD has minimized the concerns raised by commenters regarding the identity of those with whom they are trading by affixing the MMID of the sender on delivered orders and identifying the counterparties in execution reports. Moreover, because only Nasdaq market makers, ECNs, and UTP Exchanges can enter non-attributable orders into the system, the range of participants that are responsible for non-attributable orders on their own behalf or for an anonymous customer is limited. All Nasdaq Quoting Market Participants have established clearing arrangements and credit standings monitored by the NASD and the National Securities Clearing Corporation (“NSCC”). UTP Exchanges have similar provisions to ensure financial responsibility. Moreover, the Commission fully expects that the NASD will monitor the use of these quotes/orders with a view towards preventing manipulation. Finally, as discussed further below, the Commission notes that market participants that wish to interact with a specific market participant still will be able to direct or preference orders to Nasdaq Quoting Market Participants and UTP Exchanges, including ECNs. 2. Reserve Size The proposed reserve size function will allow Nasdaq Quoting Market Participants to publicly display part of the full size of their order or interest, with the remainder held in reserve on a non-attributable basis. 152 The reserve size function requires Nasdaq Quoting Market Participants to initially display a minimum of 1,000 shares, and to refresh the displayed size by a minimum of 1,000 shares each time the displayed size is decremented to zero. As originally described in the December 6, 1999 notice, reserve size would have been accessed based on time priority and status as a market maker, automatic execution ECN, or order delivery ECN. 152 Market makers must display the full size of customer limit orders in some circumstances pursuant to the Commission's Order Handling Rules. Several commenters expressed support for the reserve size feature. 153 One commenter felt that the reserve size feature would benefit investors, 154 while another believed it would minimize the adverse market price impact associated with a larger-sized order. 155 Another commenter, however, suggested that the reserve size feature should be altered to provide market participants with incentives to display large size attributable quotations. 156 153 See ITG Letter; ITAC Letter; and First Union Letter. 154 See ITG Letter. 155 See ITAC Letter. 156 See Goldman Sachs Letter. In response to the commenter, in Amendment No. 4, the NASD added the “size/time priority” characteristic to the reserve size function to provide order execution priority for orders with the larger displayed size (after being refreshed out of reserve) over smaller displayed sizes (refreshed out of reserve size), with time priority being given to identically sized quotes. 157 In addition, the NASD revised its original Order Execution Algorithm so that it no longer di [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A01-2381. Public record. Not legal advice.