Self-Regulatory Organizations; Notice of Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to a Three Month Extension of the Interim SOES Rules

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35077; File No. SR-NASD-94-68]

Self-Regulatory Organizations; Notice of Proposed Rule Change by

the National Association of Securities Dealers, Inc. Relating to a

Three Month Extension of the Interim SOES Rules

December 9, 1994.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''),\1\ notice is hereby given that on December 7, 1994,\2\ the

National Association of Securities Dealers, Inc. (``NASD'' or

``Association'') filed with the Securities and Exchange Commission

(``Commission'' or ``SEC'') the proposed rule change as described in

Items I, II, and III below, which Items have been prepared by the NASD.

The Commission is publishing this notice to solicit comments on the

proposed rule change from interested persons.

---------------------------------------------------------------------------

\1\15 U.S.C. 78s(b)(1) (1988).

\2\The NASD initially filed the proposed rule change on December

1, 1994. On December 7, 1994, the NASD filed Amendment No. 1 to

remove the short sale prohibition from its proposal to extend the

Interim SOES Rules.

---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

On December 23, 1993, the Commission approved on a one-year pilot

basis changes to The Nasdaq Stock Market, Inc.'s (``Nasdaq'') Small

Order Executive System (``SOES'') that: (1) Reduced the maximum size

order eligible for execution through SOES from 1,000 shares to 500

shares; (2) reduced the minimum exposure limit for ``unpreferenced''

SOES orders from five times the maximum order size to two times the

maximum order size, and eliminated the exposure limits for

``preferenced orders''; (3) implemented an automated function for

updating market maker quotations when the market maker's exposure limit

has been exhausted; and (4) prohibited short sales through SOES

(collectively referred to hereinafter as the ``Interim SOES

Rules'').\3\ Except for the short sale prohibition, the NASD proposes

to extend, until May 1, 1995, the effectiveness of the Interim SOES

Rules.

---------------------------------------------------------------------------

\3\See Securities Exchange Act Release No. 33377 (Dec. 23,

1993), 58 FR 69419 (Dec. 30, 1993) (``Interim SOES Rules Approval

Order'').

---------------------------------------------------------------------------

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Propoed Rule Change

In its filing with the Commission, the NASD included statements

concerning the purpose of and basis for the proposed rule change and

discussed any comments it received on the proposed rule change. The

text of these statements may be examined at the places specified in

Item IV below. The NASD has prepared summaries, set forth in Sections

(A), (B), and (C) below, of the most significant aspects of such

statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

On December 23, 1993, the SEC issued an order that approved the

Interim SOES Rules on a one-year pilot basis effective January 7, 1994.

In response to two applications requesting a stay of the Interim SOES

Rules Approval Order, however, the SEC granted a partial stay of the

effective date of the order until January 25, 1995.\4\ Thus, since the

Commission approved the Interim SOES Rules for a one-year period and

this one-year period did not commence until the Commission's order

approving the rules became effective on January 25, 1994, it is the

NASD's understanding that the Interim SOES Rules will expire on January

25, 1995, absent further Commission action.

---------------------------------------------------------------------------

\4\See Securities Exchange Act Release No. 33424 (Jan. 5, 1994).

---------------------------------------------------------------------------

As described in more detail below, because the NASD believes

implementation of these rule changes has been associated with positive

developments in the markets for Nasdaq securities and clearly has not

had any negative effect on market quality, the NASD believes it is

appropriate and consistent with the maintenance of fair and orderly

markets and the protection of investors to extend the effectiveness of

the interim SOES Rules (without the short sale prohibition) until the

rules governing the operation of The Nasdaq Primary Retail Order View

and Execution System (``NPROVE'') have been approved by the SEC

and implemented.\5\

---------------------------------------------------------------------------

\5\See Securities Exchange Act Release No. 34145 (June 1, 1994),

59 FR 29649 (June 6, 1994) (notice of original filing and Amendment

No. 1), Securities Exchange Act Release No. 34453 (July 28, 1994),

59 FR 39808 (Aug. 4, 1994) (notice of Amendment No. 2), and

Securities Exchange Act Release No. 35024 (Nov. 29, 1994), 59 FR

62755 (Dec. 6, 1994 (notice of Amendment No. 3).

---------------------------------------------------------------------------

NPROVE is a new Nasdaq system for the execution of small-

sized customer orders that will provide individual investors with

enhanced limit order protection and important price improvement

opportunities, while at the same time affording market makers an

enhanced means to manage the risks associated with market making. The

NASD anticipates that NPROVE will be ready for implementation

by May 1, 1995 and is hopeful that the SEC will consider approval of

NPROVE well prior to that date. Accordingly, assuming the SEC

approves NPROVE by May 1, 1995, the NASD believes it is

necessary for the protection of investors and the preservation of the

quality of the markets for Nasdaq securities to extend the

effectiveness of the Interim SOES Rules for approximately three months

until May 1, 1995, so that there will be no lapse between the effective

date of NPROVE and termination of the Interim SOES Rules. By

preventing a lapse in the effectiveness of the Interim SOES Rules, the

NASD believes investors and the marketplace as a whole will continue to

receive the substantial benefits derived from the Interim SOES Rules.

The Interim SOES Rules reflect a reasoned approach by the NASD to

address the adverse effects on market liquidity attributable to active

intra-day trading activity through SOES, while at the same time not

compromising the ability of small, retail investors to receive

immediate executions through SOES. Specifically, the Interim SOES Rules

are designed to address concerns that concentrated, aggressive use of

SOES by a growing number of order entry firms has resulted in increased

volatility in quotations and transaction prices, wider spreads, and the

loss of liquidity for individual and institutional investor orders. In

light of the SEC's approval of the NASD's proposed short sale rule in

June 1994,\6\ however, the NASD believes it is appropriate to permit

short sales to be entered in SOES. Accordingly, the NASD proposes to

allow the effectiveness of this particular SOES rule to lapse on

January 25, 1995.

---------------------------------------------------------------------------

\6\Securities Exchange Act Release No. 34277 (June 29, 1994), 59

FR 34885 (July 7, 1994).

---------------------------------------------------------------------------

The NASD believes that the same arguments and justifications made

by the NASD in support of approval of the Interim SOES Rules are just

as compelling today as they were when the SEC relied on them to approve

the rules. In sum, the NASD continues to believe that concentrated

bursts of SOES activity by active order-entry firms contribute to

increased short-term volatility, wider spreads, and less market

liquidity on Nasdaq and that the Interim SOES Rules are an effective

means to minimize these adverse market impacts.

The NASD also notes that the SEC made specific findings in the

Interim SOES Rules Approval Order that the interim rules were

consistent with the Act. In particular, the SEC stated in its approval

order that:

a. Because the benefits for market quality of restricting SOES

usage outweigh any potential decrease in pricing efficiency, the

Commission concludes that the net effect of the proposal is to

remove impediments to the mechanism of a free and open market and a

national market system, and to protect investors and the public

interest, and that the proposed rule changes are designed to produce

accurate quotations, consistent with Sections 15A(b)(6) and

15A(b)(11) of the Act. In addition, the Commission concludes that

the benefits of the proposal in terms of preserving market quality

and preserving the operational efficiencies of SOES for the

processing of small size retail orders outweigh any potential burden

on competition or costs to customers or broker-dealers affected

adversely by the proposal. Thus, the Commission concludes that the

proposal is consistent with Section 15A(b)(9) of the Act in that it

does not impose a burden on competition which is not necessary or

appropriate in furtherance of the purposes of the Act.\7\

---------------------------------------------------------------------------

\7\Interim SOES Rules Approval Order, supra note 1, 58 FR at

69423 (footnotes omitted).

---------------------------------------------------------------------------

b. The Commission also concludes that the proposal advances the

objectives of Section 11A of the Act. Section 11A provides that it

is in the public interest and appropriate for the protection of

investors and the maintenance of fair and orderly markets to assure

economically efficient execution of securities transactions, fair

competition among market participants, and the practicality of

brokers executing orders in the best market. The Commission

concludes that the proposal furthers these objectives by preserving

the operational efficiencies of SOES for the processing of small

orders from retail investors.\8\

---------------------------------------------------------------------------

\8\Id. (footnotes omitted).

---------------------------------------------------------------------------

c. The Commission believes that it is appropriate to restrict

trading practices through SOES that impose excessive risks and costs

on market makers and jeopardize market quality, and which do not

provide significant contributions to liquidity or pricing

efficiency. * * * The Commission believes that it is more important

to ensure that investors seeking to establish or liquidate an

inventory position have ready access to a liquid Nasdaq market and

SOES than to protect the ability of customers to use SOES for intra-

day trading strategies.\9\

---------------------------------------------------------------------------

\9\Id. at 69424-25 (footnotes omitted).

---------------------------------------------------------------------------

d. The Commission believes that there are increased costs

associated with active intra-day trading activity through SOES that

undermine Nasdaq market quality * * * . Active intra-day trading

activity through SOES can also contribute to instability in the

market.\10\

---------------------------------------------------------------------------

\10\Id. (footnotes omitted).

---------------------------------------------------------------------------

e. In addition, these waves of executions can make it difficult

to maintain orderly markets. Given the increased volatility

associated with these waves of intra-day trading activity, market

makers are subject to increased risks that concentrated waves of

orders will cause the market to move away. As a result, individual

market makers may be unwilling to narrow the current spread and

commit additional capital to the market by raising the bid or

lowering the offer. When market makers commit less capital and quote

less competitive markets, prices can be expected to deteriorate more

rapidly. Accordingly, the Commission believes that it is appropriate

for the NASD to take measured steps to redress the economic

incentives for frequent intra-day trading inherent in SOES to

prevent SOES activity from having a negative effect on market prices

and volatility.\11\

---------------------------------------------------------------------------

\11\Id. at 69425-26 (footnotes omitted).

---------------------------------------------------------------------------

f. The Commission does not believe that intra-day trading

strategies through SOES contribute significantly to market

efficiency in the sense of causing prices to reflect information

more accurately.\12\

---------------------------------------------------------------------------

\12\Id.

---------------------------------------------------------------------------

g. The Commission has evaluated each of the proposed

modifications to SOES, and concludes that each of the modifications

reduces the adverse effects of active trading through SOES and

better enables market makers to manage risk while maintaining

continuous participation in SOES. In addition, the Commission does

not believe that any of the modifications will have a significant

negative effect on market quality. To the extent that any of the

modifications may result in a potential loss of liquidity for small

investor orders, the Commission believes that these reductions are

marginal and are outweighed by the benefits of preserving market

maker participation in SOES and increasing the quality of executions

for public and institutional orders as a result of the

modifications.\13\

---------------------------------------------------------------------------

\13\Id.

---------------------------------------------------------------------------

h. The Commission * * * has determined that the instant

modifications to SOES further the objectives of investor protection

and fair and orderly markets, and that these goals, on balance,

outweigh any marginal effects on liquidity for small retail orders,

and any anticompetitive effects on order entry firms and their

customers. The Commission concludes that the ability of active

traders to place trades through a system designed for retail

investors can impair market efficiency and jeopardize the level of

market making capital devoted to Nasdaq issues. The Commission

believes that the rule change is an appropriate response to active

trading through SOES, and that the modifications will reduce the

effects of concentrated intra-day DOES activity on the market.\14\

---------------------------------------------------------------------------

\14\Id. at 69429.

The NASD believes these significant statutory findings by the SEC

regarding the Interim SOES Rules and the SEC's assessment of the likely

benefits to the marketplace that would result from the rules have been

confirmed and substantiated by an econometric study conducted by the

NASD's Economic Research Department on the effectiveness of the Interim

SOES Rules.\15\ When the SEC approved the Interim SOES Rules, it stated

that ``[a]ny further action the NASD seeks with respect to SOES--

extension of these modifications upon expiration, or introduction of

other changes--will require independent consideration under Section 19

of the Act.''\16\ In addition, the SEC stated that, should the NASD

desire to extend these SOES changes or modify SOES, the Commission

would expect ``the NASD to monitor the quality of its markets and

assess the effects of these changes on market quality for Nasdaq

securities.'' Also, if feasible, the SEC instructed the NASD to provide

a quantitative and statistical assessment of the effects of the SOES

changes on market quality; or, if an assessment is not feasible, the

SEC stated that the NASD should provide a reasoned explanation

supporting that determination.

---------------------------------------------------------------------------

\15\Securities Exchange Act Release No. 35080 (Dec. 9, 1994)

(Commission notice of a letter from Gene Finn, Vice President &

Chief Economist, NASD, to Katherine England, Assistant Director,

National Market System & OTC Regulation, SEC, dated October 24,

1994, submitted in connection with the NASD's NPROVE filing,

File No. SR-NASD-94-13).

\16\Interim SOES Rules Approval Order, supra note 1, 59 FR at

69429. Amendment No. 4 to the NASD's filing for the Interim SOES

Rules also states that the NASD ``understand[s] that because of

substantial negative comment on the modifications, the SEC may wish

to review the impact of the changes after they have been in effect

for a reasonable time frame. The NASD believes that a one-year pilot

will provide a reasonable period to observe the operation of the

modifications and confirm the absence of adverse impact on SOES

averred in the comments. The experience during the pilot period will

also permit the NASD to better evaluate the prudence of requesting

permanent approval of these interim changes. For these reasons, the

NASD hereby requests that the SEC approve the proposal for a one-

year pilot.'' See letter from Robert E. Aber, Vice President &

General Counsel, Nasdaq, to Selwyn Notelovitz, Branch Chief, SEC,

dated November 29, 1993.

---------------------------------------------------------------------------

In sum, the NASD's study found that:

Since the SOES changes went into effect in January

1994, the statistical evidence indicated that when average daily

volume, stock price, and stock price volatility are held constant

through regression techniques, quoted percentage spreads in Nasdaq

securities experienced a decline in the immediate period following

implementation of the changes and have continued to decline since

then. The statistical evidence also showed that the narrowing of

quoted percentage spreads became more pronounced and robust the

longer the Interim SOES Rules were in effect. In particular, quoted

spreads in cents per share for the 500 largest Nasdaq National

Market securities experienced a sharp decline from April 28 to May

12 and from June 23 to July 18 (footnote omitted);

With the exception of a brief, market-wide period of

volatility experienced by stocks traded on Nasdaq, the New York

Stock Exchange, and the American Stock Exchange during the Spring,

the volatility of Nasdaq securities appears to be unchanged in the

period following implementation of the changes; and

A smaller percentage of Nasdaq stocks experienced

extreme relative price volatility after implementation of the rules

and that these modifications, in turn, suggest a reduction in

relative volatilities since the rules were put into effect.

The NASD also believes that its study of the effectiveness of the

Interim SOES Rules lends credence to another NASD study that was

submitted to the SEC in support of approval of the Interim SOES

Rules.\17\ In the May 1993 SOES Study, the NASD found that concentrated

waves of orders entered into SOES by active order-entry firms resulted

in discernible degradation to the quality of the Nasdaq market.

Specifically, the study found, among other things, that: (1) Bursts of

orders entered into SOES by active order entry firms frequently result

in a decline in the bid price and a widening of the bid-ask spread; (2)

that there is a significant positive relationship between increases in

spreads and volume attributable to active order-entry firms as it

related to total SOES volume per security; and (3) activity by active

order-entry firms resulted in higher price volatility and less

liquidity--higher price changes are associated with high active trading

firm volume, even after controlling for normal price fluctuations.

Given the positive market effects associated with the Interim SOES

Rules, the NASD believes the findings of the May 1993 SOES Study as

well as the economic assumptions, principles, and hypotheses underlying

the study should not be dismissed by the Commission as ``inconclusive''

and that more weight should be given to the study.

---------------------------------------------------------------------------

\17\See NASD Department of Economic Research: Impact of SOES

Active Trading Firms on Nasdaq Market Quality (May 12, 1993) (``May

1993 SOES Study''). See also Securities Exchange Act Release No.

32313 (May 17, 1993), 58 FR 29647 (publication of the study for

comment).

---------------------------------------------------------------------------

Therefore, in light of all the above-cited statutory findings made

by the SEC when it approved the Interim SOES Rules, coupled with the

NASD's findings that the interim rules have been associated with

positive market developments in terms of lower spreads on Nasdaq and

less stocks with extreme relative price volatility, the NASD believes

it would be consistent with the Act for the Commission to extend the

Interim SOES Rules for a brief three month period so that the interim

rules can continue on an uninterrupted basis until May 1, 1995, the

anticipated implementation date for NPROVE. In sum, the NASD

believes its study affirms the validity and correctness of the SEC's

prior statutory findings made in connection with the approval of the

interim rules. Moreover, even if the Commission is unwilling to find

positive significance in the NASD's statistical analyses, at the very

least, these studies indicate that the market has not been harmed by

implementation of the Interim SOES Rules. As a result, the Commission's

rationale for the approval of the Interim SOES Rules for one year is

equally compelling, if not more compelling given the apparent positive

effects of the rules, to justify approval of the NASD's proposal to

extend the rules for approximately three months. To do otherwise would

require the SEC to refute its prior findings that the Interim SOES

Rules are consistent with the Act. Given the absence of any evidence of

unanticipated harm associated with implementation of the interim rules,

the NASD believes the Commission would have no factual basis to justify

such a refutation.

Moreover, even if the Commission concludes that the Interim SOES

Rules have had no impact on market quality, the NASD believes the

Commission's approval of New York Stock Exchange (``NYSE'') Rule 80A on

a permanent basis illustrates that the Commission would still have a

sufficient basis to approve an extension of the Interim SOES Rules for

a brief three month period.\18\ When NYSE Rule 80A was proposed, the

Commission received considerable adverse comment to the effect that

there was no causal relationship between index arbitrage and market

volatility and that activation of the rule during turbulent market

conditions could have disastrous effects on related options and futures

markets and actually exacerbate market volatility. Despite these

comments, the Commission approved the proposal on a one-year pilot

basis noting that ``the NYSE proposal represents a modest step,

proposed on a pilot basis, to attempt to address the issue of market

volatility.''\19\ After the one-year pilot, the NYSE prepared a report

that, in the SEC's words, found that ``the standard measures of NYSE

market quality appear largely unaffected by Rule 80A.'' Specifically,

the NYSE Report indicated that: (1) Quotes on the NYSE did not widen

after the 50 DJIA point trigger was reached; and (2) the imposition of

Rule 80A did not have any negative effect on price continuity and depth

in the market.\20\ In addition, in approving Rule 80A on a permanent

basis, the SEC noted that the rule ``represents a modest but useful

step by the NYSE to attempt to address the issue of market

volatility,''\21\ that the rule ``has not been disruptive to the

marketplace,''\22\ and that there was a ``lack of evidence of any

harmful effects of Rule 80A.''\23\ In sum, the SEC discussion of the

statutory basis for approval of NYSE Rule 80A focused in large part on

the fact that Rule 80A did not have any adverse impacts on market

quality on the NYSE and that, as a result, the NYSE should be given the

latitude to take reasonable steps to address excessive volatility in

its marketplace. Accordingly, the NASD believes the SEC should afford

the NASD the same regulatory flexibility that it afforded the NYSE to

implement rules reasonably designed to enhance the quality of Nasdaq

and minimize the effects of potentially disruptive trading practices.

---------------------------------------------------------------------------

\18\Rule 80A provides that when the Dow Jones Industrial Average

declines or advances by 50 points or more, all index arbitrage

orders to sell or buy must be executed in a market stabilizing

manner.

\19\See Securities Exchange Act Release No. 28282 (July 30,

1990), 55 FR 31468, 31472 (Order approving File Nos. SR-NYSE-90-5

and SR-NYSE-90-11).

\20\See Securities Exchange Act Release No. 29854 (October 24,

1994), 56 FR 55963 (October 30, 1994) (order approving file SR-NYSE-

91-21) (``Rule 80A Approval Order'').

\21\Id. 56 FR at 55967.

\22\Id.

\23\Id. 56 FR at 55967-68.

---------------------------------------------------------------------------

The NASD believes that the proposed rule change is consistent with

Sections 15A(b)(6), 15A(b)(9), 15A(b)(11) and 11A(a)(1)(C) of the Act.

Among other things, Section 15A(b)(6) requires that the rules of a

national securities association be designed to prevent fraudulent and

manipulative acts and practices, to promote just and equitable

principles of trade, to foster cooperation and coordination with

persons engaged in regulating, clearing, settling, processing

information with respect to, and facilitating transactions in

securities, to remove impediments to and perfect the mechanism of a

free and open market and a national market system and in general to

protect investors and the public interest. Specifically, the NASD is

proposing to retain the Interim SOES Rules for three months because of

concerns that concentrated, aggressive use of SOES by a growing number

of order entry firms has resulted in increased volatility in quotations

and transaction prices, wider spreads, and the loss of liquidity for

individual and institutional investor orders, all to the detriment of

public investors and the public interest. The NASD believes the Interim

SOES Rules have operated to rectify this situation while continuing to

provide an effective opportunity for the prompt, reliable execution of

small orders received from the investing public. With respect to the

proposal to remove the short sale prohibition from SOES, by expanding

the spectrum of retail orders that will be eligible to receive

automatic executions through SOES, the NASD believes the proposal may

enhance investor protection. Nonetheless, the NASD is very concerned

that re-allowing the entry of short sales into SOES may contribute to

destabilizing short term trading through SOES that could have adverse

corollary effects throughout Nasdaq.\24\ Accordingly, in order to

protect investors and the public interest, the NASD believes the

Interim SOES Rules should be extended until May 1, 1995, so that small

investors' orders will continue to receive the fair and efficient

executions that SOES was designed to provide.

---------------------------------------------------------------------------

\24\The NASD will, therefore, review the volume and impact of

short sales effected through SOES on an on-going basis to determine

whether it is appropriate in the interests of maintaining fair and

orderly markets to continue to allow short-sales through SOES.

---------------------------------------------------------------------------

Section 15A(b)(9) provides that the rules of the Association may

not impose any burden on competition not necessary or appropriate in

furtherance of the purposes of the Act. The Interim SOES Rules apply

across the board and do not target any particular user or participant.

For instance, all SOES orders must be for 500 shares or less, according

to the tier size requirements, all dealers may set their exposure

limits at two times the tier size, and all dealers may elect to utilize

the automated quote update feature. Accordingly, the NASD believes that

these rule changes are not anti-competitive, as they are uniform in

application and they seek to preserve the ability of SOES to provide

fair and efficient automated executions for small investor orders,

while preserving market maker participation in SOES and market

liquidity.

Section 15A(b)(11) empowers the NASD to adopt rules governing the

form and content of quotations relating to securities in the Nasdaq

market. Such rules must be designed to produce fair and informative

quotations, prevent fictitious and misleading quotations, and promote

orderly procedures for collecting and distributing quotations. The NASD

is seeking to continue the effectiveness of the Interim SOES Rules so

that SOES activity may not result in misleading quotations in the

Nasdaq market. Market makers place quotes in the Nasdaq system and

these quotes comprise the inside market and define the execution

parameters of SOES. When volatility in the SOES environment causes

market makers to widen spreads or to change quotes in anticipation of

waves of SOES orders, quotes in the Nasdaq market become more volatile

and may be misleading to the investing public. Accordingly, absent

continuation of the Interm SOES Rules, the quotations published by

Nasdaq may not reflect the true market in a security and, as a result,

there may be short-term volatility and loss of liquidity in Nasdaq

securities, to the detriment of the investing public. Further, the

continuation of the automated refresh feature will ensure that a market

maker's quotation is updated after an exposure limit is exhausted.

Uninterrupted use of this function will maintain continuous quotations

in Nasdaq as market makers exhausting their exposure limits in SOES

will not be subject to a ``closed quote'' condition or an unexcused

withdrawal from the market. Finally, the NASD notes that despite the

reduction in the maximum order size for SOES, market makers are still

obligated to adhere to minimum display size requirements for quotations

in Nasdaq National Market securities and Nasdaq SmallCap securities.

Finally, the NASD believes that the proposed rule change is

consistent with significant national market system objectives contained

in Section 11A(a)(1)(C) of the Act. This provision states it is in the

public interest and appropriate for the protection of investors and the

maintenance of fair and orderly markets to assure, among other things,

(i) economically efficient execution of securities transactions; (ii)

fair competition among brokers and dealers; and (iii) the practicality

of brokers executing investor orders in the best market. Specifically,

the Interim SOES Rules advance each of these objectives by preserving

the operational efficiencies of SOES for the processing of small

investors' orders, by maintaining current levels of market maker

participation through reduced financial exposure from unpreferenced

orders exceeding 500 shares, and by reducing price volatility and the

widening of market makers' spreads in response to the practices of

order entry firms active in SOES. With respect to the proposal to

remove the short sale prohibition from SOES, by expanding the spectrum

of retail orders that will be eligible to receive automatic executions

through SOES, the NASD believes the proposal may enhance investor

protection. Nonetheless, the NASD is very concerned that re-allowing

the entry of short sales into SOES may contribute to destabilizing

short term trading through SOES that could have adverse corollary

effects throughout Nasdaq.\25\

---------------------------------------------------------------------------

\25\As indicated above, the NASD will review the volume and

impact of short sales effected through SOES on an on-going basis.

---------------------------------------------------------------------------

In addition, for the same reasons provided by the SEC when it

approved the Interim SOES Rules that are cited above in the text

accompanying footnotes four through eleven, the NASD believes that the

proposed rule change is consistent with Sections 15A(b)(6), 15A(b)(9),

15A(b)(11), and 11A(a)(1)(C) of the Act.

B. Self-Regulatory Organization's Statement on Burden on Competition

The NASD believes that the proposed rule change will not result in

any burden on competition that is not necessary or appropriate in

furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments of the Proposed

Rule Change Received from Members, Participants, or Others

Comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reasons for so finding or (ii) as to

which the NASD consent, the Commission will:

A. By order approve such proposed rule change, or

B. Institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and

arguments concerning the foregoing. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

Copies of the submission, all subsequent amendments, all written

statements with respect to the proposed rule change that are filed with

the Commission, and all written communications relating to the proposed

rule change between the Commission and any person, other than those

that may be withheld from the public in accordance with the provisions

of 5 U.S.C. 552, will be available for inspection and copying in the

Commission's Public Reference Room. Copies of such filing will also be

available for inspection and copying at the principal office of the

NASD. All submissions should refer to the file number SR-NASD-94-68 and

should be submitted by January 6, 1995.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\26\

---------------------------------------------------------------------------

\26\17 CFR 200. 30-3(a)(12)(1994).

---------------------------------------------------------------------------

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-30914 Filed 12-15-94; 8:45 am]

BILLING CODE 8010-01-M