Self-Regulatory Organizations; Notice of Filing and Immediate Effectiveness of Proposed Rule Change by the National Association of Securities Dealers, Inc. (``NASD'' or ``Association'') Relating to the Application of the Primary Nasdaq Market Maker Rule to Initial Public Offerings

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-37426; File No. SR-NASD-96-25]

Self-Regulatory Organizations; Notice of Filing and Immediate

Effectiveness of Proposed Rule Change by the National Association of

Securities Dealers, Inc. (``NASD'' or ``Association'') Relating to the

Application of the Primary Nasdaq Market Maker Rule to Initial Public

Offerings

July 11, 1996.

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

(``Act''),\1\ notice is hereby given that on June 21, 1996, the

National Association of Securities Dealers (``NASD'' or

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

(``Commission'') the proposed rule change as described in Items I, II,

and III below, which Items have been prepared by the self-regulatory

organization. The Commission is publishing this notice to solicit

comments on the proposed rule change from interested persons.

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

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

of the Proposed Rule Change

The NASD proposes to amend NASD Rule 4612,\2\ the NASD's Primary

Nasdaq Market Maker Standards Rule (``PMM Rule''), to clarify and

codify NASD interpretations with respect to the application of the PMM

Rule to initial public offerings (``IPOs''). A more detailed

explanation and description of these interpretations will also be

provided in a Special Notice-to-Members to be issued contemporaneously

with the submission of this filing. Proposed new language is

italicized:

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\2\ Prior to the revision of the NASD Manual, Rule 4612 was

Section 49 of the NASD Rules of Fair Practice.

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NASD Rule 4612 Primary Nasdaq Market Maker Standards

* * * * *

(g)(2) * * *

(B) For initial public offerings (IPOs):

(i) the market maker may register in the offering and immediately

become a

[[Page 37522]]

Primary Nasdaq Market Maker if it is a Primary Nasdaq Market Maker in

80% of the securities in which it has registered; provided, however,

that if, at the end of the first review period, the Primary Nasdaq

Market Maker has withdrawn on an unexcused basis from the security or

has not satisfied the qualification criteria, it shall not be afforded

a Primary Nasdaq Market Maker designation on any subsequent initial

public offerings for the next 10 business days; or

(ii) the market maker registers in the stock as a regular Nasdaq

market maker and satisfies the qualification criteria for the next

review period.

(C) For purposes of subparagraph (B)(i) above:

(i) an issue ceases to be an IPO once it has traded on Nasdaq for

five (5) business days; and

(ii) the applicable first review period for IPOs that come to

market during the last five (5) business days of a month is the

calendar month after the month in which the IPO commenced trading on

Nasdaq.

* * * * *

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

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the NASD included statements

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

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

text of these statements and Special Notice-to-Members may be examined

at the places specified in Item IV below. The NASD has prepared

summaries, set forth in Sections A, B, and C below, of the most

significant aspects of such statements.

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

Statutory Basis for, the Proposed Rule Change

1. Purpose

On June 29, 1994, the SEC approved the NASD's short-sale rule

applicable to short sales \3\ in the Nasdaq National Market

(``NNM'').\4\ The rule, which has been approved by the Commission on a

pilot basis through August 3, 1996,\5\ prohibits member firms from

effecting short sales at or below the current inside bid as

disseminated by the Nasdaq system whenever that bid is lower than the

previous inside bid.\6\

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\3\ The term ``short sale'' refers to a sale of a security which

the seller does not own or any sale which is consummated by the

delivery of a security borrowed by, or for the account of, the

seller. To determine whether a sale is a short sale, members must

adhere to the definition of a ``short sale'' contained in SEC Rule

3b-3, which rule is incorporated into Nasdaq's short sale rule by

NASD Rule 3350(k)(1).

\4\ See Securities Exchange Act Release No. 34277 (Jun. 29,

1994), 59 FR 34885 (July 7, 1994) (order approving File No. SR-NASD-

92-12).

\5\ See Securities Exchange Act Release No. 36532 (Nov. 30,

1995), 60 FR 62519 (Dec. 6, 1995) (order approving File No. SR-NASD-

95-58).

\6\ Nasdaq calculates the inside bid and the best bid from all

market makers in the security (including bids on behalf of exchanges

trading Nasdaq securities on an unlisted trading privileges basis),

and disseminates symbols to denote whether the current inside bid is

an ``up bid'' or a ``down bid.'' Specifically, an ``up bid'' is

denoted by a green ``up'' arrow symbol and a ``down bid'' is denoted

by a red ``down'' arrow symbol. Accordingly, absent an exemption

from the rule, a member can not effect a short sale at or below the

inside bid in a security in its proprietary account or an account of

a customer if there is a red arrow next to the security's symbol on

the screen. In order to effect a ``legal'' short sale on a down bid,

the short sale must be executed at a price at least a \1/16\ of a

point above the current inside bid. Conversely, if the security's

symbol has a green up arrow next to it, members can effect short

sales in the security without any restrictions. The rule is in

effect during normal domestic market hours (9:30 a.m. to 4:00 p.m.,

Eastern Standard Time).

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In order to ensure that market maker activities that provide

liquidity and continuity to the market are not adversely constrained

when the short sale rule is invoked, the rule provides an exemption to

``qualified'' Nasdaq market makers. Even if a market maker is able to

avail itself of the qualified market maker exemption, it can only

utilize the exemption from the short sale rule for transactions that

are made in connection with bona fide market making activity. If a

market maker does not satisfy the requirements for a qualified market

maker, it can remain a market maker in the Nasdaq system, however, it

can not take advantage of the exemption from the rule.

From February 1, 1996 to August 3, 1996, a ``qualified'' Nasdaq

market maker is defined to be a market maker that satisfies the

criteria for a PMM found in NASD Rule 4612.\7\ To qualify as a PMM,

market makers must satisfy at least two of the following three

criteria: (1) The market maker must be at the best bid or best offer as

shown on the Nasdaq system no less than 35 percent of the time; (2) the

market maker must maintain a spread no greater than 102 percent of the

average dealer spread; or (3) no more than 50 pernet of the market

maker's quotation updates may occur without being accompanied by a

trade execution of at least one unit of trading. If, however, the

market maker satisfies only one of the criteria, the market maker may

still qualify as a PMM if the market maker executes 1\1/2\ times its

``proportionate'' volume in the stock.\8\ If a market maker is a PMM, a

``P'' indicator is displayed next to its market maker identification to

denote that it is a PMM.\9\

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\7\ Before the PMM standards went into effect, a ``qualified

market maker'' was defined to be a market maker that had entered

quotations in the relevant security on an uninterrupted basis for

the preceding 20 business days, the so-called ``20-day test.''

\8\ For example, if there are 10 market makers in a stock, each

dealer's proportionate share volume would be 10 percent; therefore,

1\1/2\ times proportionate share volume would mean 15 percent of

overall volume.

\9\ The review period for satisfaction of the PMM performance

standards is one calendar month. If a PMM has not satisfied the

threshold standards after a particular review period, the PMM

designation will be removed commencing on the next business day

following notice of failure to comply with the standards. Market

makers may requalify for designation as a Primary Market Maker by

satisfying the threshold standards for the next review period.

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With respect to initial public offerings, the PMM Rule provides

that if a member firm has obtained PMM status in 80 percent or more of

the stocks in which it has registered (``80 Percent Firm''), the firm

may immediately become a PMM in an IPO by registering and entering

quotations in the issue.\10\ However, if the firm: (1) withdraws from

the IPO on an unexcused basis any time during the calendar month in

which the IPO commenced trading on Nasdaq or (2) fails to meet the PMM

standards for the month in which the IPO commenced trading on Nasdaq,

then the entire firm is precluded from becoming a PMM in any other IPO

for ten business days following unexcused withdrawal or failure to meet

the PMM standards (``10-day penalty rule'').\11\

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\10\ The PMM rule also has provisions applicable to secondary

offerings and merger and acquisition situations. See subparagraphs

(g)(2)(A) and (g)(3) of NASD Rule 4612.

\11\ If a market maker were to register in an IPO as a non-PMM

despite the fact that its firm met the 80 Percent Test, then the

ten-day penalty rule would not be activated if the market maker were

to withdraw from the IPO on an unexcused basis or fail to meet the

PMM standards for the issue. Since Nasdaq automatically appends a

PMM designation to an ``80 Percent Firm'' when it registers in an

IPO, it is incumbent upon the firm to notify Nasdaq Market

Operations when it wishes to trade as a non-PMM in an IPO before it

begins quoting the issue.

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The purpose of the instant rule filing is to amend the PMM Rule to

implement and codify two recent NASD interpretations concerning the

operation of the PMM Rule in IPO situations. The first amendment

reflects that a newly-listed Nasdaq issue ceases to be an IPO once it

has traded on Nasdaq for five business days. Thus, if an ``80 Percent

Firm'' registered in a stock on the sixth business day after the issue

was first listed on Nasdaq and thereafter withdrew from the stock on an

unexcused basis during the calendar month in which the issue commenced

trading on Nasdaq, the firm would not be subject to the ``10-day

penalty

[[Page 37523]]

rule.'' \12\ The second amendment provides that the applicable first

PMM review period for IPOs that come to market during the last five

business days of a month is the calendar month after the month in which

the IPO commenced trading on Nasdaq. Thus, if an IPO comes to market on

the last day of a month, the applicable PMM review period would be the

next full calendar month, not the single day on which the issue was

first listed on Nasdaq. The NASD believes this amendment is appropriate

because it avoids situations where NASD members may be potentially

subject to the ``ten-day penalty rule'' based on just a few days of

trading activity.

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\12\ The market maker, however, would be subject to the 20 day

penalty rule. See NASD Rule 4730.

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2. Statutory Basis

The NASD believes the proposed rule change is consistent with

Section 15A(b)(6) of the Act.\13\ 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

believes the proposed rule change will help to ensure the fair and

efficient operation and administration of the PMM Rule. The NASD also

believes the proposed rule change will help to ensure that NASD members

understand the operation of the PMM Rule.

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\13\ 15 U.S.C. 78o-3(b)(6).

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

The proposed rule change does not impose 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 on the Proposed

Rule Change Received From Members, Participants, or Others

The Association has neither solicited nor received written comments

on the proposed rule change.

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

Commission Action

The foregoing rule change constitutes a stated policy, practice, or

interpretation with respect to the meaning, administration, or

enforcement of an existing rule and, therefore, has become effective

pursuant to Section 19(b)(3)(A) of the Act \14\ and subparagraph (e) of

Rule 19b-4 thereunder.\15\

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\14\ 15 U.S.C. 78s(b)(3)(A).

\15\ 17 CFR 240.19b-4.

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At any time within sixty days of the filing of such proposed rule

change, the Commission may summarily abrogate such rule change if it

appears to the Commission that such action is necessary or appropriate

in the public interest, for the protection of investors, or otherwise

in furtherance of the purposes of the Act.

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, NW., Washington, DC 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 at the

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

available for inspection and copying at the principal office of the

National Association of Securities Dealers, Inc. All submissions should

refer to File No. SR-NASD-96-25 and should be submitted by August 8,

1996.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\16\

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\16\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96-18171 Filed 7-17-96; 8:45 am]

BILLING CODE 8010-01-M