Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Notice of Filing of Proposed Rule Change by the NASD Clarifying the Operation of SOES

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38849; File No. SR-NASD-97-50]

Self-Regulatory Organizations; National Association of Securities

Dealers, Inc.; Notice of Filing of Proposed Rule Change by the NASD

Clarifying the Operation of SOES

July 17, 1997.

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

(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on July 14,

1997, 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.

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

of the Proposed Rule

The NASD is submitting this rule filing to clarify the operation of

The Nasdaq Stock Market's (``Nasdaq'') Small Order Execution System

(``SOES'') during non-locked and crossed market situations.

Specifically, the NASD proposes to amend NASD Rule 4730(b)(1) to more

explicitly state the process by which unpreferenced market orders are

executed in SOES. In particular, Rule 4730(b)(1) is being amended to

clarify that once SOES executes an unpreferenced market or marketable

limit order against a SOES market maker, that market maker is not

required to execute another unpreferenced SOES order at the same bid or

offer in the same security until seventeen seconds has elapsed, absent

a quotation update by the market maker within such seventeen second

period. Below is the text of the proposed rule change. Proposed new

language is italicized; proposed deletions are in brackets.

* * * * *

NASD Rule 4730. Participant Obligations in SOES

* * * * *

(b) Market Makers

(1) A SOES Market Maker shall commence participation in SOES by

initially contacting the SOES Operation Center to obtain authorization

for the trading of a particular SOES security and identifying those

terminals on which the SOES information is to be displayed and

thereafter by an appropriate keyboard entry which obligates the firm,

so long as it remains a Market Maker in SOES:

(A) for any security for which it is a SOES Market Maker, to

execute individual orders in sizes equal to or smaller than the

maximum order size; and

(B) for any NNM security for which it is a Market Maker, to

execute individual orders equal in the aggregate to the minimum

exposure limit.

After SOES has executed an order against a Market Maker, that Market

Maker[s] shall not be [have a period of time following their receipt

of an execution report in which to update their quotation in the

security in question before being] required to execute another

unpreferenced order at the same bid or offer in the same security

until a predetermined time period has elapsed from the time the

order was executed, as measured by the time of execution in the

Nasdaq system, provided the Market Maker has not updated its

quotation (bid, offer, or size) within such time period, in which

case the Market Maker will become immediately eligible to receive

another execution of an unpreferenced order. This period of time

shall initially be established as 17 [15] seconds, but may be

modified upon Commission approval and appropriate notification to

SOES participants. All entries in SOES shall be made in accordance

with the requirements set forth in the SOES User Guide.

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

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission,the NASD included statements

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

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

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

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

A, B, and C below, of the most significant aspects of such statements.

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

Statutory Basis for, the Proposed Rule Change

The NASD is submitting this proposal to clarify the process by

which SOES executes unpreferenced market and marketable limit orders.

Presently, NASD Rule 4730(b)(1) provides that:

Market Makers shall have a period of time following their receipt of

an execution report in which to update their quotation in the

security in question before being required to execute another

unpreferenced order at the same bid or offer in the same security.

This period of time shall initially be established as 15 seconds,

but may be modified upon appropriate notification to SOES

participants. . . .

This rule language was added to the NASD's rules in October 1991 so

that SOES market makers would be afforded a brief fifteen-second

opportunity to update their quotations in response to executions

received through SOES (``15-Second SOES Execution Response Period'').

As the current language of Rule 4730(b) reflects, the ``15-Second SOES

Execution Response Period'' commences when a market maker has received

notification of a SOES execution through the system. Indeed, the

description of the ``15-Second SOES Execution Response Period'' in the

SEC's order approving the provision provides that ``[f]ollowing receipt

of an execution report of an unpreferenced purchase or sale through

SOES, a market maker will have a period of time (15 seconds) to update

its quote prior to executing any subsequent transaction on the same

side of the market at the same

[[Page 39884]]

price.'' (footnote omitted).\1\ Because SOES does not have the

capability to determine the exact time when a market maker receives a

SOES execution report, at the time this rule was implemented Nasdaq

estimated that it took up to five seconds for SOES to execute an order

against a market maker and for the market maker to receive a report of

the execution (the ``SOES Execution Report Communication Period''). As

a result, SOES was programmed to uniformly add a five-second period to

the ``15-Second SOES Execution Response Period,'' with the effect that

the system executes unpreferenced market orders against a market maker

in twenty-second intervals, absent a quotation update by the market

maker.

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\1\ Securities Exchange Act Release No. 29810 (October 10,

1991), 56 FR 52098, 52099 (order approving file SR-NASD-91-18).

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Recently, Nasdaq undertook to estimate the time its takes for a

market maker to receive a SOES execution report. This analysis

indicates that on average, the SOES Execution Report Communication

Period is between two and three seconds, although actual time can and

does vary depending on activity and communications traffic during

different periods of the day. It was determined to be appropriate to

assign a two-second period to the SOES Execution Report Communications

Period for purposes of the rule.

With this rule filing, therefore, the NASD proposes to explicitly

incorporate this two-second period into Rule 4730. Specifically, the

NASD proposes to amend Rule 4730 to provide that a market maker shall

not be required to execute another unpreferenced SOES order at the same

bid or offer in the same security until seventeen seconds have elapsed

from the time of execution. The proposed rule change is designed to

retain the ability of a market maker to respond to SOES executions

while recognizing that, under normal circumstances, a minimal period of

time is necessary for reports of those executions to be received by the

market maker. The proposed amendments to Rule 4730(b) also clarify: (1)

That a market maker becomes immediately eligible to receive another

execution through SOES if it updates its quote (its bid, offer, or

size) during the seventeen second period;\2\ and (2) that the seventeen

second period arises regardless of whether the market maker executes an

unpreferenced market order or an unpreferenced marketable limit order.

By amending the rule in this fashion, the rule will eliminate any

ambiguities among market participants concerning the manner in which

unpreferenced orders are executed in SOES. These amendments will also

address a concern about the rule noted by the SEC in its Report

Pursuant to Section 21(a) of the Securities Exchange Act of 1934

Regarding the NASD and the Nasdaq Market (``SEC Report'').\3\

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\2\ The proposed amendments to Rule 4730(b) do not change in any

way the current functionality of SOES whereby preferenced orders are

continuously executed against a market maker without any delay

between executions. In addition, as is presently the case during

locked and crossed markets, SOES will execute orders (both

preferenced and unpreferenced) against those market makers that are

locked or crossed in five second intervals. See NASD Rule

4730(b)(4).

\3\ The SEC stated that ``[t]he NASD should have set forth in

its filings with the Commission seeking approval for the [SOES

execution] delay that the time between executions had been set at

twenty seconds, but did not do so.'' See Appendix to the SEC Report,

at 76.

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The NASD believes that the proposed rule change is consistent with

Section 15A(b)(6) of the Act and SEC Rule 11Ac1-1. 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,

by clarifying the process by which unpreferenced SOES orders are

executed in the NASD's rules, the NASD believes the proposal will

promote fair and orderly markets and the protection of investors.

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 on 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 consents, the Commission will:

A. by order approve such proposed rule change, or

B. institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

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

arguments concerning the foregoing. 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 file number SR-NASD-97-50 and

should be submitted by August 14, 1997.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\4\

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\4\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97-19446 Filed 7-23-97; 8:45 am]

BILLING CODE 8010-01-M