Self-Regulatory Organization; Notice of Filing and Order Granting Accelerated Partial Approval to Amendment No. 3 to Proposed Rule Changes by the National Association of Securities Dealers, Inc. to Institute, on a Pilot Basis, New Primary Nasdaq Market Maker Standards for Nasdaq National Market Securities

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39936; File No. SR-NASD-98-26]

Self-Regulatory Organization; Notice of Filing and Order Granting

Accelerated Partial Approval to Amendment No. 3 to Proposed Rule

Changes by the National Association of Securities Dealers, Inc. to

Institute, on a Pilot Basis, New Primary Nasdaq Market Maker Standards

for Nasdaq National Market Securities

April 30, 1998.

I. Introduction

On March 19, 1998, the National Association of Securities Dealers,

Inc. (``NASD'' or ``Association''), through its wholly-owned subsidiary

The Nasdaq Stock Market, Inc. (``Nasdaq''), submitted to the Securities

and Exchange Commission (``SEC'' or ``Commission''), pursuant to

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

Act'') \1\ and Rule 196-4 thereunder,\2\ proposed rule changes to: (a)

Implement, on a pilot basis, new Primary Nasdaq Market Maker (``PMM'')

standards for all Nasdaq National Market (``NNM'') securities; (b)

extend the NASD's Short Sale Rule pilot until November 1, 1998; and (c)

extend the suspension of existing PMM standards until May 1, 1998. On

March 30, 1998, the Commission issued notice of the filing and

approved, on an accelerated basis, the portions of the filing extending

the NASD's Short Sale Rule pilot and the suspension of existing PMM

standards.\3\

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

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

\2\ 17 CFR 240.19b-4.

\3\ Exchange Act Release No. 39819 (March 30, 1998) 63 FR 16841

(April 6, 1998).

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

On April 29, 1998, Nasdaq filed Amendment No. 3 to the proposal,\4\

proposing to: (a) Extend the comment period by 30 days to May 27, 1998;

(b) continue to suspend the current PMM standards until July 1, 1998;

(c) extend the NASD's Short Sale Rule pilot until January 4, 1999; (d)

change the dates during which the PMM pilot will run to July 1, 1998,

through January 4, 1999. Nasdaq also is proposing to amend subparagraph

(g) of NASD Rule 4612 to change the method for determining how market

makers that are not managers or co-managers in an underwriting

syndicate of a secondary offering may qualify as PMMs. Nasdaq has

requested accelerated approval of the suspension of the current PMM

standards.

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

\4\ See letter from Robert E. Aber, Senior Vice President and

General Counsel, Nasdaq, to Richard Strasser, Assistant Director,

Division of Market Regulation, SEC, dated April 29, 1998. Exchange

Act Release No. 39819 discussed Amendment No. 1 and Amendment No. 2

to the filing, which were filed with the Commission on March 25 and

26, 1998, respectively.

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

Background

Present, NASD Rule 4612 provides that a member registered as a

Nasdaq market maker pursuant to NASD Rule 4611 may be deemed a PMM if

that member meets certain threshold standards. The implementation of

new Order Execution Rules \5\ and the concurrent move towards a more

order-driven, rather than a quote-driven, market raised questions about

the continued relevance of those PMM standards. As a result, such

standards were suspended beginning in early 1997.\6\ Currently, all

market makers are designated as PMMS.

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

\5\ On August 29, 1996, the Commission promulgated a new rule,

the Limit Order Display Rule (Exchange Act Rule 11Ac1-4) and adopted

amendments to the Quote Rule (Exchange Act Rule 11Ac1-1), which

together are designated to enhance the quality of published

quotations for securities and promote competition and pricing

efficiency in U.S. securities markets (collectively, the ``Order

Execution Rules''). See Securities Exchange Act Release No. 37619A

(September 6, 1996) 61 FR 48290 (September 12, 1996) (``Order

Execution Rules Adopting Release'').

\6\ See Exchange Act Release No. 38294 (February 14, 1997) 62 FR

8289 (February 24, 1997) (approving temporary suspension of PMM

standards); Exchange Act Release No. 39198 (October 3, 1997) 62 FR

53365 (October 14, 1997) (extending suspension through April 1,

1998); Exchange Act Release No. 39819 (March 30, 1998) 63 FR 16841

(April 6, 1998) (extending suspension through May 1, 1998).

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

Since February 1997, Nasdaq has worked to develop PMM standards

that are more meaningful in an increasingly order-driven environment

and that better identify firms engaged in responsible market making

activities deserving of the benefits associated with begin a PMM, such

as being exempt from NASD Rule 3350, the NASD's short sale rule. The

NASD now proposes to suspend the existing PMM standards and to

implement new standards on a pilot basis from July 1, 1998, until

January 4, 1999. The NASD intends the new standards to better evaluate

whether a market maker providers meaningful liquidity to the market. To

determine whether a particular market maker is such a provider

liquidity, Nasdaq will analyze that market maker's trading activity

using a new test.

For the reasons discussed below, the Commission has determined to

grant accelerated approval of Nasdaq's request to continue to suspend

the current PMM standards until July 1, 1998, as requested in Amendment

No. 3. Further, given the proposal's complexity and the Commission's

desire to give the public sufficient time to consider the proposal, the

Commission has extended the comment period for the proposed rule

changes, as amended, to May 27, 1998.

II. Proposed Rule Changes

As discussed in detail in Exchange Act Release No. 39819, Nasdaq is

proposing a new set of PMM standards. In the current filing, Nasdaq is

proposing an adjustment to the PMM standards with respect to markets

that are not managers or co-managers in an underwriting syndicate of a

secondary offering. In particular, Nasdaq proposes to amend

subparagraph (g)(2) of NASD Rule 4612 to change the method for

determining how market makers that are not managers or co-managers in

an underwriting syndicate of a secondary offering may qualify as PMMs.

Under the previous rule, a market maker could become a PMM after the

secondary offering had been announced or a registration statement had

been filed with the Commission if the market maker was registered in

the security and satisfied the PMM standards for 40 days or until the

registration became effective, whichever occurred first. Thus, for

secondary offerings the rule contained a variable ``review period,''

during which a market maker was required to meet PMM standards. Due to

technological constraints and the fact that PMM calculations under the

proposed rule are more complex than they were under the previous rule,

Nasdaq, in developing the PMM pilot, has been unable to build a system

that is able to make the PMM calculation using a variable review

period. Additionally, it has become clear that the existing rule for

secondary public offerings may be rendered less meaningful because PMM

status under the proposed new standards is determined by comparing and

examining market makers' share volume and number of trades during

definite time periods. Thus, introducing a variable time period could

have consequences that were not foreseen when the new standards were

crafted.

Nasdaq recognizes, however, that market makers should be held to a

more stringent standard before they may trade secondary offerings as

PMMs. Accordingly, Nasdaq proposes to amend NASD Rule 4612 so that a

market maker that wishes to register and become a PMM in a secondary

offering will have to fulfill the following two conditions. First, the

market maker must register and become a market maker in a security for

40 days or until the registration becomes effective, whichever occurs

first. Second, at the time the registration becomes effective or 40

days passes, the market maker

[[Page 25254]]

must be a PMM in 80% or more of the Nasdaq National Market securities

in which it is registered (``80% Firm''). This proposal provides a

meaningful measure as to whether a market maker should be a PMM after a

secondary offering has been announced because it will require market

makers to register and be in a stock for a meaningful time period

(which may be as long as 40 days) and to be an 80% Firm before it may

qualify as a PMM. Furthermore, Nasdaq notes that this approach is in

line with the provisions of NASD rule 4612 regarding initial

registration situations and initial public offerings (``IPO'').

Nasdaq also proposes to amend subparagraph (g)(2)(B) of NASD rule

4612, to clarify the timing for the imposition of a 10 day prohibition

from participating in an IPO (``Over 10 Day Penalty''). This amendment

would codify an interpretation of subparagraph (g)(2)(B) of NASD Rule

4612, that was announced in a For Your Information included in the June

1996 edition of the NASD's Notice to Members. Specifically, the

amendment would clarify that if a PMM in an IPO withdraws on an

unexcused basis in the first review period, the 10 Day Penalty will

commence on the next business day after the unexcused withdrawal.

Additionally, if a PMM in an IPO fails to meet the applicable PMM

thresholds during the first review period, the 10 Day Penalty will

begin on the day the market loses its PMM designation (the third

business day of a month).

* * * * *

The proposed rule language follows. Additions are italicized;

deletions are bracketed.

Rule 4612

(a)-(f) No Change

(g) In registration situations:

(1) No Change

(2) Notwithstanding paragraph (g)(1) above, after an offering in a

stock has been publicly announced or a registration statement has been

filed with the Securities and Exchange Commission, no market maker may

register in the stock as a Primary Nasdaq Market Maker unless it meets

the requirements set forth below:

(A) For secondary offerings[:

(i)], the secondary offering has become effective [and the market

maker has satisfied the qualification criteria in the time period

between registering in the security and the offering becoming

effective] or 40 days have elapsed since the market maker registered in

the security (whichever occurs first), and at such time, the market

maker is a Primary Nasdaq Market Maker in 80% or more of the Nasdaq

National Market Maker securities in which it is registered; provided,

however, that if the member is a manager or co-manager of the

underwriting syndicate for the secondary offering and it is a [PMM]

Primary Nasdaq Market Maker in 80% or more of the Nasdaq National

Market securities in which it is registered, the member is eligible to

become a [PMM] Primary Nasdaq Market Maker in the issue prior to the

effective date of the secondary offering regardless of whether the

member was a registered market maker in the stock before the

announcement of the secondary offering[; or

(ii) the market maker has satisfied the qualification criteria for

40 calendar days].

(BN) For initial public offerings (IPOs):

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

become a 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 at any time during the first review period or has not

satisfied the [qualification criteria] applicable thresholds at the end

of the first review period, it shall not be afforded a Primary Nasdaq

Market Maker designation on any subsequent initial public offerings for

the next 10 business days following the unexcused withdrawal or the

next 10 business days following the day on which the Primary Nasdaq

Market Maker is notified that it failed to satisfy the applicable

thresholds for the first review period (as applicable); or

(ii) No Change.

(C) No Change.

(3) No Change

(h) [The Board of Governors may modify the threshold standards set

forth in paragraphs (a) and (b) above if it finds that maintenance of

such standards would result in an adverse impact on a class of

investors or on Nasdaq.] This rule shall be in effect beginning July 1,

1998, and remain in effect until January 4, 1999.

* * * * *

NASD Rule 3350

(a)-(k) No Changes

(1) This Rule shall be in effect until [November 1, 1998] January

4, 1999.

* * * * *

III. Discussion

After careful consideration, the Commission has concluded, for the

reasons set forth below, that the extension of the current suspensions

of existing PMM standards through July 1, 1998, is consistent with the

requirements of the Exchange Act and the rules and regulations

thereunder. As the Commission discussed in its previous order relating

to the PMM pilot,\7\ extending the suspension of the current PMM

standards to accommodate implementing the new pilot is consistent with

Section 15A(b)(6) \8\ of the Exchange Act. Section 15A(b)(6) of the

Exchange Act requires that the NASD's rules be designed, among other

things, to prevent fraudulent and manipulative acts and practices and

to promote just and equitable principles of trade. The Commission

believes that continued suspension of the current PMM standards will

facilitate Nasdaq's efforts in implementing more meaningful PMM

standards which should help to enhance market liquidity by rewarding

those market makers that meet the new standards. As a result,

continuing the suspension of the current PMM standards is consistent

with Section 15A(b)(6) of the Exchange Act.

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

\7\ See Exchange Act Release No. 39819 (March 30, 1998) 63 FR

16841 (April 6, 1998) (extending suspension through May 1, 1998).

\8\ 15 U.S.C. 78o-3(b)(6).

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

In finding that the suspension of the existing PMM standards is

consistent with the Exchange Act, the Commission reserves judgment on

the merits of the Short Sale Rule, any market maker exemptions to that

rule and the proposed new PMM standards. The Commission recognizes that

the current Short Sale Rule already has generated significant public

comment. Such commentary, along with any further comment on the

interaction of the Short Sale Rule with the proposed new PPM standards,

will help guide the Commission's evaluation of the Short Sale Rule and

new PMM standards. During the PMM pilot period, the Commission

anticipates that the NASD will continue to address the Commission's

questions and concerns and provide the Commission staff with any

relevant information about the practical effects and the operation of

the revised PMM standards and possible interaction between those

standards and the NASD's Short Sale Rule.

As proposed, the new PMM standards will become effectively July 1,

1998, when the suspension of the existing PMM standards, under

Amendment No. 3, expires. Nasdaq notes that currently all market makers

registered in a security are PMMs due to the suspension of the previous

PMM standards, and will continue to be so

[[Page 25255]]

designed on the pilot's proposed start date of July 1, 1998. Under the

one-month look-back provision in the PMM pilot program, Nasdaq will

consider the previous calendar month and the current month to determine

a market maker's continued PMM eligibility if the market maker attained

PMM status in a security during the previous month, but fails to meet

the applicable thresholds for the current month. Nasdaq recognizes that

once the pilot begins on July 1, 1998, PMMs will not have the ability

to avail themselves of the one-month look-back provision because there

will be no meaningful trading to analyze prior to July 1, 1998. Thus,

to give PMMs the full benefit of the one-month look-back period and to

allow market makers time to adjust their trading activity to the new

standards, Nasdaq proposes to implement the new standards so that no

market maker that is designated as a PMM when the pilot begins on July

1, 1998, will lose its PMM status--based on a failure to meet the new

PMM standards--until September 3, 1998. Nasdaq believes, and the

Commission agrees, that it is fair to give market makers this time to

make necessary adjustments to their trading activity to help them

maintain their PMM designation, particularly since PMM standards have

been suspended for more than a year and the new PMM standards are more

stringent than the previous standards. The PMM pilot, pursuant to

Amendment No. 3, would run until January 4, 1999.

The Commission finds good cause for approving the extension of the

suspension of existing PMM standards prior to the 30th day after the

date of publication of notice of filing thereof. It could be disruptive

to market making to reintroduce outdated PMM standards for a brief

period prior to implementing a new PMM pilot. Further, the current PMM

standards have been suspended until May 1, 1998, at which time the old

PMM standards--which are not a meaningful measure of a market maker's

liquidity-providing activity--would be used again to determine market

makers' PMM status. To ensure continuity in the PMM standards and the

regulation of short selling activity, to maintain orderly markets, and

to avoid confusion, it is necessary to continue the suspension of the

prior PMM standards until the new standards are implemented on July 1,

1998.

IV. Solicitation of Comments

Given the proposal's complexity and the Commission's desire to give

the public sufficient time to consider the proposal, the Commission

hereby grants Nasdaq's request to extend the comment period for the

proposed rule changes, as amended, to May 27, 1998. Interested persons

are invited to submit written data, views, and arguments concerning the

foregoing, including whether the proposed rule changes are consistent

with the Exchange Act. Persons making written submissions should file

six copies thereof with the Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W., Washington, DC 20549. Copies of the

submissions, 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 No. SR-NASD-98-26 and should be

submitted by May 27, 1998.

V. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the

Exchange Act,\9\ that Amendment No. 3 to the proposed rule change, SR-

NASD-98-26, which extends, on an accelerated basis, the suspension of

the current PMM standards to July 1, 1998, be and hereby is

approved.\10\

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

\9\ 15 U.S.C. 78s(b)(2).

\10\ In approving the proposal, the Commission has considered

the proposal's impact on efficiency, competition, and capital

formation. The proposal likely will provide the Commission with data

necessary to enable it to evaluate the impact of the proposed PMM

standards on the Nasdaq market and market participants. 15 U.S.C.

78c(f).

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\11\

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

\11\ 17 CFR 200.30-3(a)(12).

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

Jonathan G. Katz,

Secretary.

[FR Doc. 98-12142 Filed 5-6-98; 8:45 am]

BILLING CODE 8010-01-M