Self-Regulatory Organizations; Notice of Filing and Order Granting Accelerated Partial Approval to Amendment No. 4 to Proposed Rule Change 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. 34-40140; File No. SR-NASD-98-26]

Self-Regulatory Organizations; Notice of Filing and Order

Granting Accelerated Partial Approval to Amendment No. 4 to Proposed

Rule Change 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

June 26, 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 19b-4 thereunder,\2\ a proposed rule

change 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\

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

\2\ 17 CFR 240.19b-4.

\3\ Securities Exchange Act Release No. 39819 (March 30, 1998)

63 FR 16841 (April 6, 1998).

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On April 30, 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 would run to July 1, 1998,

through January 4, 1999; and (e) 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. Also on April 30, 1998, the Commission

issued notice of Amendment No. 3 and approved, on an accelerated basis,

Nasdaq's request to continue to suspend the current PMM standards until

July 1, 1998.\5\ The Commission also extended the comment period for

the proposed rule change.

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

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

Division, of Market Regulation (``Division''), SEC, dated April 29,

1998. Securities 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.

\5\ See Securities Exchange Act Release No. 39936 (April 30,

1998) 63 FR 25253 (May 7, 1998).

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On June 24, 1998, Nasdaq filed Amendment No. 4 to the proposal,\6\

proposing to: (a) extend the comment period to July 27, 1998; (b)

continue to suspend the current PMM standards until October 1, 1998;

and (c) change the dates during which the PMM pilot would run to

October 1, 1998, until April 1, 1999.

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\6\ See letter from Robert E. Aber, Senior Vice President and

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

Division, SEC, dated June 24, 1998.

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Background

Presently, 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

the SEC Order Handling Rules \7\ and what some perceive as a concurrent

move toward 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.\8\

Currently, all market makers are designated as PMMs.

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\7\ 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 designed to enhance the quality of published quotations

for securities and promote competition and pricing efficiency in

U.S. securities markets (collectively, the ``Order Handling

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

6, 1996) 61 FR 48290 (September 12, 1996).

\8\ See Securities Exchange Act Release No. 38294 (February 14,

1997) 62 FR 8289 (February 24, 1997) (approving temporary suspension

of PMM standards); Securities Exchange Act Release No. 39198

(October 3, 1997) 62 FR 53365 (October 14, 1997) (extending

suspension through April 1, 1998); Securities Exchange Act Release

No. 39819 (March 30, 1998) 63 FR 16841 (April 6, 1998) (extending

suspension through May 1, 1998); Securities Exchange Act Release No.

39936 (April 30, 1998) 63 FR 25253 (May 7, 1998) (extending

suspension through July 1, 1998).

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Since February 1997, Nasdaq has worked to develop PMM standards

that are more meaningful in what may be an increasingly order-driven

environment and that better identify firms engaged in responsible

market making activities deserving of the benefits associated with

being a PMM, such as being exempt from NASD Rule 3350, the NASD's Short

Sale Rule. The NASD now proposes to extend the current suspension of

the existing PMM standards and to implement new standards on a pilot

basis from October 1, 1998, until April 1, 1999. The NASD intends the

new standards to better evaluate whether a market maker provides

meaningful liquidity to the market. To determine whether a particular

market maker is such a provider of 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, in Amendment No. 4, to

continue to suspend the current PMM standards until October 1, 1998.

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 to the proposed rule change,

as amended, to July 27, 1998.

II. Proposed Rule Change

As discussed in detail in Securities Exchange Act Release No.

39819, Nasdaq is proposing a new set of PMM standards. In the current

filing, Nasdaq would amend the timing of the proposed pilot through

which the NASD, the SEC, and the public may evaluate those new

standards.

* * * * *

[[Page 36465]]

The proposed rule language, as amended, follows. Additions are

italicized; deletions are bracketed.

Rule 4612

(a)-(g) 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 October

1, 1998, and remain in effect until April 1, 1999.

* * * * *

III. Discussion

After careful consideration, the Commission has concluded, for the

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

of existing PMM standards until October 1, 1998, is consistent with the

requirements of the Exchange Act and the rules and regulations

thereunder. Extending the suspension of the current PMM standards to

accommodate implementing the new pilot is consistent with Section

15A(b)(6) \9\ of the Exchange Act. Section 15A(b)(6) of the Exchange

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

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

market and a national market system 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.

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\9\ 15 U.S.C. 78o-3(b)(6).

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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 NASD's Short Sale Rule, any market maker exemptions

to that rule, and the proposed new PMM standards. The Commission

recognizes that the 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 PMM 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 effective October 1,

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

Amendment No. 4, 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 designated on the pilot's

proposed start date of October 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. 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 October 1, 1998, will lose its PMM

status--based on a failure to meet the new PMM standards--until

December 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 proposed new PMM standards are more stringent than the

previous standards. The PMM pilot, pursuant to Amendment No. 4, would

run until April 1, 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 the filing in the Federal Register. 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 July 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 October 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 change, as amended, to July 27, 1998. Since making the

proposal, the NASD has issued reports to all Nasdaq market makers in

NNM issues to show how those market makers would have performed for

April and May of 1998 had the proposed PMM standards been in place. The

NASD also posted on The Nasdaq Trader Web Site \10\ a stock-by-stock

analysis of what percentage of market makers in each stock would have

been PMMs under the proposed PMM standards in April and May of 1998.

The Commission expects such data will allow market participants to

submit more meaningful comments.

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\10\ See http://www.nasdaqtrader.com.

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

arguments concerning the foregoing, including whether the proposed rule

change is consistent with the Exchange Act. In particular, the

Commission requests that commenters provide alternative PMM standards,

explaining why such alternative standards better identify and reward

market participants who provide meaningful liquidity to the Nasdaq

market. 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 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. Sec. 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 July 27, 1998.

[[Page 36466]]

V. Conclusion

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

Exchange Act,\11\ that the portion of Amendment No. 4 to the proposed

rule change, SR-NASD-98-26, that extends the suspension of the current

PMM standards to October 1, 1998, be and hereby is approved on an

accelerated basis.\12\

\11\ 15 U.S.C. 78s(b)(2).

\12\ In partially approving the proposal, the Commission has

considered the approved portion's impact on efficiency, competition,

and capital formation. Moreover, the pilot program, if fully

implemented, 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).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\13\

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\13\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-17718 Filed 7-2-98; 8:45 am]

BILLING CODE 8010-01-M