[Federal Register: December 24, 2002 (Volume 67, Number 247)]
[Notices]
[Page 78534-78537]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr24de02-140]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-46999; File No. SR-NASD-98-26 Amendment No. 13]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of a Proposed Rule Change by National
Association of Securities Dealers, Inc. Relating to Extension of Short
Sale Rule and Continued Suspension of Primary Market Maker Standards
Set Forth in NASD Rule 4612
December 13, 2002.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'')\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on December 13, 2002, the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association''), through its subsidiary, The Nasdaq
Stock Market, Inc. (``Nasdaq'') filed with the Securities and Exchange
Commission (``SEC'' or ``Commission'') the proposed rule change as
described in Items I and II below, which Items have been prepared by
the Nasdaq.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
Nasdaq is proposing to extend the pilot program of the NASD short
sale rule from December 15, 2002 until June 15, 2003. Nasdaq is also
seeking to continue the suspension of the effectiveness of the Primary
Market Maker (``PMM'') standards currently set forth in NASD Rule 4162
also from December 15, 2002 until June 15, 2003. Finally, Nasdaq is
proposing to modify the method used to calculate the bid tick indicator
used by members to determine whether a short sale is permitted. The
text of the proposed rule change is as follows. Additions are in
italics; deletions are bracketed.
NASD Rule 3350
(a)
(b)(1) With respect to trades executed on or reported to the ADF,
[N]o member shall effect a short sale for the account of a customer or
for its own account in a Nasdaq National Market security at or below
the current national best (inside) bid when the current national best
(inside) bid is below the preceding national best (inside) bid in the
security.
(2) With respect to trades executed on or reported to Nasdaq, no
member shall effect a short sale for the account of a customer or for
its own account in a Nasdaq National Market security at or below the
current best (inside) bid displayed in the Nasdaq National Market
Execution System when the current best (inside) bid is below the
preceding best (inside) bid in the security.
(b)-(k) No Change.
(l) This section shall be in effect until June 15, 2003 [December
15, 2002].
IM-3350. Short Sale Rule
(a) No Change.
(b) (1) With respect to trades executed on or reported to the ADF,
Rule 3350 requires that no member shall effect a short sale for the
account of a customer or for its own account in a Nasdaq National
Market security at or below the current national best (inside) bid when
the current national best (inside) is below the proceeding national
best (inside) bid in the security. NASD has determined that in order to
effect a ``legal'' short sale when the current best bid is lower than
the preceding best bid the short sale must be executed at a price of at
least $0.01 above the current inside bid when the current inside spread
is $0.01 or greater. The last sale report for such a trade would,
therefore, be above the inside bid by at least $0.01.
(2) With respect to trades executed on or reported to Nasdaq, Rule
3350 requires that no member shall effect a short sale for the account
of a customer or for its own account in a Nasdaq National Market
security at or below the current best (inside) bid displayed in the
Nasdaq National Market Execution System when the current best (inside)
bid is below the proceeding best (inside) bid in the security. Nasdaq
has determined that in order to effect a ``legal'' short sale when the
current best bid is lower than the preceding best bid the short sale
must be executed at a price of at least $0.01 above the current inside
bid when the current inside spread is $0.01 or greater. The last sale
report for such a trade would, therefore, be above the inside bid by at
least $0.01.
(c) No Change.
[[Page 78535]]
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, Nasdaq included statements
concerning the purpose of and basis for the proposed rule change. The
text of these statements may be examined at the places specified in
Item III below. Nasdaq 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. Background and Description of the NASD's Short Sale Rule
Section 10(a) of the Act gives the Commission plenary authority to
regulate short sales of securities registered on a national securities
exchange, as needed to protect investors. Although the Commission has
regulated short sales since 1938, that regulation has been limited to
short sales of exchange-listed securities. In 1992, Nasdaq, believing
that short-sale regulation is important to the orderly operation of
securities markets, proposed a short sale rule for trading of its
National Market securities that incorporates the protections provided
by SEC Rule 10a-1. On June 29, 1994, the SEC approved the NASD's short
sale rule (the ``Rule'') applicable to short sales \3\ in Nasdaq
National Market (``NNM'') securities on an eighteen-month pilot basis
through March 5, 1996.\4\ The NASD and the Commission have extended
Rule 3350 numerous times, most recently, until December 15, 2002.
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\3\ A short sale is a sale of a security that the seller does
not own or any sale that is consummated by the delivery of a
security borrowed by, or for the reason of, the seller. To determine
whether a sale is a short sale members must adhere to the definition
of a ``sort sale'' contained in SEC Rule 3b-3, which is incorporated
into Nasdaq's short sale rule by NASD Rule 3350(k)(1).
\4\ See Securities Exchange Act Release No. 34277 (June 29, 199)
(``Short Sale Rule Approval Order'').
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The Rule employs a ``bid'' test rather than a tick test because
Nasdaq trades are not necessarily reported to the tape in chronological
order. The Rule prohibits short sales at or below the inside bid when
the current inside bid is below the previous inside bid. Nasdaq
calculates the inside bid from all market makers in the security
(including bids for 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.'' To effect a
``legal'' short sale on a down-bid, the short sale must be executed at
a price at least $.01 above the current inside bid. The Rule is in
effect from 9:30 a.m. until 4 p.m. each trading day.
To reduce the compliance burdens on its members, the Rule also
incorporates seven exemptions contained in SEC Rule 10a-1 that are
relevant to trading on Nasdaq.\5\ For example, in an effort to not
constrain the legitimate hedging needs of options market makers, the
Rule also contains a limited exception for standardized options market
makers. The Rule also contains an exemption for warrant market makers
similar to the one available for options market makers.
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\5\ See NASD Rule 3350(c)(2)-(8). The Rule also provides that a
member not currently registered as a Nasdaq market maker in a
security that has acquired the security while acting in the capacity
of a block positioner shall be deemed to own such security for the
purposes of the Rule notwithstanding that such member may not have a
net long position in such security if and to the extent that such
member's short position in such security is subject to one or more
offsetting positions created in the course of bona fide arbitrage,
risk arbitrage, or bone fide hedge activities. In addition, the NASD
has recognized that SEC staff interpretations to SEC Rule 10a-1
dealing with the liquidation of index arbitrage positions and an
``international equalizing exemption'' are equally applicable to the
NASD's short sale rule.
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2. Background of the Primary Market Maker Standards
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, Rule 3350 provides an exemption for ``qualified''
market makers (i.e., market makers that meet the PMM standards).
Presently, NASD Rule 4612 provides that a member registered as a market
maker pursuant to NASD Rule 4611 may be deemed a PMM if that member
meets certain threshold standards.
Since the Rule has been in effect, Nasdaq has used three methods to
determine whether a market maker is eligible for the market maker
exemption. Specifically, from September 4, 1994 through February 1,
1996, Nasdaq market makers that maintained a quotation in a particular
NNM security for 20 consecutive business days without interruption were
exempt from the Rule for short sales in that security, provided the
short sales were made in connection with bona fide market making
activity (``the 20-day'' test). From February 1, 1996 until the
February 14, 1997, the ``20-day'' test was replaced with a four-part
quantitative test known as the PMM standards.\6\
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\6\ Under the PMM standards, a market maker was required to
satisfy at least two of the following four criteria each month to be
eligible for an exemption from the short sale rule: (1) The market
maker must be at the best bid or best offer as shown on Nasdaq no
less than 35 percent of the time; (2) the market maker must maintain
a spread not greater than 102 percent of the average dealer spread;
(3) no more than 50 percent of the market maker's quotation updates
may occur without being accompanied by a trade execution of at least
one unit of trading; or (4) the market maker executes 1\1/2\ times
its ``proportionate'' volumn in the stock. If a PMM did not satisfy
the threshold standards after a particular review period, the market
maker lost its designation as a PMM (i.e., the ``P'' next to its
market maker identification was removed). Market makers could re-
qualify for designation as a PMM by satisfying the threshold
standards in the next review period.
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On February 14, 1997, the PMM standards were waived for all NNM
securities due to the impacts of the SEC's Order Handling Rules and
corresponding NASD rule change and system modifications on the
operation of the four quantitative standards.\7\ For example, among
other impacts, the requirement that market makers display customer
limit orders adversely affected the ability of market makers to satisfy
the ``102% Average Spread Standard.'' Since that time all Nasdaq Market
Makers have been deemed to be PMMs.
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\7\ See Securities Exchange Act Release No. 34-38294 (February
17, 1997), 62 FR 8289 (February 24, 1997).
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In March 1998, Nasdaq proposed PMM standards that received
substantially negative comments.\8\ In light of those comments, Nasdaq
staff convened an advisory subcommittee to develop new PMM standards
(``Subcommittee'') in August 1998. The Subcommittee met nine times and
formulated new PMM standards. NASD/Nasdaq staff requested to meet with
the Commission staff and the Subcommittee to receive informal feedback
on the new PMM standards. This meeting occurred on December 9, 1998. At
the conclusion of the meeting, Commission staff noted the progress made
by the Subcommittee and requested time to digest and more carefully
analyze the proposed new PMM standards.
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\8\ See Securities Exchange Act Release 39189 (March 30, 1998),
63 FR 16841 (April 6, 1998).
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On July 29, 1999, members of the Nasdaq staff conducted a
conference call with members of the Commission staff to receive
feedback on the PMM standards that Nasdaq presented at the December 9,
1998 meeting. During the meeting, the Commission staff requested that
Nasdaq modify several of the proposed standards and analyze the impact
of those modifications on the primary market maker determination. On
September 27, 1999, Nasdaq reported that the NASD Economic Research
staff had analyzed data based on the Commission's recommended revisions
and concluded that the Commission's modified standards
[[Page 78536]]
produced unfavorable results. Nasdaq requested that the Commission
comment on the outcome of this test ``as we intend to communicate your
comments to the Subcommittee in an effort to resume the process of
developing new standards.''\9\
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\9\ See Letter, dated September 27, 1999 from John F. Malitzis,
Assistant General Counsel, Nasdaq, to Richard Strasser, Assistant
Director, Division of Market Regulations, SEC.
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Nasdaq suspended development of PMM standards in late-1999 after
the Commission signaled to the securities industry that it is
considering fundamental changes to Rule 10a-1, changes that could
impact the manner in which Nasdaq and the other markets regulate short
sales. In October 1999, the Commission issued a Concept Release on
Short Sales in which it sought comment on, among other things, revising
the definition of a short sale, extending short sale regulation to non-
exchange listed securities, and eliminating short sale regulation
altogether. Nasdaq believed that it would be inappropriate for Nasdaq
to dramatically alter its regulation of short sales while the
Commission is considering fundamentally changing Rule 10a-1. At the
request of the staff of the Division of Market Regulation, Nasdaq has
resumed development of PMM standards and has been working with the
Commission staff towards that goal.
3. Proposal To Extend the Short Sale Rule and Suspend the PMM Standards
Nasdaq believes that it is in the best interest of investors to
extend the short sale regulation pilot program. When the Commission
approved the NASD's short sale rule on a pilot basis, it made specific
findings that the Rule was consistent with Sections 11A,\10\ 15A(b)(6),
\11\ 15A(b)(9), \12\ and 15A(b)(11) \13\ of the Act. Specifically, the
Commission stated that, ``recognizing the potential for problems
associated with short selling, the changing expectations of Nasdaq
market participants and the competitive disparity between the exchange
markets and the OTC market, the Commission believes that regulation of
short selling of Nasdaq National Market securities is consistent with
the Act.''\14\ In addition, the Commission stated that it ``believes
that the NASD's short sale bid-test, including the market maker
exemptions, is a reasonable approach to short sale regulation of Nasdaq
National Market securities and reflects the realities of its market
structure.''\15\ The benefits that the Commission recognized when it
first approved Rule 3350 apply with equal force today.
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\10\ 15 U.S.C. 78k-1.
\11\ 15 U.S.C. 78o-3(b)(6).
\12\ 15 U.S.C. 78o-3(b)(9).
\13\ 15 U.S.C. 78o-3(b)(11).
\14\ See Short Sale Rule Approval Order, supra note 4.
\15\ Id.
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Similarly, the concerns that caused the Commission to waive the PMM
standards in February 1997 continue to exist today. Nasdaq and the
Commission agreed to waive the PMM standards for three reasons that
were discovered only after the Order Handling Rules were
implemented.\16\ Through late-1999, Nasdaq worked diligently to address
those concerns to the Commission's satisfaction, including convening a
special subcommittee on PMM issues, proposing two different sets of PMM
standards, and being continuously available and responsive to
Commission staff to discuss this issue. Despite these efforts, the
Commission and Nasdaq were unable to establish satisfactory PMM
standards. At the request of Commission staff, Nasdaq has begun
developing PMM standards suitable to today's rapidly changing
marketplace. Re-instating the PMM standards set forth in NASD Rule 4612
would be extremely disruptive to the market and harmful to investors.
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\16\ Implementation of the Order Handling Rules created the
following three issues: (1) Many market makers voluntarily chose to
display customer limit orders in their quotes although the Limit
Order Display Rule does not yet require it; (2) SOES decrementation
for all Nasdaq stocks significantly affected market makers' ability
to meet several of the primary market maker standards; and (3) with
the inability to meet the existing criteria for a larger number of
securities, a market maker may be prevented from registering as a
primary market maker in an initial public offering because it fails
to meet the 80% primary market maker test contained in Rule
4612(g)(2)(B).
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4. Proposal To Modify Bid Tick Indicator
Nasdaq would like to modify the method it uses to calculate the
last bid by having it refer to the ``Nasdaq Inside'' which is comprised
of quotations from all participants in Nasdaq execution systems (e.g.,
SuperMontage), rather than referring to the National Best Bid and Offer
(``NBBO''). As explained in more detail below, this change is necessary
to maintain a fair and orderly market within Nasdaq.
Historically, the NBBO only included Nasdaq market makers. In 1996,
when the Chicago Stock Exchange began trading Nasdaq-listed issues, the
NBBO and thus the Nasdaq bid-tick indicator became inclusive of other
exchanges even though those exchanges are not subject to NASD Rule
3350. Due to Chicago's participation in Nasdaq systems and their
willingness to be linked into Nasdaq execution systems, the NBBO and
the best bid and offer in Nasdaq were identical and there was no need
to calculate a separate best bid for Nasdaq.
Recently, several markets have begun trading Nasdaq securities
pursuant to unlisted trading privileges. As a result, the NBBO is
regularly different from the best bid that is accessible to Nasdaq
market participants using Nasdaq execution systems. It is possible for
a market without a short sale rule to affect the direction of the short
sale arrow and accordingly have an impact on NASD members' short sale
rule obligation in Nasdaq. This is inequitable since those markets
currently impose no short selling obligations on their own members.
Nasdaq has a compelling interest in resolving this issue in order to
maintain a fair and orderly market within Nasdaq.
The separation of Nasdaq's market systems from the systems it
operates as the exclusive securities information processor for Nasdaq
securities has enabled Nasdaq to calculate an independent Nasdaq Inside
Price (``Nasdaq Inside'') and a last bid change based upon that Nasdaq
Inside. The Nasdaq Inside is comprised of the best bid and offer quote
from among all participants in the Nasdaq National Market Execution
System (commonly known as ``SuperMontage'')--including all Nasdaq
market participants as well as UTP exchanges that choose to participate
in SuperMontage.
Given this new capability and the presence of markets with no short
sale rules, Nasdaq proposes to modify the short sale rule to refer to
the Nasdaq Inside rather than the NBBO. It is damaging to the Nasdaq
market and its participants to restrict the short sales of Nasdaq firms
based upon the quotations of markets with no short sale rule.
Additionally, this approach is similar to the approach that the SEC has
adopted under the short sale rule that applies to the listed markets
where a primary exchange (e.g., NYSE) is permitted to look only to
transactions occurring on the primary exchange in determining its
members' short sale rule obligations.
Nasdaq currently has the ability to calculate and apply the Nasdaq-
based bid tick indicator to SuperMontage, and it will implement the
proposed rule change immediately with respect to SuperMontage. With
respect to trades executed outside Nasdaq execution systems and
reported to Nasdaq, Nasdaq anticipates that it will have the ability to
display the Nasdaq-based bid tick indicator to market participants on
[[Page 78537]]
January 13, 2003.\17\ Nasdaq participants will then have up to 90
calendar days to transition from the NBBO-based bid tick to the Nasdaq-
based bid tick for trades executed outside Nasdaq execution systems and
reported to Nasdaq. In the event that Nasdaq is unable to display the
Nasdaq-based bid tick indicator at that time, Nasdaq will inform the
Commission and delay implementation of this transition period. In
addition, Nasdaq is working with the NASD to ensure a continued high
level of short sale compliance during that transition period.
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\17\ At that time, Nasdaq anticipates that the quotations of
exchanges that lack a hard-wired linkage to Nasdaq will be removed
from the Nasdaq Quotation Data Service (``NQDS'') data feed. Nasdaq
is currently analyzing alternative methods for calculating the
Nasdaq-based bid tick indicator in the event the removal from NQDS
of quotations of exchanges that lack hard-wired linkages is delayed.
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B. Self-Regulatory Organization's Statement on Burden on Competition
Nasdaq 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. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street NW., Washington, DC 20549-0609.
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 in the caption
above and should be submitted by January 14, 2003.
IV. Commission's Findings and Order Granting Accelerated Approval of
the Amendment
After careful consideration, the Commission finds, for the reasons
set forth below, that the extension of the Short Sale Rule Pilot until
June 15, 2003, the suspension of the existing PMM standards until June
15, 2003 and the modification of the method used to calculate the bid
tick indicator used by members to determine the permissibility of a
short sale are consistent with the requirements of the Act and the
rules and regulations thereunder. In particular, the proposal is
consistent with Section 15A(b)(6)\18\ of the Act, which 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.
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\18\ 15 U.S.C. 78o-3(b)(6).
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The Commission finds that the continuation of the Short Sale Rule
Pilot, the continued suspension of the PMM standards, and the
modification of the method used to calculate the bid tick indicator
will maintain the status quo while the Commission is considering
amending Rule 10a-1 under the Act. This extension of the pilot,
continued suspension of the PMM standards, and modification of the bid
tick test is subject to modification or revocation should the
Commission amend Rule 10a-1 under the Act in a manner as to deem the
extension, suspension, or modification unnecessary or in conflict with
any adopted amendments.\19\
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\19\ Absent an exemption, Rule 10a-1 under the Act would apply
to Nasdaq on Commission approval of its exchange registration.
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The Commission finds good cause for approving the extension of the
Short Sale Rule Pilot, the suspension of existing PMM standards, and
the modification of the method used to calculate the bid tick indicator
prior to the 30th day after the date of publication of notice of the
filing in the Federal Register. It could disrupt the Nasdaq market and
confuse market participants to reintroduce the previous PMM standards
while new PMM standards are being developed and while the Commission
considers amending Rule 10a-1 under the Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\20\ that Amendment No. 13 to the proposed rule change, SR-NASD-98-
26, which extends the NASD Short Sale Rule Pilot through June 15, 2003,
suspends the PMM standards through June 15, 2003, and modifies the
method used to calculate the bid tick indicator is approved on an
accelerated basis.\21\
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\20\ 15 U.S.C. 78s(b)(2).
\21\ In approving Amendment No. 13, the Commission has
considered its impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\22\
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\22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-32315 Filed 12-23-02; 8:45 am]
BILLING CODE 8010-01-P