[Federal Register: February 19, 2003 (Volume 68, Number 33)]
[Notices]
[Page 8055-8061]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr19fe03-133]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-47351; File No. SR-NASD-2002-60]
Self-Regulatory Organizations; Order Granting Approval of a
Proposed Rule Change and Notice of Filing and Order Granting
Accelerated Approval of Amendment Nos. 1, 2, and 3 to the Proposed Rule
Change by the National Association of Securities Dealers, Inc. Relating
to Permanent Approval of the Primex Auction System[reg]
February 11, 2003.
I. Introduction
On May 1, 2002, the National Association of Securities Dealers,
Inc. (''NASD''), through its subsidiary, The Nasdaq Stock Market, Inc.
(``Nasdaq''), filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') a proposed rule change, pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'')\1\ and Rule
19b-4 thereunder,\2\ requesting permanent approval of the Primex
Auction System[reg] (``Primex'' or ``System''). The proposed rule
change was published for public comment in the Federal Register on May
31, 2002.\3\ On May 28, 2002, Nasdaq filed Amendment No. 1 to the
proposed rule change.\4\ The comment period expired on June 21,
2002.\5\ On July 25, 2002, the Commission received one comment letter
on the Original Proposal.\6\ On October 7, 2002, Nasdaq filed a
response to the NYSE Comment Letter.\7\ On November 1, 2002, Nasdaq
filed Amendment No. 2 to the proposed rule change.\8\ On February 4,
2003, Nasdaq filed Amendment No. 3 to the proposed rule change.\9\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 45983 (May 23,
2002), 67 FR 38152 (``Original Proposal'').
\4\ See letter from Peter R. Geraghty, Associate Vice President
and Associate General Counsel, Nasdaq, to Katherine England,
Assistant Director, Division of Market Regulation (``Division''),
Commission, dated May 1, 2002 (``Amendment No. 1''). In Amendment
No. 1, Nasdaq removed the following language inadvertently included
in proposed NASD Rule 5013(c)(2): ``Participants that are Primex
Auction Market Makers for a security may submit Market Orders in
that security for an immediate (i.e., ``zero second'') Auction,
provided the Participant attaches certain match parameters as set
forth in proposed NASD Rule 5014(b). Market Orders for at least
10,000 shares or $200,000 in market value are also eligible for a
zero second Auction, regardless of whether or not match parameters
are attached.''
\5\ Nasdaq has granted the Commission several extensions of time
to consider Nasdaq's proposal, the most recent extending the time
period until February 14, 2003.
\6\ See letter from Darla C. Stuckey, Corporate Secretary, New
York Stock Exchange, Inc. (``NYSE''), to Jonathan G. Katz,
Secretary, Commission, dated July 24, 2002 (``NYSE Comment
Letter'').
\7\ See letter from Edward S. Knight, Executive Vice President
and General Counsel, Nasdaq, to Jonathan G. Katz, Secretary,
Commission, dated October 7, 2002 (``Nasdaq Response Letter'').
\8\ See letter from Peter R. Geraghty, Associate Vice President
and Associate General Counsel, Nasdaq, to Katherine England,
Assistant Director, Division, Commission, dated October 31, 2002
(``Amendment No. 2''). In Amendment No. 2, Nasdaq seeks permanent
approval of the following changes to Nasdaq's application of Primex:
(1) Elimination of the end-of-day anonymity feature; (2)
implementation of a system change to prohibit appropriately marked
orders from executing in violation of the NASD short sale rule; (3)
amendments to proposed NASD Rule 5020 to reflect that Nasdaq delayed
for an additional calendar quarter the rule requiring Primex Auction
Market Makers (``PAMMs'') to submit a certain percentage of their
orders to Primex; (4) amendments to proposed NASD Rule 5016 to
reflect that orders not fully executed in Primex can be forwarded to
the SuperMontage version (``SuperMontage'') of the Nasdaq National
Market Execution System (``NNMS''); and (5) the addition of two new
conditions that can be attached to orders submitted to Primex: an
Anti-Internalization Qualifier and an All or None condition.
\9\ See letter from Mary M. Dunbar, Vice President and Deputy
General Counsel, Nasdaq, to Katherine England, Assistant Director,
Division, Commission, dated February 3, 2003 (``Amendment No. 3'').
In Amendment No. 3, Nasdaq seeks permanent approval to (1) change
the minimum size requirement for Predetermined Relative Indications
from a tiered structure depending on the amount of price
improvement, to a standard minimum size requirement of 100 shares;
(2) reprogram the System to reject trading interest marked as
``short'' or ``short exempt'' in any exchange-listed security
eligible for participation in the InterMarket Trading System; and
(3) modify proposed NASD Rule 5017 to be consistent with the system
change relating to short sales set forth in Amendment No. 2.
Telephone call among Peter R. Geraghty, Associate Vice President and
Associate General Counsel, Nasdaq; Gordon Fuller, Counsel to the
Assistant Director, Division, Commission, and Jennifer Lewis,
Attorney, Division, Commission, on February 7, 2003.
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This order approves the proposed rule change. In addition, the
Commission is publishing this notice to solicit comments on Amendment
Nos. 1, 2, and 3 from interested persons, and approving Amendment Nos.
1, 2, and 3 on an accelerated basis.
[[Page 8056]]
II. Background
Nasdaq has operated Primex as a facility of the NASD since December
17, 2001. Primex operates as a Pilot Trading System pursuant to a
temporary, two-year exemption from the rule filing requirements of
Section 19(b) of the Act \10\ under Rule 19b-5 under the Act.\11\
Nasdaq represents that Primex has exceeded the volume threshold
required to maintain its status as a Pilot Trading System pursuant to
Rule 19b-5 under the Act.\12\ Accordingly, Nasdaq now seeks permanent
approval of the Primex rules. Pending such approval, the NASD submitted
a proposed rule change setting forth the rules governing Primex and
permitting Nasdaq to continue to operate Primex on a temporary
basis.\13\
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\10\ 15 U.S.C. 78s(b).
\11\ 17 CFR 240.19b-5.
\12\ 17 CFR 240.19b-5. See Securities Exchange Act Release No.
45983 (May 23, 2002), 67 FR 38152 (``Original Proposal'').
\13\ Notice of the filing and the immediate effectiveness of the
proposed rule change was published on May 31, 2002 in the Federal
Register. See Securities Exchange Act Release No. 45982 (May 23,
2002), 67 FR 38163.
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III. Brief Description of Primex \14\
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\14\ See the Original Proposal for a more detailed description
of Primex and the NASD Rules governing Primex.
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Participants
Primex is a voluntary system available to any NASD member and other
entities that a member chooses to sponsor. To access the System, a
member must be in good standing and have executed the necessary
agreements with Nasdaq. Members granted access to the System are
referred to as Primex Auction System Participants (``Participants''),
and can access Primex for their customers or for themselves. Entities
that are not members can access the System by becoming a Sponsored
Subscriber of a Participant (``Sponsored Subscriber''). The Participant
assumes responsibility for all activity conducted through the System by
the Sponsored Subscriber.
There are two categories of Primex Participants: Primex Auction
Market Makers (``PAMMs'') and Crowd Participants. By becoming a
Participant, a member automatically receives the right to trade as a
Crowd Participant for any security eligible for trading in the System.
In general, Crowd Participants can view all orders exposed in the
System; interact with any order in the System; submit orders to the
System; and trade as principal, agent, or riskless principal. In
addition, PAMMs are entitled to exercise certain matching rights that
allow a PAMM to commit capital to its customer orders in conjunction
with the order exposure process; provide execution guarantees for its
own customer orders submitted to the System; and use certain types of
orders that permit the PAMM to facilitate block trades and ``clean
crosses.'' PAMMs are also entitled to share in transaction revenue paid
by other Participants when those other Participants execute against a
PAMM's customer orders.
To become a PAMM, a member must register as such with Nasdaq for
each security in which the member wishes to trade in such capacity.
Members that seek to become PAMMs also must be registered as Nasdaq
market makers with respect to Nasdaq-listed securities (i.e., Nasdaq
National Market[reg] and The Nasdaq SmallCap Market\SM\ securities) or
Consolidated Quotation Services (``CQS'') market makers with respect to
exchange-listed securities. With respect to any security eligible for
which a Participant is registered as a PAMM, such PAMM must submit to
the System a minimum percentage \15\ of its Mandatory Eligible \16\
public customer orders (including customer orders of another broker-
dealer that directs such orders to the PAMM) for those securities in
which it is registered as a PAMM.
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\15\ See proposed NASD Rule 5020.
\16\ See proposed NASD Rule 5011 (definition of ``Mandatory
Eligible Order'') and proposed NASD Rule 5020.
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Orders
Participants may submit unpriced market orders, as well as orders
that have specified, fixed prices that are marketable or priced between
the NBBO. Orders can be submitted in any round lot or mixed lot, but
odd lot orders are not accepted. Fixed price orders are eligible only
for ``immediate or cancel'' treatment.
Participants can choose the maximum duration of the exposure for
their orders. Unpriced market orders generally have a default maximum
broadcast period of 15 seconds, but executions can take place sooner if
there are satisfactory responses from the crowd at any time during the
exposure of the order. Executions can occur instantaneously when there
is crowd trading interest residing in the System. Trading interest can
reside in the System when Participants define their interest in advance
of an order being placed, or when other, contra side orders are already
in the process of being exposed. In addition, Participants also may
elect to have the order exposed for an immediate or ``zero second''
execution, depending on the size of the order or, as described below,
guarantee an execution by committing liquidity in the absence of
satisfactory interest from the crowd. Transactions always are executed
at or within the NBBO.
An order also can be submitted with a condition attached requiring
a minimum amount of price improvement relative to the current NBBO at
the time of execution. A Participant utilizing this feature for an
order to buy would specify, when entering the order into the System,
that the order be executed only if the exposure yields an execution
with price improvement of 3 cents below the ``Best Offer'' as publicly
displayed in the NBBO at the time of execution.
PAMMs are entitled to attach certain match parameters to customer
orders they submit to the System. For example, a PAMM may submit a
customer order with a 50% match parameter. Any interest provided by the
crowd is matched in both size and price by a corresponding execution
with the PAMM. The PAMM must be willing to execute the entire order
when using this match parameter, in the absence of sufficient response
from the crowd.
PAMMs also can submit customer orders with a Two Cent Match
parameter. This function allows the PAMM entering the order to execute
the customer order, provided it is willing to match the price
established by the crowd for the entire order to the extent the price
offered by the crowd is within two cents of the NBBO. If there is crowd
interest willing to provide more than two cents of price improvement,
the PAMM loses that portion of the order to the crowd.
PAMMs also are entitled to provide execution guarantees within the
System. This feature ensures that any balance of an order remaining
after exposing it to the crowd will receive a liquidity guarantee,
established by the PAMM for each order submitted, at a price at least
as good as the NBBO at that time.
Any condition, match parameter, or guarantee must be attached to an
order at the time it is submitted to the System. The existence of any
condition, match parameter, or guarantee that may be attached to an
order is never communicated or displayed to the crowd.
The System also provides participants the option of having the
balance of an unexecuted order returned to them or forwarded to other
Nasdaq systems for execution. Participants must indicate their
preference upon submission of an order to the System. For example, a
Participant can submit an order with an indication that it should be
forwarded to another Nasdaq system if the order is
[[Page 8057]]
not completely executed in Primex. To the extent the exposure concludes
and there is a portion of the order remaining, that balance will be
converted by the System to an order that is forwarded to SuperSoes (for
Nasdaq National Market securities), SuperMontage, or ITS/CAES (for
exchange-listed securities, provided the participant also is an ITS/
CAES market maker). A Participant's preference is not displayed,
exposed or communicated to any other Participant.
Responses and Indications
Participants may submit Responses and Indications to the System,
for the purpose of interacting with orders on Primex. Responses and
Indications are not communicated to any Participant, except to the
extent they result in an execution with an order. Responses and
Indications cannot execute against other Responses and Indications.
Responses are instructions submitted to the System by Participants to
interact with available orders exposed on Primex. Responses may be
either a Fixed Price Response (e.g., buy 1,000 at $20) or a Relative
Priced Response (e.g., buy 1,000 at the bid plus 3 cents).
Indications are instructions submitted to the System to interact
with future orders exposed on Primex by either the next day or the next
five days, as selected by the Participant. An Indication may be a
Predefined Relative Indication (``PRI'') or a Go-Along Indication. PRIs
have no specific fixed price, but are expressed at time of entry in
terms relative to the best bid or offer publicly displayed at such time
when the System activates the PRI against orders on Primex. PRIs are
ranked in relative price/time priority among all other PRIs and any
same-side orders currently being exposed. When activated by the System,
a PRI will match against orders at a price equal to the best bid (for
PRIs to buy) or offer (for PRIs to sell) publicly displayed at that
time in the NBBO, plus or minus (respectively) the relative price term
associated with that PRI; provided that such price also satisfies any
applicable condition associated with the order to which it is
responding. All PRIs must be for at least 100 shares. The System will
only accept PRIs that meet the required amounts of price improvement
(set forth in proposed NASD Rule 5018(c)(1)(C)). Participants may
associate a Per Auction Maximum size with a PRI, which will provide the
Participant with an opportunity to withdraw the PRI once the Per
Auction Maximum is exhausted.
Go-Along Indications also have no specific fixed price, and are
also expressed at time of entry in terms relative to the best bid or
offer publicly displayed at such time when the System activates the PRI
against orders on Primex. Go-Along Indications are only activated when
there has been at least one other contemporaneous Crowd execution at
the NBBO, provided there are no PRIs available or orders being exposed.
Each Go-Along Indication is required to be for at least 10,000 shares.
All orders submitted to the System are identified as either a
Public Order (in general, an order for the account of a customer) or a
Professional Order (in general, an order for the proprietary account of
a broker-dealer). This status is not communicated to any other
Participant, but is used to determine whether an order is available to
interact with the Response or Indication of a Crowd Participant. A
Participant that responds to orders on Primex can choose whether its
Responses and Indications interact with both Public and Professional
Orders, or just Public Orders. However, a Participant entering an order
does not have the ability to select or control whether public or
professional interest may interact with the order.
IV. NYSE Comment Letter and Nasdaq Response
In the NYSE Comment Letter, the NYSE argued against the Commission
granting permanent approval to Primex. The NYSE argued that the
Commission must evaluate whether Primex complies with Nasdaq's
regulatory obligations as an exchange pursuant to Section 6 of the
Act,\17\ even though Nasdaq's exchange application is pending with the
Commission. The NYSE argued, among other things, that Primex's true
character is not that of an auction, but rather, an anti-competitive
dealer internalization system. For example, the NYSE argued that
Primex's ``match mechanism'' for dealer guarantees allows dealers to
jump ahead of pre-existing customer orders.
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\17\ 15 U.S.C. 78f.
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In the Nasdaq Response Letter, Nasdaq stated that it would respond
to all of the comments raised by the NYSE Comment Letter, even though
it is only required to comply with the requirements of Section 15A of
the Act \18\ because of its current status as a registered securities
association. Nasdaq further stated that Primex is fully consistent with
these statutory obligations.
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\18\ 15 U.S.C. 78o-3.
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The NYSE argued that the requirement that PAMMs submit 80% of their
order flow is anti-competitive and compromises the ability of broker-
dealers to comply with their best execution obligations. The NYSE
further stated that the 80% requirement is an off-board trading
restriction which conditions the ability of any member to effect any
transaction otherwise than on Primex. The NYSE also believes the
requirement unfairly discriminates against members with high volume of
order flow.
Nasdaq responded that the 80% delivery requirement applies only to
those dealers who wish to take advantage of the benefits of certain
rebates and features available to PAMMs. Nasdaq stated that the only
penalty for not meeting the 80% delivery requirement is to be
ineligible for PAMM status; there are no disciplinary sanctions for
failing to meet the 80% requirement, and such dealers will still have
access to the other features of Primex. Nasdaq contended that the
requirement does not place participant in a position where it must
choose between violating a NASD rule and its duty of best execution;
rather, each participant is free to execute its orders in whichever
manner it believes can obtain best execution. Finally, Nasdaq stated
that all orders that are exposed in Primex are eligible for the 80%
test, even if they are executed elsewhere.
Nasdaq further argued that the 80% requirement is designed to
encourage dealers with customer order flow to expose customer's orders
to the public. It asserted that, without the 80% requirement, the
market would believe that dealers were only posting unwanted orders.
NYSE argued that Primex allows participating dealers to provide
customers with trade prices no better than if their orders had been
internalized, and therefore should not claim to offer an auction-type
execution. NYSE contended that there are no true market makers on
Primex because no participant has an affirmative obligation to provide
the liquidity of continuous two-sided quotations. NYSE further argued
that Primex does not display quotes or even the existence of any
trading interest in the ``virtual'' trading crowds that Nasdaq claims
exists as a source of liquidity, nor does it display most orders
entered onto the system to interact with the putative trading crowd.
NYSE stated that customer orders may be entered for immediate auction,
which it argued would not provide any opportunity for participants to
respond.
Nasdaq responded that Primex is designed to expose to a broader
audience orders that might otherwise be internalized. Moreover, Nasdaq
stated that even if such orders are internalized, federal securities
laws do not prohibit
[[Page 8058]]
internalization. In addition, some customers value speed more than
other factors. Speed has become an indication of execution quality.
Nasdaq characterized Primex's use of PRIs as designed to ensure that
notwithstanding the need for speed on the order entry side, there would
still remain a fair and reasonable opportunity for any and all crowd
participants to respond to such order flow if they choose to do so,
regardless of the auction selected. Nasdaq argued that Primex's
technology allows this immediate interaction.
The NYSE argued that Primex artificially limits the ability of
dealers to enter PRIs below established minimum sizes, thereby
discouraging trading interest and constraining liquidity. As a result
of consultation with members, Nasdaq has modified the minimum size
requirements for PRIs to a less burdensome standard requirement of 100
shares.
The NYSE argued that Primex participants may selectively trade
against agency orders alone by using a mechanism to screen out
professional orders. NYSE contends that this is discriminatory, not an
auction, and acts as a disincentive to participation.
Nasdaq responded that this feature ensures that any price
improvement or enhanced liquidity opportunities be reserved for public
customers, and not necessarily professional traders who could otherwise
take advantage of the System's benefits and ``pre-empt'' the ability of
a public customer to receive such benefits.
The NYSE argued that Primex's fee structure penalizes liquidity
providers. Fees are charged to liquidity providers, and rebates are
given when PRIs result in a trade. The NYSE believes the fee structure
formalizes a payment for order flow arrangement to compensate PAMMs
when they are displaced from internalizing their own customer orders.
Nasdaq stated that even though the fee structure is not included in
the proposed rule change and thus not before the Commission for review,
it would respond to the NYSE's arguments. Nasdaq explained that orders
exposed in Primex are not charged for an execution so as to avoid any
penalty that would discourage participants, particularly dealers, from
exposing customer order flow to others. A fee is charged only to those
who choose to respond to such order flow with Primex's unique bidding
tools. Nasdaq also responded that it is not required to have a uniform
pricing principle for all of its systems. The only requirement is an
equitable allocation of reasonable fees among members, and the fees for
Primex comply with this standard.
The NYSE argued that Primex fails to provide a market structure
that ensures its participants comply with Rule 10a-1 under the Act (the
``Short Sale Rule'').\19\ As a result of consultation with members,
Nasdaq has implemented a system modification that will prohibit
appropriately marked orders from executing in violation of NASD Rule
3350, the NASD short sale rule.\20\ In addition, Nasdaq has
reprogrammed the System to reject trading interest marked as ``short''
or ``short exempt'' in any exchange-listed security eligible for
participation in the InterMarket Trading System.\21\
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\19\ 17 CFR 240.10a-1.
\20\ Telephone call among Peter R. Geraghty, Associate Vice
President and Associate General Counsel, Nasdaq, Gordon Fuller,
Counsel to the Assistant Director, Division, Commission, and
Jennifer Lewis, Attorney, Division, Commission, on October 24, 2002.
See Amendment No. 2, supra note 8.
\21\ See Amendment No. 3, supra note 9.
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The NYSE argued that Nasdaq has not provided any market data or
analysis regarding its trading history for public evaluation. In
addition, individual market makers have opted to include Primex
executions within their own ``market center'' reports, rather than as
orders routed to and executed on another market system. Primex includes
these trades in statistics used in its advertising and press releases.
The Nasdaq responded that it has been working closely with SEC
staff to confirm how Rule 11Ac1-5 will be applied to Primex.
V. Amendment No. 2
In Amendment No. 2, Nasdaq seeks permanent approval of the
following changes to Nasdaq's application of Primex: (1) Elimination of
the end-of-day anonymity feature; (2) implementation of a system
modification that will prohibit appropriately marked orders from
executing in violation of NASD Rule 3350, the NASD short sale rule; (3)
amendments to proposed NASD Rule 5016 to reflect that orders not fully
executed in Primex can be forwarded to SuperMontage once it is
available for a particular security; (4) the addition of two new
conditions that can be attached to orders submitted to Primex, the
Anti-Internalization Qualifier (``AIQ'') and the All or None (``AON'')
condition; and (5) amendments to proposed NASD Rule 5020 to reflect
that Nasdaq delayed for an additional calendar quarter the rule
requiring PAMMs to submit a certain percentage of their orders to the
System. The amended rule text follows. New language is italicized;
deleted language is in brackets.
5011. Definitions
For purposes of this Rule Series, unless the context requires
otherwise:
(a) ``Application'' or ``Nasdaq Application'' as used in this Rule
Series, and ``Nasdaq Application of the Primex Auction System'' as used
throughout the NASD Rules means the voluntary Nasdaq trading service
facility that permits NASD member firms, among other things, to submit
orders in Primex Eligible Securities to be exposed to a Crowd of
Participants in an [anonymous,] electronic auction format for the
purpose of obtaining an execution for their own account or the account
of a customer; to have required reports of any resulting trades
automatically disseminated to the public and the industry; and to
``lock in'' these trades as necessary by sending both sides to the
applicable clearing agency designated by the Participants involved for
clearance and settlement, all in accordance with this Rule Series and
other applicable rules and policies of Nasdaq.
* * * * *
5016. Option to Route Orders Outside of the System After Exposure in
the Application
(a) (1) All Market Orders submitted to the Application shall
include an identifier as to whether any unexecuted balance, after the
order is exposed to the Crowd, should be forwarded to the
SuperSoesSM version of the Nasdaq National Market Execution
System, in the case of a Nasdaq security, or to ITS/CAES, in the case
of an exchange-listed security, or whether the order should be returned
to the entering Participant. This option to route orders outside of the
Application to SuperSoes or ITS/CAES is available for Market Orders
only. Orders submitted to the Application with a specified, fixed price
cannot be automatically forwarded to SuperSoes or ITS/CAES [Nasdaq's
other execution systems].
Routing identifiers are not displayed, exposed or communicated to
any other Participant in the Application.
(2) For securities eligible for the SuperMontage version of the
Nasdaq National Market Executions System, all orders submitted to the
Application shall include an identifier as to whether any unexecuted
balance, after the order is exposed to the Crowd, should be forwarded
to SuperMontage, or whether the order should be returned to the
entering Participant. Orders forwarded to SuperMontage will be treated
as
[[Page 8059]]
immediate or cancel orders. Routing identifiers are not displayed,
exposed or communicated to any other Participant in the Application.
(b) No changes.
5020. Market Maker Participation
(a) No Change.
(b) With respect to each security in which a Participant is
registered as a Primex Auction Market Maker, the Participant shall:
(1) No Change.
(2) No Change.
(3) submit to the Application a minimum of 80%\*\ of the number of
its Mandatory Eligible Orders (including customer orders of another
broker-dealer that has directed such orders to the Participant) as soon
as practicable upon receipt by the Participant, for the purpose of
exposing such orders to the Primex Crowd. Mandatory Eligible Orders do
not include:
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\*\The 80% test will be applied on a quarterly basis, and will
be phased in as follows: For the calendar quarters commencing on
October 1, 2001; January 1, 2002; April 1, 2002; [and] July 1, 2002,
and October 1, 2002, any participant may register in any eligible
security as a Primex Auction Market Maker and maintain that status
during such calendar quarters without regard to the percentage of
its orders it submits to the System for such security during that
time, provided it also satisfies all other requirements of a Primex
Auction Market Maker pursuant to these rules.
Beginning with the calendar quarter that commences on [October
1, 2002] January 1, 2003, a participant previously registered as a
Primex Auction Market Maker for a particular security may maintain
its status as such until [December 31, 2002] March 30, 2003 only if
it submitted at least 50% of its Mandatory Eligible Orders during
the calendar quarter that commences on [July] October 1, 2002 (or
during such portion of the calendar quarter that commences on [July]
October 1, 2002 in which the participant was so registered if the
participant registered in mid quarter), provided it also satisfies
all other requirements of a Primex Auction Market Maker pursuant to
these rules. A participant that is newly registering as a Primex
Auction Market Maker for a particular security any time after the
start of the calendar quarter that commences on [October 1, 2002]
January 1, 2003 may maintain its status as such until the end of the
calendar quarter in which it registered without regard to the
percentage of its orders it submits to the System for such security
during that time.
Beginning with the calendar quarter that commences on [January]
April 1, 2003, and each calendar quarter thereafter, a participant
previously registered as a Primex Auction Market Maker for a
particular security may maintain its status as such until the end of
that calendar quarter only if it submitted at least 80% of its
Mandatory Eligible Orders during the previous calendar quarter (or
during the portion of such previous calendar quarter in which it was
so registered if the participant registered in mid quarter),
provided it also satisfies all other requirements of a Primex
Auction Market Maker pursuant to these rules.
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* * * * *
5021. [Anonymity, Execution,] Reporting[,] and Clearing
(a) [Anonymity--The Application will process all activity among
Participants on an anonymous basis until the end of the day.] After
facilitating an execution, the Application will send an execution
report to all Participants involved as soon as practicable. The
execution report will indicate the details of the transaction, and [but
will not] contain the identity of the contra-party. [At the end of each
trading day, the actual contra-party for executions obtained within the
Application will be made available to the Participants involved through
Nasdaq's systems. For regulatory and other necessary purposes, the NASD
and Nasdaq will have the ability to determine the identity of the
actual contra-parties at any time.]
(b) [Tape Reporting and Clearing--]Matches within the Application
are executed and reported through Nasdaq systems for public tape
reporting and forwarding to NSCC for clearing, where necessary.
Participants (or their clearing brokers) are the parties responsible
for the clearance and settlement of all trades executed through the
Application. Once a transaction is executed, Participants do not have
the ability within the Application to modify or reallocate any portion
of the execution to a clearing broker other than the clearing broker
that the Application associates with the [Participant] transaction at
the time of execution. Neither the NASD (and its affiliates) nor any
operator or administrator of the Primex Auction System shall be
directly or indirectly a party to any transaction entered into,
matched, or otherwise effected through the Application[,
notwithstanding that, for the remainder of the trading day after a
transaction, the actual contra-parties have not had their identities
disclosed to each other by the Application].
* * * * *
Nasdaq represents that it eliminated the end-of day anonymity
feature to respond to concerns raised by clearing firms, and to
harmonize the anonymity features of Primex and SuperMontage. Nasdaq
represents that Primex continues to offer pre-trade anonymity, which
also is a feature of SuperMontage.
Nasdaq states that Primex originally was designed with an anonymity
feature that masked until the end of the day the identity of parties
trading in the System. When a match occurred in Primex, the parties
would be notified that they executed a trade, but they would not know
the identity of their counterparty until the end of the day.\22\ At the
end of the day, the System would send messages to the parties revealing
the identities of their counterparties. A participant would receive a
message for each trade executed in the System. Nasdaq represents that
the messages formats were unique to Primex, which required Primex users
to program their internal systems to recognize the messages. Nasdaq
believes this additional programming requirement created a disincentive
for firms to participate in Primex. Nasdaq states that, in particular,
clearing firms expressed a concern about the additional programming
requirements, and some chose not to make the changes and thus not
participate in Primex. Nasdaq states that when a clearing firm chose
not to participate, its correspondent firms also could not participate.
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\22\ The anonymity feature only masked the identity from the
parties to the trade. Nasdaq staff could obtain the identity of the
parties immediately.
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Nasdaq represents that it eliminated the anonymity feature to
remove this disincentive. With the end-of-day anonymity feature
removed, the parties to a trade will be informed of their
counterparty's identity immediately upon a match. Therefore, the need
for the messages at the end of the day is eliminated. Nasdaq expects
this change will result in greater participation in Primex.
To further encourage participation in Primex, Nasdaq represents
that it added a feature to assist members in complying with the NASD
short sale rule. Specifically, Nasdaq represents that the System has
been reprogrammed to prevent appropriately marked orders from executing
in violation of this rule. An order that is marked to indicate that it
is short sale, for which no exemption from the short sale rule is
available (e.g., the market maker exemption), will not execute at or
below the current best bid when the current best bid as displayed by
Nasdaq is below the preceding best bid in the security.
Primex also has been modified to account for Nasdaq simultaneously
operating SuperSoes and SuperMontage. Primex always provided members an
option to have certain orders routed to other Nasdaq execution systems
after exposure in Primex.\23\ Nasdaq represents that, when Primex began
operation, the SuperSoes version of NNMS was the only system to which
orders in Nasdaq-listed stocks could be forwarded. Recently, however,
Nasdaq began to phase in the SuperMontage version of NNMS on a
security-by-security basis. As such, until the phase-in is complete,
Nasdaq simultaneously will operate SuperSoes and SuperMontage.
Accordingly, Primex has the functionality to route orders to
[[Page 8060]]
either of these systems, depending on whether the security is eligible
for SuperSoes or SuperMontage. Nasdaq states that the functionality for
routing orders to either SuperSoes or SuperMontage generally is the
same. Only orders that are marked for routing outside Primex will be
routed to SuperSoes or SuperMontage, and only after the order has been
exposed in Primex and an unexecuted balance remains. While only Market
Orders can be routed to SuperSoes, both Fixed Price Orders \24\ and
Market Orders will be eligible for routing to SuperMontage. Orders
routed to SuperMontage will be considered as immediate or cancel
orders.
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\23\ See proposed NASD Rule 5016.
\24\ The term Fixed Price Order is defined in proposed NASD Rule
5011(n) as an order submitted to Primex to purchase or sell a
security at a specified, fixed price or better.
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To permit Primex to operate more efficiently with SuperMontage,
Nasdaq also modified the System to allow it to accept orders with AIQ
and AON conditions. These conditions can be attached to orders
submitted to SuperMontage, but Primex originally was not designed to
accept these types of orders. The AIQ functionality, when selected, can
preclude an order from executing against proprietary interest from the
same firm. The AIQ condition may be applied to orders, responses and
indications. The function is designed to prevent intra-firm trades that
may not be permissible for certain types of accounts, such as those
subject to ERISA or an investment advisory relationship.
The AON functionality allows Primex subscribers to place a
condition on certain orders that ensures the order will be executed in
its entirety or not at all. The AON condition can be used for orders
that the subscriber exposes for a ``zero-second'' auction.
Finally, Nasdaq is modifying the language in proposed NASD Rule
5020 to reflect that it has delayed for an additional calendar quarter
the rule implementing the requirement that PAMMs submit a certain
percentage of Mandatory Eligible Orders \25\ to the System to be
eligible for certain features of the System (the ``percentage test'').
Some firms, especially those that are now expected to participate in
Primex because the anonymity feature has been removed, need to
reprogram their internal systems to make Primex an order routing
destination. Nasdaq believes delaying the percentage test will allow
firms to make these changes and gain experience with the System. The
percentage test will continue to be measured on a quarterly basis.
However, the phase-in schedule was amended to implement the test
starting with the calendar quarter that begins on January 1, 2003,
instead of October 1, 2002. Specifically, beginning on January 1, 2003,
a participant previously registered as a PAMM can retain this status if
it submitted to the System 50% of its Mandatory Eligible Orders during
the calendar quarter that commences on October 1, 2002. Beginning on
April 1, 2003, and every calendar quarter thereafter, a PAMM can retain
its status if it submits 80% of its Mandatory Eligible Orders during
the previous calendar quarter.
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\25\ The term ``Mandatory Eligible Order'' is defined in
proposed NASD Rules 5011 and 5020.
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VI. Amendment No. 3
In Amendment No. 3, Nasdaq seeks permanent approval to (1) change
the minimum size requirement for Predetermined Relative Indications
from a tiered structure depending on the amount of price improvement,
to a standard minimum size requirement of 100 shares, regardless of the
amount of price improvement offered; (2) reprogram the System to reject
trading interest marked as ``short'' or ``short exempt'' in any
exchange-listed security eligible for participation in the InterMarket
Trading System; and (3) modify proposed NASD Rule 5017 to be consistent
with the system change relating to short sales set forth in Amendment
No. 2. The amended rule text follows. New language is italicized;
deleted language is in brackets.
5017. Short Sales
* * * * *
(a) Participants [are responsible for] must properly identify
trading interest as a long sale, short sale, or short sale exempt.
[complying with applicable short sale rules when using the Application.
No Participant shall submit to the Application an order for a security
that, if executed, would result in a ``short sale'' as that term is
defined in Exchange act Rule 3b-3, unless the transaction would be
exempt from, or otherwise permissible under, the requirements of NASD
Rule 3350 or Exchange Act Rule 10a-1, as applicable.]
(b) The Application will not process trading interest to sell short
a Nasdaq-listed security if the execution of such trading interest will
violate Rule 3350.
(c) The Application will reject trading interest identified as a
short sale or short sale exempt in any exchange-listed security
eligible for participation in the InterMarket Trading System.
5018. Responses and Indications
* * * * *
(c) Indications--Indications are instructions, with the
characteristics set forth below, submitted to the Application by
Participants to interact with orders exposed in an Auction. An
Indication may be a Predefined Relative Indication (``PRI'') or a Go-
Along Indication.
(1) Predefined Relative Indications
(A) No changes.
(B) At the time of its original entry, each PRI submitted to the
Application must be for at least 100 shares. [the following share
amounts:
(i) NBBO PRIs must be for at least 3000 shares upon entry;
(ii) NBBO +/-.01 or .02 must be for at least 2000 shares upon
entry;
(iii) NBBO +/-.03 or greater must be for at least 1000 shares upon
entry.]
(C) No changes.
(D) No changes.
(E) No changes.
* * * * *
Nasdaq represents that the graduated PRI size requirement was
intended to make it less expensive to offer greater price improvement
by requiring less of a share commitment as more price improvement was
offered. Discussion with current and prospective users of Primex
indicated to Nasdaq that the minimum size requirements are a
disincentive to using PRIs because many of the trading strategies that
would employ PRIs are most effective if the user has flexibility in the
number of shares that must be committed. Nasdaq therefore proposes to
eliminate the graduated, minimum size requirement and instead require a
commitment of 100 shares, regardless of the amount of price improvement
offered. With this change, Primex users would be able to enter PRIs for
any round or mixed lot greater than 100 shares. Nasdaq believes this
modification will encourage more users to submit PRIs, thus increasing
the liquidity in Primex and the opportunities for price improvement.
VII. Discussion
After careful consideration, the Commission finds, for the reasons
discussed below, that the proposed rule change, as amended, is
consistent with the Act and the rules and regulations applicable to the
NASD, a registered securities association.\26\ We do not believe, as
the NYSE suggests, that the
[[Page 8061]]
fact that Primex allows dealers to internalize customer orders should
be viewed as a reason to deny permanent approval of Primex. The
Commission believes that Primex may provide an opportunity for customer
orders to receive price improvement, even if the customer order is
internalized. In addition, the Commission believes that Primex may
provide an opportunity for customer orders to be exposed to possible
execution by market participants other than the Primex participant that
brought the order to Primex. The Commission notes that its analysis of
these issues may change in the context of Nasdaq's exchange
application.
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\26\ In this regard, the Commission disagrees with NYSE's
argument that it must apply statutory requirements applicable to
registered exchanges to Primex. The Commission notes that Nasdaq
operates Primex as a facility of the NASD. The NASD is a registered
securities association under Section 15A of the Act and is not a
registered exchange under Section 6 of the Act. Nasdaq's application
for registration as an exchange is pending with the Commission.
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In addition, the Commission believes the proposal is consistent
with Rule 19b-5(f)(1) under the Act,\27\ because it has been submitted
within two years after commencement of the operation of the System.
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\27\ 17 CFR 240.19b-5(f)(1).
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The Commission finds good cause for approving Amendment No. 1 of
the proposed rule change prior to the thirtieth day after notice of the
publication in the Federal Register. The language to be deleted by the
amendment was inadvertently included; Amendment No. 1 reflects the
current rules governing Primex's operation. The Commission also finds
good cause for approving Amendment No. 2 of the proposed rule change
prior to the thirtieth day after notice of the publication in the
Federal Register. Amendment No. 2 also reflects the current rules
governing Primex's operation. In addition, Amendment No. 2 removes a
disincentive to participation in Primex by deleting a programming
requirement associated with an end-of-day anonymity feature; assists
participants in complying with the Short Sale Rule by adding a useful
feature that prevents violative orders from executing on the System;
promotes opportunities for greater order interaction and possible price
improvement by allowing unexecuted Primex orders to be routed to
SuperMontage; and enhances Primex as a potential order-routing
destination by providing firms with additional time to program their
internal systems to accommodate Primex. The Commission also finds good
cause for approving Amendment No. 3 of the proposed rule change prior
to the thirtieth day after notice of the publication in the Federal
Register. Amendment No. 3 also reflects the current rules governing
Primex's operation. In addition, Amendment No. 3 assists participants
in complying with the Short Sale Rule and removes a disincentive to
participation in Primex by implementing a less restrictive minimum size
requirement for PRIs. The Commission believes Amendment Nos. 1, 2, and
3 are consistent with Sections 15A(b)(6) and (11), and 11A(a)(1)(C) of
the Act,\28\ and Rule 19b-5 under the Act,\29\ and therefore the
approval of Amendment Nos. 1, 2, and 3 on an accelerated basis is
appropriate.
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\28\ 15 U.S.C. 78o-3(b)(6) and (11), and 15 U.S.C. 78k-
1(a)(1)(C).
\29\ 17 CFR 240.19b-5.
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Interested persons are invited to submit written data, views, and
arguments concerning Amendment Nos. 1, 2, and 3, including whether the
proposed amendments are 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 amendments that are
filed with the Commission, and all written communications relating to
the amendments 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
NASD. All submissions should refer to File No. SR-NASD-2002-60 and
should be submitted by March 12, 2003.
VIII. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\30\ that the proposed rule change (SR-NASD-2002-60) is approved
and Amendment Nos. 1, 2, and 3 are approved on an accelerated basis.
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\30\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\31\
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\31\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-3945 Filed 2-18-03; 8:45 am]
BILLING CODE 8010-01-P