[Federal Register: September 10, 2003 (Volume 68, Number 175)]
[Notices]
[Page 53409-53411]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr10se03-107]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-48434; File No. SR-NASD-2003-81]
Self-Regulatory Organizations; Order Granting Approval of
Proposed Rule Change and Amendment No. 1 Thereto by National
Association of Securities Dealers, Inc. Relating to Quote
Decrementation in SuperMontage
September 3, 2003.
I. Introduction
On May 12, 2003, 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''), pursuant to section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend NASD Rule 4710 and the
decrementation of Quotes/Orders of order delivery Electronic
Communication Networks (``Order Delivery ECNs'') in Nasdaq's National
Market Execution System (``NNMS'' or ``SuperMontage''). On May 29,
2003, Nasdaq filed Amendment No. 1 to the proposal.\3\ The proposed
rule change, as amended, was published for notice and comment in the
Federal Register on June 12, 2003.\4\ The Commission received one
comment letter on the proposed rule change.\5\ This order approves the
proposed rule change, as amended.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Mary M. Dunbar, Vice President and Deputy
General Counsel, Nasdaq, to Katherine A. England, Assistant
Director, Division of Market Regulation (``Division''), Commission,
dated May 29, 2003 (``Amendment No. 1''). In Amendment No. 1, Nasdaq
replaced the proposed rule change in its entirety.
\4\ See Securities Exchange Act Release No. 47993 (June 5,
2003), 68 FR 35246 (June 12, 2003).
\5\ See letter from Kim Bang, Bloomberg Tradebook, LLC, to
Jonathan G. Katz, Secretary, Office of the Secretary, Commission,
dated July 14, 2003 (``Bloomberg Letter'').
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II. Description of the Proposed Rule Change
Nasdaq proposes to modify the SuperMontage decrementation process
when an Order-Delivery ECN declines,\6\ partially-fills, or fails to
respond to a non-directed order delivered to it within 30 seconds
(``time-out'').\7\ Currently, SuperMontage rules provide that when an
Order Delivery ECN declines, partially-fills, or times-out, without
immediately transmitting a revised attributable Quote/Order at an
inferior price, SuperMontage will zero out all of the ECN's Quotes/
Orders on the same side of the market at the price of the declined
order (or better). Under this proposal, Order Delivery ECNs will not
have all of their trading interest at the declined price level (or
better) removed from the system. Instead, SuperMontage would only
remove the total amount of each individual Quote/Order to which an
order was delivered by SuperMontage.
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\6\ An ECN's decline of a delivered order must comply with the
Commission's Quote Rule, 17 CFR part 240. 11Ac1-1. NASD Regulation
surveils for Quote Rule violations.
\7\ See Securities Exchange Act Release No. 48196 (July 17,
2003), 68 FR 43777 (July 24, 2003) (Notice of filing and immediate
effectiveness of File No. NASD-2003-108 to temporarily increase the
non-directed order maximum response time for Order-Delivery ECNs in
Nasdaq's SuperMontage System.)
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Nasdaq provided the following example of how the proposed
modification to the decrementation process would operate for an ECN
alone at the inside that elected to enter three separate bid Quotes/
Orders at the same price level in SuperMontage:
ECN Quote (1)--1,000 shares @ 20.00
ECN Order (2)--500 shares @ 20.00
ECN Order (3)--300 shares @ 20.00
The inside aggregated bid shows 1,800 shares @ 20.00.
1. SuperMontage receives an 800 share market sell order.
2. In response, SuperMontage sends an 800 share delivery to ECN
Quote (1). Upon dispatch, SuperMontage immediately decrements
ECN Quote (1) by the amount of the delivery (800 shares)
leaving a display quote of 1,000 shares in ECN Quote (1) that
remains available for execution.
3. The ECN declines to execute the 800 share delivery to ECN Quote
(1).
4. The ECN's decline results only in the immediate removal of ECN
Quote (1), i.e., the 800 shares originally decremented and the
200 share remainder of ECN Quote (1). Orders (2) and
(3) remain in the system and continue to be eligible for
execution.
The system reallocates the 800 shares from the incoming order in
Step 1 against ECN orders (2) and (3), if not
executed by a subsequent incoming order, before moving, if necessary,
to the next best bid.\8\
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\8\ Nasdaq clarified under the proposal a subsequent incoming
order could potentially execute against an ECN's remaining orders
prior to the return of a declined order to the system. Telephone
conversation between Thomas P. Moran, Associate General Counsel,
Office of the General Counsel, to Marc McKayle, Special Counsel,
Division, Commission on August 27, 2003.
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Thus, under the proposal, only individual Quotes/Orders would be
removed in full by a decline, partial-fill, or a time-out when no
revised attributable Quote/Order is immediately transmitted at an
inferior price; not all trading interest at the declined price level or
better. Other ECN Quotes/Orders at a particular price level that are
not part of a SuperMontage delivery resulting in a decline, partial-
fill, or time-out would be retained in the system and remain available
for execution, and are not traded through. Nasdaq represents that
locked or crossed markets will not be created as a result of the
proposed rule change.
III. Summary of Comments
The Commission received one comment letter from Bloomberg
Tradebook, LLC (``Bloomberg'') on the proposed rule change.\9\
Bloomberg neither explicitly supported nor opposed the proposed rule
change, although it commented on decrementation generally, as well as
on the proposed rule change. Bloomberg noted that conceptually,
``(d)ecrementation is a design feature of SuperMontage that is intended
to preserve the continuity of the market
[[Page 53410]]
and to prevent locked and crossed markets.'' However, Bloomberg also
opined that the current decrementation procedures unfairly discriminate
against Order Delivery ECNs, cuts squarely against an ECN's obligations
under the Order Display Rule,\10\ are subject to being gamed by market
participants, and implicate a broker-dealer's duty of best execution.
In Bloomberg's view, ``[t]he problems decrementation has created * * *
result from access fees ECNs are permitted to charge and the
unwillingness of some market participants to pay those fees.''
Bloomberg believed that the Commission should address the access fee
issue, and that all access fees, including fees charged by market
centers, should be eliminated.
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\9\ See Bloomberg Letter, supra note 5.
\10\ 17 CFR 240.11Ac1-4.
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Bloomberg also believed that Nasdaq's proposed amendment would not
reduce the adverse impact of decrementation on Order Delivery ECNs
since each ECN's Quote/Order would still be subject to decrementation.
In addition, Bloomberg did not believe that Nasdaq's proposed amendment
would provide any practical benefit since ECNs manage their own
internal matching engines and aggregate multiple orders for
representation as a single Quote/Order in SuperMontage. Further,
Bloomberg believed that the decrementation process could still be gamed
since firms seeking to knock an ECN out of the quote in SuperMontage
would still be able to do so.
In response to the Bloomberg Letter, Nasdaq stated that many of
Bloomberg's comments extended beyond the narrow scope of the proposed
rule change to modify SuperMontage's decrementation process to
decrement only the ECN Quote/Order that an incoming order interacts
with at a particular price level, as opposed to all of an ECN's
available trading interest at a particular price level.\11\ In Nasdaq's
view, Bloomberg's comments were directed at the decrementation process
generally, its impact on ECNs and their customers, and its relationship
to ECN access fees. In response, Nasdaq noted that the Commission
approved the SuperMontage decrementation process, and that Nasdaq was
merely proposing to modify the process. Nasdaq emphasized that its
current decrementation process and its proposed modification to the
process retain the key component that declining Quotes/Orders be
removed from the system. Further, Nasdaq stated that the only issue
presented by the filing is the method of such removal; the proposed
rule change does not seek to change ECN access fee standards.
Therefore, according to Nasdaq, Bloomberg's views on eliminating access
fees would be more properly expressed in a petition for Commission
rulemaking.
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\11\ See letter from Thomas P. Moran, Office of General Counsel,
to Jonathan G. Katz, Secretary, Office of the Secretary, Commission,
dated July 30, 2003.
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Nasdaq also offered general comments regarding the decrementation
process. Nasdaq explained that decrementation was proposed as part of
the original SuperMontage proposal to address locked and crossed
markets that occurred in Nasdaq prior to SuperMontage. Nasdaq noted
that access fee disputes could result in locked and crossed markets
that would not only shut down Nasdaq's automatic execution
functionality, but also many internal order-execution systems of Nasdaq
market participants, until the locks or crosses were resolved. Nasdaq
also stated that decrementation allows Nasdaq to fairly balance the
needs and desires of a wide variety of users by accomodating ECNs, by
allowing them to receive and decline orders (as opposed to receiving
executions) while eliminating locked and crossed markets.
With regard to Bloomberg's specific comments on the proposed rule
change, Nasdaq emphasized its proposed modification to the
decrementation process is an internal SuperMontage system change that
imposes no new obligation on any market participant. Instead, the
proposal is intended to make the current decrementation process more
discerning and provide options to ECNs that voluntarily elect to change
the way they represent their Quotes/Orders in SuperMontage. Nasdaq
stated that the proposed rule change gives ECNs the option to mitigate
decrementation by providing them, if they enter multiple Quotes/Orders,
an increased opportunity for their individualized Quotes/Orders to
interact with counterparties with which the ECN is willing to trade.
Nasdaq stated it should not be precluded from altering its system to
provide options to ECNs that choose to take the initiative to serve
their customers better. According to Nasdaq, if an ECN chooses to enter
individual representations of trading interest, Nasdaq's new processing
would allow more of the ECN's customers to remain in the SuperMontage
system longer, thereby increasing the potential interaction of those
customers with orders from parties that will pay the ECN's access fee.
Those ECNs that do not alter the way they represent their customers in
SuperMontage would, in effect, continue to have their single quotes
decremented in the same manner as the current SEC-approved process.
According to Nasdaq, Bloomberg opposes a rule that forces them to do
nothing, and will have no impact on them if they continue to do
business as they do today.
IV. Discussion
The Commission has carefully reviewed the proposed rule change, the
Bloomberg Letter, and Nasdaq's response and finds that the proposed
rule change, as amended, is consistent with the requirements of the Act
and the rules and regulations thereunder applicable to a national
securities association.\12\ In particular, the Commission finds that
the proposed rule change, as amended, is consistent with section
15A.\13\ Specifically, the Commission finds that the proposed rule
change is consistent with section 15A(b)(6) of the Act because it is
designed to promote just and equitable principles of trade, to foster
cooperation and coordination with persons engaged in regulating,
clearing, settling, processing information with respect to, and
facilitating transactions in securities, to remove impediments to and
perfect the mechanism of a free and open market and a national market
system, and, in general, to protect investors and the public
interest.\14\ The Commission also finds that the proposed rule change
is consistent with section 15A(b)(11) because it is designed to produce
fair and informative quotations, to prevent fictitious or misleading
quotations, and to promote orderly procedures for collecting,
distributing, and publishing quotations.\15\
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\12\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
\13\ 15 U.S.C. 78o-3.
\14\ 15 U.S.C. 78o-3(b)(6).
\15\ 15 U.S.C. 78o-3(b)(11).
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While the Commission appreciates and considered Bloomberg's
comments regarding decrementation generally, whether decrementation is
consistent with the Act was decided on January 19, 2001, when the
Commission approved decrementation in SuperMontage.\16\ The ability of
SuperMontage to decrement Quotes/Orders of Order Delivery ECNs is not
at issue in the proposed rule change.\17\ Instead, what is at issue is
[[Page 53411]]
whether the modification to the decrementation process, wherein
SuperMontage can decrement only the single ECN Quote/Order that
declines to trade with an order sent to it by the system, is consistent
with the Act.\18\ The Commission finds that it is.
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\16\ See Securities Exchange Act Release No. 43863 (January 19,
2001), 66 FR 8020 (January 26, 2003)(``Original SuperMontage
Approval Order'').
\17\ Id. See also Domestic Securities, Inc. v. Securities and
Exchange Commission, 333 F.3d 239 (DC Cir. 2003). The Court found,
in pertinent part, that the Original SuperMontage Approval Order
marked the consummation of the Commission's decisionmaking process
concerning the system rules, including decrementation, and the rules
finally determined the rights and obligations of the market and of
each market participant who traded on the system.
\18\ While the Commission acknowledges that ECN access fees
maintain a significant tangential relationship to the SuperMontage
decrementation process, the abolition of ECN fees is not at issue in
this proposed rule change. Nasdaq recently submitted File No. NASD-
2003-128 relating to ECN fees.
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The Commission notes that the amendment is essentially identical to
the process as originally approved,\19\ except that an ECN's Quotes/
Orders would be removed from the system on an individual basis.
Bloomberg stated that the proposal would not have any practical effect
because it is the practice of ECNs to aggregate orders within the quote
sent to SuperMontage. The Commission believes that Nasdaq has
adequately responded to Bloomberg's comments. Nasdaq has correctly
represented that the proposed rule change provides a new option for
Order Delivery ECNs. The Commission recognizes that many proposed rule
changes relating to a self-regulatory organization's trading system
will require the affected market participants to either reprogram their
internal trading systems or alter their business practices to ensure
system compatibility and compliance. In that regard, this proposed rule
change is not unique. The proposed rule change may allow ECNs that opt
to change their method of quote management and submit individual orders
to SuperMontage to mitigate the impact of access fee disputes on their
ability to trade with participants with which no dispute exists.
However, ECNs may also choose to continue aggregating multiple orders
for representation, and decrementation, as a single Quote/Order in
SuperMontage. Thus, while ECNs that do not reconfigure their trading
systems or revise their quote management practices would not benefit
from this proposed rule change, ECNs that choose to make the necessary
operational and technological adjustments may benefit.
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\19\ See Original SuperMontage Approval Order, supra note 15.
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The Commission believes that Nasdaq's approach reasonably balances
the interests of accommodating Order Delivery ECNs and providing an
efficient trading system. Nasdaq represents that SuperMontage
decrementation has eliminated the ECN access fee-related locked or
crossed markets which caused the shutdown of Nasdaq's automatic
execution functionality, and many internal order-execution systems,
until the lock or cross was resolved. The Commission continues to
believe that the SuperMontage decrementation process should help to
reduce instances of locked and crossed markets and the problems
associated with locked and crossed markets, while accommodating ECNs
with an alternative to automatic execution.\20\ The Commission also
continues to believe that the reduction of locked and crossed markets
in the Nasdaq market should improve market quality and enhance the
production of fair and orderly quotations.\21\ In the Commission's
view, the NASD's proposal is reasonably designed to maintain the
integrity of Nasdaq quotes by reducing the incidence of locking and
crossing quotations displayed in Nasdaq. The proposal will continue to
reduce locked and crossed markets because a declined order, if
necessary, would decrement each ECN's individual Quote/Order. The
Commission believes that the proposal, by retaining ECNs' trading
interest that is not decremented by the incoming order in the system,
could enhance SuperMontage liquidity and transparency, and provide ECN
customers with an increased opportunity to have their orders executed
by market participants that are willing to pay the ECN access fee.
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\20\ The Commission has concluded previously that continued
locking and crossing of markets can negatively impact market
quality. Id. See also Division of Market Regulation, The October
1987 Market Break 9-6 (February 1988) (Stating that the continued
existence of locked and crossed markets indicates that the
quotations for a security are suspect and may not provide an
accurate reflection of the market for a security).
\21\ Id.
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V. Conclusion
For the foregoing reasons, the Commission finds that the proposal,
as amended, is consistent with the requirements of the Act and rules
and regulations thereunder.
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\22\ that the proposed rule change (SR-NASD-2003-81), as amended,
is approved.\23\
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\22\ 15 U.S.C. 78s(b)(2).
\23\ The proposed rule change will become effective within 60
days of the date of this Order. Telephone conversation between
Thomas P. Moran, Associate General Counsel, Office of the General
Counsel, to Marc McKayle, Special Counsel, Division, Commission on
September 3, 2003.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\24\
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\24\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-22983 Filed 9-9-03; 8:45 am]
BILLING CODE 8010-01-P