[Federal Register Volume 68, Number 120 (Monday, June 23, 2003)]
[Notices]
[Pages 37183-37186]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-15773]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-48035; File No. SR-NASD-98-26]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Amendment Nos. 14 and 15 to a Proposed
Rule Change by the National Association of Securities Dealers, Inc.
Relating to an Extension of the Short Sale Rule and Continued
Suspension of the Primary Market Maker Standards Set Forth in NASD Rule
4612
June 16, 2003.
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 March 19, 1998, 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 (``Commission'') the proposed rule change as described in
Items I and II below, which Items have been prepared by the Nasdaq. The
NASD subsequently filed several amendments to the proposed rule change.
On June 11, 2003, the NASD filed Amendment No. 14 to the proposed rule
change.\3\ On June 16, 2003, the NASD filed Amendment No. 15 to the
proposed rule change.\4\ The Commission is publishing this notice to
solicit comments on the proposed rule change, as amended, and to grant
accelerated approval of 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, NASD, to Kathy England, Assistant Director,
Division of Market Regulation (``Division''), Commission, dated June
10, 2003 (``Amendment No. 14'').
\4\ See letter from Mary M. Dunbar, Vice-President and Deputy
General Counsel, NASD, to Kathy England, Assistant Director,
Division, Commission, dated June 10, 2003 (``Amendment No. 15'').
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Nasdaq is proposing to extend the pilot program of the NASD
short sale rule from June 15, 2003, until December 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 June 15, 2003, until December 15, 2003. The text of
the proposed rule change is below. Proposed new language is italicized;
deletions are [bracketed]. NASD Rule 3350
[[Page 37184]]
(a)-(k) No Change.
(l) This section shall be in effect until [December 15, 2003 [June
15, 2003]].
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item III below. The NASD 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. Purpose
Background and Description of the NASD's Short Sale Rule
Section 10(a) of the Act \5\ 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 Rule 10a-1 of the Act.\6\ On June 29, 1994, the
Commission approved the NASD's short sale rule (the ``Rule'')
applicable to short sales \7\ in Nasdaq National Market (``NNM'')
securities on an eighteen-month pilot basis through March 5, 1996.\8\
The NASD and the Commission have extended NASD Rule 3350 numerous
times, most recently, until June 15, 2003.
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\5\ 15 U.S.C. 78j.
\6\ 17 CFR 240.10a-1.
\7\ 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 account of, the seller. To
determine whether a sale is a short sale members must adhere to the
definition of a ``short sale'' contained in Rule 3b-3 of the Act,
which is incorporated into Nasdaq's short sale rule by NASD Rule
3350(k)(1).
\8\ See Securities Exchange Act Release No. 34277 (June 29,
1994), 59 FR 34885 (July 7, 1994), (SR-NASD-92-12), (``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 Rule 10a-1 of the Act,\9\
and other exemptions that are relevant to trading on Nasdaq.\10\ 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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\9\ 17 CFR 240.10a-1.
\10\ 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 bona fide hedge activities. In addition, the NASD
has recognized that Commission staff interpretations to Rule 10a-1
of the Act 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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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, NASD Rule 3350 provides an exemption for
``qualified'' market makers (i.e., market makers that meet the PMM
standards). 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.\11\
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\11\ 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 that 35 percent of the time; (2) the market maker must maintain
a spread no 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 or trading; or (4) the market maker executes 1\1/2\ times
its ``proportionate'' volume 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 Commission's Order Handling Rules
and corresponding NASD rule change and system modifications on the
operation of the four quantitative standards.\12\ 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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\12\ See Securities Exchange Act Release No. 38294 (February 17,
1997), 62 FR 8289 (February 24, 1997), (SR-NASD-97-07).
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In March 1998, Nasdaq proposed PMM standards that received
substantially negative comments.\13\ 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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\13\ See Securities Exchange Act Release No. 39819 (March 30,
1998), 63 FR 16841 (April 6, 1998), (SR-NASD-97-73).
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On July 29, 1999, members of the Nasdaq staff conducted a
conference
[[Page 37185]]
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 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.'' \14\
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\14\ See Letter, dated September 27, 1999 from John F. Malitzis,
Assistant General Counsel, Nasdaq, to Richard Strasser, Assistant
Director, Division of Market Regulation, Commission.
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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 of the Act,\15\ 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 of the Act.\16\ At the request of the Division, Nasdaq has
resumed development of PMM standards and has been working with the
Commission staff towards that goal.
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\15\ 17 CFR 240.10a-1.
\16\ 17 CFR 240.10a-1.
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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,\17\
15A(b)(6),\18\ 15A(b)(9),\19\ and 15A(b)(11) \20\ 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.'' \21\ 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.'' \22\ The benefits that the Commission recognized
when it first approved NASD Rule 3350 apply with equal force today.
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\17\ 15 U.S.C. 78k-1.
\18\ 15 U.S.C. 78o-3.
\19\ Id.
\20\ Id.
\21\ See Short Sale Rule Approval Order, supra note 8.
\22\ 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.\23\ 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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\23\ 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 did 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 NASD Rule
4612(g)(2)(B).
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2. Statutory Basis
Nasdaq believes that the proposed rule change is consistent with
the provisions of section 15A of the Act,\24\ in general and with
section 15A(b)(6) of the Act,\25\ in particular, in that it is designed
to prevent fraudulent and manipulative acts and practices, to promote
just and equitable principles of trade, remove impediments to a free
and open market and a national market system, and, in general, to
protect investors and the public interest.
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\24\ 15 U.S.C. 78o-3.
\25\ 15 U.S.C. 78o-3(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Nasdaq does not believe that the proposed rule change will
impose any burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
The Nasdaq neither solicited nor received written comments with
respect to the proposed rule change.
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 file number SR-NASD-98-26 and
should be submitted by July 14, 2003.
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change as a Pilot Program
After careful consideration, the Commission finds, for the reasons
set forth below, that the extension of the Short Sale Rule Pilot until
December 15, 2003, and the suspension of the existing PMM standards
until December 15, 2003, are consistent with the requirements of the
Act and the rules and regulations thereunder. In particular, the
extension is consistent
[[Page 37186]]
with section 15A(b)(6) \26\ 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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\26\ 15 U.S.C. 78o-3(b)(6).
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The Commission finds that the continuation of the Short Sale Rule
Pilot and the continued suspension of the PMM standards will maintain
the status quo while the Commission is considering amending Rule 10a-1
of the Act.\27\ This extension of the pilot and continued suspension of
the PMM standards is subject to modification or revocation should the
Commission amend Rule 10a-1 of the Act \28\ in a manner as to deem the
extension or suspension unnecessary or in conflict with any adopted
amendments.\29\
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\27\ 17 CFR 240.10a-1.
\28\ Id.
\29\ Absent an exemption, Rule 10a-1 under the Act would apply
to Nasdaq on Commission approval of its exchange registration.
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Accordingly, the Commission finds good cause for approving the
extension of the Short Sale Rule Pilot and the suspension of existing
PMM standards prior to the 30th day after the date of publication of
notice of the filing in the Federal Register. It could 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 of the Act.\30\
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\30\ 17 CFR 240.10a-1.
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It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\31\ that Amendment Nos. 14 and 15 to the proposed rule change, SR-
NASD-98-26, which extends the NASD Short Sale Rule Pilot through
December 15, 2003, and suspends the PMM standards through December 15,
2003, is approved on an accelerated basis.\32\
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\31\ 15 U.S.C. 78s(b)(2).
\32\ In approving Amendment Nos. 14 and 15, 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.\33\
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\33\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary
[FR Doc. 03-15773 Filed 6-20-03; 8:45 am]
BILLING CODE 8010-01-P