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93-61 Mail Vote — NASD Solicits Member Vote on New Rule Governing the Pricing of Open Orders;

Last Voting Date: October 29, 1993

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Executive Summary

The NASD invites members to vote on a proposed new section to the Rules of Fair Practice that would require a member holding an open order to adjust the order by the amount of any dividend, payment, or distribution on the day that the security is quoted ex-dividend, ex-rights, ex-distribution, or ex-inter-est. The text of the proposed amendment follows this Notice. The last date for member vote is October 29, 1993.

Background and Description of The Proposal

The NASD is proposing to amend Article III of the Rules of Fair Practice to require a member holding an open order to adjust the price and, if necessary, the size of the order by the amount of any dividend, payment, or distribution on the day that the security is quoted ex-dividend, ex-rights, ex-distribution, or ex-interest. An open order is one that remains in effect until it is executed, canceled, or expires. Such orders are also known as "good 'til canceled," "limit," or "stop limit."

Because no current NASD rule governs open orders, members holding such orders adjust them according to their own procedures unless the rules of another self-regulatory organization apply to the transaction. These procedures can vary from automatic adjustment, automatic withdrawal, reconfirmation of the order with the customer, or no action. Further, the procedures may vary among orders entered at the same firm because the orders are routed to different firms for execution. As a result, investors may find that their open orders are executed without adjustment after the ex-date at a higher cost per share than they intended based on their valuation of the security. For example, an investor that enters a limit order for a security at $10 per share before the dividend date may have evaluated the security based on the impending dividend declaration. If the investor's order remains open after the ex-dividend date, the investor may find the order "in the money" and executed at a price that assumed a dividend even though he would not be entitled to the dividend.

Moreover, the fact that some members might adjust open orders on ex-dates while others do not, creates confusion for customers and is inconsistent with the high quality and confidence the NASD has sought to promote in The Nasdaq Stock MarketSM and the markets for securities traded over-the-counter. Therefore, the NASD Board of Governors has determined to recommend the adoption of a Rule of Fair Practice to set forth a standard for business practices and ethics in dealing with customer open orders.

Proposed subsection (a) of the new Rule of Fair Practice would require a member holding an open order from a customer or broker/dealer, before executing or permitting the order to be executed, to adjust the price of the order by the amount of any dividend, payment, or other distribution on the ex-date. Paragraphs (a)(i) through (a)(iii) specify the adjustment procedures for certain situations. Paragraph (a)(i) provides that, in the case of a cash dividend or distribution, the price of the order shall be reduced by subtracting the dollar amount of the dividend or distribution from the price of the order and rounding the result to the next lower 1/8 of a dollar. For example, if an issuer declares a $.30 per share dividend, on the ex-dividend date the price of an investor's open order to purchase 100 shares of that security at $10 per share would be reduced by $.30, which, when rounded down to the nearest variation in trading units, results in a price of 9 5/8 per share. Thus, the investor's initial valuation at $10 per share before the ex-dividend date is proportionately maintained by revising the order to 9 5/8 per share after the ex-date, reflecting the diminished post-dividend value of the security.

Paragraph (a)(ii) provides that for stock dividends or splits, the price of the order shall be reduced by rounding the dollar value of the dividend or split to the next higher 1/8 of a dollar and subtracting that amount from the price of the order. Another method of calculating the price adjustment is to express it as a mathematical formula where the new price per share (rounded to the next lower 1/8) is equal to the number of shares being exchanged for new shares multiplied by the current price per share and is then divided by the number of new shares.

Where:

n = resulting or new price,

D = number of new shares being distributed,

C = number of shares being exchanged for new shares,

P = current price per share;

Then: n = (P x C)/D.

Example #1 — For an open order @ $10 per share and a 3 for 2 distribution, the resulting price per share is:

n = (10 x 2)/3 = 20/3 = $6.67, rounded down to the nearest 1/8 = 6 5/8 per share.
Example #2 — For an open order @ $10 per share and a 5 for 3 distribution, the resulting price per share is:

n = (10 x 3)/5 = 30/5 = $6, which does not require rounding = 6.

Paragraph (a)(ii) also provides for increasing the size of the order to maintain its proportionality with the dollar amount of the original order, taking into account the price reduction. This is accomplished by multiplying the number of shares of the original order by the number of shares to be distributed for each share. The result is then divided by the number of shares to be exchanged for new shares in the distribution. For example, in a 3 for 2 distribution, multiply the size of the original order by 3 and divide the result by 2. Finally, round the resulting number of shares to the next lower round lot. Expressing this as a formula:

Where:

n = the resulting number of shares,

O = the number of shares in the original order,

D = number of new shares being distributed,

C = number of shares being exchanged for new shares;

Then: n = (O x D)/C.

Example #1 — For a 100-share open order and a 3 for 2 distribution, the resulting number of shares is:

n = (100 x 3)/2 = 150 shares, which when rounded down to the next lower round lot = 100 shares, the size of the original order.
Example #2 — For a 1,000-share open order and a 3 for 2 distribution, the resulting number of shares is:

n = (1,000 x 3)/2 = 1,500 shares, which is equal to a round lot and therefore does not require rounding.
Example #3 — For a 1,000-share open order and a 5 for 3 distribution the resulting number of shares is:

n = (1,000 x 5)/3 = 1,666 shares, which when rounded down to the next lower round lot = 1,600 shares.

Paragraph (a)(iii) provides that when a dividend is payable at the option of the stockholder in either cash or securities, the order shall be reduced by the dollar value of the cash or securities, whichever is greater, according to the formulas in Paragraphs (a)(i) and (a)(ii) of the proposed rule. Moreover, if the stockholder opts for securities, the size of the order shall be increased according to the formula in Paragraph (a)(ii).

Proposed subsection (b) requires the member to reconfirm an open order before execution if the value of the distribution cannot be determined. Proposed subsection (c) requires open orders to be cancelled where the security is the subject of a reverse split. Proposed subsection

(d) defines the term "open order" as an order to buy that remains in effect for a definite or indefinite period of time until it is either executed, canceled, or expires, including, but not limited to, orders marked "good 'til canceled," "limit," or "stop limit."

Finally, proposed subsection (e) exempts: (1) open orders subject to the rules of a registered national securities exchange, (2) open stop orders to buy, and (3) open sell orders, as well as orders marked "do not reduce" or "do not increase." Open stop orders to buy and open sell orders are exempt because the assumptions underlying such an order may not include the value of an upcoming dividend and the combination of stop and limit prices in such an order makes the effect of repricing unpredictable.

Orders marked "do not reduce" or "do not increase" are the method for the customer to state that he is aware of the implications of not adjusting the order on the ex-date.

Request for Vote

The Board of Governors believes that the adoption of a single method of handling the adjustment of open orders after the ex-date is important to enhancing the quality of The Nasdaq Stock Market and the over-the-counter marketplace. In addition to eliminating the basic unfairness associated with the failure to adjust such orders, the incorporation of a uniform standard contributes to the order and predictability that form the basis for investor confidence and participation. The Board considers the proposal necessary and appropriate and recommends that members vote their approval.

The text of the proposed new section that requires member vote is below. Please mark the enclosed ballot according to your convictions and mail it in the enclosed, stamped envelope to The Corporation Trust Company. Ballots must be postmarked no later than October 29, 1993. The amendment will not be effective until it is filed with and approved by the Securities and Exchange Commission.

Questions concerning this Notice should be directed to Elliott R. Curzon, Senior Attorney, at (202) 728-8451, and Robert J. Smith, Attorney, (202) 728-8176 at the Office of General Counsel.

Text of Proposed Rule of Fair Practice

(Note: New language is underlined.)

Sec__

(a) A member holding an open order from a customer or another broker/dealer shall, before executing or permitting the order to be executed, reduce, increase, or adjust the price and the number of shares of such order by an amount equal to the dividend, payment, or distribution, on the day that the security is quoted ex-dividend, ex-rights, ex-distribution, or ex-interest, as follows:
(i) In the case of a cash dividend or distribution, the price of the order shall be reduced by subtracting the dollar amount of the dividend or distribution from the price of the order and rounding the result to the next lower 1/8 of a dollar;
(ii) In the case of a stock dividend or split, the price of the order shall be reduced by rounding the dollar value of the stock dividend or split to the next higher 1/8 of a dollar and subtracting that amount from the price of the order; provided, further, that the size of the order shall be increased by (1) multiplying the size of the original order by the numerator of the ratio of the dividend or split, (2) dividing the result by the denominator of the ratio of the dividend or split, and (3) rounding the result to the next lower round lot; and
(iii) In the case of a dividend payable in either cash or securities at the option of the stockholder, the price of the order shall be reduced by the dollar value of the cash or securities, whichever is greater, according to the formulas in (a)(i) or (a)(ii), above; provided, that if the stockholder opts for securities, the size of the order shall be increased pursuant to the formula in (a)(ii), above.
(b) If the value of the distribution cannot be determined, the member shall not execute or permit such order to be executed without reconfirming the order with the customer.
(c) If a security is the subject of a reverse split, all open orders shall be canceled.
(d) The term "open order" means an order to buy or an open stop order to sell, including but not limited to "good 'til canceled," "limit," or "stop limit" orders which remain in effect for a definite or indefinite period until executed, canceled, or expired.
(e) The provisions of this rule shall not apply to orders: (1) governed by the rules of a registered national securities exchange; (2) marked "do not reduce"; (3) marked "do not increase"; (4) open stop orders to buy; or (5) open sell orders.

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