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95-60 NASD Solicits Member Comment On Refined N*Aqcess Proposal;
Comment Period Expires August 30, 1995
On July 14, 1995, the NASD® Board of Governors approved the issuance of a Notice to Members to solicit comment on the refined proposal for a nationwide limit-order protection and price improvement facility. Referred to as N*AqcessSM (pronounced nack-cess), the new proposed trading service of The Nasdaq Stock MarketSM will automate the matching of individual investors' limit and market orders, and provide market-wide price protection of investor's limit orders. The original proposal for the national limit-order facility set forth in Notice to Members 95-20 (March 21, 1995) provided a conceptual overview of the system that was the subject of refinement based upon the comments received. A total of 74 commenters expressed a variety of views concerning the original proposal. After consulting with member firms, individual investors, market makers, academics, and others, the NASD made modifications to and provided further detail regarding the N*Aqcess proposal as set forth below. The Board now seeks comment on the specific elements embodied in the amended proposal.
The NASD will consider comments received on the proposal and resubmit the proposal to the Board in mid-September. If the Board thereafter approves the system and its rules, the NASD will promptly file the proposal with the Securities and Exchange Commission (SEC) for approval.
In Notice to Members 95-20 (the original proposal), the NASD circulated for comment a proposal for significant modifications to The Nasdaq Stock Market represented by development of a national limit-order facility that would provide investors market-wide price protection of their limit orders and the opportunity to seek price improvement in Nasdaq stocks. The key elements of the original proposal were:
- A facility for displaying and executing investor limit orders of 3,000 shares or less in Nasdaq National Market® securities (1,000 shares or less for The Nasdaq SmallCap MarketSM securities);
- The public dissemination of the best-priced orders in the facility;
- A requirement that eligible-sized limit orders either be entered into the facility or be guaranteed executions equivalent to what they would receive if they were entered in the facility;
- Automated execution of market orders of 1,000 shares or less in Nasdaq National Market securities (500 shares or less for The Nasdaq SmallCap Market securities) against orders in the facility or market-maker quotes based upon price and time priority; and
- An exposure mechanism for market orders of 1,000 shares or less in Nasdaq National Market securities (500 shares or less for The Nasdaq SmallCap Market securities) to achieve price improvement.
The NASD received 74 comment letters on the original proposal. The comment letters came from member firms, including wholesale and integrated market makers and order-entry firms, individual investors, academics, and organizations representing market makers. The NASD also met extensively with a broad cross-section of market participants to obtain their views on the key features of the proposed system. A sizeable number of commenters expressed support for the underlying investor protection features in the proposal, in particular the limit-order protection and order-interaction features. On the other hand, a number of commenters expressed concern with the market-order handling and price-improvement proposal, as well as the proposed size of eligible limit orders. Many commenters believed that the proposed means of handling market orders could result in unacceptable queues or was otherwise unworkable. Other comments questioned the basis on which the NASD selected 3,000 shares as the appropriate size for limit orders eligible for entry into the system. Certain of these commenters believed that because N*Aqcess should be structured for retail customer order entry, the size of limit orders eligible for the system should more closely reflect the average retail order size. These commenters believed that the average size of such orders was under 500 shares and thus the limit-order size should not be larger than 1,000 shares. Other commenters argued the NASD should remove any limitation size of limit orders and that any customer, retail or otherwise, should be permitted to have orders placed in the system.
Additionally, certain commenters recommended that firms should be permitted to enter proprietary orders into N*Aqcess. These commenters believed that allowing member firm proprietary orders in N*Aqcess could encourage professional order flow to remain in Nasdaq and would be fairer on the basis of equal treatment of all market participants.
Finally, many commenters believed that while the proposal set forth meritorious concepts, it was difficult to provide meaningful comment because of the lack of detail in the proposal. These commenters recommended that before submitting any proposal to the SEC, the NASD should provide the membership a further opportunity to comment when greater detail was available.
The Revised N*Aqcess System And Companion Rules
After reviewing the comments and conferring with various market participants, the NASD has made several modifications to the original proposal and articulated the details of the regulatory structure to govern the proposed system. The new proposal, which includes many of the key features of the original proposal, may be subject to further revision based on the comments received.
The NASD and the Nasdaq Stock Market, Inc. are proposing rules of operation and procedure and companion Rules of Fair Practice for a new service that would provide retail investors market-wide price protection of their limit orders, the opportunity to obtain price improvement in buying and selling Nasdaq stocks, and increased access to the Nasdaq market. The new facility, to be named N*Aqcess and operated by The Nasdaq Stock Market, will permit significant opportunity for retail investors in Nasdaq securities to enter limit orders inside the Nasdaq dealer quotation and enhance the opportunity for investors to receive executions between the best dealer bid and offer without such orders interacting with market makers.
The best price limit orders in N*Aqcess limit-order file will be available for display through information vendors, thereby providing new levels of transparency, increased price efficiency, and greater investor protection. Further, the companion rule and Interpretations accompanying the new system will provide retail customers with enhanced price protection of their limit orders, a significant expansion over current limit-order protection in Nasdaq.
Finally, N*Aqcess will provide customers that choose to enter market orders into the system with the opportunity to obtain price improvement over the dealer quotation through interaction with customer limit orders in the N*Aqcess file. In sum, N•Aqcess will provide investors with an increased opportunity to receive a prompt, cost-effective execution at the best price available in the market at any particular point in time.
Scope Of System
N*Aqcess will be available for all Nasdaq issues. It will completely replace the Small Order Execution System (SOESSM) which will operate until the effective date for operation of N*Aqcess and will be discontinued as of that date. N*Aqcess participation will be mandatory for market makers in all Nasdaq National Market securities. N*Aqcess participation for The Nasdaq SmallCap Market market makers will be voluntary, as is SOES participation today for such market makers.
Agency orders may be entered into N*Aqcess only by member firms on behalf of customers. The term "customers" excludes any broker, dealer, person associated with a member, or a member of the immediate family of such person associated with a member. Because the purpose of the system is to provide small retail customers with access to The Nasdaq Stock Market, member firms, with one limited exception, may not enter proprietary orders.
The only exception to the proprietary order prohibition is an order designated by a market maker as a "marker order." A marker order is a principal order entered by a market maker in a transaction that is functionally the equivalent of a riskless principal transaction. The firm may place a principal account limit order in N*Aqcess, and if an execution is obtained, immediately pass along the benefit of such execution to a retail customer order it holds. Because the order is part of a principal transaction for the benefit of the retail customer, the NASD believes that it is appropriate to permit this limited exception to the prohibition of proprietary orders in N*Aqcess. The NASD will require member firms entering such orders to mark their order tickets accordingly, and will examine a firm's trading activities carefully to determine that such proprietary orders are being effected for the purposes of engaging in a riskless principal-like transaction.
Member firms may enter so-called "takeout" orders for their own accounts or for a customer. A takeout order results in an immediate automatic execution of a limit order or orders in the N*Aqcess limit-order file at the limit-order price(s). There is no size limitation on the takeout order. Thus, if the N*Aqcess file displays limit orders at a price with an aggregate size of 15,000 shares, a single takeout order of 15,000 shares may be entered and executed. Similarly, a firm may enter a takeout order to immediately execute multiple limit orders at multiple prices in N*Aqcess. When there are multiple limit orders being taken out, each limit order will execute at each limit order's price.
N*Aqcess will accept customer limit orders up to 1,000 shares in Nasdaq National Market and The Nasdaq SmallCap Market issues, except for the Nasdaq 100 Index® issues, in which case a limit order may be 3,000 shares. This represents a difference from the original proposal of 3,000 shares for all Nasdaq National Market issues.1 Many commenters believed that because N*Aqcess is intended to provide small retail customers with limit-order protection, the initial approach should reflect more closely that the average retail-order size is well under 1,000 shares. These commenters urged that N*Aqcess could significantly affect market-maker participation, particularly in less active securities. As a result, they suggested that the N*Aqcess order size should be set at lower levels at least until the NASD had thoroughly evaluated the effect of the system on market liquidity.
While the NASD believes that N*Aqcess will have overall positive effect on market quality, we believe that it is prudent in this start-up period to scale back the limit-order size eligibility to 1,000 shares, except for those securities that comprise the Nasdaq 100 Index, where there are high levels of volume, greater market-maker participation and significant market liquidity. The NASD proposes to monitor the limit-order size requirement carefully in the initial operation of N*Aqcess and may choose to expand the eligible size of limit orders, if experience demonstrates that such expansion has merit.
Market orders in Nasdaq National Market issues may be 1,000, 500, or 200 shares depending upon tier size determination made in the same manner as done in SOES today. Similarly, market orders in The Nasdaq SmallCap Market issues will be tiered at 500 shares as is done in SOES.
The NASD will permit market makers to establish minimum exposure limits that are equal to the maximum market-order tier size. In addition, N*Aqcess will contain an automated update feature that will automatically change the market maker's quotation by a minimum increment set by the market maker after the market maker has executed a trade at a price level and has exhausted its minimum exposure limit for non-directed orders. The NASD believes that these aspects of N*Aqcess are critical to effective operations that permits a market maker to manage its risk capital, and are consistent with the SEC firm quote rule as applied to all other registered markets.
Customers may choose to enter "marketable limit orders." A marketable limit order is a limit order that is priced at the time of entry at the current inside quotation or better on the opposite side of the market, i.e., a marketable limit order to buy is equal to or higher than the current inside offer, while a marketable limit order to sell is equal to or lower than the inside bid. For example, if the current inside quotation is 20 - 20 1/4, the entry of limit orders to sell priced at 20 or 19 7/8 would be considered marketable limit orders. Marketable limit orders will be treated as market orders. Thus, if a firm enters a customer limit order to sell at 20 at the time the inside bid is 20, the limit order will be passed over the limit order file and if no match occurs, it will be treated as a market order and executed as discussed in the market order handling section. If a marketable limit order, however, is greater than 1,000 shares, the order will be returned to the order-entry firm for handling outside of N*Aqcess.
Neither a limit order nor a market order may be split to meet the size parameters of N*Aqcess. The NASD will examine order-handling practices of order-entry firms to determine compliance with this requirement.2
Display Of Limit Orders
To enhance the transparency of The Nasdaq Stock Market and to assist in the price discovery process, the NASD will provide for the display of limit orders entered into N*Aqcess. There will be two separate approaches to the display: the Top of the File Display and the Full Limit Order File Display.
Top Of The File Display
The Top of the File Display consists of the best limit-order price to buy, the best limit-order price to sell, and the aggregate sizes at both such prices. The top of the file will be displayed contiguous with, and separate from, the inside-dealer quotation. A number of commenters on this issue urged that the NASD maintain separate displays, because The Nasdaq Stock Market has a competing dealer market structure. Further, although there will be two separate displays, they will be viewable together, and thus the limit-order file information will assist in the price discovery process. Indeed, NASD member firm obligations for price protection will be triggered by the limit-order file as displayed.
The Top of the File will be dynamically updated on Nasdaq workstations® and will be made available to securities information processors.
Full Limit Order File Display
The Full Limit Order File Display for a particular security will be made available on a query basis over Nasdaq Workstations only to Nasdaq market makers in that security. The NASD believes that, as with other
U.S. market centers, display of the entire limit-order file should be reserved to market makers in a particular security to assist in price discovery and to provide the market maker with an incentive to provide liquidity by risking its capital. In fact, no U.S. exchange registered with the SEC publicly disseminates any display (full or partial) of a limit order book maintained by an exchange specialist. Because of the accompanying rules described below that the NASD has proposed, customer limit orders in the file will be protected from inferior executions.
N*Aqcess will provide significant improvements over SOES in the way that customer limit orders and market orders will be handled. N*Aqcess will attempt to match all incoming orders, limit or market, directed or non-directed, against limit orders already resident in N*Aqcess on a price and time priority basis. If a match is found, the orders will be automatically executed against each other without the participation of a market maker. For example, assume the current inside quotation for a security is 20 - 20 1/2 and the N*Aqcess Top of the File Display contains a 1,000-share limit order to buy at 20 1/8 and a 1,000-share limit order to sell at 20 3/8. If a customer enters a 1,000-share limit order to sell at 20 1/8, the incoming limit order to sell will match against the 1,000-share limit order to buy in N*Aqcess at 20 1/8 and will be executed against that order. If a customer next sends in a market order to buy, the market order will match against the limit order to sell at 20 3/8, rather than the dealer offer of 20 1/2. Thus, the market order will be automatically executed immediately at 20 3/8. In both cases, the orders received price improvement and immediate execution without the participation of a market maker.
The system will only execute such matches when the execution prices would equal or better the inside market. Nevertheless, limit orders priced away from the inside market, i.e., limit orders to sell priced higher than the inside offer and limit orders to buy priced lower than the inside bid, will be stored in N*Aqcess. When the inside market moves to a price so that the limit order equals or betters the inside market, the limit order will become eligible for matching as described in this section.
When a limit order in N*Aqcess equals the inside market, the time priority of the limit order compared with the inside market will govern which price interacts first with incoming orders. The NASD believes that this well-understood approach is a reasonable means for determining the interaction of such orders and provides a further incentive to market makers to provide liquidity and narrow spreads.
Market Order Handling
In an important change from the original proposal, the NASD has significantly revised the market order handling features of N*Aqcess. Because the original proposal suggested a price-improvement feature that would have distributed one order at a time, commenters expressed concern that significant queues could develop. The revised proposal does away with the market-order-stop feature and now provides for immediate distribution of an order when received, unless all available market orders have already been assigned an order. Thus, if no limit orders reside in N*Aqcess, market orders will be immediately assigned and distributed to market makers at the inside market. This rapid distribution should minimize the potential for queues that the original proposal could have caused.
From the time the order is first assigned to a market maker, the system will provide the market maker up to 20 seconds to decline a non-directed order, if such action is consistent with the SEC's firm-quote rule, Rule 11Ac1-1. In other words, if the market maker, immediately before the presentation of the N*Aqcess order effected a trade and was in the process of updating its quotation to reflect that transaction, the market maker is permitted to decline the N*Aqcess order. A N*Aqcess order declined by a market maker will be presented to the next available market maker. If that market maker is at the same price as the market maker that originally declined the order, the market maker also has 20 seconds to react to the order. If, however, the order is presented a second time at a different price level from that when the order first entered N*Aqcess, it is automatically executed without any decline capability.
The NASD believes that 20 seconds is appropriate because it ensures that the market maker will have a full 15 seconds to react to the order especially when the system experiences peak usage. The extra five seconds is accounted for by the system time required to process both the presentation of the order and the market maker reaction to it.
The NASD is developing an automated surveillance capability to monitor on a real-time basis whether an order was properly declined. The NASD believes that this capability is crucial to engendering investor confidence in the firmness of Nasdaq market-maker quotations and should alleviate any concerns regarding "backing away" questions.
Order-entry firms have two alternatives when entering N*Aqcess orders—they may direct the order to a particular market maker with whom they have established a directed order arrangement, or they may enter a non-directed order. In either circumstance, market orders and marketable limit orders will first pass over the limit-order file to obtain a match with a limit order before execution against a market maker, directed or not. If an order is directed pursuant to a valid agreement between the order-entry firm and the market maker, the market maker may not decline the order.3
N*Aqcess will have special opening procedures that are consistent with the order matching and price improvement opportunities provided intra-day by N*Aqcess.
N*Aqcess's operating hours are from 9:30 a.m. to 4 p.m. Eastern Time (ET). However, limit orders may be entered and stored in N*Aqcess from 4 to 6 p.m., ET, and limit and market orders may be entered from 8:30 a.m. to 9:28 a.m., ET. At 9:28 a.m., ET, no further orders for opening purposes will be accepted.4 At 9:30 a.m., ET, Nasdaq will rank all limit orders stored as of 9:28 a.m., ET, according to price and time of entry. Limit orders will be matched against each other to obtain the largest number of executions possible and their prices will be reported. When all available limit-order matches are effected, any remaining limit orders within the inside dealer quote will be matched against market orders stored as of 9:28 a.m., ET, and will be executed at such limit order prices. Any remaining orders will be subject to the normal intra-day, order distribution and execution procedures.
Rules Of Fair Practice
The NASD is also proposing three major changes to the Rules of Fair Practice in conjunction with N*Aqcess. Under the proposed new rule and Interpretations, the treatment of limit orders will be significantly changed to promote price protection of such orders throughout The Nasdaq Stock Market. These proposed rule changes provide greatly enhanced limit-order treatment over current practices. Together with existing limit-order protections already in place (e.g., the so-called "Manning" rule), the new proposals provide investors placing limit orders with significantly enhanced protections against trade-throughs throughout The Nasdaq Stock Market.
The NASD is proposing a new Interpretation under Article III, Section 1 of the Rules of Fair Practice that provides, if a customer requests that his or her order be entered into N*Aqcess, the member firm must do so. While the Interpretation permits a firm to charge for such services and to recommend the use of its own execution system, the member is not permitted to discriminate against customers that choose N*Aqcess over an internal system by imposing unfair commissions or charges. The proposed Interpretation covers both market and limit orders.
The NASD is also proposing to prohibit a member firm, whether acting as a principal or as an agent, from executing any order at a price inferior to any limit orders that the firm is able to see in N*Aqcess.5 An inferior price means an execution price that is lower than a buy limit order or higher than a sell limit order that a member firm is able to see in the N*Aqcess limit order file. This prohibition means that limit orders in the N*Aqcess file will not be traded through elsewhere in Nasdaq in most circumstances. For example, if N*Aqcess has a 1,000-share limit order to buy at 20 1/8 displayed at the top of the file, no member firm is permitted to execute any transaction below 20 1/8 without first satisfying the 20 1/8 N*Aqcess limit order. If the transaction that the firm wanted to do was 1,000 shares at 20, the firm would have to execute the 1,000 share N*Aqcess limit order at 20 1/8 and then it could execute its order at 20. If the order that the firm wanted to execute was for 10,000 shares at 20 1/16, under the proposed new rule, the firm could execute and report the 10,000-share trade at 20 1/16, as long as it contemporaneously executed all 1,000 shares of the N*Aqcess order at 20 1/8.
The price-protection obligation is related to the ability of the firm to view the orders in the limit-order file. Thus, limit orders at the top of the file must be protected by all member firms. Under N*Aqcess rules, limit orders ranked below the top of the file are viewable only by market makers in the particular security. Accordingly, market makers in a particular security would be obligated to protect all limit orders in that security in N*Aqcess from inferior executions that they may effect. Thus, if a market maker in a security sought to execute a 1,000-share trade at 20, when the N*Aqcess file displayed limit orders to buy at 20 1/16, 20 1/8, and 20 1/4, the market maker would be required to execute the limit orders.6
Equivalent Price Protection
As noted earlier, the NASD, to encourage competition and to enhance the liquidity of The Nasdaq Stock Market, has determined that market makers should continue to operate their own internal execution systems and to handle limit orders outside of N*Aqcess. However, the NASD also believes it is important to provide limit orders held outside of N*Aqcess with price protection substantially equivalent to that which N*Aqcess orders would have. Accordingly, the NASD will propose an Interpretation to Article III, Section 1 of the Rules of Fair Practice to provide substance to the term equivalent price protection.7
First, a member firm holding a protectible customer limit order outside of N*Aqcess must provide such order with print protection, if any transaction at a price inferior to the customer limit order occurs. A "protectible" order is a customer order of a size that would be eligible for entry into N*Aqcess. Accordingly, the Interpretation requirements do not extend to customer limit orders that are larger than 1,000 shares (or larger than 3,000 shares for Nasdaq-100 Index). Thus, any firm holding a protectible customer limit order is required to contemporaneously execute, up to the size of the reported transaction, the customer limit order at the limit order price if an inferior-priced execution is reported in that security. For example, firms A and B each hold 1,000 share customer limit orders to buy priced at 20 1/8. A 1,000 share trade is reported at 20. Both firms A and B are obligated to execute their limit orders at 20 1/8. If the triggering trade report had been 500 shares at 20, each firm owed their customers executions of at least 500 shares at 20 1/8.
Next, if the firm holds a protectible customer limit order at a price that would match a limit order in N*Aqcess, the firm must either execute its limit order or direct its limit order to N*Aqcess for matching. "Matching" means that the N*Aqcess limit order is the same price or lower than the firm's customer's limit order to buy or higher than the limit order to sell.
The same matching would be required if the firm holds offsetting limit orders within its own file. If the firm holds a limit order to sell at 20 1/4 and accepts a limit order to buy at 20 1/4 or higher, the firm must execute the two orders against each other. Finally, if the firm holds a limit order that equals or betters the inside quotation in Nasdaq, if the firm accepts a customer market order for automated execution at the inside quotation, the firm must first match the market order against the limit order before it can execute the market order for its own account. The last requirement is consistent with a member firm's limit-order protection obligations under the Manning rule.
N*Aqcess and the accompanying new Rules of Fair Practice provide multiple benefits to retail investors that were heretofore unavailable. Retail investors will be able to have limit orders placed in a central file where they can interact directly with other customer orders entered into the system. N*Aqcess will provide increased transparency of the best-priced limit orders in N*Aqcess because Nasdaq will make available to securities information processors a data feed consisting of the best-priced limit orders and their aggregate sizes in a particular security. This increased transparency will enhance the Nasdaq price-discovery process. N*Aqcess will match incoming limit and market orders against limit orders resident in the N*Aqcess file so as to permit customer orders to interact directly with each other without the participation of a market maker. The N*Aqcess proposal will also provide market-wide price protection to customer orders.
Questions regarding this Notice should be directed to Robert E. Aber, General Counsel, at (202) 728-8290 or Eugene A. Lopez, Assistant General Counsel, at (202) 728-6998.
Request For Comments
The NASD requests all members and interested parties to comment on this proposal. Comments must be received no later than August 30, 1995, and should be directed to:
Joan C. Conley, Secretary NASD 1735 K Street, N.W. Washington, DC 20006-1500.
1 The Nasdaq SmallCap Market issues have a limit-order size of 1,000 shares.
2 In this regard, the NASD notes that order-entry firms may only enter agency orders. The rules continue in effect the definition of agency orders as found in the current SOES Rules and the new rules carry forward the existing principles regarding the aggregation of orders based on a single investment decision entered by an order-entry firm.
3 Odd lot orders in N*Aqcess will be executed automatically at the inside quotation. Market makers will received an execution report.
4 Orders entered from 9:28 a.m. to 9:30 a.m., ET, will be stored and handled after the opening in line with ordinary matching and handling procedures described above.
5 It should be noted that placement of a customer limit order in N*Aqcess does not relieve a member firm of its obligation under the Limit-Order Protection Interpretation of Article III, Section 1 of the Rules of Fair Practice that prohibits a member firm from trading ahead of a customer limit order that it is holding. Under the "Manning" Interpretation, if a member firm holding a customer limit order, whether from its own customer or as a result of a member-to-member order, places that order into N*Aqcess, the member firm is nevertheless prohibited from trading at the same price or at an inferior price as the customer order. Thus, while the newly proposed price-protection rules speak in terms of protecting N*Aqcess orders from inferior priced transactions, if the N*Aqcess order is the firm's customer's order or a member-to-member order it placed, the firm may not trade at the same price without protecting that order.
6 The price-protection rule will not apply to member firms that operate passively priced crossing systems, such as POSIT and Instinet's Crossing Network. Generally speaking, such systems execute prices at the dealer quotation spread midpoint and would not likely trade through a N*Aqcess order. The proposed rule would apply to, however, all continuous trading systems operated by NASD members. Because trades handled through such continuous trading systems could occur at prices that could be inferior to limit orders in N*Aqcess, the NASD believes it appropriate that NASD member firms operating continuous trading systems should protect N*Aqcess customer limit orders as would any other registered broker/dealer member firm. Orders placed in SelectNetSM that trade through N*Aqcess are also subject to the price-protection rule.
7 The equivalent price-protection Interpretation would not apply to continuous trading systems operated by member firms, because such customers are generally sophisticated and have deliberately opted to trade in an alternative trading system. Such customers are institutions and broker/dealers that seek other advantages in trading in these alternative systems. Because of their sophistication and their direct control of their orders, the NASD preliminarily does not believe that application of the equivalent price-protection requirement is appropriate. The NASD would consider an exemption from the Interpretation to brokers operating such systems if they sought one.
Text Of Proposed Amendments To Rules Of Fair Practice Related To N*Aqcess
Interpretations Related To Member Firm Responsibilities Regarding Orders In N*Aqcess
In its efforts to maximize the protection of investors and to enhance the quality of the marketplace, the NASD and The Nasdaq Stock Market, Inc. have developed a nationwide limit-order protection, price-improvement, and market-order handling facility of The Nasdaq Stock Market. This nationwide facility is herein referred to as "N*Aqcess."
The NASD Board of Governors is issuing these Interpretations to the Rules of Fair Practice to provide: (1) customers the right to have their orders entered and protected in N*Aqcess; and (2) member firm provision of equivalent protection for limit orders held in a member firm's proprietary limit order system. These Interpretations are based upon a member firm's obligation to provide best execution to customer orders under Article III, Section 1 of the Rules of Fair Practice and a member firm's obligations in dealing with customers as principal or agent to buy and sell at fair prices and charge reasonable commissions or service charges under Article III, Section 4 of the Rules of Fair Practice. Accordingly, it shall be deemed a violation of Article III, Section 1 of the Rules of Fair Practice for a member or a person associated with a member to violate the following provisions:
N*Aqcess will provide individual investors with significant opportunities to achieve limit order protection and price improvement. The NASD recognizes that member firms operating as market makers also operate trading systems which offer significant protection and execution opportunities for customer limit orders. Accordingly, nothing herein is intended to limit a member's ability to recommend use of its own or another member firm's proprietary system for handling limit and market orders where equivalent protection is afforded. In light of the significant benefits offered to customers by the N*Aqcess system, however, members must abide by the directions of its customers who request that the firm enter their orders in N*Aqcess.
Further, nothing in this Interpretation requires a member firm to accept any or all customer limit orders. Member firms accepting limit orders that are placed in N*Aqcess or otherwise may charge fair and reasonable commissions, commission-equivalents, or service charges for such handling, provided that such commissions, commission-equivalents, or service charges do not violate Article III, Section 4 of the Rules of Fair Practice. In no event, however, shall a member impose any fee or charge that effectively operates as a disincentive to the entry of orders in the nationwide facility and thereby interferes with the investor's ability to choose order handling alternatives.
As a further adjunct to a member firm's best execution obligations, the NASD Board of Governors has interpreted Article III, Section 1 of the Rules of Fair Practice to require member firms that do not enter customer limit orders into N*Aqcess, but hold such protectible orders in their own proprietary system, to provide such orders with price protection at least equivalent in substance to that which the order would have received had the order been entered into N*Aqcess. For the purposes of this Interpretation, a "protectible limit order" shall mean a limit order that meets the maximum limit-order size criteria as set forth in the Rules of Operation and Procedure for N*Aqcess at Section I(m). For the purposes of this Interpretation, equivalent price protection shall mean:
If a transaction in a Nasdaq security is reported via the Automated Confirmation Transaction (ACTSM) Service at a price inferior to the price of customer limit order(s) that the firm is holding (i.e., if the reported price is a price lower than a buy limit order or higher than a sell limit order being held by the firm), the firm holding the limit order(s) is required on a contemporaneous basis to execute the limit order(s) at the limit price(s) up to the size of the reported transaction.
If the firm holds a customer buy (sell) limit order in its proprietary limit order file and that limit order matches a sell (buy) limit order in N*Aqcess, the firm holding the limit order must either provide its customer with an immediate execution at the limit order price or must immediately direct the order to N*Aqcess. A limit order held by a firm would match a limit order in N*Aqcess when the limit order in N*Aqcess is at the same price or is priced lower than the firm's customer's limit order to buy or higher than the firm's customer's limit order to sell ("offsetting limit orders").
If the firm holds two or more offsetting customer limit orders within its own proprietary file, the firm must execute the offsetting limit orders.
While holding a customer limit order that is priced equal to or better than the best bid or offer in the security disseminated in Nasdaq, if a firm accepts customer market orders for automated execution against the best bid or offer in the security disseminated in Nasdaq, the firm, pursuant to its obligation set forth in the Interpretation to the Rules of Fair Practice, Article III, Section 1, (the so-called "Manning Interpretation"), must first permit the market orders to execute against any applicable limit orders it holds before the firm may execute the market orders for its own account.
The NASD Board of Governors has provided the following examples to further explain a member firm's equivalent protection obligation for orders held outside of N*Aqcess:
Print Protection—The best dealer bid and offer in Nasdaq ("the inside price") is 20 bid - 20 1/4 offer. Firm ABCD holds a customer limit order of 1,000 shares to buy at 20 1/8 in its own proprietary file. Firm MNOP reports a transaction in the subject security via the ACT Service, disseminating a price of 20 1/16 for 500 shares. Contemporaneous with the dissemination of the trade report, firm ABCD is required to provide an execution of its customer limit order for at least 500 shares at 20 1/8.
Matching Limit Orders—The inside price is 20 bid - 20 1/4 offer. N*Aqcess is displaying a 1,000 share customer limit order to buy at 20 1/8 for customer X. Firm ABCD thereafter receives from customer Y a 1,000 share limit order to sell at 20 1/8 that the firm ABCD retains for handling outside of N*Aqcess. Upon receipt of the limit order, firm ABCD must execute customer Y's limit order for 1,000 shares at 20 1/8.
Matching Limit Order Interaction Within A Firm's File—The inside price is the same as above. Firm ABCD holds a customer limit order to buy 1,000 shares at 20 1/8. Firm ABCD thereafter receives a customer limit order to sell 1,000 shares at 20 1/8. Firm ABCD must match the orders and execute the trade.
Interaction Between Limit And Market Orders Held Within A Firm's File—The inside price is the same as above. Firm ABCD holds a customer limit order to buy 1,000 shares at 20 1/8. Firm ABCD thereafter receives a customer market order to sell 1,000 shares. Firm ABCD must match the two orders and execute the trade at 20 1/8. Similarly, if the limit order to buy were priced at 20, the firm would have to execute the market order against the limit order at 20.
Text Of Proposed Section 50 To Article III Of The Rules of Fair Practice
(Note: New text is underlined.)
Price Protection For N*Aqcess Limit Orders
No member firm shall execute an order as principal or as agent at a price inferior to any limit order(s) viewable in N*Aqcess to the member firm, provided however, that a member firm executing a transaction that is larger than the limit order(s) viewable in N*Aqcess at an inferior price must contemporaneously satisfy the limit order(s) viewable in N*Aqcess. An "inferior price" means an execution price that is lower than a buy limit order or higher than a sell limit order that is viewable in N*Aqcess. The term "limit orders viewable in N*Aqcess" shall mean those orders that the member firm is able to view in either the Top of the File Display or the Full Limit Order File Display as the firm is authorized to view under the Rules of Operation and Procedure.
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