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95-20 NASD Solicits Member Comment On Proposals For Comprehensive Improvements To The Regulation And Operation Of The Nasdaq Stock Market;

Comment Period Expires April 21, 1995


Senior Management
Corporate Finance
Legal & Compliance

Executive Summary

On March 17, 1995, the NASD Board of Governors approved the issuance of a Notice to Members, soliciting comment on a proposal for comprehensive structural changes in The Nasdaq Stock Market™ through the 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, buying and selling Nasdaq® stocks. As described in more detail below, this fully automated facility, to be called AqcessSM, would include:

  • 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 is soliciting comment on these proposals described in more detail below. Further, the NASD seeks comment on any other issues that this proposal may raise for members or other interested parties. Comments received on or before April 21, 1995, will be considered by the Board at its next meeting.


For over 24 years, The Nasdaq Stock Market1 has provided investors with a growing, strong, and vibrant marketplace. Nasdaq has allowed investors to participate in the growth of new companies at the forefront of innovation in new and emerging industries and seasoned companies in well-established sectors of the American and global economies. With the growth and success of its listed companies, Nasdaq, as a marketplace, also has grown significantly and has continuously invested in technology and improved its regulatory effectiveness to better serve investors, issuers, and member firms. As a result, Nasdaq now constitutes the second largest equity market in the world.

This unprecedented growth has been achieved in the context of a quotation-driven dealer market structure that has provided effective sponsorship and coverage of listed companies while maintaining liquidity and continuity for investors' transactions. Over time, the marketplace and its participants have developed new trading systems that permit member firms and institutional investors to electronically discover, for customer or proprietary orders, buyers or sellers at prices between the best bid and offer. Similarly, continuous trading offer. Similarly, continuous trading systems also have provided very significant opportunities for price improvement to member firms and institutional investors. The NASD strongly believes that in light of these structural developments, it is important that The Nasdaq Stock Market adjust to provide all investors greater opportunities to receive executions between the best bid and offer.

After consulting closely with investors, issuers, and member firms, the NASD is proposing to develop Aqcess, which will provide new levels of transparency and price protection for customer limit orders and new opportunities for price improvements for customer market orders.

Key Features Of Nasdaq's New National Limit-Order Facility And Companion Regulations

The National Limit-Order Facility

The NASD is proposing to develop a national limit-order facility in which customers,2 through their brokers, may place orders of up to 3,000 shares in Nasdaq National Market securities and up to 1,000 shares in The Nasdaq SmallCap Market securities. There are several elements to this limit-order facility that will provide significant protection for investors and increase market transparency.

First, the entire limit-order facility will be displayed on Nasdaq Workstation® presentation devices of NASD members; thus, any member firm that is a Workstation subscriber will be able to see all limit orders in the facility. The NASD also proposes to make available for vendor dissemination the total number of shares and the price of limit orders at the best prices in the facility. Accordingly, subscribers to vendor services will be able to see not only the best bids and offers being quoted by Nasdaq market makers, but also the aggregated best limit orders to buy and sell.3

Matching limit orders in the facility would be automatically executed against each other. This automatic matching of limit orders provides instantaneous execution and greater opportunity for investors' limit orders to meet at prices better than those represented by the best bid and offer of the market makers in a stock.

For example, an investor places a limit order through a broker in Nasdaq's limit-order facility. The order is to buy 3,000 shares of a Nasdaq stock at 20 1/4. The best bid (the highest price at which a market maker is willing to buy) and the best offer (the lowest price at which a market maker is willing to sell) among all the competing market makers at the time is 20 1/8 - 20 3/8. The order is stored and displayed. Another investor places a limit order in the facility through a broker to sell 2,000 shares of the same stock at 20 1/4. The orders are automatically matched at 20 1/4 for 2,000 shares. The remaining portion of the buyer's order—1,000 shares—remains in the limit-order facility at 20 1/4 until executed or canceled.

Investor limit orders in the facility that are at prices better than the best current quotes of Nasdaq market makers (i.e., between the best bid and best offer) would be automatically executed against investor market orders of 1,000 shares or less that are entered into the facility. Market orders are orders to buy or sell at best current prices. These orders do not specify prices or "limits."

For example, an investor places a limit order to buy 1,000 shares of a Nasdaq stock at 20 1/4 through a broker in the limit-order facility. As in the last example, the current best bid and offer is 20 1/8 - 20 3/8. The investor limit order to buy at 20 1/4 is 1/8 of a point better (i.e., higher) than the best market-maker bid to buy at that time. Concurrently, an investor places a market order through a broker into the Nasdaq system to sell 1,000 shares of the stock at the best price in the market. The seller's market order is automatically matched and executed with the buyer's order.

Both investors get better prices. The buyer bought at 20 1/4 instead of at 20 3/8, the best market-maker offer to sell in the system at the time. The seller received 20 1/4 for his or her stock instead of 20 1/8, the best market-maker bid to buy on Nasdaq at the time.

Price Protection For Nasdaq Limit Orders Entered Into The Facility

Under the proposed revisions, investor limit orders entered into the facility would be protected throughout The Nasdaq Stock Market. No NASD member will be permitted to execute a trade at a price lower than a buy limit-order price, or higher than a sell limit-order price until the limit order is executed.4

For example, three investors place limit orders in the facility through their broker to buy a total of 5,000 shares of a Nasdaq stock (via separate orders of 2,500, 1,500, and 1,000 shares) at 20 1/4. The best bid and offer continue to be 20 1/8 - 20 3/8. A Nasdaq market maker sees on the Nasdaq computer screen that there are investor limit orders to buy 5,000 shares at 20 1/4. The Nasdaq market maker wants to buy 10,000 shares at 20 1/8. The market maker must execute the investors' limit orders to buy 5,000 shares at 20 1/4 before buying any other shares at a price less than 20 1/4.

Member Obligations For Limit Orders Not Entered Into The Facility

The NASD's proposed revisions are intended to preserve and enhance the multiple dealer structure of the markets. Historically, Nasdaq's dealer structure has promoted competition, resulting in enhanced pricing efficiencies, innovation, and technological advances that have benefited investors and issuers. It is desirable that these benefits are maintained as changes are made in market structure. Thus, member firms may continue to operate their own automatic execution and continuous trading systems.

The implementation of a limit-order facility, however, will be accompanied by enhanced best-execution obligations for member firms that do not place a limit order in the Nasdaq facility. Specifically, the NASD would interpret member firms' best-execution obligations, pursuant to Article III, Sections 1 and 4 of the NASD Rules of Fair Practice, to require them to provide limit orders they hold with price protection equivalent to or better than that which the order would have received in the Nasdaq facility.

For example, an investor places a limit order with a member firm to buy shares of a Nasdaq stock at 20 1/4. The current best bid and best offer is 20 1/8 - 20 3/8. Firm XYZ may hold the customer's limit order rather than forward it to the Nasdaq limit-order facility. In doing so, it would be obligated to execute the customer's limit order at 20 1/4 when and if there were a reported transaction on Nasdaq below 20 1/4.5

Small Customer Market-Order Execution Enhancements

In addition to the development of a new limit-order facility, The Nasdaq Stock Market will develop a small customer market-order execution capability that provides new price-improvement opportunities for customer market orders of 1,000 shares or less in Nasdaq National Market securities (500 or less for The Nasdaq SmallCap Market securities). Customer market orders in the Nasdaq facility for 1,000 shares or less in Nasdaq National Market securities (500 or less for The Nasdaq SmallCap Market securities) will be automatically executed against limit orders that are priced better than market-maker quotes.

For example, the best market-maker bid to buy a Nasdaq stock is 20 1/8. There is also a 1,000 share limit order to buy in the facility priced at 20 3/16. If a customer sell order of 1,000 shares is entered into the facility, the customer market order to sell is executed against the customer limit order at 20 3/16.6 The new facility also will provide small customer market orders the opportunity for price improvement when the best market-maker quotes are priced better than the best-priced limit orders. For example, the best market-maker bid to buy a Nasdaq stock is 20 1/8 and there are no limit orders to buy in the limit-order facility priced above 20 1/8. Sell market orders of 1,000 shares or less in Nasdaq National Market securities (500 or less in The Nasdaq SmallCap Market securities) entered into the facility are exposed to all market makers in the stock for 15 seconds to attract an execution that would be at a price at least 1/16 above the best bid (i.e., 20 3/16). If no market maker executes at a price above the best bid during the 15-sec-ond exposure, the order would be executed against the best price on Nasdaq, 20 1/8.

If the dealer quotes and the best limit-order price in the facility are equal in price, price improvement opportunities are also possible. In this case, the market order is exposed for 15 seconds to market makers at a price at least 1/16 better than the best quote or limit-order price. If the price is not improved during this 15-sec-ond period, then the market order is executed against either the quote or the order, depending on which has time priority.7 In all cases where price improvement is sought, the market order is guaranteed execution at the best available price at the time the order is exposed for price improvement.

Summary Of Features, Requirements, And Implications

The Nasdaq Stock Market, Inc., proposes to take these steps in its continuing efforts to develop a marketplace that guarantees investor protection and fairness to all market participants. The NASD believes that the proposed changes will result in better prices to investors because it will provide true market-wide limit-order protection in The Nasdaq Stock Market. Enhanced price discovery features, market-order interaction with limit orders, and the price improvement features of the facility will only add to the liquidity, immediacy, and efficiency already provided by Nasdaq's competing dealer-market structure. While the Board's proposed changes maintain the ability of dealers to provide liquidity and competitive mechanisms for handling customer orders, individual investors can take comfort in the strong investor protection standards incorporated in the new approach.

Solicitation Of Comments

The Board is soliciting comments from members and interested parties so that it may better evaluate the implications, and address and refine issues raised by the regulatory and market structure changes proposed in this Notice. In particular, the Board seeks comment on the scope of the changes. In addition to any issues raised in the discussion above; commenters are asked to address the following issues:

  • The Board's proposal extends these changes to Nasdaq National Market and The Nasdaq SmallCap Market securities. Should the changes be implemented for all such securities simultaneously or in a phased approach, progressing according to market capitalization or trading activity characteristics?

  • As noted above, Nasdaq-facility information will be displayed separately from Nasdaq dealer quotations. Limit orders reflect more temporal buying and selling interest, whereas dealer quotations reflect more continuous information that is inherently less volatile in nature. The NASD solicits comment on the desirability of providing a separate display of these streams of information.

Comments must be received no later than April 21, 1995, and should be addressed to Joan C. Conley, Secretary, NASD, 1735 K Street, NW, Washington, DC 20006-1500.

Questions regarding this Notice should be directed to Robert E. Aber, General Counsel, at (202) 728-8290, or Eugene A. Lopez, Senior Attorney, at (202) 728-6998.

1 The National Association of Securities Dealers, Inc. (NASD) is a self-regulatory organization registered with the Securities and Exchange Commission as a national securities association that regulates The Nasdaq Stock Market. The Nasdaq Stock Market. Inc., owns and operates the facilities that make up The Nasdaq Stock Market.

2 The term "customer" is defined to exclude broker/dealers. See NASD Rules of Fair Practice, Article II, Section 1(f).

3 Limit orders in the facility will not be integrated into the Nasdaq dealer-quote display.

4 A member firm will be obligated to place the order in the Nasdaq facility, if so requested by the customer.

5 Illustrative examples contained herein are not intended to suggest any change in a member firm's continuing obligation not to trade in front of a customer's limit order that it holds.

6 A market order executing against a limit order priced better than the quote has obtained price improvement over the quotes.

7 The priority rules for orders placed in the Nasdaq facility are: (1) the limit order at the best price has priority over all other limit orders within the facility; (2) limit orders in the facility at the same price are afforded priority according to time, i.e., the order at that price entered first in time is entitled to priority in executions over an order placed later in the facility; and (3) as to limit orders in the facility priced at the same price as the inside dealer quotation, the order or quotation that is first in time has priority. This last rule regarding time priority between orders in the facility and dealer quotes has relevance only for market orders of 1,000 shares or less entered into the facility.

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