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85-52 SEC Request for Comment on Issues Relating to the Designation of NASDAQ/NMS Securities

IMPORTANT

TO: All NASD Members and Other Interested Persons

In November 1984, the SEC approved, by a split vote, the NASD's longstanding petition that the Commission amend its rule governing the qualifications for companies seeking inclusion in the NASDAQ National Market System.

This landmark decision which, in essence, substitutes qualitative standards for market activity criteria, made an additional 1,500 National Newspaper List companies eligible for admission to the NASDAQ National Market System. In the opinion of the NASD Board, it has been one of the most important developments to have occurred in the continuing development of our nation's securities markets, and a decision that has resulted in substantial benefits for investors, NASDAQ companies and the securities industry. NASDAQ/NMS combines up-to-the-minute last-sale reporting characteristics of the major stock exchanges with the unique strength of the NASDAQ market — its highly competitive network of competing dealers.

Notwithstanding the benefits that are directly attributable to this decision, the SEC has determined to revisit this very issue less than eight months later. It is doing so mainly in response to complaints from competing markets during the rulemaking proceeding, particularly the American Stock Exchange, which claimed that the NASD was using "NMS designation" as a marketing device in competing with the exchanges for "listings."

Among the questions being raised by the SEC at this time are:

  • Is the NMS Securities Rule still necessary in its present form to maintain last-sale reporting in the NASDAQ market?
  • If the NMS Securities Rule is no longer essential for that purpose, should the entire group of NASDAQ stocks that have last-sale reporting continue to be designated as NASDAQ/NMS securities?
  • Is last-sale reporting sufficiently developed in the NASDAQ market that issuer choice should be removed from the Tier 2 designation criteria? In other words, should some or all of the securities that satisfy the Tier 2 criteria now be designated automatically in the same manner as securities qualified for Tier 1?
  • If the NMS Securities Rule retains its current focus, is there a danger of misperception of the significance of NMS designation with respect to the investment quality of a stock? Would such possible misperceptions be ameliorated if NMS designation were not limited to NASDAQ stocks?
  • To the extent the rule is deemed either to be no longer necessary to encourage NASDAQ last-sale reporting or to confer an unfair advantage on NASDAQ stocks designated as NMS securities, should the rule be refocused to desig nate other types of securities as NMS securities, i.e., securities listed on national securities exchanges, securi ties that essentially meet New York or American Stock Exchange listing criteria, securities traded in two or more markets, and securities traded through the Intermarket Trading System of the exchanges and the NASD?

NASDAQ companies have found that inclusion in NASDAQ/NMS has substantially improved the visibility of their stocks and the amount of market data that is available regarding their trading. Many have found, too, that they have attracted additional institutional investors, overseas interest and other investors who use market data and technical analyses. NASD members have confirmed the companies' findings.

As the foregoing list of questions suggests, the SEC is still responding to complaints from competing markets about issues that were thought to be settled less than one year ago. It is essential, therefore, that NASD members make their views known. At stake is the future visibility and credibility of the NASDAQ National Market System which paradoxically is an innovation of the SEC and one of its most successful efforts.

In commenting to the SEC, it is suggested that you convey your enthusiastic support for NASDAQ/NMS to the SEC by addressing the following:

  • What designation as a NASDAQ/NMS security has meant to your customers.
  • Why the NMS Securities Rule should be continued.
  • Why the SEC should ignore the complaints of competing markets.

The NASD Board strongly believes that there is considerable danger in changing the NMS designation rule after it has been approved. It is baffling to think that something so successful, something that has produced substantial benefits for so many — investors, NASDAQ companies, the securities industry — and something that was decided only recently with extensive input from many NASD member firms, NASDAQ company CEO's and others could now be questioned by the same entity that created it, the SEC.

It is important to note that the NASD has never claimed an exclusive right to the term "National Market System." The NASD has repeatedly stated that NASDAQ/NMS is but a subsystem or component of a broader national market system. The NASD has never said that NASDAQ constitutes the national market system. There is no restriction on the use of the term National Market System by the exchanges for securities that were, in fact, NMS designated. The Amex's claim that the NASD has attempted to mislead investors and issuers through use of the "NMS" term is without foundation in fact. To the degree NASDAQ/NMS is successful in retaining companies, it is doing so on merit and not on unfair competition.

Further, the NASD, like the SEC, has not represented, nor would it, that designation as a "National Market System" security warrants the quality of the issuer of any security so designated. It does represent that at the time of inclusion in NASDAQ/NMS, certain threshold standards were met. NMS designation does not substitute, nor has it ever been intended to substitute, for the quality judgments of investors.

The SEC's release also raises the question of issuer choice in electing NMS designation. The thinking of the NASD Board has been that as issuers are free to select the market in which their shares are traded, so too they should be free to elect the segment of NASDAQ in which their shares are to be traded. As a practical matter, the overwhelming majority of eligible companies have sought inclusion in NASDAQ/NMS.

In its release, the SEC is also asking a number of collateral questions:

  • If the SEC were to grant unlisted trading privileges to the exchanges, whether trading in NASDAQ/NMS securities should be integrated with exchange trading via existing or other possible linkages.
  • Whether the NASD's best-execution rule provides displayed NASDAQ/NMS quotations with sufficient price protection.
  • Whether short-sale rules should be applied to NASDAQ/ NMS securities.

These questions are presently under discussion and study by several NASD committees, including the Market Surveillance Committee and the National Business Conduct Committee, prior to their formal consideration by the NASD Board of Governors. The NASD Board believes that this deliberative process should run its course. It would be much appreciated if NASD members would send their comments and suggestions on these issues to the Board.

* * *

All NASD members are urged to express their views on this release to the SEC on or before the comment period ending date of September 30, 1985. Your ideas and opinions are extremely important and the nature of your comments will substantially affect the final SEC decision on this matter.

Your comments to the SEC should reference File No. S7-737 and be directed to:

Mr. John Wheeler, Secretary Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

If you have questions concerning the release that you would like answered before writing to the SEC, please feel free to call either John H. Hodges, Jr., Senior Vice President, Market Services, at (212) 839-6326, or S. William Broka, Vice President, NASDAQ Operations—Companies, at (202) 728-8050.

Finally, it would be very helpful to the NASD if you would send us a copy of your comment letter to the SEC. It may be sent to:

Mr. S. William Broka, Vice President
National Association of Securities Dealers, Inc.
1735 K Street, N.W. Washington, D.C. 20006

Once again, it is important for your voice to be heard on these issues. The SEC's November 1984 decision on NMS was the right decision and under no circumstances should it now be dismantled.

Sincerely,

Gordon S. Macklin
President

Attachment

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-22127; File No. S7-737]

National Market System Securities

AGENCY: Securities and Exchange Commission.

ACTION: Solicitation of public comments.

SUMMARY: The Commission solicits comments on issues relating to the designation of securities as National Market System Securities, In connection with the recent expansion of the criteria for designation as a National Market System Security, the Commission believes that it would be useful to obtain comments on a broader range of issues regarding National Market System designation.

DATES: Comments to be received by September 30, 1985.

ADDRESSES: All comments should be submitted in triplicate to John Wheeler, Secretary, Securities and Exchange Commission, 450 Fifth Street NW., Washington, D.C. 20549. All comments should refer to File No. S7-737, and will be available for inspection at the Commission's Public Reference Room 450 Fifth Street NW., Washington, D.C.

FOR FURTHER INFORMATION CONTACT:

Andrew E. Feldman, Esq., (202) 272-2414, Room 5205, Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street NW., Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION:

I. Summary

Rule llAa2-l ("NMS Securities Rule" or "Rule")1 under the Securities Exchange Act of 1934 ("Act")2 establishes procedures by which certain securities traded in the over-the-counter ("OTC") market are designated as qualified for trading in a national market system ("OTC/NMS Securities"). On December 18, 1984, the Commission adopted amendments to the Rule that increased the number of OTC securities eligible for designation as NMS Securities from approximately 1350 to approximately 2500.3 The Commission believes it is appropriate to solicit comment on the direction which the designation process for National Market System ("NMS") Securities should take and the manner in which these securities should participate in the NMS. Accordingly, the Commission requests comment on the manner in which current OTC/NMS Securities should be integrated into additional NMS facilities and initiatives, and whether the Rule should be amended to focus on other groups of securities or to achieve different purposes.

II. Background

In the 1975 Amendments, Congress directed the Commission "to facilitate the establishment of a national market system for securities." 4 In giving the Commission this broad mandate, Congress neither defined the term "national market system" nor specified the minimum components of such a system. Instead, Congress vested in the Commission "broad discretionary powers to oversee the development of a national market system" and "maximum flexibility" in working out its specific details in a manner consistent with the findings and goals of the 1975 Amendments.5

As part of the general mandate to facilitate the establishment of an NMS. Congress specifically directed the Commission, by rule, to "designate the securities or classes of securities qualified for trading in the national market system." 6The 1975 Amendments, however, were silent as to the particular standards the Commission should employ in designating NMS Securities, Similarly, the legislative history did not mandate the use of any particular standard in the designation process. Instead, Congress provided the Commission with the flexibility and discretion to base NMS designation standards upon the Commission's experience in facilitating the development of a national market system. Given the Congressional desire that the system develop primarily through the interplay of market forces, such flexibility appears essential.7

On February 17, 1981, the Commission adopted the NMS Securities Rule. The Rule provides criteria and procedures by which certain securities traded exclusively OTC are designated as NMS Securities.

The primary effect of designating OTC stocks as NMS Securities at the present time is that transactions in such securities must be reported in a realtime system in accordance with the Commission's last sale reporting rule,8 and quotations for such securities must be firm as to the quoted price and size in accordance with the Commission's firm quotation rule.9 In adopting the Rule, the Commission determined, among other things, that real-time transaction reporting and firm quotations would increase market efficiency and enhance opportunities for public investors to obtain execution of their orders in the best possible market.10

The Rule employe a two-tiered approach for designation.11 Tier 1, which became effective April 1, 1982, requires that the most actively traded OTC securities be designated as NMS Securities.12 Tier 2, which became effective on February 1, 1983, permits certain additional OTC securities to become NMS designated at the election of the issuer.13

Based on the early trading experience of OTC/NMS Securities, the Commission and most industry participants concluded that last sale reporting and firm quotations have improved the markets for OTC/NMS Securities and benefited investors without imposing undue burdens on market makers.14 In February 1984, the NASD petitioned the Commission to expand the Tier 2 designation criteria to allow more issuers of OTC securities to elect NMS status.15 On December 18, 1984, the Commission amended the Tier 2 designation criteria to incorporate the standards used by the NASD in determining its National List (i.e., the list of NASDAQ securities that the NASD supplies to the national news media), thereby increasing the number of OTC securities eligible for NMS designation from 1350 to approximately 2500.16

III. Discussion and Request for Comment

In adopting the Rule, the Commission stated that designating "OTC securities as NMS Securities and thereby including these Securities for the first time in a real-time transaction reporting system, is only one in a series of steps ... toward the development of an NMS."17 In the nearly three years since the first OTC securities were designated as NMS Securities, the Commission believes that last sale reporting has become an established part of the OTC market. Accordingly, the Commission finds that the designation of OTC/NMS Securities has progressed sufficiently that it is now appropriate to consider the relative costs and benefits of taking additional steps in the development of an NMS.18

The Commission today solicits, comment on several issues regarding NMS Securities. These issues include whether and how OTC/NMS Securities should be integrated into other NMS facilities and initiatives,19 and in particular the extent to which these securities should be made subject to trade-through and short sale rules.20 A further issue is whether the Rule should be amended to include exchange-traded securities or be revised to eliminate any unnecessary competitive burden on competing exchange markets.

A, Inclusion of OTC/NMS Securities in Additional Facilities and Initiatives

1. Linkages
The Commission has requested comment on whether exchanges should be granted unlisted trading privileges ("UTP") in OTC/NMS Securities.21 If the Commission determines to grant such requests,22an important issue that must be addressed is the integration of OTC and exchange trading in these securities. In this regard, a fundamental finding of the 1975 Amendments was that "[tjhe linking of all markets for [NMS] securities through communications and data processing facilities" would benefit investors and the securities markets.23
Accordingly, the Commission solicits comment on whether OTC/NMS Securities should be integrated into existing or other possible linkages, and the manner in which this could be accomplished. In this regard, the Commission notes that the NASD has developed a Computer Assisted Execution System ("CAES") to link OTC market makers and to provide, among other things, an automated order routing and execution system. CAES also is linked to the Intermarket Trading System ("ITS").24 The Commission requests comment on whether OTC/ NMS Securities should be included in CAES25 and the ITS/CAES linkages.26 In this connection, commentators should address whether inclusion should be accompanied with any changes in the present operation of these linkages.27 The Commission requests commentators to consider whether any other linkage facilities would be appropriate for OTC/ NMS Securities.
2. Price Protection
As early as 1973, the Commission indicated that the facilities of an NMS should provide a broker-dealer with the ability to insure that "his customer's order is executed in the best market available." 28 Similarly, the 1975 Amendments declared that "[i]t is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure . . . the practicability of brokers executing investor's orders in the best market. . . ." 29 In accord with these principles, the Commission has stated that " 'trade-throughs' are inconsistent with the goals of a national market system." 30In response to these concerns, the ITS Plan participants submitted, and the Commission approved, amendments to the ITS Plan that provide "trade-through" protection for displayed bids and offers for securities traded through ITS.31
In adopting the NMS Securities Rule, the Commission stated that it "may be appropriate to reexamine a broker-dealer's responsibilities with respect to the execution of a customer's order in an NMS Security" once OTC securities are designated as NMS Securities.32 Noting that OTC/NMS Securities would be traded "in an environment characterized by real-time transaction reporting and firm quotations," the Commission further stated "that it may be appropriate to expect that... a broker-dealer either will route his customer's order to the best displayed bid or offer (in size) or will provide his customer with a price equal to the best displayed bid or offer (in size)."33
Because last sale reporting and firm quotations are now present for OTC/ NMS Securities, the Commission solicits comments on whether price protection should be provided for displayed bids or offers for these securities.34 Specifically, the Commission requests comment on whether an OTC "trade-through" rule should apply to OTC/NMS Securities, and whether some or all OTC/NMS Securities should be subject to these requirements.35 The Commission also requests comment on how an OTC "trade-through" rule should be structured. The Commission urges commentators to focus on the degree to which the present regulation of "trade-throughs" for ITS (including ITS/CAES) securities can, or should, be applied to the OTC markets.36
In discussing this questions, commentators should address the practical effect of such a rule on the OTC market. The Commission recognizes that virtually all OTC market makers currently display quotes with a size of 100 shares (the minimum that can be displayed in NASDAQ),37 even though they generally are willing to effect larger trades at their quoted price.38The Commission requests comment on how a trade-through rule would affect the display of quote-size by OTC market makers and by exchanges receiving UTP in OTC/NMS Securities.39
3. Short Sales
The Commission's short sale rule, Rule 10a-l under the Act,40generally does not apply to the OTC market.41 However, with the implementation in 1975 of a consolidated reporting system 42for transactions in listed securities both on the exchanges and in the "third market," 43 the Commission extended Rule 10a-l to OTC transactions in reported securities.44
In adopting the NMS Securities Rule, and thereby extending last sale reporting to OTC/NMS securities, the Commission specifically sought comment on whether short sale limitations should be extended to OTC/ NMS Securities.45 Now that over 1900 OTC securities have been designated as NMS Securities, with prospects that additional securities will soon be designated, the Commission again solicits comment on whether and how short sales in OTC securities designated as NMS Securities should be regulated. In particular, The Commission asks that commentators discuss whether Rule 10a-l should be amended to cover all, or a portion of, OTC/NMS Securities.46
In assessing the feasibility of existing short-sale regulations to OTC/NMS Securities, it would be beneficial if commentators discuss the operation of Rule 10a-l in the listed market.47
Accordingly, the Commission solicits comment on the costs and benefits of Rule 10a-l to the listed markets, e.g., to what extent has the Rule been successful in preventing manipulative short sales and to what extent has the Rule inhibited legitimate short-selling activities? Additonally, the Commission requests comment on the harms, if any, attributable to the absence of short sale rules for OTC/NMS Securities. In this connection, the Commission requests commentators to discuss whether the absence of short sale rules for OTC/ NMS securities has contributed to manipulative or fraudulant activity.48 Alternatively, has the absence of such rules benefited investors, issuers, or the markets in these stocks?

B. NMS Securities

Commentators in the rulemaking proceeding that adopted the NASD's proposals raised certain fundamental concerns about NMS Securities. These commentators questioned whether the Rule continued to be necessary to bring last sale reporting to the OTC market, arid whether the Rule should be redirected to encompass listed securities that have been included in other NMS facilities.49 Accordingly, the Commission believes that it is appropriate to consider whether the Rule should be refocused.

At present, the only practical effect of designation as an NMS Security is to require last sale trade reporting in that security. When the NMS Securities Rule was adopted in 1981, this narrow focus was considered appropriate because the Rule was seen initially as a mechanism for gradually introducing last sale reporting to the OTC market. The Commission intended the mandatory Tier 1 standards to automatically include those OTC securities which clearly belonged in NMS disclosure facilities. The lower Tier 2 designation criteria, which rely on issuer choice, were intended to insure that, in the early stages of last sale reporting in the OTC market, only those other securities whose markets would benefit from NMS designation would be designated.50 As a practical matter, including exchange-listed securities within the scope of the NMS Securities Rule would have had no effect at that time because most exchange-listed securities already were included in NMS last sale and quotation disclosure facilities.51

The Commission believes that last sale reporting has become an established part of the OTC market. There are over 1900 OTC/NMS Securities today. In addition, the NASD and many OTC issuers and market makers strongly endorsed the recent amendments to the Rule that increased the number of qualified securities from approximately 1350 to around 2500.52 On the other hand, opponents of the NASD's petition to expand the number of securities eligible for NMS designation argued that the NASD was using the fact of NMS designation as a marketing device in competing with exchanges for "listings."53

In view of the foregoing, the Commission requests public comment on the following questions:

(i) Is the NMS Securities Rule still necessary in its present form to maintain last sale reporting in the OTC market?
(ii) If the NMS Securities Rule is no longer essential for that purpose, should the entire group of OTC stocks that have last sale reporting continue to be designated OTC/NMS Securities?
(iii) Is last sale reporting sufficiently developed in" the OTC market that issuer choice should be removed from the Tier 2 designation criteria? In other words, should some or all of the securities that satisfy the Tier 2 criteria now be designated automatically in the same manner as securities qualified for Tier 1?
(iv) If the NMS Securities Rule retains its current focus, is thers a danger of niispercoption of the significance of NMS designation with respect to the investment quality of a stock? Would such possible misperceptions be ameliorated if NMS designation were not limited to OTC stocks?
(v) To the extent the Rule is deemed either to be no longer necessary to encourage OTC last sale reporting or to confer an unfair advantage on OTC stocks designated as NMS Securities, should the Rule be refocused to designate other types of securities as NMS Securities? These types could include:
(a) securities with last sale reporting. The main consequence of OTC/NMS security designation, last sale reporting, also is present for securities listed on national securities exchanges. In discussing whether all securities with last sale reporting should be designated as NMS Securities, commentators should consider the costs and benefits of NMS designation fpr these securities.
(b) "reported securities". Listed securities substantially meeting NYSE or Amex listing criteria are eligible to be reported through the consolidated transaction reporting system and as such are deemed "reported securities " under rule 11Aa3-1 and other rulses.
(C) multiply traded securities. This group of securities could include securities traded through the ITS or ITS/CAES linkages, and current OTC/NMS Securities if, for example, the Commission were to grant exchanges UTP in these securities and such securities were included in an intermarket linkage.
(d) Securities subject to trade â€"through rules. At present ITS and ITS/CAES securities are subject such a rule. In the future, other securities such as OTC/NMS Securities also could be provided with trade-through protuction.

IV. Conclution

By publishing this release soliciting public comment, the commission seeks to elicit suggestions on possible direction in which the NMS Securities Rule should evolve. Commens should be addressed To Jhon Weeler, Secretary, Securities and Exchange commission, 450 Fifth street NW., Washington, DC. 20549. Comments should be received by September 30, 1985.

By the commission

Shirly E. Hollis,
Assistant secretary.
June 21, 1985.

[FR Doc. 85-15401 Filed 6-26-85; 8:45 am]

BILLING CODE 8010-01-M


1 17 CFR 240.11Aa2-l. See Securities Exchange Act No. 17549 (February 17, 1981), 46 FR 13992 ("Adoption Release").

2 15 U.S.C. 78a el seq., as amended by the Securities Acts Amendments of 1975 ("1975 Amendments"), Pub. L. 94-29 (June 4, 1975), 89 Stat. 97, [1975] U.S. Code Cong. & Ad. News 97.

3 Securities Exchange Act Release No. 21583 (December 18, 1984), 50 FR 730 ("Amendments Release"). At that time 1104 OTC securities had actually been designated as NMS Securities.

4 Section 11A(a)(2) of the Act.

5 Senate Comm. on Banking, Housing, and Urban Affairs, Report to Accompany S. 249: Securities Acts Amendments of 1975. S. Rep. No. 94-75.94th Cong., 1st Sess. 7-9 [Comm. Print 1975], reprint in [1975] U.S. Code Cong. & Ad News 179,185-87 ("Senate Report"). See also Securities Exchange Act Release No. 14416 (January 28, 1978, 43 FR 4354 ("January Statement"): Securities Exchange Act Release No. 15671 (March 22, 1979), 44 FR 20360 ("Status Report").
The 1975 Amendments establish that "[t]he securities markets are an important national asset which must be preserved and strengthened" through the application of "new data processing techniques." Section HA(a)(l) of the Act. Congress found that these techniques should be used to foster intermarket linkages, enhance investor protection, and maintain fair and orderly markets. Congress stated as goals of an NMS the availability of quotation and transaction information, the efficient execution of transactions, fair competition between the markets, the execution of customer orders in the best possible market, and, where consistent with other goals, the execution of orders without the participation of a dealer. Section llA(a)(2) of the Act.

6 Section HA(a)(2) of the Act.

7 Amendments Release, supra note 3, at 737.

8 17 CFR 240.1lAa3-l.

9 17 CFR 204.11Acl-l.

10 See Adoption Release, supra note 1. at 13996.

11 OTC securities for which quotation information is disseminated in the National Association of Securities Dealers, Inc.'s ("NASD") electronic interdealer quotation system ("NASDAQ") are eligible for designation. The Rule provides for the removal of the NMS designation "li]f such security becomes listed and registered, or admitted to unlisted trading privileges, on an exchange." 17 CFR 240.11Aa2-l(a), (b). In this regard, the Commission recently published for public comment a rule proposal that would allow certain NMS Securities also to be listed on a regional securities exchange. See Securities Exchange Act Release No. 21703 (February 1, 1985), 50 FR 7065.
In adopting the NMS Securities Rule, the Commission,concluded that imposing NMS qualification criteria upon listed securities was unnecessary at that time because most listed securities already were included in NMS last sale and quotation disclosure facilities, and selection of less than all reported securities as NMS Securities couid create unwarranted distinctions among these securities. Nonetheless, the Commission specifically left open whether exchange traded securities should be designated as NMS Securities in the future. See Adoption Release, supra note 1, at 13995.

12 17 CFR 240.11 Aa2-l(b) (4)(i).

13 17 CFR 240.11 Aa2-l(b) (4)(ii)

14 See Amendments Release, supra note 3, at 735.

15 For a discussion of the NASD's petition, see Securities Exchange Act Release No. 20902 (April 30, 1984). 49 FR 19314. For a discussion of the views of OTC market makers and issuers, see Amendments Release, supra note 3. at 733.

16 Amendments Release, supra note 3. As of June 4, 1985. there were 1.997 OTC/NMS Securities.

17 Adoption Release, supra note 1. at 14000.

18 The Commission believes that the concerns expressed by certain commentators in 1979 regarding the "premature incorporation" of NMS Securities into additional NMS facilities and initiatives may not be applicable today. For those concerns, see Status Report, supra note 5. at 20367.

19 The Commission's directive to facilitate the development of a national market system includes specific recognition that there could be subsystems of an NMS. Section HA(a)(2) of the Act. The Commission requests commentators to address the possible inclusion of some NMS Securities in one or more other subsystems of an NMS.

20 In addition to these NMS initiatives, the Commission has issued releases requesting comment on granting exchanges unlisted trading privileges in OTC securities (Securities Exchange Act Release No. 21498 (November 16, 1984), 49 FR 46156) {"UTP Release"), and proposing amendments to its confirmation rule. Rule 10b-10 under the Act. requiring broker-dealers executing trades in reported securities as principal with customers to disclose the trjde price and mark-up in the trade (Securities Exchange Act Release No. 21708 (February 4, 1985). 50 FR 5786.

21 The Commission emphasizes that the question whether exchanges should be granted UTP in OTC securities is under consideration and no determination has been made.

22 UTP Release, supra note 20. at 46160.

23 Section llA(a)(l)(D) of the Act.

24 The ITS is an intermarket linkage and order routing facility operated jointly pursuant to an NMS Plan by certain national securities exchanges and the NASD. The current ITS Plan participants are the New York ("NYSE"), American ("Amex"), Boston ("BSE"), Cincinnati ("CSE"), Midwest "(MSE"). Pacific ("PSE"), and Philadelphia ("Phlx") Stock Exchanges, and the NASD.
At present, the ITS/CAES interface links exchange and OTC markets in Rule 19c-3 securities. See Securities Exchange Act Release Nos. 17744 (April 21, 1981), 46 FR 23856; 18713 (May 9, 1982), 47 FR 20413; and 19372 (December 23, 1982), 47 FR 58287.
Rule 19c-3 under the Act eliminates exchange off-board trading restrictions for reported securities which were listed after April 26, 1979, or were listed on April 26, 1979 but ceased to be traded on an exchange for any period of time thereafter. Securities Exchange Act Release Nos. 16888 (June 11, 1980). 45 FR 41125; 17744 (April 21, 1981), 46 FR 23656; and 20074 (August 12, 1983), 48 FR 38250.

25 NMS Securities can now be traded in CAES at the election of one market maker; however, there is no requirement that all market makers in securities traded in CAES be participants in CAES. The Commission understands that trading activity in CAES continues to be very light. The Commission requests comments regarding whether all market makers trading in a CAES linked stock should be required to participate in CAES.

26 If OTC/NMS«ecurities were traded on an exchange pursuant to UTP, they would become Rule 19c-3 securities and thus eligible for inclusion in the ITS/CAES interface.

27 The Commission notes that orders entered into the ITS/CAES interface by exchange specialists are executed automatically, but that orders entered into ITS by CAES market makers are not. CAES market makers have complained that this disparity puts them at a competitive disadvantage in making markets in Rule 19c-3 securities. The exchange in return, have argued that this disparity was introduced by the NASD in designing CAES.

28 SEC, Policy Statement on the Structure of a Central Market System, at 17 (March 29, 1973) ("Policy Statement"), reprinted in [1973) Sec. Reg. & L. Rep. (BNA) No. 196 at D-l, D-4.

29 See Section llA(a)(l)(C)(iv) of the Act.

30 Securities Exchange Act Release No. 17314 (November 20, 1980), 45 FR 79018, 79020 n.22. The term trade-through generally refers to the execution of an order in one market center at a price inferior to that being displayed in another market center. Id at 79019 n.12.

31 Securities Exchange Act Release No. 17703 (April 9, 1981); Securities Exchange Act Release No. 19249 (November 17, 1982), 47 FR 53552.

32 Adoption Release, supra note 1. at 14003.

33 ID

34 The Commission also notes that, under the NASD's rules, a broker has an obligation to use reasonable diligence to both "ascertain the best interdealer market" for a security and execute his customer's order "so that ihe resultant price to the customer is as favorable as possible under prevailing market conditions." NASD, Interpretation of the Board of Governors—Review of Corporate Financing, Rules of Fair Practice, Art. III. section 1, NASD Manual (CCH) •] 2151.03(A), at 2035. The Commission requests comment on whether this NASD rule interpretation provides displayed OTC/ NMS quotations with sufficient price protection.

35 If OTC/UTP is not requested by an exchange or granted by the Commission, these requirements would apply only to the OTC market. If such UTP were to be requested and granted, these requirements would apply to all markets.

36 The current ITS "trade-through" rule includes an exception for quotes of 100 shares, reflecting the use of automatic quotation-generation devices by regional exchanges to generate 100 share quotes in certain stocks. Because automatic quotation generating devices are not used in the OTC market, this exception need not necessarily be carried over to the OTC market if a trade-through rule were applied to that market.

37 The Commission continues to believe that the display of quotes with size would be of benefit to the OTC market, and encourages OTC market makers to reflect accurately the size at which they are willing to trade in their quotations.

38 In particular, market maker participants in the NASD's Small Order Execution System ("SOES") stand willing to accept trades of 500 Shares or less in SOES stocks at the best NASDAQ quote. Therefore, these market makers could be considered to be quoting 500 share markets at the best NASDAQ price in these stocks. In addition, some market makers are willing to accept orders of up to 1000 shares at the best NASDAQ bid or offer in other OTC automatic execution systems.

39 In this regard, it is noted that, unlike OTC market-makers, exchanges typically compete both on the basis of price and by displaying quote size in stocks in which they make an active market.

40 17CFR240.10a-l.

41 Rule 10a-l currently applies to securities as to which last sale information is disseminated in the consolidated transaction reporting system. It relies on a tick test which is not easily workable without current last sale reporting. Securities Exchange Act Release No. 11468 (June 12, M75), 40 FR 25442. 25443 ("1975 Rule 10a-l Adoption Release"). The tick' test compares the price of a proposed short sale to immediately preceding transactions to determine its permissibility. Under this rule, short sales may be t effected only on a plus tick [i.e.. at a price above the price at which the immediately preceding last sale was effected) or a zero-plus tick (i.e., at a price equal to the last sale if the last preceding transaction at a different price was at a lower price), established by reference to the last sale either in the consolidated transaction report system or in a particular marketplace. Securities Exchange Act Release No. 17347 (November 28, 1980). 45 FR 80834. 80834 n.2.

42 The Consolidated Tape Association ("CTA") collects and disseminates transaction reports for listed securities from all markets. The CTA members are the NYSE, Amex. BSE, CSE. MSE. PSE. Phlx, and NASD. See Securities Exchange Act Release Nos. 10787 (May 10, 1974). 39 FR 17799; and 11255 (February 18, 1975). 40 FR 9397.

43 The third market is a term used to describe OTC transactions in listed securities.

44 1975 Rule 10a-l Adoption Release, supra note 41. The Commission stated that its original short sale rules did not apply to [OTC] transactions since, in the absence of publicity concerning [OTC] short sales (such as that afforded by the CTA], there appeared to be little reason to fear that such sales would have a manipulative or destabilizing impact on the market." Id. at 25443.

45 Adoption Release, supra note 1. at 14001-02. In response to that solicitation, the NASD stated that "short selling regulations prior to and during a distribution of NMS securities would be appropriate but that it is not necessary, at this time, to impose across-the-board short sale regulations on transactions in NMS Securities." Letter from S. William Broka, Secretary. NASD, to George A. - Fitzsimmons, Secretary, SEC (July 31, 1981) ("1981 NASD Short Sale Comment"), at 1. The NASD asserted that short sale limitations comparable to those imposed on the market for listed securities were unnecessary for the market for OTC/NMS securities because NMS issues will have volume and market maker requirements which will ensure an active competitive market." Id. at 1-2.
The Commission notes that under the amended NMS Securities Rule, a minimum trading volume standard is retained only in the Tier 1 designation criteria. See Amendments Release, supra note 3, at 737. The Commission also notes that the revised maintenance criteria for NMS Securities, which it has approved on a temporary basis, do not contain a trading volume requirement. See Securities Exchange Act Release No. 21670 (January 17, 1985), 50 FR 3610. Accordingly, the Commission solicits comment on the question whether the elimination of trading volume requirements from the Tier 2 designation criteria and the NMS maintenance criteria affects the need to extend Rule 10a-l to OTC/NMS Securities.

46 If the short sale rule were to be extended to cover all, or a portion of, OTC/NMS securities, should it operate in the same manner as Rule 10a-l currently operates with respect to listed securities (i.e.. relying on the tick test)? The Commission also solicits comments on the question of whether there are unique issues associated with OTC/NMS Securities generally that would make another approach preferable.
In considering this question, commentators may wish to consider the two alternative versions of proposed Rule 10b—21 under the Exchange Act, which would restrict short sales of securities, including OTC securities, prior to and during underwritten offerings of securities of the same ciass as outstanding securities. The first version of proposed Rule 10b-21 would deter manipulative short selling prior to underwritten offerings by limiting the ability of short sellers to make covering purchases from certain persons within certain periods during an underwriting. Securities Exchange Act Release No. 11328 (April 12, 1975), 40 FR 16090. The second version, which focused on short selling itself rather ihan on covering purchases, would regulate short sales from the preoffering period until the end of post-offering stabilization arrangements through the use a "tick test." Securities Exchange Act Release No. 13092 (December 21, 1976). FR 56542. Neither version of proposed Rule 10b-21 has been adopted.

47 In 1976, the Commission instituted a public rulemaking proceeding to determine whether Rule lOa-l's regulation of short sales of securities registered, or admitted to unlisted trading privileges, on national securities exchanges was still necessary. See Securities Exchange Act Release No. 13091 (December 21, 1976), 41 FR 56530. Stating that commentators generally indicated that the operative provisions of Rule 10a-l worked wall and should not be modified, the Commission withdrew proposed rules which would have suspended in part the operation of the "tick test". See Securities Exchange Act Release No. 17347 (November 28, 1980), 45 FR 80834.

48 See. e.g.. Serving Readersor Sources? OTC Review, January, 1985 at 16.

49 See Amendments Release, supra note 3, at 734-35.

50 Adoption Release, supra note 1, at 13998-99.

51 Adoption Release, supra note 1, at 13994-95.

52 Amendments Release, supra note 3, at 732.

53 Id. at 734. In approving the proposed Hmer.dments to the Rule, the Commission stated that it "has never suggested that NMS designation warrants the quality of these securities," and that "there was no intent on the Commission's part to use this initiative as a vehicle to contrast the relative merits of OTC and listed securities". Id at 737 n.89.



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