SEC and Other Investigations of Illegal Trading: NASD Loosens Rules???

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NASD Notice to Members 04-28

SEC Approves Amendments to Repeal Rule 4613A(e)(1) Requiring Same-Priced Quotations on Multiple Markets; Effective Date: March 12, 2004

Executive Summary

On March 12, 2004, the Securities and Exchange Commission (SEC)
approved amendments to repeal Rule 4613A(e)(1), which requires
members that display priced quotations for a Nasdaq Stock Market, Inc.
(NASDAQ) security on multiple market centers to display the same-priced
quotations on each market center.1 Rule 4613A, as amended, is set forth
in Attachment A. The amendments are effective as of March 12, 2004.

Questions/Further Information

Questions regarding this Notice may be directed to Grace Yeh, Office of
General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-
6939.

Background and Discussion

As originally adopted, Rule 4613A(e)(1) required members that display
priced quotations for a NASDAQ security in two or more market centers
to display the same priced quotations for that security in each market
center. Pursuant to the Rule, members that chose to quote in multiple
market centers were not permitted to display an inferior quote in any of
those market centers. Rule 4613A(e)(1) was proposed as part of the
Alternative Display Facility (ADF) pilot rules2 because NASD believed it
important to prevent fragmentation of quotations by a member (which
might serve to undermine the transparency of the best quotes in the
market), given the increased potential that members might choose to dual
quote on several market centers, including ADF. The provision was
modeled closely after Rule 2320(g)(2), which applies to over-the-counter
(OTC) securities, such as those securities quoted through the OTC
Bulletin Board and the Electronic Pink Sheets.

Since its adoption, NASD has monitored the impact of Rule 4613A(e)(1)
and concluded that the benefits of the same-priced quotation requirement
to the trading in NASDAQ securities have been difficult to quantify. As an
initial matter, the SEC's Vendor Display Rule (Rule 11Ac1-2 under the
Exchange Act) generally requires that vendors provide a consolidated
display of quotation information for NASDAQ securities from all
reporting market centers. As such, the Vendor Display Rule ensures that
quotations in NASDAQ securities from each market center are visible,
thereby facilitating transparency in the market and best execution. A
similar provision, however, does not apply to the OTC market, making it
more important to require that members display the same priced quotation
in multiple markets to promote transparency in that marketplace.

Further, Rule 4613A(e)(1) resulted in problems given recent market
structure developments. For example, a member may have several
completely distinct business units, such as a market making unit and an
electronic communications network (ECN), which are used by different
types of clients and, therefore, represent separate pools of liquidity. A
member may choose to display quotations relating to its market making
unit on NASDAQ and its ECN on ADF. Under such circumstances,
compliance with Rule 4613A(e)(1) would, in effect, require the member to
consolidate these distinct business units for purposes of displaying
quotations on each market, which would be contrary to the business model
of the firm since these quotes represent separate liquidity pools. As an
alternative, the member could establish separate broker-dealers for each
business unit, which NASD believes is overly burdensome for members
given the marginal benefits associated with Rule 4613A(e)(1).

For the reasons discussed above, NASD has repealed Rule 4613A(e)(1).
However, NASD will continue, as it currently does today, to monitor and
surveil for any potentially collusive or manipulative conduct relating to
quotation activity on markets under its regulatory authority.

Endnotes

1 See Securities Exchange Act Release No. 49413 (March 12, 2004),
69 Fed. Reg, 12882 (March 18, 2004) (File No. SR-NASD-2003-175)
(SEC Approval Order).

2 Exchange Act Release No. 46249 (July 24, 2002), 67 Fed. Reg.
49822 (July 31, 2002). Subsequent to the initial approval of the ADF
rules, the Commission approved an initial extension of the pilot until
January 26, 2004, and a subsequent extension of the pilot until October 26,
2004. Exchange Act Release No. 47633 (April 10, 2003), 68 Fed. Reg.
19043 (April 17, 2003); Exchange Act Release 49131 (January 27, 2004),
69 Fed. Reg. 5229 (February 3, 2004).

©2004. NASD. All rights reserved. Notices to Members attempt to present
information to readers in a format that is easily understandable. However,
please be aware that, in case of any misunderstanding, the rule language
prevails.

ATTACHMENT A

New language is underlined; deletions are in brackets.

4613A. Character of Quotations

(a) through (d) No change.

(e) Other Quotation Obligations
[(1) Members that display priced quotations on a real-time basis for Nasdaq
securities in two or more market centers that permit quotation updates on a
real-time basis must display the same priced quotations for the security in each
market center.]

[(2)] As required by Rule 11Ac1-2(e) under the Exchange Act, a member that
uses an ADF terminal or other approved ADF electronic interface shall be
obligated to have available in close proximity to the ADF terminal or interface a
quotation service that disseminates the bid price and offer price from all markets
trading that Nasdaq security.

-- posted by Kirk