Daily Rules, Proposed Rules, and Notices of the Federal Government
The proposed rule change seeks Commission approval of Nasdaq's proposal to establish a riskless principal customer facilitation exemption to NASD Interpretative Material 2110-2-Trading Ahead of Customer LimitOrder ("Manning Interpretation" or "Manning"). NASD's current ManningInterpretation prohibits market makers from trading at prices equal or superior to customer limit orders they hold without executing those limit orders.
Nasdaq has determined to adopt a customer facilitation exemption to Manning that would exempt from Manning single-priced riskless principal transactions done by market makers who are buying or selling securities to satisfy the order(s) of other customers. In these situations, since the true beneficiary of the market maker's activity is another customer, and not the firm's proprietary account, Manning will be interpreted to exempt such trading from being considered triggering trades obligating the market maker to protect other held customer limit orders.
To ensure that market maker transactions that will not trigger Manning obligations are being done for the ultimate benefit of other customers, the customer facilitation exemption will be strictly construed. As such, only those market maker trades meeting all of the following requirements would be eligible for an exemption from Manning:
Non-agency trades not meeting all of these standards would remain subject to Manning and require, upon execution, the protection and execution of appropriate limit orders in full conformity with the Interpretation. This exemption would apply only to the actual number of shares executed by the member necessary to fill the customer order(s).
In Nasdaq's view, a transaction meeting these requirements is closely akin to an agency trade and does not materially implicate a market maker's proprietary trading. Nasdaq notes that the Commission in its release concerning the availability of the section 28(e) safe harbor also highlighted the similarities in compensation transparency provided by agency and riskless principal trade reporting pursuant to NASD Rules 4632(d)(3)(B), 4642(d)(3)(B), and 6420(d)(3)(B), coupled with the requirements of Exchange Act Rule 10b-10.
The Commission received two comment letters in response to the proposed rule change. Knight Trading Group, Inc. ("Knight") supported the proposed rule change but expressed concern about the conditions included in the exemption. In particular, Knight objected to the requirements that an offsetting riskless principal transaction must be allocated within 60 seconds of execution and that the transaction be allocated to a separate "allocation account." Knight contended that these requirements were redundant in light of the proposed condition that members must have systems in place that enable a member to accurately and readily reconstruct, in a time sequenced manner, all orders upon which a member relies in claiming the exemption.
Another commenter, Schwab Capital Markets L.P. ("Schwab"), expressed a broader concern about the application of the Manning Interpretation in a decimals environment where subpenny quotes are rounded to the nearest penny. Schwab stated that under certain market conditions, a member may attempt to execute a trade at least $0.01 ahead of a customer limit order it holds pursuant to Manning but because a quote was rounded to the nearest penny the execution may trigger a fill of a customer limit order held by the member. Schwab suggested several solutions to the problem, including requiring an asterisk identifier to a rounded quote and the elimination of a penny price improvement standard
Nasdaq submitted Amendment No. 1 in response to one of the concerns raised by Knight. As discussed, Amendment No. 1 seeks to provide an alternative allocation account for those members for whom it may be cumbersome to establish a separate "riskless principal account." With regards to Knight's concern about the requirement that an offsetting transaction be allocated to either a riskless principal or customer account within 60 seconds, Nasdaq has not sought to make any changes to the proposed rule in response to this concern as this condition is consistent with previously stated Nasdaq policy regarding the handling of mixed capacity trades and compliance with the Manning Interpretation.
Further, Nasdaq has not sought any changes to the rule proposal in response to the concerns raised by Schwab. The issues raised by Schwab largely relate to the operation of Manning relative to the rounding of quotes to the nearest penny due to subpenny trading that are beyond the scope of the proposed rule change.
The Commission has reviewed carefully the proposed rule change and the two comment letters and finds that the proposed rule change is consistent with the Act and the rules and regulations promulgated thereunder.
The Commission finds that proposed rule change is consistent with section 15A(b)(6) of the Act
The Commission also finds good cause for approving proposed Amendment No. 1 prior to the 30th day after the date of publication of notice of the filing in the
Interested persons are invited to submit written data, views, and arguments concerning Amendment No. 1, including whether the Amendment is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission,450 Fifth Street, NW., Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of Nasdaq. All submissions should refer to file number SR-NASD-2002-66 and should be submitted by January 10, 2003.
For the above reasons, the Commission finds that the proposed rule change is consistent with the provisions of the Act, in general, and with section 15A(b)(6),