Notice To Members 87-6

Request for Comments on Proposed Amendments to the NASD's Rules of Practice and Procedure For the Small Order Execution System (SOES)

Published Date:

TO: All NASD Members and Other Interested Persons

LAST DATE FOR COMMENTS: MARCH 2, 1987.

EXECUTIVE SUMMARY

The NASD requests comments on two proposed amendments to Section (c)(l)(B) of the Rules of Practice and Procedure governing the NASD's Small Order Execution System (SOES). One amendment would prohibit NASDAQ market makers from utilizing SOES to execute agency orders in securities in which they are not registered as SOES market makers. The second amendment would prohibit persons associated with NASD members from utilizing SOES for executions in their personal accounts or in accounts in which they have an economic interest

The NASD believes that these amendments will help ensure maximum use of SOES for the benefit of public customers. The text of the proposed amendments is attached.

PROPOSED AMENDMENTS

The NASD's Small Order Execution System was designed to provide a cost-effective system for the automated execution of small, public, agency orders in NASDAQ securities. Currently, customer transactions for up to 1,000 shares in NASDAQ National Market System securities or up to 500 shares in other NASDAQ securities may be automatically executed through SOES. Because SOES was designed to benefit public customers, only agency orders, including riskless principal transactions, received from public customers may be entered by SOES order-entry firms into SOES for execution.

At the recommendation of the NASD Market Surveillance and Trading Committees, the Board of Governors has approved the publication for comment of two proposed amendments to the SOES rules, both of which are intended to ensure that SOES is utilized for the benefit of public customers.

The first proposed amendment would prohibit NASDAQ market makers from utilizing SOES to execute agency orders in securities in which they are not registered as SOES market makers. For example, if firm ABC is a registered NASDAQ market maker in Apple Computer, but is not a registered SOES market maker in that security, it would be prohibited from using SOES to execute agency trades in the security. Although statistics indicate that the number of agency orders entered by non-SOES market makers is minimal in comparison to total SOES transaction volume, the Board of Governors believes that the proposed prohibition will eliminate the possible execution of principal transactions through SOES.

The second proposed amendment would prohibit persons associated with NASD members from using SOES for executions in their personal accounts or in accounts in which they have an economic interest. "Economic interest" is defined as an ownership interest in an account or any other type of direct financial interest, including the sharing of profits in an account. The proposed amendment is designed to ensure that SOES is utilized consistent with its intended purpose — to provide for the automated execution of small, public, agency orders in NASDAQ securities. To the extent that SOES is used to execute orders in the personal accounts of industry professionals, the Board is concerned that SOES may not be serving its intended purpose.

The second proposed amendment also addresses concerns of the NASD Market Surveillance and Trading Committees with respect to the practice of dividing agency orders in excess of the 500- or 1,000-share execution limits into smaller orders to meet SOES size requirements. This practice, which has resulted in the institution of NASD disciplinary proceedings against several NASD members, often involves the placing of orders in the personal accounts of persons associated with NASD members or accounts in which such persons have an economic interest.

The NASD encourages all members and other interested persons to comment on the proposed amendments. Comments should be directed to:

Mr. Lynn Nellius
Secretary
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006-1506

Comments must be received no later than March 2, 1987. Comments received by this date will be considered by the NASD Market Surveillance and Trading Committees and the NASD Board of Governors. If the proposed amendments are approved by the Board, the amendments must be filed with and approved by the Securities and Exchange Commission before becoming effective.

Questions concerning this notice may be directed to either S. William Broka, Vice President, NASDAQ Operations-Members, at (202) 728-8050, or James M. Cangiano, Director, NASD Market Surveillance, at (202) 728-8186.

Sincerely

Frank J. Wilson
Executive Vice President and General Counsel

Attachment

PROPOSED AMENDMENTS TO RULES OF PRACTICE AND PROCEDURE FOR THE SMALL ORDER EXECUTION SYSTEM (SOES)

(Existing language has been reorganized and divided into subsections. New language is underlined.)

Sec. 1

B. SOES Order Entry Firms

(i) All entries in SOES shall be made in accordance with the procedures and requirements set forth in the SOES User Guide. Orders may be entered in SOES by the SOES Order Entry Firm through either its NASDAQ terminal or computer interface. The firm will receive an immediate execution report on the terminal screen and printer, if requested, or through the computer interface, as applicable.
(ii) SOES will accept both market and limit orders for execution; however, limit orders not immediately executed due to price will be returned to the SOES Order Entry Firm. Orders may be preferenced to a specific SOES Market Maker or may be unpreferenced, thereby resulting in execution in rotation against SOES Market Makers.
(iii) Only agency orders of limited size, as defined herein, received from public customers may be entered by a SOES Order Entry Firm into SOES for execution against a SOES Market Maker. Agency orders in excess of limited size may not be divided into smaller parts for purposes of meeting the size requirements for orders entered into SOES.
(iv) No member or person associated with a member shall utilize SOES for the execution of agency orders in a security in which the member is not a SOES market maker.
(v) No member or person associated with a member shall utilize SOES for the execution of transactions in his personal account or in any account in which" he has an economic interest. The term "economic interest" shall mean an ownership interest in an account or another type of direct financial interest, including the sharing of profits in an account.