Notice To Members 90-57

Implementation of Amendment to Rules of Practice and Procedures for the Small Order Execution System Re: Market Makers' Entry of Agency Orders into SOES, Effective July 27, 1990

Published Date:

SUGGESTED ROUTING*

Senior Management
Legal & Compliance
Operations
Trading

*These are suggested departments only. Others may be appropriate for your firm.

EXECUTIVE SUMMARY

Effective July 27, 1990, the NASD implemented a new rule for NASDAQ's Small Order Execution System (SOES) that prohibits a market maker from entering agency orders into SOES in a security in which it is registered as a market maker, unless the market is locked or crossed. The rule emphasizes the market maker's continuing obligations of best execution for agency orders, even when use of SOES is prohibited. The text of the new rule follows this notice.

BACKGROUND

On July 26, 1990, the SEC approved an NASD rule change that prohibits market makers from entering agency orders into SOES in securities in which they make markets, and emphasizes a market maker's obligation to obtain best execution for its customer orders.1 The new rule became effective July 27, 1990.

The new rule prohibits a market maker from receiving its own customers' orders and reviewing them, deciding not to act as market maker for those orders, and sending them into SOES for an automatic execution on an order-entry basis. An exception to the rule exists when the prevailing market is locked or crossed. In such instances, a market maker will be permitted to submit its own customer orders into SOES on an agency basis so that the locking market maker will refresh its quotes. At all other times, market makers are prohibited from entering agency orders in securities in which they are registered as market makers.

SOES is designed to facilitate the efficient and economical execution and comparison of small, retail orders in NASDAQ securities. SOES is available only for retail customer orders of specified size, and the SOES rules enumerate certain market-maker and order-entry participant obligations to ensure that SOES operates efficiently. The Association believes that the new rule furthers these goals by reemphasizing a market maker's obligation to execute its customers' orders, either in its own right as a market maker or through telephone negotiation. Furthermore, the change relieves SOES market makers from the burden of executing those orders emanating from a competing market maker's customer base and entered as agency orders for execution in an automated SOES environment. Finally, the new rule specifically establishes that a market maker's duty to provide best execution to its customer is in no way diminished by the unavailability of a SOES execution.

TEXT OF AMENDMENT TO THE RULES OF PRACTICE AND PROCEDURES FOR THE SMALL ORDER EXECUTION SYSTEM

(Note: New language is underlined; deleted language is in brackets.)

c) PARTICIPATION OBLIGATIONS IN SOES

* * * * * *

2. Market Makers
(A) through
(C) No Change
(D) For each security in which a Market Maker is registered, the Market Maker may not enter orders on an agency basis into SOES, unless a locked or crossed market as defined in Part IV, Section 2(e) of Schedule D to the NASD By-Laws, exists for that security. This prohibition against use of SOES does not obviate the Market Maker's duty to give its agency orders orders best execution in the prevailing market, according to the NASD Board of Governors' Interpretation on Executions of Retail Transactions.
(E) [(D)] No change
(F) [(E)] No change
(G) [(F)] No change
(H) [(G)] No change
(I) [(H)] No change

1See Release No. 34-28268, 55 FR 31,273; File No. SR-NASD-89-52.