SEC Approves Modified Excess Spread Parameters for Market Makers

Executive Summary

On June 4, 1993, the Securities and Exchange Commission (SEC) approved amendments to Part VI, Section 2 of Schedule D to the NASD^®. By-Laws to reduce excess spread parameters for Nasdaq and Consolidated Quotation Service (CQS) securities. The rule change establishes new excess spread parameters for Nasdaq^® and CQS securities, limiting a dealer's spread in a security to 125 percent of the average of the narrowest three dealer spreads in that security. The NASD believes that reducing excess spread parameters may reduce dealer spreads overall, which would result in a more competitive market. The amendments take effect July 26, 1993. The text of the amendments follows the discussion below.

Background and Description of Amendments

This rule change amends Schedule D to the NASD By-Laws¹ by reducing excess spread parameters for securities quoted in Nasdaq. The NASD is concerned that its current excess spread parameters are too wide, in some instances permitting spreads of 200 percent of the average dealer spread.² Nasdaq market makers are required to maintain continuous, two-sided quotations that are reasonably related to the transactions they are effecting. The current system of excess spread parameters, which uses all market-maker spreads in the calculation of average dealer spread, gives undue weight to spreads that may reflect one-sided buying or selling interest on the part of a few market makers. After a study of the impact on members of reducing spread parameters, the NASD determined that an average of the three best dealer spreads was an appropriate benchmark for calculating maximum allowable spreads.³

The rule change simplifies the current cumbersome and unwieldy system of excess spread parameters. Currently, the maximum allowable spread in a security varies, depending on the average dealer spread at that time. These excess spread parameters — set out in a chart in Part VI, Section 2 of Schedule D — vary between 125 percent and 200 percent of the average dealer spread in a security, depending on the size of the prevailing average dealer spread. The rule change eliminates the chart in Schedule D and applies a uniform standard for calculating maximum permissible spreads — 125 percent of the average of the narrowest three dealer spreads in a security. However, in no event, will a dealer be required to quote less than a 1/4 point spread.

The amendments take effect July 26, 1993. Questions regarding this Notice may be directed to Richard Coster, Manager, Market Surveillance, at (301) 590-6442 and Beth E. Weimer, Associate General Counsel, Office of General Counsel, at (202) 728-6998.

¹ SEC Release No. 34-32419 (June 4, 1993).

² Excess spread parameters establish the maximum allowable bid/ask spreads that individual dealers may quote in a market.

³ The NASD will conduct a study of dealer spreads in the Nasdaq National Market^® before and after the effective date of the rule change to determine the effect of new parameters.

Text of Amendments to Part VI, Section 2 of Schedule D to the NASD By-Laws

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

Part VI

Sec. 2. Character of Quotations

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(d) Excess Spreads. A marketmaker shall not enter quotations in[to the NASDAQ System] Nasdaq or Consolidated Quotation Service (CQS) securities that exceed the parameters for maximum allowable spreads as approved by the NASD Board of Governors and that may be published from time to time by the Association. [*] The maximum allowable spreads shall be 125 percent of the average of the three (3) narrowest market maker spreads in each security (if there are fewer than three (3) market makers in a security, the maximum allowable spread will be 125% of the average spread); provided however, that the maximum allowable spread shall never be less than 1/4 point.

[*The following are the current maximum allowable spreads approved by the NASD Board of Governors.

Maximum Allowable Spreads

For an average spread of 3 or more, the maximum allowable spread is 125 percent of the average spread rounded to the next highest whole number.]

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