SEC Approves Quotation-Size Requirements for Market Makers in OTC Equity Securities

Executive Summary

On July 1, 1993, the Securities and Exchange Commission (SEC) approved an amendment to Schedule H to the NASD By-Laws regarding quotation-size requirements for market makers in over-the-counter (OTC) equity securities. The rule change revises the minimum-size requirements applicable to market makers displaying quotations in the OTC Bulletin Board^® (OTCBB) service or any comparable inter-dealer quotation system accommodating OTC equity securities. The new size requirements take effect September 8, 1993. The text of the amendment follows this Notice.

Description of Amendment

Until now, whenever an NASD member entered a proprietary bid/offer into the OTCBB for a domestic OTC equity security,¹ the firm was required to honor that bid or offer for at least one trading unit, typically 100 shares, regardless of the price of the shares quoted. This rule change replaces the one-trading-unit requirement with a tiered structure of minimum-size requirements based on the price level of the individual bid or offer.² Each registered market maker that publishes a firm bid or offer in a domestic OTC equity security will be required to honor its bid or offer for individual orders up to the size prescribed for the particular price range. These requirements will apply to members' quotes displayed in the OTCBB and any other inter-dealer quotation system that supports quotation updates in OTC equity securities on a real-time basis.³

For example, a market maker enters a quote of $.45 bid and offer $.55. The firm must honor its displayed bid for up to 5,000 shares and its displayed offer for up to 2,500 shares. If the same firm updates its quotation to reflect a bid of $.40 and an offer of $.50, a size requirement of 5,000 shares attaches to both sides of the market maker's quotation. As is the case today, OTCBB market makers will retain the option of entering an unpriced indication of interest or a one-sided quotation. The unpriced indication triggers no obligation per se to trade the subject security at a particular price or size specified by the new requirements.⁴ However, a one-sided entry obligates the market maker to honor that bid (or offer) for the size prescribed by the new rule.

After the NASD completes the necessary system enhancements, the OTCBB will display size for quotations, and will have a default feature to ensure display of the correct minimum size if a market maker neglects to enter that size when updating quotes.⁵ Meanwhile, each market maker will be responsible for determining the minimum-size requirement applicable to its bid or offer and must honor the quote for the specified size.⁶ The amendment takes effect September 8, 1993.

Questions regarding this Notice may be directed to Michael J. Kulczak, Associate General Counsel, at (202) 728-8811. To obtain interpretive guidance or report potential instances of noncompliance, members should contact NASD Market Surveillance at (301) 590-6080.

Text of New Section 5 to Schedule H to the NASD By-Laws

(Note: New text is underlined.)

Section 5 - Minimum Quotation Size Requirements For OTC Equity Securities

Every member firm that functions as a market maker in OTC Equity Securities by entering firm quotations into the OTC Bulletin Board service (OTCBB) (or any other inter-dealer quotation system that permits quotation updates on a realtime basis) must honor those quotations for the minimum size defined in the table below. In this regard, it is the market maker's responsibility to determine the minimum size requirement applicable to its firm bid and/or offer in each of its registered securities (excluding OTC Equity Securities for which the OTCBB will not accept firm quotations). Depending on the price level of the bid or offer, a different minimum size can apply to each side of the market being quoted by the member firm in a given security.

For purposes of this rule, the term "OTC Equity Security" means any equity security not classified as a "designated security" for purposes of Parts XII or XIII of Schedule D to the NASD By-Laws, or as an "eligible security," for purposes of Schedule G to the NASD By-Laws. The term does not include "restricted securities," as defined by Rule 144(a)(3) under the Securities Act of 1933, nor any securities designated in the PORTAL^SM Market.

*The OTCBB can accept bids/offers expressed in fractions as small as 1/256 or in decimals up to six places. In applying the price test for minimum quotation size, any increment beyond an upper limit in the right hand column will trigger application of the minimum quote size for the next tier. For example, a bid (or offer) of $.505 must be firm for a size of 2,500 shares.

¹ For purposes of this rule, the term "OTC equity security" means any equity security not classified as a "designated security" for purposes of Parts XII or XIII of Schedule D to the NASD By-Laws. The term does not include restricted securities, as defined by Rule 144(a)(3) under the Securities Act of 1933, or any securities designated in The PORTAL^SM Market. The new size requirement will not apply to any foreign/ADR issue in which firm quotations are not permitted to be entered into the OTCBB.

² SEC Release No. 34-32570 (July 1, 1993); 58 FR 36725 (July 8, 1993).

³ At present, no electronic quotation medium other than the OTCBB accommodates real-time quotation updates in OTC equity securities.

⁴ Nevertheless, a market maker displaying an unpriced indication of interest has an obligation to supply on request to another broker/dealer a bid/offer that must be firm for at least one trading unit, which is typically 100 shares.

⁵ The NASD anticipates the OTCBB will have size-display capability and the minimum-size default feature by mid-1994.

⁶ A table setting forth the tiered minimum size requirements will be reproduced in a newsframe accessible to OTCBB market makers on the workstations they use to enter and update their quotations.