Notice To Members 94-73

SEC Approves Clearance And Settlement Proposal For Nasdaq And OTCBB Market Makers

Published Date:

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Executive Summary

On July 28, 1994, the Securities and Exchange Commission (SEC) approved an NASD rule change that deals with clearance and settlement requirements applicable to NASD member firms functioning as market makers in The Nasdaq Stock Market™ (Nasdaq) or the OTC Bulletin Board Service (OTCBB®).1 Specifically, the rule change eliminates the "25-mile exception" from Section 7(a) in Part V, Schedule D to the NASD By-Laws and adds a new paragraph (d) to Section 4 of the OTCBB Rules.2 As a result, Nasdaq and OTCBB market makers must participate in the facilities of a registered clearing agency either directly or through another NASD member. Since most Nasdaq and OTCBB market makers already have clearing arrangements, this rule change affects few firms. The text of the amended language follows the discussion below. This rule change takes effect October 11, 1994.

Background And Description

The SEC recently approved an NASD rule change requiring market makers to use the facilities of a registered clearing agency to ensure efficient clearance and settlement of securities transactions effected between member firms. For Nasdaq securities, the rule change eliminates the 25-mile exception from Section 7(a) in Part V, Schedule D to the NASD By-Laws. Until now, this exception was only available to market makers that were located more than 25 miles from a clearing facility and that limited their market-making activity to The Nasdaq SmallCap Market™ securities that do not participate in the Small Order Execution System (SOESSM).3 Section 7(a) now states that a market maker must clear and settle transactions in Nasdaq securities through a registered clearing agency located within 25 miles of the market maker. In addition, Section 7(b) states that regardless of its proximity to a particular clearing facility, a market maker must clear and settle all SOES transactions via a registered clearing facility that uses a continuous net settlement system. This requirement can be satisfied either by directly participating in such a clearing facility or by entering into a corresponding clearing arrangement with a member that clears through such a facility.

For equity securities quoted in the OTCBB, the NASD had not mandated market-maker participation in a registered clearing agency. A new requirement mandates that market makers participate in a registered clearing agency for transactions in the approximately 95 percent of OTCBB securities that are clearing eligible. Implementation of these requirements will maximize use of the Automated Confirmation Transaction (ACTSM) Service for trade-reporting and comparison purposes.

ACT is the primary facility for collecting, processing, and disseminating transaction reports on Nasdaq securities and equity issues quoted in the OTCBB. ACT also facilitates the clearance and settlement of inter-member transactions by locking in trade details for transmission to the National Securities Clearing Corporation (NSCC). By generating locked-in trades, ACT enhances clearing efficiency by virtually eliminating a member's risk exposure from uncompared trades. These benefits cannot be fully realized, however, unless the broker/dealers on both sides of a trade have some form of participation in a registered clearing agency. In sum, these changes minimize risk exposure from uncompared trades and foster optimal use of ACT to lock in trades before submission to a registered clearing agency.

The rules take effect on October 11, 1994. Questions regarding this matter may be directed to Michael J. Kulczak, Associate General Counsel, The Nasdaq Stock Market, Inc., at (202) 728-8811.

1See Release No. 34-34457, July 28, 1994; 59 FR 39797, August 4, 1994.

2 Part V, Schedule D contains the basic requirements applicable to Nasdaq market makers while Section 4 contains the corresponding requirements for OTCBB market makers.

3 Although registered market makers in Nasdaq National Market® securities must be SOES participants, SOES participation is voluntary for market makers in Nasdaq SmallCap market issues.

Approved Amendments To Part V, Schedule D Of The NASD By-Laws

(Note: New text is underlined. Deleted text is in brackets.)

Part V

Requirements Applicable To Nasdaq Market Makers

Sec. 1-6. No change.

Sec 7. Clearance and Settlement

(a) A market maker shall clear and settle transactions in [NASDAQ] Nasdaq securities [other than securities in SOES] through the facilities of a registered clearing agency [where clearing facilities are located within 25 miles of the market maker.] that uses a continuous net settlement system. This requirement may be satisfied by direct participation, use of direct clearing services, or by entry into a correspondent clearing arrangement with another member that clears trades through such an agency.
(b) [Notwithstanding its proximity to a particular clearing facility, a market maker may also clear and settle its transactions in a security that is not a SOES security through any registered clearing facility using a continuous net settlement system; enter into a correspondent clearing arrangement with a member that clears through a continuous net settlement clearing facility; settle transactions "ex-clearing" provided both parties to the transaction agree; or use direct clearing services.] Notwithstanding paragraph (a), transactions in Nasdaq securities may be settled "ex-clearing" provided that both parties to the transaction agree.
(c) No change.

* * *

OTC Bulletin Board® Service Rules

Sec. 1-3. No change.

Sec. 4. Requirements Applicable to Market Makers

No change.

(a)–(c) No change.
(d) Clearance and Settlement
(1) A market maker shall clear and settle transactions in OTCBB-quoted securities through the facilities of a registered clearing agency that uses a continuous net settlement system. This requirement applies only to transactions in OTCBB securities that are clearing eligible.
(2) The foregoing requirement may be satisfied by direct participation, use of direct clearing services, or by entry into a correspondent clearing arrangement with another member that clears trades through such an
(3) Notwithstanding paragraph (d)(1), transactions in OTCBB-quoted securities may be settled "ex-clearing" provided that both parties to the transaction agree.