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May 31, 1998

NASD's Battle on Primary Market-Making Rules Complex New Standards Raising Concern Among Nasdaq T

By Jeffrey L. Winograd

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  • NASD's Battle on Primary Market-Making Rules Complex New Standards Raising Concern Among Nasdaq T

Citing convoluted language, the use of difficult formulae and a need for more testing, several Nasdaq trading firms have slammed the National Association of Securities Dealers' proposed new standards for primary market makers.

With the advent of the order handling rules, the original standards were shelved because old market-maker evaluations were unreliable. One standard, for instance, required market-maker spreads to be no greater than 102 percent of the average spread.

But it was practically impossible to measure when a market makers' quote change was driven by a customer order, entered and later canceled without an execution, making it difficult for desks to meet the 102 percent parameter, according to one major trading desk.

Since the order handling rules, all market makers have been designated primary market makers. The NASD's effort to impose new standards, however, is facing stiff opposition from some firms. Firms have complained about insufficient time to conduct independent analyses, and have expressed trouble understanding the NASD's primary market-making criteria for net-liquidity ratios, proportionate volume and proportionate trades.

Extended Comment Period

The NASD extended the public-comment deadline for the standards from May 1 to the end of May. In comment letters filed with the Securities and Exchange Commission before May 1, several firms blasted the NASD.

Wall Street investment-banking giant Morgan Stanley, Dean Witter, Discover & Co. urged the NASD to withhold approval of its pilot program for the new standards until the NASD submitted "clarifying language to assist firms in making an independent evaluation of its [primary market-making] status, and provide member firms with an initial analysis of its [primary market-making] status on a stock-by-stock basis."

"Until we have a better understanding of the impact of the proposed amendments, we are unable to provide more substantive comment," the letter noted.

Morgan Stanley said the new standards, as drafted, were onerous and difficult to calculate. In addition, the limited comment period and the immediate effectiveness of the technical proposal did not afford members sufficient time to comprehend the consequences of the amendments.

Favors Small Minority

Jersey City-based M.H. Meyerson & Co. stated in a comment letter that the NASD proposal was "blatantly slanted in favor of a small minority of market makers."

In a follow-up letter, the firm linked the proposed standards to another NASD proposal for an integrated order-delivery and execution system.

"The feature of sponsored access [to the limit-order book] by non-members in itself is a terrific concept, provided it is not tied to primary market status," the Meyerson letter noted. "We implore you to use this recommendation without any status modifiers."

"In essence, the NASD has asked that the SEC approve a major restructuring of Nasdaq without affording the public sufficient time to understand, comment or test the proposed changes," stated a CS First Boston letter. More time was needed for industry participants most affected by the changes to "review and reflect" the proposed amendments, the letter added.

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