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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

New York-based CS First Boston was upset with the convoluted language of the NASD's proposal, and urged the association to consider an SEC initiative requiring brokerages to disclose invesment information to investors in understandable English. The investment-banking giant noted that the NASD's proposal requires "multiple footnotes to explain essential, yet perplexing phrases."

"While we understand the concerns raised by the SEC and the NASD regarding the need for more meaningful criteria for the designation of [primary market-making standards] and the concomitant exemption from the short-sale rule, we are very uncertain whether the proposal is the proper way to achieve this goal," noted a letter from Wall Street investment-banking giant J. P. Morgan & Co.

J. P. Morgan worried that the relatively complex formulae appear to require primary market makers to accept significant risks in times of severe market conditions.

"While it does not seem particularly improper to expect a market maker to satisfy its proportional share of trading in an up or down market to be deemed a primary market maker, requiring a minimum arbitrary level of trading against the trend of buying or selling may prove especially harsh in certain circumstances, potentially imposing significant risk on market makers," the J.P. Morgan letter added.

The new standards would also require a market maker to "engage in significant levels of such putative liquidity-building transactions while being limited in its ability to sell short in a down market," J. P. Morgan noted.

Consequently, a market maker trying to buy in a down market would be unable to first sell short to position itself to buy that stock. Thus, the market maker would have to buy first, hoping to sell before the market fell further, potentially making qualification as a primary market maker quite risky.

An NASD spokesman told Traders Magazine that the comment period was extended so industry participants could read and comment on the materials published.