[Federal Register Volume 65, Number 84 (Monday, May 1, 2000)]
[Notices]
[Pages 25401-25408]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-10725]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-42713; Form Type 34-36 MR; File No. 79-9]
Notice of Application and Order Temporarily Granting Application
for a Conditional Exemption by the National Association of Securities
Dealers, Inc. Relating to the Acquisition and Operation of a Software
Development Company by the Nasdaq Stock Market, Inc
April 24, 2000
Pursuant to Rule 0-12 \1\ under the Securities Exchange Act of 1934
(``Exchange Act''), notice is hereby given that on March 3, 2000, the
National Association of Securities Dealers, Inc. (``NASD'') and the
Nasdaq Stock Market, Inc. (``Nasdaq'') filed with the Securities and
Exchange Commission (``Commission'') an application for a conditional
exemption under Section 36(a)(1) of the Exchange Act \2\ relating to
Nasdaq's acquisition and operation of a software development company.
In addition, the NASD requested that, if the Commission determined to
solicit comment on the application for a permanent exemption, the
Commission grant a temporary conditional exemption for a period of one
year.
---------------------------------------------------------------------------
\1\ 17 CFR 240.0-12.
\2\ 15 U.S.C. 78mm(a)(1).
---------------------------------------------------------------------------
The Commission is publishing this notice to solicit comments from
interested persons on the NASD's application for a permanent exemption.
For the reasons discussed below, the Commission also is issuing an
order at this time approving the NASD's request for a temporary
conditional exemption for a period of one year from the date of this
release. The Commission will make a final determination concerning the
request for a permanent exemption after reviewing the comments
submitted in response to this notice and prior to the expiration of the
temporary exemption.
The text of the NASD's application is set forth in section 1
below,\3\ followed by the Commission's solicitation of comments on the
NASD's request for a permanent exemption in section II and the
Commission's order granting the NASD's request for a temporary
exemption in section III.
---------------------------------------------------------------------------
\3\ The NASD filed its application on March 3, 2000.
Subsequently, Nasdaq completed its acquisition of the assets of the
software development company.
---------------------------------------------------------------------------
I. NASD's Application for Exemption
On behalf of the NASD and Nasdaq, pursuant to Section 36 of the
Securities Exchange Act of 1934 and Rule 0-12 thereunder, we are
writing to apply for an exemption from Section 19(b) of the Exchange
Act, to (1) permit Nasdaq to acquire and operate a software development
company, Financial Systemware, Inc. (``FSI''), to market certain
financial services software, ``OTC Tools'' and related software
(``Software''), and to expand the products and services offered by FSI
to include service bureau and back-office functions for NASD broker-
dealers, without filing proposed rule changes pursuant to Rule 19b-4
under the Exchange Act of before making or implementing any
modifications to the Software, or with respect to each new software
product or service offered by FSI (provided those new software products
and services are offered in a manner that is not inconsistent with the
presentation contained in this letter), and (2) permit FSI to determine
prices for such software products and services based on competitive
market factors without filing proposed rule changes pursuant to Rule
19b-4 under the Exchange Act.
A. Background
The NASD is a national securities association registered under
Section 15A of the Exchange Act. As a national securities association,
the NASD is a self-regulatory organization (``SRO'') as defined by
Section 3(a)(26) of the Exchange Act. Though its subsidiaries, NASD
Regulation, Inc., the American Stock Exchange, Inc. and Nasdaq, the
NASD develops rules and regulations, conducts regulatory review of its
members' business activities, and designs and operates marketplace
facilities and services.
The NASD also has three other subsidiaries: (1) Nasdaq
International, Ltd., which provides services to domestic and foreign
companies, (2) Securities Dealers Insurance Co., Inc., which provides
reinsurance services in connection with a fidelity bond program for
NASD members, and (3) Securities Dealers Risk Purchasing Group, which
provides professional liability insurance to NASD members.
The NASD sets the overall strategic direction and policy agenda of
the whole organization, oversees the effectiveness of its subsidiaries
and ensures that the organization's statutory and self-regulatory
obligations are fulfilled.
Subject to receiving the exemptive relief requested herein, Nasdaq
plans to acquire the assets of FSI, whose primary line of business is
the development and distribution of a financial services software
product called ``OTC Tools.'' OTC Tools is designed for and marketed
[[Page 25402]]
to NASD broker-dealers that use Nasdaq Workstation II terminals. OTC
Tools is a Microsoft Windows-based software product that enhances and
simplifies a user's interactions with, and use of, the Nasdaq
Workstation II terminal, but does not change or alter the current
features of Nasdaq, SelectNet or SOES (i.e., the facilities of the
NASD).
Currently, the Software which is being commercially marketed to
NASD broker-dealers, offers a variety of features to assist them in
efficiently managing their quotes, monitoring and executing incoming
orders, continually checking for closed, locked or crossed markets, and
monitoring the depth of the market. There is a high level of effective
competition in providing these types of software products and services
to market participants. For example, Automatic Securities Clearance,
through its BRASS service, provides order-management services and
software to a large number of NASD member firms that are in many
respects similar to the Software. Other firms, such as Eagle Trading,
ADP, TCAM and Royal Blue, offer order handling packages that compete
with those offered by FSL. Similarly, many NASD member firms have
developed internal order management and order-routing software that
provides independent functions comparable to those provided by the
Software.
Given the NASD's complex infrastructure and the dramatic
acceleration of technological changes that are impacting the securities
markets, the NASD and Nasdaq believe that they must have the capability
to respond quickly to the technological needs of NASD members. The NASD
and Nasdaq believe that the acquisition of FSI will greatly improve
Nasdaq's ability to provide such rapid solutions to its members'
technological needs. Nasdaq also plans to expand the products and
services offered by FSI to include service bureau and back-office
functions \4\ for NASD broker-dealers.
---------------------------------------------------------------------------
\4\ For example, FSI may perform for its customers, service
bureau and back-office functions, including ACT trade reporting,
trade comparison, and position and account management functions
(e.g., profit and loss calculations).
---------------------------------------------------------------------------
B. Basis for Relief Sought and Anticipated Benefits to Investors
Section 19(b)(1) of the Exchange Act requires an SRO,\5\ including
the NASD (as a registered securities association under Section 15A of
the Exchange Act), to file with the Commission its proposed rule
changes accompanied by a concise general statement of the basis and
purpose of the proposed rule change. Once a proposed rule change has
been filed, the Commission is required to publish notice of it and
provide an opportunity for public comment. The proposed rule change may
not take effect unless approved by the Commission by order, or unless
the rule change is within the class of rule changes that are effective
upon filing pursuant to Section 19(b)(3)(a).\6\
---------------------------------------------------------------------------
\5\ Section 3(a)(26) of the Exchange Act defines the term
``self-regulatory organization'' to mean ``any national securities
exchange, registered securities association, registered clearing
agency, and, for purposes of Section 19(b) and other limited
purposes, the Municipal Securities Rulemaking Board (``MSRB'').''
\6\ Under Section 19(b)(3)(A) of the Exchange Act and rule 19b-
4(e) thereunder, a proposed rule change may take effect upon filing
without the notice and approval procedures required by Section
19(b)(2) if the proposed rule change comes within prescribed
statutory categories, including rule changes that (1) constitute a
stated policy, practice, or interpretation with respect to the
meaning, administration, or enforcement of an existing rule of the
SRO, (2) establish or change a due, fee, or other charge imposed by
the SRO, (3) are concerned solely with the administration of the
SRO, or (4) are matters which the Commission may, consistent with
the public interest and the purposes of this subsection, specify by
rule.
---------------------------------------------------------------------------
Section 19(b)(1) of the Exchange Act defines the term ``proposed
rule change'' to mean ``any proposed rule or rule change in, addition
to, or deletion from the rules of [a] self-regulatory organization.''
Pursuant to Section 3(a)(27) and 3(a)(28) of the Exchange Act, the term
``rules of a self-regulatory organization'' means (1) the constitution,
articles of incorporation, bylaws and rules, or instruments
corresponding to the foregoing, of an SRO, and (2) such stated
policies, practices and interpretations of an SRO (other than the MSRB)
as the Commission, by rule, may determine to be necessary or
appropriate in the public interest or for the protection of investors
to be deemed to be rules. The Commission has exercised this rulemaking
authority by adopting Rule 19b-4(b) under the Exchange Act, which
defines the term ``stated policy, practice, or interpretation.''
Rule 19b-4(b) defines the term ``stated policy, practice, or
interpretation to mean generally ``any material aspect of the operation
of the facilities of the self-regulatory organization \7\ or any
statement made available to the membership, participants, or specified
persons thereof that establishes or changes any standard, limit, or
guideline with respect to rights and obligations of specified persons
or the meaning, administration, or enforcement of an existing rule.''
(Emphasis added.)
---------------------------------------------------------------------------
\7\ The term ``facilities of the self-regulatory organization''
is not defined in the Exchange Act. The term ``facility'' is defined
in Section 3(a)(2) of the Exchange Act, but only with respect to an
exchange (as defined in Section 3(a)(1), to ``include * * * its
premises, tangible or intangible property whether on the premises or
not, any right to use such premises or property or any service
thereof for the purpose of effecting or reporting a transaction on
an exchange (including, among other things, any system of
communication to or from the exchange, by ticker or otherwise,
maintained by or with the consent of the exchange), and any right of
the exchange to the use of any property or service.''
---------------------------------------------------------------------------
To the extent that the software or related services (or portions
thereof) offered by FSI to Nasdaq member firms would be a ``facility''
of an SRO, Section 19(b) of the Exchange Act, and rule 19b-4, would,
absent an exemption, require the NASD to file proposed rule changes
with the Commission in certain instances where FSI seeks to modify the
Software or the fees it charges for providing it. Technology
applications for broker-dealers and market makers develop and change
very rapidly, and FSI needs to be able to move quickly to modify
existing products and develop new software products. If FSI were
required to follow the procedures for rule filings and approvals each
time the Software is modified or enhanced, the delays and
administrative difficulties associated with the rule filing process
would put FSI at a significant competitive disadvantage relative to
other software developers that are not affiliated with an SRO.
Moreover, the NASD and Nasdaq would not be able to provide NASD broker-
dealers with the type of timely and effective software development that
users desire and have indicated they need. Thus, in this competitive
software market, the delays and administrative difficulties associated
with the rule filing process would, in the NASD's view, put FSI at such
a competitive disadvantage so as to render the acquisition of FSI or
the rights to the software impracticable.
As noted above, because of the NASD's complex infrastructure and
the dramatic acceleration of technological changes that are impacting
the securities markets, the NASD believes that it must have the
capability to respond quickly to the technological needs of its
members. The NASD believes that the acquisition of FSI by Nasdaq will
greatly improve Nasdaq's ability to provide such rapid solutions to its
members' technological needs. If, however, the NASD and Nasdaq cannot
as a practical matter compete in the software market, the result would
be the inhibition of the development of more efficient and effective
market operations and economically efficient execution of securities
transactions--each a stated Congressional goal under Section 11A of the
Exchange Act, which directs the Commission to facilitate the
development of a national market
[[Page 25403]]
system. Furthermore, as more efficient means are developed for NASD
broker-dealers to manage and monitor their quotations, order flow,
executions and positions, the cost savings derived from these
efficiencies can be passed on to investors through reduced spreads and
transactions costs, as well as through increased liquidity in the over-
the-counter market. Absent full and effective competition in the
software market, the incentive to develop new and beneficial software
for market maker use is reduced, thereby reducing the opportunity to
pass along the benefits to investors.
C. Discussion
The Commission has general exemptive authority pursuant to Section
36 of the Exchange Act, and Rule 0-12 thereunder, in pertinent part, to
exempt any person from any Exchange Act provision or rule, to the
extent that such exemption is necessary or appropriate, in the public
interest, and is consistent with the protection of investors. In order
for the NASD and Nasdaq to compete effectively in providing software
and service bureau functions to NASD broker-dealers, the NASD
respectfully requests that the Commission exercise its general
exemptive authority and exempt the NASD from the requirements of
Sections 19(b) to (1) permit it to operate FIS and offer software to
market makers (and other NASD member firms) without filing proposed
rule changes with respect to making or implementing any modifications
to the Software, or with respect to each new software product or
service offered by FSI to (provided those new software products and
services are offered in a manner that is not inconsistent with the
representations contained in this letter), and (2) permit FSI determine
prices for such software products and services based on competitive
market factors without filing proposed rule changes. In particular, the
NASD requests an exemption form Section 19(b) of the Exchange Act with
respect to any rule filings that would otherwise be required under that
Section and the rules and regulations thereunder.
Given the rapid advances in technology, the increasing reliance of
the financial industry on automation and the degree of competition in
the supply of technological solutions, we believe that in certain
circumstances, including those presented in this request, a policy
distinction can be made between essential or core SRO services and
ancillary non-essential or optional services such as those offered by
FSI to permit the latter category of services to be offered by an SRO
on a fully competitive basis without compliance with the notice and
comment process while at the same time ensuring that those services are
offered in a way that is consistent with the goals and requirements of
the Exchange Act.
As noted above, OTC Tools offers a variety of features to assist
NASD broker-dealers in efficiently managing their quotes, monitoring
and executing incoming orders, continually checking of closed, locked
or crossed markets, and monitoring the depth of the market. These
functions to be performed by OTC Tools are not central to the core
functionality of Nasdaq's marketplace. Rather the functions involved
are supplemental to, and independent of, the primary functions of
Nasdaq.
Moreover, the NASD and Nasdaq believe that the exemption requested
is consistent with the purposes of the Exchange Act, particularly the
protection of investors, the maintenance of fair and orderly markets,
and the fostering of competition. This segment of the financial
software market is highly competitive. As discussed above, there are a
number of other firms that offer competing products to OTC Tools. The
NASD and Nasdaq purpose that Nasdaq will operate FSI as a stand-alone
business, capitalized separately and not subsidized by NASD members or
other revenues of the NASD or Nasdaq.\8\
---------------------------------------------------------------------------
\8\ The NASD, of course, reserves the right to provide capital
to FSI adequate for it to compete effectively in the market place
and to develop and market new products and services.
---------------------------------------------------------------------------
In addition, the NASD and Nasdaq would take appropriate steps to
ensure that FSI would not have any information advantage regarding
planned developments and changes to Nasdaq that would not also be
available to other competing vendors. Finally, the core functions of
Nasdaq would not be altered as a result of the acquisition, and the
NASD and Nasdaq will take all reasonable steps necessary to ensure that
market makers and order-entry firms will continue to have the ability
to trade effectively through Nasdaq's essential facilities without
using the Software.
D. Conditions
As described in Exchange Act Rule 0-12, in connection with a
request for exemption from any provision of the Exchange Act, the
applicant is required to state any conditions or limitations it
believes would be appropriate for the protection of investors. As a
general matter, the NASD and Nasdaq believe the request submitted
herein is appropriate because it deals with nonessential services of
the NASD and provides the benefit of optional technological innovation
designed to improve the productivity of NASD member firms. The
following limitations on the exemptive relief requested are, in the
view of NASD and Nasdaq, not objectionable to further this objective
and to ensure that the operation of FSI is generally consistent with
the requirements of the Exchange Act applicable to SROs.
Continued Presence of Competition--As indicated above, at the time
of this application, there is a high level of effective competition in
providing software to market makers. Automatic Securities Clearance,
through its BRASS service, for example, provides order-management
services and software that are in many respects similar to the Software
to a large number of NASD member firms. Other firms, such as Eagle
Trading, ADP, TCAM and Royal Blue, offer order handling packages that
compete with those offered by FSI. Similarly, many NASD member firms
have developed internal order management and order management and
order-routing software that provides independent functions comparable
to those provided by the Software. Moreover, the software industry in
general, and the financial software industry in particular, have low
barriers to entry, so that, as the markets evolve and technology is
increasingly brought to bear on securities trading, new entrants can,
in our view, emerge, NASD and Nasdaq understand that the Commission may
reconsider at a later date its decision to grant the exemptive relief
requested herein in the event that effective competition for these
software products and services no longer exists.
Independent Functionally of Nasdaq and Other NASD-Sponsored
Services--NASD and Nasdaq believe that providing the Software to NASD
member firms does not, and will not, affect the basic functionality of
the Nasdaq system. In acquiring FSI and providing the software to NASD
member firms, the core functions of Nasdaq (currently provided through
the Nasdaq Workstation II terminal system) will not be changed. Nasdaq
and other NASD-sponsored systems (such as the Automated Confirmation
Transaction Service) operate and will continue to operate independently
of the Software. Use of the Software is not, and will not in the
future, be necessary to access Nasdaq or any other NASD market-related
facility, and NASD members that do not use the Software will be able to
enter and change quotes, route orders, effect transactions and perform
all market functions in Nasdaq. The NASD
[[Page 25404]]
and Nasdaq believe that requiring full Nasdaq core functionality
without use of the Software is an appropriate condition to the grant of
the exemptive relief requested.
Full Public Access to Nasdaq through the Application Programming
Interface (``API'') \9\ will Continue--As the Commission is aware, the
Nasdaq system is an open architecture system and Nasdaq has provided an
API that enables firms to have access to the Nasdaq system through
their own software or computer system. The NASD and Nasdaq are fully
committed to maintaining the API to provide for fair and equitable
access to the system and to encourage the development of software by
NASD member firms and competing software vendors. Thus, we believe that
conditioning the exemptive relief on continued free and open access to
Nasdaq through the API is appropriate in light of the commitment of the
NASD and Nasdaq to maximum competition in offering services to NASD
members.
---------------------------------------------------------------------------
\9\ API provides an electronic interface between a subscriber's
computer system and the Nasdaq Workstation II system, Through the
use of the API, a subscriber may build its own workstation
presentation software to integrate the Nasdaq Workstation II service
into the subscriber's existing presentation facilities. The API
allows a subscriber to emulate the Nasdaq Workstation II
presentation software with equivalent functionality, capacity
utilization and through-put capability, in addition to providing
enhanced capability to develop customized internal presentations for
use in support of a subscriber's activities. API also allows a
subscriber to operate a quote-update facility to assist solely in
complying with the Commission's Order Handling Rules. Generally, a
subscriber establishes an API ``linkage,'' such as Nasdaq
Workstation II substitute or quote update facility, which in turn
connects to a service delivery platform via an API server.
---------------------------------------------------------------------------
Fair Access to Information on Nasdaq Developments--As a fourth
condition consistent with the statutory objective and our stated
objective of maintaining a competitive software market, the NASD and
Nasdaq, as noted above, agree not to provide FSI an information
advantage concerning Nasdaq core facilities, particularly changes and
improvements to the system, that is not available to the industry
generally or to vendors of financial software for market makers and
order entry firms, and will prevent FSI from having any advance
knowledge of proposed changes or modifications to core Nasdaq
facilities. This is appropriate to avoid giving FSI any informational
advantage in the development and enhancement of software products for
the Nasdaq market.
In this regard, FSI will not share employees with the NASD, Nasdaq
or any other NASD affiliate, and will be housed in office space from
that of the NASD or Nasdaq. In addition, FSI will be notified of any
change or improvements to the Nasdaq system in the same manner that
other competing vendors are notified of such changes or improvements.
For example, in addition to mailings and Web site disclosure of changes
to Nasdaq or to Nasdaq technical specifications, Nasdaq currently meets
at least quarterly with all vendors to discuss proposed modifications
to the System and changes that are in the pipeline (subject to
Commission approval, where needed). FSI will be treated, for purposes
of these mailings, disclosures and meetings, the same as any third
party vendor and will not receive any information regarding planned or
actual changes to Nasdaq in advance of other vendors. Conversely, FSI
will not disclose any system or design specifications, or any other
information to any employees with the NASD, Nasdaq or any other NASD
affiliate that would give FSI and unfair advantage over its
competitors.
E. Conclusion
For the reason set forth above, the NASD hereby requests that the
Commission grant an exemption from Sections 19(b), and the rules and
regulations thereunder, to (1) permit the Nasdaq to operate FSI and
offer software to market makers (and other NASD member firms) without
filing proposed rule changes with respect to making or implementing any
modifications to the Software, or with respect to each new software
product or service offered by FSI (provided those new software products
services are offered in a manner that is not inconsistent with the
representations contained in this letter), and (2) permit FSI to
determine prices for such software products and services based on
competitive market factors without filing proposed rule changes. If the
Commission believes that notice of this request and an opportunity for
public comment is necessary, the NASD requests that the Commission
grant the relief requested, on a temporary basis, for a period of one
year, and that thereafter, following the conclusion of any such notice
and comment period, the Commission grant the requested relief on a
permanent basis.
II. Solicitation of Comments
Section 36(b) of the Exchange Act provides that the Commission
shall, by rule or regulation, determine the procedures under which an
exemptive order shall be granted. Exchange Act Rule 0-12(g) provides
that the Commission, in its sole discretion, may choose to publish in
the Federal Register a notice of an application for an exemption under
Section 36 and to allow any person to submit information that relates
to the action requested in the application. The Commission has
determined that, prior to taking final action on the NASD's application
for a permanent exemption, it would be helpful to offer the public an
opportunity to submit information concerning the permanent exemption
and the conditions on which the exemption is based. Accordingly,
interested persons are invited to submit written data, views, and
arguments concerning the NASD's application for an exemption. Persons
making written submissions should file six copies thereof with the
Secretary, Securities and Exchange Commission, 450 Fifth Street NW.,
Washington DC 20549-0609. All submissions should refer to Form Type 34-
36 MR; File No. 79-9 and should be submitted by July 31, 2000. Comment
letters received will be available for public inspection and copying in
the Commission's Public Reference Room.
III. Order Granting Temporary Conditional Exemption
The Commission has determined to grant the NASD's request for a
temporary conditional exemption for a period of one year from the date
of this release. The Commission finds that the temporary conditional
exemption from the provisions of Section 19(b) is necessary or
appropriate in the public interest and is consistent with the
protection of investors. In particular, the exemption could help
promote efficiency and competition in the market to provide enhanced
software services to broker-dealers who interact with the NASD's
facilities, while upholding the regulatory objectives of the Exchange
Act. After the end of the public comment period set forth in section II
above and prior to expiration of the temporary exemption, the
Commission will make a final determination concerning the NASD's
application for a permanent exemption.\10\
---------------------------------------------------------------------------
\10\ The Commission's approval of the NASD's request for a
temporary conditional exemption should not be interpreted as
suggesting that the Commission is predisposed to approving the
NASD's application for a permanent exemption subject to the same
conditions.
---------------------------------------------------------------------------
As discussed further below, the NASD, as a registered self-
regulatory organization, operates a number of facilities used by
broker-dealers that effect transactions in securities in the over-the-
counter market, particularly securities that are qualified for
inclusion in Nasdaq. These facilities, which
[[Page 25405]]
include the automated quotations network that is the heart of Nasdaq,
order delivery and execution systems, and a transaction reporting
system, are made available to broker-dealer subscribers primarily
through the Nasdaq Workstation II (``NWII'') service. The NASD has
adopted an open architecture system that provides an API between the
NWII system and a subscriber's computer system. The API allows broker-
dealers to employ specialized software that supplements the NWII
service and enhances their interaction with the NASD's facilities,
thereby facilitating their trading and other proprietary activities.
Currently, a number of companies independent of the NASD offer this
type of software product for sale to broker-dealers. Nasdaq has
acquired one of these companies--FSI.
Certain of the functions offered through FSI's products, when
considered together with the other services offered by the NASD and its
affiliates,\11\ could cause such products to be considered part of the
NASD's facilities. Consequently, changes to the products or the fees
charged for the products could trigger the proposed rule change
requirements of Section 19(b), which includes filings with the
Commission, public notice and comment on those filings, and Commission
review and approval of the proposed rule change. These requirements
could significantly hamper the ability of FSI to compete effectively in
a rapidly changing technology market to provide specialized software to
broker-dealers. The requested temporary conditional exemption would
allow FSI to modify its products, offer new products, and set fees for
its products without going through the proposed rule change procedures
of Section 19(b).
---------------------------------------------------------------------------
\11\ The companies that currently offer the enhanced software
products for broker-dealers are not owned by an SRO. When considered
alone, their activities do not fall within the definition of a
facility of an SRO, and they therefore are not subject to the
proposed rule change requirements of Section 19(b).
---------------------------------------------------------------------------
In granting the Commission broad exemptive authority in Section 36,
Congress intended to incorporate flexibility into the Exchange Act
regulatory scheme to reflect a rapidly changing marketplace. Congress
particularly intended for the Commission to use this flexibility to
promote efficiency and competition. The Commission believes that the
NASD's requested temporary conditional exemption will help achieve
these goals, while upholding the regulatory objectives of the Exchange
Act. In particular, the exemption could facilitate vigorous competition
in the market to provide enhanced software services to broker-dealers
by allowing FSI to compete on a more equal footing with companies that
are not subject to the regulatory requirements applicable to an SRO.
The exemption is subject to four principal conditions to help assure
that FSI will not obtain an unfair competitive advantage because of its
ownership by Nasdaq.
The Commission believes that granting a temporary conditional
exemption is warranted because (1) the products of FSI will not be
required for broker-dealers to access the NASD's fundamentally
important or core services, including quotation collection and
dissemination, order routing and execution, and transaction reporting,
and (2) the opportunity for fair competition will be preserved in the
market to provide enhanced software services to broker-dealers who use
the NASD's facilities. Under these circumstances, the Commission
believes that competitive forces, rather than the regulatory
protections provided by the proposed rule change process, can be relied
on to uphold the objectives of the Exchange Act in an efficient manner
during the one-year period of the temporary exemption. Fair and
vigorous competition, by creating incentives for companies to provide
superior software products at fair prices, can serve the interests of
broker-dealers, and ultimately those of their investor customers.
A. The NASD's Facilities and Its Open Architecture System
The NASD currently operates a number of facilities for broker-
dealers that effect transactions in securities traded in the OTC
markets. These facilities include (1) an automated quotations system,
(2) the SelectNet order delivery system,\12\ (3) the Small Order
Execution System (``SOES''), and (4) the Automated Confirmation
Transaction Service (``ACT'').
---------------------------------------------------------------------------
\12\ The Commission recently approved a proposed rule change by
the NASD to establish a revised order delivery and execution
system--the Nasdaq National Market Execution System. Securities
Exchange Act Release No. 42344 (Jan. 18, 2000), 65 FR 3987. After
implementation of the system, SelectNet will be re-established as a
non-liability system for purposes for order delivery and negotiation
only.
---------------------------------------------------------------------------
At its heart, Nasdaq is a telecommunications network for the
centralized collection and dissemination of quotations from market
makers and electronic communications networks (``ECNs''). This service
allows broker-dealers to enter, retrieve, monitor, and adjust
quotations throughout the trading day. The NASD's SelectNet facility
offers broker-dealers the ability to automate the negotiation and
execution of trades and eliminates the need for verbal contact between
trading desks. It allows Nasdaq subscribers to direct orders for the
purchase and sale of Nasdaq stocks to specified market makers or ECNs,
or to broadcast orders for Nasdaq stocks to all market makers and ECNs.
SelectNet also identifies incoming and outgoing orders and allows
traders to see subsequent messages and negotiation results. The NASD's
SOES facility automatically executes small agency orders routed to
market makers, reports completed trades for public dissemination, and
sends information with respect to those trades to clearing corporations
for comparison and settlement. Finally, the NASD's ACT facility is an
automated service that speeds the post-execution steps of price and
volume reporting and the comparison and clearing of securities
transactions.
Access to the NASD's facilities is made available primarily through
the NASD's NWII service. In addition, the NASD has adopted an open
architecture system that provides full public access to its facilities
through API. The API provides an electronic interface between a
subscriber's computer system and the NWII system. Through the use of
the API, a subscriber may employ its own workstation presentation
software to integrate the NWII services into its presentation
capabilities. The API thereby allows a subscriber to develop customized
internal presentations for use in support of the subscriber's
activities. In sum, fundamentally important or core NASD services are
provided through the NWII system, while subscribers also are able to
develop or purchase customized software that enhances the NWII services
and responds to their individual needs.
Many broker-dealers have taken advantage of the API and employ
software to enhance the NASD services provided through the NWII system.
Some broker-dealers have developed such software internally. In
addition, a number of companies independent of the NASD have developed
this type of software and offered it for sale to broker-dealers. For
example, the promotional materials of one company states that its
product ``provides fully integrated and enhanced Nasdaq Workstation II
features,`` including automated management of quotations, automated ACT
reporting, and automated SelectNet order entry and order acceptance.
Other competing companies make similar
[[Page 25406]]
assertions concerning the ability of their products to enhances the
interaction of broker-dealers with the NASD's facilities, as well as to
facilitate a wide array of other broker-dealer proprietary activities.
The Nasdaq has acquired one of these companies--FSI. FSI is a
software development company that offers a product called OTC Tools.
OTC Tools includes a variety of features to assist NASD members in
conducting their proprietary activities, including efficiently managing
their quotes, monitoring and executing incoming orders, continually
checking for closed, locked, or crossed markets, and monitoring the
depth of the market.\13\ To enable FSI to modify its products, offer
new products, and set fees for its products as freely and quickly as
its competitors that are not owned by an SRO, the NASD has requested a
temporary conditional exemption from the proposed rule change
provisions of Section 19(b).
---------------------------------------------------------------------------
\13\ For example, the current version of OTC Tools enables a
user (1) to maintain a pre-configured maximum market spread in
specific securities when making adjustments in a quotation at one
side of the market; (2) to capture and execute incoming SelectNet
orders in several different fashions by combining multiple keystroke
or mouse functions; (3) to send, with a single point-and-click
feature, multiple SelectNet preferenced orders to preset market
makers or ECNs; and (4) to monitor SelectNet broadcast orders for
electronic execution based on the user's pre-configured order
selection file.
---------------------------------------------------------------------------
B. Proposed Rule Change Provisions of Section 19(b)
Section 10(b) requires that every SRO file with the Commission
copies of any proposed rule or any proposed change in, addition to, or
deletion from the rules of such SRO, accompanied by a concise general
statement of the basis and purpose of such proposed rule change. The
Commission is required to publish notice of the filing of a proposed
rule change and to give interested persons an opportunity to submit
written data, views, and arguments. Section 19(b) provides that the
Commission shall approve an SRO's proposed rule change if it is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to the SRO.
The term ``rules of a self-regulatory organization'' is defined in
Section 3(a)(28) of the Exchange Act to include the rules of an
association of broker-dealers that is a registered securities
association, and the term ``rules of an association'' is defined in
Section 3(a)(27) to include such of the stated policies, practices, and
interpretations of the association as the Commission determines by rule
to be necessary or appropriate in the public interest or for the
protection of investors. In Exchange Act Rule 19b-4,\14\ the Commission
has defined ``stated policy, practice, or interpretation'' to include
any material aspect of the operation of the facilities of a self-
regulatory organization. The term ``facility'' when used with respect
to an exchange\15\ is defined very broadly in Section 3(a)(2) to
include, among other things, any tangible or intangible property of the
exchange and any right to the use of such property or any service
thereof for the purpose of effecting or reporting a transaction on an
exchange (including any system of communication to or from the
exchange).
---------------------------------------------------------------------------
\14\ 17 CFR 240.19b-b
\15\ The Commission has found that Nasdaq falls within the
definition of ``exchange'' under Section 3(a)(1) of the Act.
Securities Exchange Act Release No. 40760 (Dec. 8, 1998), 63 FR
70844 (``ATS Release''), at nn. 58-61 and accompanying text.
---------------------------------------------------------------------------
Certain aspects of the software products that enhance a broker-
dealer's interaction with the NASD's facilities could, when considered
together with the other services offered by the NASD and its
affiliates, fall within the Exchange Act definition of a facility and
therefore require the filing of a proposed rule change for material
changes in the software and the fees charged for the software. The NASD
has requested a temporary conditional exemption from this requirement
under Section 36 of the Exchange Act.
C. Commission's Exemptive Authority Under Section 36
Section 36(a)(1) of the Exchange Act grants the Commission broad
authority to exempt any person from any provision of the Act to the
extent that such exemption is necessary or appropriate in the public
interest and is consistent with the protection of investors. In
enacting Section 36, Congress indicated that it expected that ``the
Commission will use this authority to promote efficiency, competition
and capital formation.'' \16\ It particularly intended to give the
Commission sufficient flexibility to respond to changing market and
competitive conditions.
---------------------------------------------------------------------------
\16\ H.R. Rep. No. 104-622, 104th Cong., 2nd Sess. 38 (1996).
The Committee recognizes that the rapidly changing marketplace
dictates that effective regulation requires a certain amount of
flexibility. Accordingly, the bill grants the SEC general exemptive
authority under both the Securities Act and the Securities Exchange
Act. This exemptive authority will allow the Commission the
flexibility to explore and adopt new approaches to registration and
disclosure. It will also enable the Commission to address issues
relating to the securities markets more generally. For example, the
SEC could deal with the regulatory concerns raised by the recent
proliferation of electronic trading systems, which do not fit neatly
into the existing regulatory framework.\17\
---------------------------------------------------------------------------
\17\ S. Rep. No. 104-293, 104th Cong., 2nd Sess. 15 (1996).
At the same time that it added Section 36 to the Exchange Act,
Congress enacted Section 3(f), which charges the Commission, when it is
engaged in rulemaking itself or reviewing an SRO rule and is required
to consider whether an action is necessary or appropriate in the public
interest, also to consider whether the action will promote efficiency,
competition, and capital formation.
Section 36 and Section 3(f) reaffirm a fundamental and long-
established principle of the Exchange Act--investor interests are best
served by a regulatory structure that facilitates fair and vigorous
competition among market participants. Congress emphasized this
principle, for example, when it amended the Exchange Act in 1975:
In 1936, this Committee pointed out that a major responsibility
of the SEC in the administration of the securities laws is to
`create a fair field of competition.' This responsibility continues
today. * * * The objective would be to enhance competition and to
allow economic forces, interacting within a fair regulatory field,
to arrive at appropriate variations in practices and services. It
would obviously be contrary to this purpose to compel elimination of
differences between types of markets or types of firms that might be
competition-enhancing. \18\
---------------------------------------------------------------------------
\18\ S. Rep. No. 94-75, 94th Cong., 1st Sess. 8 (1975).
In recent years, the Commission has exercised its Section 36
exemptive authority by seeking to enhance competition as a means to
meet the objectives of the Exchange Act. For example, it exempted
alternative trading systems from many of the requirements that
otherwise would apply to an ``exchange,'' including registration and
the filing of proposed rule changes, when such requirements were not
necessary or appropriate to further the Exchange Act's objectives. In
adopting this exemption, the Commission stated that it ``believes that
its regulation of markets should both accommodate traditional market
structures and provide sufficient flexibility to ensure that new
markets promote fairness, efficiency, and transparency.'' \19\
---------------------------------------------------------------------------
\19\ ATS Release, note 15 above, section I.
---------------------------------------------------------------------------
In addition, the Commission has used its exemptive authority to
revise the proposed rule change requirements of
[[Page 25407]]
Section 19(b) to meet the changing needs of the SROs in a competitive
international marketplace. For example, the Commission amended Rule
19b-4 in 1998 to streamline the requirements for introduction of new
derivative securities products.\20\ At the same time, the Commission
adopted rule 19b-5 to help reduce impediments to competitive innovation
by SROs by exempting them from the requirement to file proposed rule
changes for pilot trading systems for a two-year period. In adopting
this exemption, the Commission noted that ``excessive regulation of
traditional exchanges, alternating trading systems, or other markets
hinders these exchanges' ability to compete and survive in the global
arena'' and found that the exemption from Section 19(b) for pilot
trading programs ``responds to the SROs' need for a more balanced
competitive playing field.'' \21\
---------------------------------------------------------------------------
\20\ Securities Exchange Act Release No. 40761 (Dec. 8, 1998),
63 FR 70952.
\21\ ATS Release, note 15 above, section VI.A.
---------------------------------------------------------------------------
D. Temporary Conditional Exemptions for FSI
The NASD has requested a temporary conditional exemption that would
allow FSI to modify its products, offer new products, and set fees for
its products without filing proposed rule changes under Section 19(b).
The exemption would be subject to four principal conditions: (1) the
continued presence or effective competition in the market to provide
software products that enhance a broker-dealer's interaction with the
NASD's facilities; (2) the independent functionality of the NASD's
facilities; (3) continued full public access to the NASD's facilities
through the API; and (4) fair access to information concerning the
NASD's facilities and systems.
The Commission believes that the requested temporary conditional
exemption could help promote efficiency and competition, while
upholding the regulatory objectives of the Exchange Act. Nasdaq's
ownership of a software company whose products facilitate a broker-
dealer's interaction with the NASD's facilities could promote
efficiency and competition in at least two ways. First, Nasdaq's
detailed knowledge of the needs of NASD members could lead FSI to
develop products with features that more closely respond to those needs
and that increase the efficiency of broker-dealer operations. Second,
Nasdaq ownership could help assure that software is developed and made
available that will meet the needs of the wide variety of broker-
dealers that are NASD members, both large and small. Thus, the
existence of a Nasdaq-owned company offering enhanced software products
could act as a spur to competition and thereby help generate better
software products for broker-dealers.
Given the pace of change in software technology and market
conditions, the Commission believes at this point that the procedural
requirements of Section 19(b) could significantly hamper the ability of
FSI to compete effectively with companies that are not subject to the
same regulatory requirements. A software company needs to act rapidly
and nimbly in developing and pricing its products. If FSI were required
to comply with the proposed rule change requirements, it necessarily
would be subject to greater expense, delay, and uncertainty in offering
products and setting prices than its competitors. Although the
requirements of Section 19(b) serve vital regulatory functions,
particularly with respect to the fundamentally important or core
services of an SRO, the Commission does not believe at this point that
they are necessary to further the public interest in the context of the
limited services to be provided by FSI.
In reviewing a proposed rule change under Section 19(b) the
Commission focuses on the particular section of the Exchange Act that
sets forth substantive requirements for the SRO's rules. For a national
securities association such as the NASD, Section 15A of the Exchange
Act requires, among other things, that its rules (1) provide for the
equitable allocation of reasonable dues, fees, and other charges among
members using any facility or system which the association operates or
controls (subparagraph (b)(5)); (2) be designed to promote just and
equitable principles of trade, to remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, to protect investors and the public interest, and not be
designed to permit unfair discrimination between customers, issuers, or
broker-dealers (subparagraph (b)(7)); and (3) not impose any burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act (subparagraph (b)(9)).
The four principal conditions of the requested temporary exemption
will help assure that these regulatory objectives are upheld during the
one-year period of the exemption without requiring Commission review
and approval of FSI's products and fees.\22\ First, the products of FSI
will not be necessary for broker-dealers to access the NASD's
fundamentally important or core services, including quotation
collection and dissemination, order routing and execution, and trade
reporting.\23\ The NASD and Nasdaq have agreed to maintain an
independent functionality for the NASD's market-related facilities--
that is, FSI's products nor enhance software products of any kind will
be necessary for a broker-dealer to obtain access to the NASD's
fundamentally important or core services. The basic software products
necessary to obtain such access (currently provided through the NWII
service) will be provided separately from FSI.
---------------------------------------------------------------------------
\22\ The Commission reserves the right to modify, by order, the
terms and scope of the exemption from the proposed rule change
requirements if it determines such modification is appropriate for
the protection of investors or in the public interest.
\23\ This approach is consistent with the Commission's decision
in an administrative proceeding that included a denial of access
claim under Section 19(d) of the Exchange Act. In the Matter of the
Application of Morgan Stanley & Co., Admin. Proc. File No. 3-9289
(Dec. 17, 1997) (``In those cases in which we have found a denial of
access, an SRO had denied or limited the applicant's ability to
utilize one of the fundamentally important services offered by the
SRO. The services at issue were not merely important to the
applicant but were central to the function of the SRO.'').
---------------------------------------------------------------------------
In addition, for broker-dealers who wish to employ software
products that enhance their interaction with the NASD's facilities, the
exemption is conditioned on the continued existence of effective
competition in the market to provide such type of products. This
condition will assure that broker-dealers have a variety of viable
software products from which to choose. To maintain an opportunity for
fair competition, the NASD and Nasdaq have agreed to continue to
provide open architecture systems that enable full public access to the
NASD's facilities through the API. The NASD and Nasdaq also have agreed
not to provide an unfair information advantage to FSI. FSI will not be
given information that is not available to the industry generally or to
other companies competing to provide enhanced software products to
broker-dealers. In particular, the NASD and Nasdaq will prevent FSI
from having any advance private knowledge of proposed changes or
modifications to the NASD's facilities. To help meet this condition,
FSI will not share employees with the NASD or any NASD affiliate and
will be housed in office space separate from that of the NASD and
Nasdaq.
Given these conditions, the Commission does not believe that the
regulatory protections offered by Commission review and approval of
[[Page 25408]]
proposed rule changes are necessary or appropriate to further the
Exchange Act's regulatory objectives during the one-year period of the
temporary exemption. Access to the NASD's fundamentally important and
core services will be independently maintained by the NASD and fully
subject to the Exchange Act's regulatory scheme, including the proposed
rule change requirements of Section 19(b). Fair competition will be
maintained in the market to provide enhanced software products to
broker-dealers. Under these circumstances, the Commission believes at
this point that competitive forces can be relied upon to produce
software products at fair prices that meet the needs of broker-dealers.
In sum, the Commission believes that FSI will neither be unnecessarily
hampered in its competition to provide software services to broker-
dealers nor given an unfair competitive advantage because of its
ownership by Nasdaq.
For the reasons discussed above, the Commission finds that the
temporary conditional exemption requested by the NASD is necessary or
appropriate in the public interest and is consistent with the
protection of investors.
It Is Therefore Ordered, pursuant to Section 36(a)(1) of the
Act,\24\ that the NASD's application for a temporary conditional
exemption (Form Type 34-36 MR; File No. 79-9) is granted for a period
of one year until April 24, 2001.
---------------------------------------------------------------------------
\24\ 15 U.S.C. 78mm(a)(1).
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-10725 Filed 4-28-00; 8:45 am]
BILLING CODE 8010-01-M