[Federal Register Volume 65, Number 154 (Wednesday, August 9, 2000)]
[Notices]
[Pages 48771-48774]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-20057]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43107; File No. SR-NASD-00-37]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by National Association of Securities Dealers, Inc. Relating to 
Permanent Approval of the Nasdaq Application of the OptiMark System.

August 2, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder, \2\ notice is hereby given 
that on June 19, 2000, the National Association of Securities Dealers, 
Inc. (``NASD'' or

[[Page 48772]]

``Association'') through its subsidiary The Nasdaq Stock Market, Inc. 
(``Nasdaq''), filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by Nasdaq. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement Of The Terms Of 
Substance Of The Proposed Rule Change

    Nasdaq is filing this proposed rule change to seek permanent 
approval of the Nasdaq Application of the OptiMark System (``Nasdaq 
Application'' or ``Application'') without any restrictions on the 
trading activity to be conducted through the facility.

II. Self-Regulatory Organization's Statement Of The Purpose Of, And 
Statutory Basis For, The Proposed Rule Change

    In its filing with the Commission, Nasdaq included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. Nasdaq has prepared summaries, set forth in Sections A, 
B, and C below, of the most significant aspects of such statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
a. Summary of Nasdaq's Application of the OptiMark System
    Since October 1999, Nasdaq has operated a new Nasdaq facility 
called the Nasdaq Application of the OptiMark System (``Nasdaq 
Application'' or ``Application''). \3\ The Application is a screen-
based trading service intended for use by NASD members and other non-
member users. The Application employs technology developed by OptiMark 
Technologies, Inc. to provide a computerized mechanism designed to 
satisfy the trading desires of all market participants, including 
retail and institutional investors as well as broker-dealers. The 
Application enables these participants to anonymously represent their 
trading interest across a full spectrum of prices and sizes, and 
performs a sophisticated, computer-based, optimal search and match for 
liquidity in securities listed on Nasdaq. \4\
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    \3\ The OptiMark System was developed by OptiMark, Inc. a 
computer technology firm located in Jersey City, New Jersey, based 
on certain patent-pending technology referred to as ``The 
OptiMark\TM\ System.''
    \4\ For a more complete discussion of the operation of the 
Nasdaq Application, see Securities Exchange Act Release No. 41967 
(September 30, 1999), 64 FR 54704 (October 7, 1999) (``OptiMark 
Approval Order'').
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    The Application is available to all Nasdaq market participants and 
is in addition to existing Nasdaq trading systems. Specifically, the 
Nasdaq Application is available to any NASD member who chooses to 
become a User and complies with all applicable rules. A User is a 
subscriber who has entered into an agreement with Nasdaq and OptiMark 
Services, Inc. to access the Application. In addition, a non-member may 
become a User provided it is authorized in advance by one or more NASD 
members who agree to sponsor the non-member. A non-member User or a 
member User that is not self-clearing must establish a relationship 
with a clearing broker that can be deemed a Designated Broker. \5\ 
Orders from sponsored Users are routed, executed, and reported in the 
Designated Broker's name. To allow a sponsored User to enter a Profile 
into the Application, Nasdaq must have on file an agreement signed by a 
Designated Broker stating that the Designated Broker is willing to act 
in this capacity for a particular User. These agreements include any 
applicable credit limits imposed by the Designated Broker on the 
sponsored User. \6\ The Designated Broker is responsible for all of its 
sponsored Users' orders and resulting transactions.
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    \5\ A member user that is not self-clearing is referred to as a 
correspondent User. Correspondent Users and non-member Users are 
collectively referred to as sponsored Users.
    \6\ A User's credit limits, as such limits may be established 
from time to time by a Designated Broker/Clearing Broker, will be 
programmed into the OptiMark System. The Designated Broker will be 
alerted to its potential exposure to its Users, individually or in 
the aggregate, approaches the established credit limits (``Alarm 
Threshold'') or reaches the limit at which the Designated Broker 
will no longer permit a User to submit Profiles (``Trading Limit'').
    \7\ DTCC was formed by the recent combination of The Depository 
Trust Company and the National Securities Clearing Corporation.
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    Transactions that result from matches through the Application will 
be cleared using Nasdaq's post-execution service, the Automated 
Confirmation Transaction Service (``ACT''). Accordingly, final locked-
in trades will be forwarded to The Depository Trust and Clearing 
Corporation (``DTCC'') in the ordinary course, and will clear and 
settle the regular way through DTCC, just as any other transaction 
executed on Nasdaq. \7\ All Users will receive a report of any 
execution resulting from a match of the Profiles submitted by them 
(including Profiles generated from a quote in the Nasdaq Quote Montage) 
as soon as possible after the execution takes place. Users that are not 
self-clearing will have the option of re-allocating for clearing 
purposes all or a portion of any execution to another broker by the end 
of the trading day. If the User has designed a trade as set for end-of-
day release (i.e., has chosen to re-allocate all or a portion of any 
trade or trades for clearing purposes), the Designated Broker generally 
will be notified promptly after the close of the trading day to the 
extent it has been allocated for clearing purposes any transaction 
resulting from a Profile submitted by a User sponsored by that 
Designated Broker.
    It is important to note in the comparison, clearance and settlement 
process, that although the specific identity of the contraparties to a 
particular trade will be temporarily masked until 4:30 p.m. of the 
trade day, the Designated Broker that agreed to sponsor a User in the 
Application is fully responsible for the clearance and settlement of 
that trade. Nasdaq and the operator of the Application are not 
responsible for either the User or a Designated Broker failing to pay 
for or to deliver the securities traded through this facility. Rule 
4994(b) clearly states that responsibility for clearance and settlement 
remains with the Designated Broker. The User and Designated Broker 
Agreements that each party must sign prior to entering a Profile into 
the Application likewise make clear that it is the Designated Broker's 
responsibility to clear and settle the trades, and that the Designated 
Broker must evaluate the ability of Users to settle trades when it 
authorizes a User to submit Profiles under its sponsorship.
b. SEC Approval Order
    On September 30, 1999, the SEC approved the Nasdaq Application as a 
pilot program for six months ending on April 3, 2000.\8\ Nasdaq 
commenced operation of the Application in October 1999 for 10 
securities and has recently expanded the application to include a total 
of 205 securities.\9\ The Commission recently extended the pilot 
program for an additional six month period.\10\ The order initially 
approving the Nasdaq Application includes several trading

[[Page 48773]]

parameters that limit the operation of the facility until Nasdaq 
refines the Application's risk management tools. The Commission, along 
with other market participants, was concerned that some of the ACT risk 
management tools were not available to monitor transactions executed in 
the Application. The trading parameters include the following: (1) a 
limitation on trading to 250 of the most actively traded Nasdaq 
securities; (2) a limitation on cycle frequency to once every five 
minutes; (3) a suspension of trading in the Application for 15 minutes 
if its volume equals or exceeds 12.5% of the average Nasdaq volume in 
the 250 securities; and (4) suspension of trading in the Application 
for the remainder of the trading day if its volume equals or exceeds 
15% of the average Nasdaq volume in the 250 securities.\11\
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    \8\ See OptiMark Approval Order, supra note 4.
    \9\ See Nasdaq Head Trader Alert 2000-38 (May 23, 2000). Nasdaq 
Head Trader Alerts are available at http://www.nasdaqtrader.com/Trader/News/headtraderalerts.
    \10\ See Securities Exchange Act Release No. 42618 (Apr. 4, 
2000); 65 FR 19420 (Apr. 11, 2000).
    \11\ See OptiMark Approval Order, supra note 7.
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c. Proposed Changes
    Nasdaq has developed several modifications to the Application's 
risk management systems to address the SEC's concerns. Accordingly, 
Nasdaq seeks to rescind Rule 4999, which contains the trading 
parameters mentioned above, and seeks approval of the Application on a 
permanent basis without any of the restrictions contained in Rule 4999.
    The first modification enables clearing brokers that are Designated 
Brokers under the Application's rules (``Designated Brokers/Clearing 
Brokers'') to require correspondent and non-member Users to use the 
``immediate release'' instruction on transactions effected through the 
Application. This requirement would be specified in the Designated 
Broker Consent Agreement that each user must execute. The immediate 
release instruction prevents the User from selecting the end-of-day 
option discussed earlier. Therefore, this instruction prevents the User 
from re-allocating a trade from one Designated Broker/Clearing Broker 
to another at the end of the trading day. In this way, Designated 
Brokers/Clearing Brokers will be given the ability to know immediately 
after a trade is done that a sponsored User that the Designated Broker/
Clearing Broker allowed to use the Application has completed a trade 
under the Designated Broker/Clearing Broker's name. To facilitate this 
flow of information to the Designated Broker/Clearing Broker, the 
Application has also been modified to permit a one-sided give-up \12\ 
when immediate release instructions have been specified.
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    \12\ In a one-sided give-up, the identity of the sponsored User 
is immediately disclosed to the Designated Broker/Clearing Broker, 
but their identity is not disclosed to the counterparty to the trade 
until the end of the day.
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    The second modification permits Designated Brokers/Clearing Brokers 
to modify directly through Nasdaq's Act system the Application trading 
limits that they establish for their Users. As originally constructed, 
the Application did not permit a Designated Broker/Clearing Broker to 
adjust a trading limit through ACT's Risk Management system. Instead, 
Designated Brokers/Clearing Brokers were required to send messages 
through the electronic data interface or call the Nasdaq/OptiMark desk 
to change the limits. Nasdaq has developed a new interface between the 
Application and ACT that permits a Designated Broker/Clearing Broker to 
directly query and adjust, through the ACT system, the trading limits 
it establishes in the Application.
2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of section 15A(b)(6)\13\ and section 11A \14\ of the 
Act.
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    \13\ 15 U.S.C. 78o-3(b)(6).
    \14\ 15 U.S.C. 78k-1.
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    Section 15A(b)(6) \15\ requires that the rules of a registered 
national securities association be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principals of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, 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, brokers, or 
dealers.
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    \15\ 15 U.S.C. 78o-3(b)(6).
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    Section 11A(a)(1) \16\ sets forth findings of Congress that new 
data processing and communications techniques create the opportunity 
for more efficient and effective market operations. Section 
11A(a)(1)(C) \17\ states that it is in the public interest and 
appropriate for the protection of investors and the maintenance of fair 
and orderly markets to assure (i) economically efficient execution of 
securities transactions; (ii) fair competition among brokers and 
dealers; (iii) the availability to brokers, dealers, and investors of 
information with respect to quotations for and transactions in 
securities; (iv) the practicability of brokers executing investors' 
orders in the best market; and (v) an opportunity for investors orders 
to be executed without the participation of a dealer.
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    \16\ 15 U.S.C. 78k-1(a)(1).
    \17\ 15 U.S.C. 78k-1(a)(1)(C).
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    The Commission previously recognized that the Nasdaq Application is 
consistent with sections 15A \18\ and 11A \19\ of the Act when it 
approved the pilot program.\20\ The Application was approved as a pilot 
program with the limitations discussed above because the Commission, 
along with other market participants, was concerned that the 
Application did not provide Designated Brokers/Clearing Brokers with 
the same type of risk management tools that were available to these 
firms when transactions were executed outside of the Application. 
Specifically, the commission was concerned that Designated Brokers/
Clearing Brokers did not have the ability to monitor their intra-day 
risk.
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    \18\ 15 U.S.C. 78o-3.
    \19\ 15 U.S.C. 78K-1.
    \20\ See OptiMark Approval Order, supra note 7.
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    The immediate release function provides a Designated Broker/
Clearing Broker with immediate notice that a trade has been executed by 
one of its sponsored Users and prevents Users from re-allocating trades 
to other Designated Brokers/Clearing Brokers at the end of the day. 
Consequently, Designated Brokers/Clearing Brokers are able to monitor 
their Users' positions on an intra-day basis, which provides these 
brokers with the opportunity to manage and mitigate their risk. Nasdaq 
believes this function directly addresses the Commission's concern 
about the Application's risk management tools. In addition, Nasdaq 
believes the immediate release function coupled with the one-sided, 
give-up capability strikes the appropriate balance between a Designated 
Broker/Clearing Broker's need to manage its risk and its sponsored 
User's desire to trade anonymously. In a one-sided, give-up situation, 
the identity of the sponsored User is immediately disclosed to the 
Designated Broker/Clearing Broker, but their identity is not disclosed 
to the counterparty to the trade until the end of the day.
    Furthermore, Designated Brokers/Clearing Brokers will now be able 
to use the ACT system to query or adjust the credit limits they set for 
their sponsored Users. Designated Brokers/Clearing brokers previously 
were required to call the Nasdaq/OptiMark desk or submit instructions 
through an electronic data interface. The ACT system provides 
Designated Brokers/Clearing Brokers with a more efficient mechanism to

[[Page 48774]]

query or change the credit limits they have set.
    Nasdaq expects that the systems change necessary to implement the 
features described above will be in place in the third quarter of 2000. 
Because these changes address the issues raised by the commission in 
its approval order, Nasdaq believes that the trading parameters 
contained in the approval order and reflected in Application rule 4999 
can be eliminated. Further, Nasdaq believes that the Application should 
be permanently approved because the only concerns that were raised 
during the approval process have been addressed.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    The Association has neither solicited nor received written 
comments.

III. Date Of Effectiveness Of The Proposed Rule Change and Timing 
For Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposal is 
consistent with the Act. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 fifth Street, NW., Washington, DC 20549-0609. Copies of 
the submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying in the commission's 
Public Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to the file number SR-NASD-00-37 and should be 
submitted by August 30, 2000.
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    \21\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-20057 Filed 8-8-00; 8:45 am]
BILLING CODE 8010-01-M