[Federal Register Volume 66, Number 228 (Tuesday, November 27, 2001)]
[Notices]
[Pages 59273-59277]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-29458]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45081; File No. S7-24-89]


Joint Industry Plan; Order Granting Approval of Amendment No. 12 
to the Joint Self-Regulatory Organization Plan Governing the 
Collection, Consolidation, and Dissemination of Quotation and 
Transaction Information for Exchange-Listed Nasdaq/National Market 
System Securities and for Nasdaq/National Market System Securities 
Traded on Exchanges on an Unlisted Trading Privileges Basis; Submitted 
by the National Association of Securities Dealers, Inc., the Pacific 
Exchange, Inc. and the Boston, Chicago, Philadelphia, and Cincinnati 
Stock Exchanges

November 19, 2001.

I. Introduction

    On August 29, 2001, the Cincinnati Stock Exchange Inc. (``CSE'') on 
behalf of itself and the National Association of Securities Dealers, 
Inc. (``NASD''), the Boston Stock Exchange, Inc. (``BSE''), the Chicago 
Stock Exchange, Inc. (``Chx''), the Pacific Exchange, Inc. (``PCX''), 
and the Philadelphia Stock

[[Page 59274]]

Exchange, Inc. (``PHLX'') (collectively, ``Participants''),\1\ as 
members of the operating committee (``Operating Committee'')\2\ of the 
Plan submitted to the Securities and Exchange Commission (``SEC'' or 
``Commission'') Amendment No. 12 to the Plan, pursuant to Rule 11Aa3-2 
under the Securities Exchange Act of 1934 (``Act'').\3\ On September 
18, 2001, the Participants submitted an amendment to Amendment No. 
12.\4\ Notice of the proposed 12th Amendment, as amended, was published 
for comment in the Federal Register.\5\ The Commission received four 
comment letters on the proposed Plan Amendment \6\ and a response to 
the comments from the Operating Committee,\7\ as well as a response to 
the issues raised by Knight from the CSE and PCX/Archipelago.\8\ This 
order approves the 12th Amendment to the Plan for nine months through 
August 19, 2002.
---------------------------------------------------------------------------

    \1\ The CSE was elected chair of the Operating Committee for the 
Joint Self-Regulatory Organization Plan Governing the Collection, 
Consolidation, and Dissemination of Quotation and Transaction 
Information for Exchange-Listed Nasdaq/National Market System 
Securities and for Nasdaq/National Market System Securities Traded 
on Exchanges on an Unlisted Trading Privileges Basis (``Plan'') by 
the Participants.
    \2\ The Operating Committee is made up of all the Participants.
    \3\ 17 CFR 240.11Aa3-2.
    \4\ See letter from Jeffrey T. Brown, Committee Chairman, CSE, 
to Jonathan G. Katz, Secretary, SEC, dated August 29, 2001.
    \5\ Securities Exchange Act Release No. 44822 (September 20, 
2001), 66 FR 50226 (October 2, 2001).
    \6\ See letters to Jonathan G. Katz, Secretary, SEC, from Jon 
Kroeper, Vice President, Regulatory Policy/Strategy, Instinet, dated 
October 25, 2001 (``Instinet''); Cameron Smith, General Counsel, 
Island, dated October 26, 2001 (``Island''); Michael T. Dorsey, 
Senior Vice President, General Counsel, and Secretary, Knight 
Trading Group, dated November 1, 2001 (``Knight''); and Michael J. 
Ryan, Jr., Executive Vice President and General Counsel, American 
Stock Exchange (``Amex''), dated November 14, 2001.
    \7\ See letter from Jeffrey T. Brown, Chairman, Operating 
Committee, to Jonathan G. Katz, Secretary, SEC, dated November 14, 
2001.
    \8\ See letter from Jeffrey T. Brown, CSE and James P. Selway, 
PCX/Arca to Jonathan G. Katz, Secretary, SEC, dated November 14, 
2001 (``CSE/Arca letter'').
---------------------------------------------------------------------------

    Extension of Unlisted Trading Privileges (``UTP'') In addtion, the 
PCX requested that the Commission extend UTP to all Nasdaq National 
Market securities (``Nasdaq/NM securities'')\9\ and to Nasdaq SmallCap 
securities (``SmallCap securities'').\10\ The Commission solicited 
comment on the request to extend UTP to Nasdaq/NM securities \11\ and 
received four comment letters.\12\ In connection with the publication 
of the 12th Amendment, the Commission solicited comment on extending 
UTP to SmallCap securities.
---------------------------------------------------------------------------

    \9\ See letter from Thomas E. Connaghan, Senior Vice President, 
Equities, PCX, to Messrs. Robert L.D. Colby, Deputy Director, 
Division of Market Regulation, SEC and Robert E. Aber, Senior Vice 
President and General Counsel, The Nasdaq Stock Market, Inc., dated 
October 16, 2000.
    \10\ See letter from Mr. Connaghan to Messrs. Colby and Aber, 
dated November 20, 2000.
    \11\ See Securities Exchange Act Release No. 43545 (November 9, 
2000), 65 FR 69581 (November 17, 2000).
    \12\ See letters from Roger Phillips to Mr. Colby, undated 
(``Phillips''); Steven E. Kamensky, Security Traders, Inc. to 
Secretary, SEC, dated December 4, 2000 (``Kamensky''); Richard G. 
Ketchum, President, The Nasdaq Stock Market, Inc., to Jonathan G. 
Katz, Secretary, SEC, dated December 5, 2000 (``Nasdaq''); and 
Michael T. Dorsey, Senior Vice President and General Counsel, and 
Knight Trading Group to Jonathan G. Katz, Secretary, SEC, dated 
December 13, 2000 (``Knight letter'').
---------------------------------------------------------------------------

II. Background

    The Plan governs the collection, consolidation, and dissemination 
of quotation and transaction information for Nasdaq/NM securities 
listed on an exchange or traded on and exchange pursuant to UTP.\13\ 
The Plan provides for the collection from Participants, and the 
consolidation and dissemination to vendors, subscribers and others, of 
quotation and transaction information in ``eligible securities.'' \14\ 
The Plan also contains various provisions concerning its operation and 
sets out the responsibilities of the Participants with respect to each 
other and the Plan Processor.
---------------------------------------------------------------------------

    \13\ Section 12 of the Act generally requires an exchange to 
trade only those securities that the exchange lists, except that 
Section 12(f) of the Act permits UTP under certain circumstances. 
For example, Section 12(f) of the Act, among other things, permits 
exchanges to trade certain securities that are traded over-the-
counter (``OTC/UTP''), but only pursuant to a Commission order or 
rule. 15 U.S.C. 78l(f). For a more complete discussion of the 
Section 12(f) requirement, see November 1995 Extension Order, infra 
note 16.
    \14\ Currently, the Plan defines ``eligible securities'' as any 
Nasdaq/NM security as to which UTP have been granted to a national 
securities exchange pursuant to Section 12(f) of the Act or that is 
listed on a national securities exchange. The Participants propose 
to amend the definition of ``eligible security'' in this amendment 
to include SmallCap securities.
---------------------------------------------------------------------------

    The Commission approved the Plan on a pilot basis on June 26, 
1990.\15\ The parties did not begin trading until July 12, 1993, 
accordingly, the pilot period commenced on July 12, 1993. The Plan has 
since been in operation on a pilot basis.\16\
---------------------------------------------------------------------------

    \15\ See Securities Exchange Act Release No. 28146, 55 FR 27917 
(July 6, 1990) (``1990 Plan Approval Order'').
    \16\ See Securities Exchange Act Release Nos 34371 (July 13, 
1994), 59 FR 37103 (July 20, 1994); 35221 (January 11, 1995), 60 FR 
3886 (January 19, 1995); 36102 (August 14, 1995), 60 FR 43626 
(August 22, 1995); 36226 (September 13, 1995), 60 FR 49029 
(September 21, 1995); 36368 (October 13, 1995), 60 FR 54091 (October 
19, 1995); 36481 (November 13, 1995), 60 FR 58119 (November 24, 
1995) (``November 1995 Extension Order''); 36589 (December 13, 
1995), 60 FR 65696 (December 20, 1995); 36650 (December 28, 1995), 
61 FR 358 (January 4, 1996); 36934 (March 6, 1996), 61 FR 10408 
(March 13, 1996); 36985 (March 18, 1996), 61 FR 12122 (March 25, 
1996); 37689 (September 16, 1996), 61 FR 50058 (September 24, 1996); 
37772 (October 1, 1996), 61 FR 52980 (October 9, 1996); 38457 (March 
31, 1997), 62 FR 16880 (April 8, 1997); 38794 (June 30, 1997) 62 FR 
36586 (July 8, 1997); 39505 (December 31, 1997) 63 FR 1515 (January 
9, 1998); 40151 (July 1, 1998) 63 FR 36979 (July 8, 1998); 40896 
(December 31, 1998), 64 FR 1834 (January 12, 1999); 41392 (May 12, 
1999), 64 FR 27839 (May 21, 1999) (``May 1999 Approval Order''); 
42268 (December 23, 1999), 65 FR 1202 (January 6, 2000); 43005 (June 
30, 2000), 65 FR 42411 (July 10, 2000); 44099 (March 23, 2001), 66 
FR 17457 (March 30, 2001); and 44348 (May 24, 2001), 66 FR 29610 
(May 31, 2001); 44552 (July 13, 2001), 66 FR 37712 (July 19, 2001); 
44694 (August 14, 2001), 66 FR 43598 (August 20, 2001); 44804 
(September 17, 2001), 66 FR 48299 (September 19, 2001); 44937 
(October 15, 2001), 66 FR 53271 (October 19, 2001).
---------------------------------------------------------------------------

III. Description of the Amendment

    The complete text of the Plan, as amended, was published in the 
Federal Register.\17\ The following is a summary of the significant 
changes made by the 12th Amendment.
---------------------------------------------------------------------------

    \17\ See note 5 supra.
---------------------------------------------------------------------------

    First, the name of the Plan has been changed. Second, the BSE and 
the Amex were added as Participants \18\ and references in the Plan to 
the status of a Limited Participant \19\ have been eliminated. Third, 
the definition of ``eligible security'' has been amended to include 
Small Cap securities.\20\ Fourth, the Participants established the 
voting and quorum requirements for Committee meetings and the manner in 
which formal actions may be taken on behalf of the committee. Fifth, a 
process for selecting a new Securities information Processor (``SIP'' 
or ``Processor'') for the Plan was established.\21\
---------------------------------------------------------------------------

    \18\ This change was effective on filing. See note 5 supra.
    \19\ Section III had defined a Limited Participant to mean a 
registered national securities exchange whose participation in the 
Plan was restricted to reporting to the processor quotation 
information and transaction reports in Nasdaq/NM securities listed 
on that exchange. The only Limited Participant was the BSE.
    \20\ See NASD Rule 4200 for the definition of SmallCap security.
    \21\ The Committee included this section of the Plan pursuant to 
the discussion in the order approving the proposed rule change by 
the NASD relating to the establishment of the Nasdaq Order Display 
Facility and Order Collector Facility and modifications of the 
Nasdaq Trading Platform (``SuperMontage Order''). See Securities 
Exchange Act Release No. 43863 (January 19, 2001), 66 FR 8020 
(January 26, 2001). In the SuperMontage Order, the Commission 
directed the Participants to negotiate a revised Plan to, among 
other things, provide for either a fully viable alternative 
exclusive SIP for all Nasdaq securities, or a fully viable 
alternative non-exclusive SIP.
---------------------------------------------------------------------------

    Sixth, the section of the Plan that discusses the functions of the 
Processor (Section VI) was amended to clarify the priority rules. 
Specifically, if an

[[Page 59275]]

exchange participant or Nasdaq market participant changes its bid and/
or offer, it will be treated as a new quote for purposes of time 
priority. However, a change to only bid size and/or ask size will not 
change the time priority of the quote. Section VI also addresses how 
Participant quotes will be carried over from one trading day to the 
next, including the use of previous day's quotes in the calculation of 
the consolidated best bid and best offer (``BBO'').
    Seventh, Section VI.C.1. specifies procedures for the Processor to 
follow when the BBO results in a locked or crossed market and states 
that the Processor shall normally cease calculation of the BBO at 6:30 
p.m. Eastern Time (``ET''). It also contains a ``phase-in'' schedule 
for the addition of Nasdaq securities that will be eligible for trading 
pursuant to UTP by the Participants if the Commission extends UTP to 
all Nasdaq/NM securities and SmallCap securities. The Participants 
proposed the phase-in to minimize the threat to available Processor 
capacity that may arise as Participants trade additional Eligible 
Securities pursuant to UTP. The Committee believes that the phase-in 
period will allow the Processor to monitor the effects, if any, that 
the increased quote traffic and trading have upon Processor capacity. 
The phase-in schedule does not apply to Nasdaq, Nasdaq market 
participants acting in their capacity as Nasdaq market participants, or 
to any Participant that does not engage in auto-quoting.\22\
---------------------------------------------------------------------------

    \22\ See Section VI.C.2(a)(v) and Section VI.C.2(b).
---------------------------------------------------------------------------

    Eighth, the 12th Amendment limits the practice of auto-quoting if 
the Processor has made a determination that it is necessary to maintain 
adequate capacity and provides 30 days notice to Participants. If a 
Participant thereafter exceeds the auto-quoting limitations, the 
Processor may initiate proceedings, before the entire Committee, that 
will put the Participant on notice of the violation and afford ample 
time and procedures to rectify the situation.\23\ The auto-quoting 
limitation ends once the Operating Committee selects a new Processor. 
The auto-quoting limitation includes a ``grandfather clause'' exempting 
a Participant from the auto-quoting limitations and the phase-in 
schedule for the number of securities that the Participant quoted, 
pursuant to the Plan, as of May 1, 2001.\24\
---------------------------------------------------------------------------

    \23\ The Participants proposed a notice and cure period in which 
a Participant may rectify the situation on its own accord, as well 
as providing for formal proceedings to be held before the Committee 
before any remedial action may be taken against a violating 
Participant. See Section VI.C.2(e).
    \24\ See Section VI.C.2(f).
---------------------------------------------------------------------------

    Ninth, the section on Operational Issues establishes Participant 
responsibilities with respect to the collection, validation, and 
transmission of data to the Processor. It also establishes operational 
procedures that the Processor must follow in collection data from 
Participants, such as performing gross validation processing for quotes 
and last sale messages and consolidating and disseminating trade and 
quote information from each Participant.
    Finally, the 12th Amendment to the Plan amends Exhibit 1 to the 
Plan to eliminate the ``minimum-maximum'' payment formula and replace 
it with a formula for determining Participants' total trades, total 
share volume, operating expenses, and operating income for the purposes 
of distribution of gross operating revenue to the Participants, as well 
as a provision for reimbursing the Processor in the event that 
operating expenses exceed operating revenues.\25\
---------------------------------------------------------------------------

    \25\ The Commission put Exhibit 1 into effect summarily on 
October 2, 2001 on a temporary basis not to exceed 120 days. See 
note 5 supra.
---------------------------------------------------------------------------

    In addition, Exhibit 1 includes criteria and schedules for 
determining Participant eligibility for receiving distributions of 
gross operating revenue. Exhibit 1 also establishes procedures and cost 
allocations for retaining an independent auditor for the purpose of 
auditing the Processor's costs or other calculations used in the 
determination of operating expenses, operating revenues, and 
distribution shares, among other calculations.\26\
---------------------------------------------------------------------------

    \26\ The 12th Amendment also contains numerous ``house-keeping'' 
corrections, such as changing the term ``NASDAQ'' to ``Nasdaq,'' 
officially removing the Chicago Board Options Exchange, and ensuring 
that references to amended sections are consistent with the 
amendments discussed above.
---------------------------------------------------------------------------

    Thus, the Plan, as amended, will govern the collection, 
consolidation, and dissemination of quotation information and 
transaction reports in Nasdaq/NM securities and SmallCap securities.

IV. Summary of Comments

    The Commission received four comment letters on Amendment No. 
12.\27\ Instinet raised several concerns about the Amendment. First, 
Instinet believes Amendment No. 12 does not fulfill the conditions the 
Commission set forth with respect to the Plan in the SuperMontage 
Order. Specifically, Amendment No. 12 does not provide a timeframe 
within which a new processor will be selected and does not require that 
Nasdaq step down as the processor. Second, Instinet notes that 
Amendment No. 12 does not provide for participation in decision-making 
by non-self-regulatory organizations. Instinet believes that this will 
inhibit its ability to compete. Instinet also assert that Section 11A 
of the Act requires the Commission to provide automated trading systems 
(``ATSs'') with the opportunity to directly participate in the Plan. 
Third, Instinet objects to the provision in the Plan that prohibits 
ECNs and ATSs in their role as Nasdaq market participants from imposing 
any access or execution fee or charge with respect to transactions with 
Participants and their members effected through the telephone. Instinet 
believes this provision is not consistent with the Act. Instinet also 
objects to a provision in Section IX of the Plan that states that an 
exchange Participant may charge for access, other than telephone 
access, to its floor or facilities. Fourth, Instinet argues that the 
provision in Section IX regarding what constitutes access is not 
clear.\28\ Finally, Instinet favors extension of UTP to all Nasdaq/NM 
securities and SmallCap securities.
---------------------------------------------------------------------------

    \27\ See note 6 supra.
    \28\ See Instinet at p. 8.
---------------------------------------------------------------------------

    Island objects to the methodology and formula used to calculate 
costs submitted by Nasdaq in operating the Processor. Island also 
objects to some of the costs of the Processor that are subtracted from 
gross revenue before disbursements are made to the Participants. With 
respect to the Commission's request for comment on extending UTP to all 
Nasdaq/NM as well as SmallCap securities, Island urges the Commission 
to expand the number of securities that can be traded from 1,000 
Nasdaq/NM securities to all Nasdaq/NM securities and also to expand UTP 
to SmallCap securities.
    Knight objects to the concept of exchanges trading over-the-counter 
(``OTC'') securities because Knight believes that the rules that 
exchange members must comply with are not as demanding as the NASD's 
rules and therefore, the playing field is not level between exchanges 
and Nasdaq market makers trading the same securities. Knight 
specifically claims that exchanges do not have to comply with the 
NASD's firm quote rule.\29\ Knight also raises concerns about the 
NASD's Trade or Move rule \30\ and asserts that the Commission should 
not approve the 12th Amendment until either exchange participants are 
subject to the NASD's rules or they adopt comparable rules. Knight also 
argues that the Commission should not extend UTP to additional 
securities until the Commission has had

[[Page 59276]]

a chance to review the impact of trading in a decimals environment on 
Nasdaq/NM and SmallCap securities.
---------------------------------------------------------------------------

    \29\ NASD Rule 4613(b)(1).
    \30\ NASD Rule 4613(b)(2).
---------------------------------------------------------------------------

    Knight also raises concern that, under the 12th Amendment, UTP 
exchanges will be able to charge non-members access fees for 
interacting with their quotes that are included in the NASD'S montage. 
Finally, Knight believes that the Commission should not grant an 
extension of the exemption from Rule 11Ac1-2 under the Act \31\ 
regarding calculation of the BBO. Knight opposes continuation of the 
exemption from calculating the BBO based on price, size, time priority. 
Currently, Nasdaq uses price, time, size to calculate the BBO. 
According to Knight, using the calculation required by Rule 11Ac1-2 
under the Act \32\ will encourage depth in the market.
---------------------------------------------------------------------------

    \31\ 17 CFR 240.11Ac1-2.
    \32\ Id.
---------------------------------------------------------------------------

    Amex's main concern is with the ability of the Processor to 
determine that there is a capacity concern. Once the Processor makes 
this determination, the autoquoting restrictions are activated. Some 
Participants are grandfathered out of the limitaiton on autoquoting. 
Amex believes that these provisions are unfair and anticompetitive. 
Because Amex was not yet a Participant, it did not vote on the 12th 
Amendment.
    In addition, the Commission received four comment letters in 
response to its request for comments regarding raising the number of 
Nasdaq/NM securities that can be traded pursuant to UTP consistent with 
Section 12(f) of the Act.\33\ Two of the commenters (Phillips and 
Kamensky) supported extension of the UTP to all Nasdaq/NM securities. 
They both stated that extending UTP would add liquidity to the market 
for these securities and enhance competition. Kamensky stated that the 
earlier increases in the number of Nasdaq/NM securities that could be 
traded pursuant to UTP had increased the liquidity of the markets for 
these securities and enhanced competition. A third commenter, Knight, 
objected to the extension of the UTP to all Nasdaq/NM securities 
because of the level playing field argument raised in its comment on 
the 12th Amendment. Knight also stated that PCX had not demonstrated 
how the expansion of the number of securities that could be traded 
pursuant to UTP would help maintain fair and orderly markets and 
further the National Market System (``NMS'') goals. According to 
Knight, problems appeared in the market for Nasdaq/NM securities after 
the Commission raised the number of securities that could be traded 
pursuant to UTP from 500 to 1,000 in 1999.
---------------------------------------------------------------------------

    \33\ 15 U.S.C. 78l(f). See note 12, supra. See also Instinet at 
4.
---------------------------------------------------------------------------

    Nasdaq stated that it did not object to the Commission raising the 
number of Nasdaq/NM securities that could be traded pursuant to UTP; 
however, it raised concerns about the capacity of the Nasdaq SIP to 
handle quote and trade reporting of all Nasdaq/NM securities given the 
potential new entrants to the Plan and the advent of decimal trading. 
Nasdaq also stated that the Commission should wait until Nasdaq and 
other interested market participants had resolved the issue of the 
exclusive SIP before granting PCX's request.

V. Discussion

    The Commission has determined to approve the 12th Amendment, 
including Exhibit 1 to the Plan, on a pilot basis until August 19, 
2001, to grant UTP to the Participants to trade all Nasdaq/NM 
securities as well as Small Cap securities pursuant to Section 12(f) of 
the Act,\34\ and to continue the exemption from Rule 11Ac1-2 \35\ 
regarding the calculation of the BBO.\36\
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 781(f).
    \35\ 17 CFR 250.11Ac1-2.
    \36\ With this order, SmallCap securities will now be securities 
reported pursuant to a transaction reporting plan approved by the 
Commission. Accordingly, SmallCap securities will now be subject to 
all Commission rules that cover securities reported pursuant to a 
Commission approved transaction reporting plan.
---------------------------------------------------------------------------

    The Commission notes that the 12th Amendment to the Plan has been 
vigorously debated by the Participants and represents the result of 
good faith negotiations among the Participants. The Plan, as amended, 
is regarded by the Participants and the Commission as an interim plan. 
The Participants are currently negotiating a further amendment to the 
Plan to address the remaining outstanding items outlined in the 
Commission's SuperMontage order. In particular, the Commission notes 
that the Participants approved a proposed request for proposal 
(``RFP'') to select a new SIP. The Commission understand that the RFP 
has been issued. The Commission therefore believes that the 
Participants will continue to make progress in amending the Plan and 
responding to the concerns that the Commission noted in the 
SuperMontage Order.
    Instinet argued that Section 11A of the Act requires the 
participation of ATSs in the Plan, and noted that the 12th Amendment 
does not contain provisions to permit the participation of non-self-
regulatory organizations. As the Commission stated in the SuperMontage 
Order, the Commission believes that ATSs and ECNs should be given a 
role in the governance of the Plan; however, the Commission does not 
believe that Section 11A requires that the role of ECNs and ATSs be the 
same as the role of the SROs. While at this time the Plan does not 
contain a specific provision for receiving input from non-participants, 
the Commission notes that a number of ECNs have been represented at 
meeting of the Operating Committee over the past year, and the 
Commission expects that the Participants will address this issue in the 
next amendment to the Plan.\37\
---------------------------------------------------------------------------

    \37\ The Commission notes that the Participants are working on 
an amendment to add the NASD as a new Participant once Nasdaq's 
exchange registration is approved. Nasdaq will continue as a 
Participant.
---------------------------------------------------------------------------

    Instinet also raised objections to Section IX of the Plan that 
prohibits Participants from charging any access or execution fee with 
respect to transactions with Participants and their members effected by 
telephone. The Commission notes that the Plan sets forth the terms of 
free telephone access to quotes of all market participants, including 
the ECNs, market makers, and specialists. The Commission therefore 
believes that the Plan establishes consistent standards for access to 
quotes displayed on any Participant by the members of other 
Participants.\38\ Instinet also objects to a specific provision in 
Section IX of the Plan that permits exchange participants to charge for 
access, other than telephone access. Instinet believes that the Plan 
should jump NASD participant to charge for such access. As the Plan is 
silent on this matter, the Commission believes that, this provision is 
not meant to change the way that ECNs current operate.
---------------------------------------------------------------------------

    \38\ The Commission notes that, since its inception, the Plan 
approved by the Commission prohibited fees for telephone access to 
market makers. See also 17 CFR 242.301(b)(4).
---------------------------------------------------------------------------

    Island objected to the methodology and formula used to calculate 
the costs of the Processor. In general, Island believes that some of 
the costs included are more properly associated with the costs of 
operating the Nasdaq market as opposed to the costs of operating the 
SIP. However, the Participants unanimously agreed to the cost for which 
the Processor will be reimbursed. Moreover, the Commission believes 
that the ambiguities related to the dual roles of Nasdaq supporting 
both the Process and the Nasdaq market will be resolved by the next 
amendment to the Plan and the selection of a new Processor.
    Knight objects to exchanges being able to trade Nasdaq securities 
without either being subject to the NASD's rules or having comparable 
rules. The

[[Page 59277]]

Commission notes that all exchange participants, as well as the NASD's 
market participants, are subject to the Commission's Firm Quote 
Rule.\39\ All exchange participants must comply with the Firm Quote 
Rule unless the exchange participant qualifies for one of the two 
exceptions in the Rule. In addition, Knight is concerned about not 
being able to open the market or trade because of a locking or crossing 
quote. The Commission notes that it recently approved an NASD proposal 
on a temporary basis, which provides, among other things, that 
SuperSOES may trade-through the superior quote of a UTP exchange that 
does not participate voluntarily in SuperSOES.\40\ The Commission 
believes that this rule deals with the substance of Knight's objection.
---------------------------------------------------------------------------

    \39\ 17 CFR 240.11Ac1-1.
    \40\ See Securities Exchange Act Release No. 45047 (November 8, 
2001).
---------------------------------------------------------------------------

    Knight also raises concerns about the effects of decimal trading 
with minimum price increments on trading in the Nasdaq market and 
cautions the Commission not to approve the 12th Amendment or extent UTP 
until the Commission has reviewed the implications of decimalization. 
While the Commission is aware that decimalization has had a significant 
effect on the markets for securities, the Commission is not aware of 
any particular effect specific to UTP trading of Nasdaq/NM securities. 
The Commission will continue to monitor the impact of decimal trading 
on the securities markets. Knight also objects to the Commission 
extending the temporary exemption from Rule 11Ac1-2 \41\ regarding the 
BBO calculation. Since the inception of this Plan, Nasdaq has 
calculated the BBO based on price, time, size priority. The 
Participants are currently discussing a change to the calculation to 
make it consistent with the requirement in Rule 11AC1-2. The Commission 
expects the issue to be resolved in connection with the next amendment 
to the Plan.
---------------------------------------------------------------------------

    \41\ 17 CFR 240.11Ac1-2.
---------------------------------------------------------------------------

    Finally, while the Commission understands Amex's concern with 
respect to the Processor (which is both an exclusive SIP and a 
competitor of the Amex's) making determinations regarding capacity, as 
an exclusive SIP, the Processor is subject to the provisions of Section 
11A of the Act. Furthermore, the auto-quoting restrictions and the 
grandfather clause do not come into play until the Processor determines 
that there is a capacity concern. If the Processor determines that a 
capacity concern exists, it must provide Participants with 30 calendar 
days notice and the basis for the determination. After 30 days, the 
Processor can invoke the auto-quoting limitation. The Commission 
believes that the Plan contains adequate procedural safeguards 
surrounding the Processor's determination that a capacity concern 
exists. The Commission expects the Participants to move quickly to 
select a processor, consistent with the discussion in the SuperMontage 
Order.

Extension of UTP

    Knight objected to the extension of UTP for two reasons. First, it 
stated that PCX had not made a case that extending UTP to all Nasdaq/NM 
securities would further the goals of NMS. The Commission notes that 
since 1993 there has been UTP trading of Nasdaq/NM securities and the 
Commission is not aware of any negative effects from having extending 
UTP to Nasdaq/NM securities. Indeed, two of the commenters stated that 
UTP for Nasdaq/NM securities had had a positive effect on the liquidity 
in the market and had provided additional competition. Second, Knight 
raised the issue that UTP exchanges do not have to comply with NASD 
rules. This argument is addressed above.
    Nasdaq, the only other commenter to voice concerns, raised concerns 
about capacity of the SIP and the effects of the implementation of 
trading in decimals on Nasdaq/NM securities. It urged the Commission 
not to extend trading to all Nasdaq/NM securities until these issues 
had been addressed. Nasdaq also wanted the Commission to wait until a 
new SIP was in place. The Commission believes that the Participants to 
the Plan, including Nasdaq itself, addressed these concerns adequately 
in the 12th Amendment.

VI. Commission Findings and Conclusion

Plan Amendment

    For the reasons discussed above, the Commission finds that the 12th 
Amendment, including Exhibit 1, to the Plan is consistent with the 
requirements of the Act and the rules and regulations thereunder and, 
in particular, Section 11A(a)(1) and Rules 11Aa3-1 and 11Aa3-2. The 
Commission finds that the 12th Amendment to the Plan is necessary and 
appropriate in the public interest, for the protection of investors and 
the maintenance of fair and orderly markets, to remove impediments, to, 
and perfect the mechanisms of, a national market system.

Extension of UTP

    The Commission finds that extending UTP to all Nasdaq/NM securities 
and SmallCap securities is consistent with Section 12(f) of the Act. 
Specifically, extending UTP to these securities is consistent with the 
maintenance of fair and orderly markets, the protection of investors 
and the public interest, and otherwise in furtherance of the purposes 
of the Act. The Commission has taken into account the public trading 
activity in these securities, the character of the trading, the impact 
of the extension on existing markets for the securities, and the 
desirability of removing impediments to, and the progress that has been 
made toward, the development of a national market system.

Exemptive Relief

    For the reasons discussed above, the Commission has determined to 
grant an exemption for Nasdaq/NM and SmallCap securities from the 
requirement in Rule 11Ac1-2 under the Act regarding calculation of the 
BBO. The Commission has determined that granting exemptive relief for 
the duration of the 12th Amendment is consistent with the public 
interest and the protection of investors. The Commission notes that the 
Participants have undertaken to address this issue in the next 
amendment to the Plan and the Commission urges that Participants to act 
quickly to implement the amendment.
    It is therefore ordered, pursuant to Section 11A of the Act and 
paragraph (c)(2) of Rule 11Aa3-2, thereunder, that the 12th Amendment 
to the Plan described above be, and hereby is, approved on a pilot 
basis until August 19, 2002. Further, the Commission hereby extends UTP 
pursuant to Section 12(f) of the Act to all Nasdaq/NM securities and 
SmallCap securities. Finally, the Commission hereby grants a temporary 
exemption from the requirement in Rule 11Ac1-2 that the BBO be 
calculated based on price, size, time priority for the duration of the 
12th Amendment.
---------------------------------------------------------------------------

    \42\ 17 CFR 200.30-3(a)(27); 17 CFR 200.30-3(a)(2); 17 CFR 
200.30-3(a)(36).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\42\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-29458 Filed 11-26-01; 8:45 am]
BILLING CODE 8010-01-M