[Federal Register Volume 67, Number 72 (Monday, April 15, 2002)]
[Notices]
[Pages 18278-18279]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-8997]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45704; File No. SR-NASD-2001-69]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Amending 
NASD Rule 4720 Relating to the Inclusion of UTP Exchanges in the Nasdaq 
National Market Execution System

April 8, 2002.

I. Introduction

    On October 5, 2001, the National Association of Securities Dealers, 
Inc. (``NASD''), through its subsidiary, the Nasdaq Stock Market, Inc. 
(``Nasdaq''), filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change amending NASD Rule 4720, 
SelectNet Service, relating to the inclusion of exchanges trading 
Nasdaq securities pursuant to unlisted trading privileges (``UTP 
Exchanges'') in the Nasdaq National Market Execution System (``NNMS''). 
On December 19, 2001, the NASD submitted Amendment No. 1 to the 
proposed rule change.\3\ On January 16, 2002, the NASD submitted 
Amendment No. 2 to the proposed rule change.\4\ The proposed rule 
change, as amended, was published for comment in the Federal Register 
on January 28, 2002.\5\ The Commission received two comments on the 
proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Mary M. Dunbar, Vice President, Office of 
General Counsel, Nasdaq, to Katherine England, Assistant Director, 
Division of Market Regulation, SEC, dated December 18, 2001 
(``Amendment No. 1''). In Amendment No. 1, the NASD removed language 
that was subsequently incorporated into a different NASD rule 
change. See Securities Exchange Act Release No. 45057 (November 8, 
2001), 66 FR 57496 (November 15, 2001).
    \4\ See letter from Mary M. Dunbar, Vice President, Office of 
General Counsel, Nasdaq, to Katherine England, Assistant Director, 
Division of Market Regulation, SEC, dated January 16, 2002 
(``Amendment No. 2'').
    \5\ See Securities Exchange Act Release No. 45319 (January 18, 
2002), 67 FR 3923.
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II. Description of the Proposal

    In SR-NASD-2001-69, Nasdaq is proposing to amend NASD Rule 4720 to 
specify that a UTP Exchange will be permitted access to SelectNet on a 
basis similar to that which is offered to NASD members. As a result, 
SelectNet will be available only in connection with participation in 
the NNMS (hereinafter referred to as ``SuperSOES''). Nasdaq believes 
that the rule change will bring UTP Exchanges into parity with Nasdaq 
market makers, as well as reduce the risk of dual liability for both 
Nasdaq market makers and UTP Exchanges participating in SuperSOES. 
Nasdaq believes that the rule would also limit the possibility of 
backing away from quotes by UTP Exchanges and would limit the instances 
of locked/crossed markets among market participants that participate in 
a Nasdaq execution system.
    Nasdaq believes establishing SuperSOES as the primary platform for 
trading Nasdaq-listed securities is a critical step in improving the 
quality of its market. Nasdaq believes that implementation of SuperSOES 
has significantly improved the Nasdaq Stock Market. In particular, 
Nasdaq's initial assessment based on preliminary data shows that 
SuperSOES orders are processed quickly, enjoy high fill rates, and 
execute at the current market price. Moreover, according to Nasdaq, 
SuperSOES has not had a significant negative impact on spreads, depth 
or volatility. In addition, SuperSOES has been voluntarily adopted by 
the Chicago Stock Exchange, Inc. (``CHX'') and the Boston Stock 
Exchange, Inc., which currently represent the vast majority of the 
trading volume in Nasdaq-listed stocks by UTP Exchanges. CHX has 
participated in SuperSOES since it was implemented in July 2001.\6\ As 
SuperSOES becomes a more familiar feature in the Nasdaq market place, 
Nasdaq believes it will benefit Nasdaq market participants and public 
investors by making the operation of Nasdaq more efficient.
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    \6\ In July 2001, the Commission approved a rule change to 
permit UTP Exchanges to participate on a voluntary basis in 
SuperSOES. See Securities Exchange Act Release No. 44526 (July 6, 
2001), 66 FR 36814 (July 13, 2001).
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    According to Nasdaq, permitting UTP Exchanges to participate in 
Nasdaq without automatic execution functionality perpetuates the 
potential for ``dual liability'' that Nasdaq designed SuperSOES to 
eliminate. Nasdaq represents that the potential for dual liability 
exists when market participants, such as UTP Exchanges, send SelectNet 
liability messages to

[[Page 18279]]

Nasdaq market makers that simultaneously receive executions through 
SuperSOES. Additionally, according to Nasdaq, permitting UTP Exchanges 
to access Nasdaq via SelectNet could disrupt and slow the market. To 
improve the trading environment for all of Nasdaq's market 
participants, and to avoid potential market disruptions, Nasdaq is 
proposing to require UTP Exchanges that choose to participate in Nasdaq 
to accept automatic executions through SuperSOES.

III. Summary of Comments

    The Commission received two comment letters on the proposal: One 
from the Knight Trading Group, Inc. (``Knight''),\7\ and one from the 
Philadelphia Stock Exchange, Inc. (``Phlx'').\8\ In Knight's letter, 
Knight expresses general support for Nasdaq's proposal and agrees with 
the reasons set forth by Nasdaq as the basis for the proposed 
amendment.\9\
    In the Phlx letter, the Phlx argues generally that the proposed 
rule change is an anti-competitive attempt to require UTP Exchanges to 
be subject to automatic execution in Nasdaq's NNMS. Phlx contends that 
such participation would have an adverse effect on the attractiveness 
of UTP Exchanges as alternative trading venues for Nasdaq securities.
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    \7\ See letter from Michael T. Dorsey, Senior Vice President, 
General Counsel and Secretary, Knight, to Jonathan G. Katz, 
Secretary, Commission, dated February 21, 2002.
    \8\ See letter from Meyer S. Frucher, Chairman and Chief 
Executive Officer, Phlx, to Jonathan G. Katz, Secretary, Commission, 
dated February 25, 2002.
    \9\ Knight incorporated by reference the comment letters it 
submitted in connection with the following releases: Securities 
Exchange Act Release Nos. 45182 (December 20, 2001), 66 FR 67609 
(December 31, 2001); and 45081 (November 19, 2001), 66 FR 59273 
(November 27, 2001). The Commission notes that the comments 
incorporated by reference were addressed in the approval orders in 
the respective releases.
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    Specifically, the Phlx believes that forcing UTP Exchanges to 
accept automatic executions will make it difficult for UTP Exchanges to 
attract Electronic Communication Networks (``ECNs'') as direct 
participants, impose per share trade execution fees on the UTP 
Exchanges for their orders executed through NNMS, and force the UTP 
Exchanges to relinquish any claim over inter-market trades executed 
through the NNMS (either as indications of the UTP Exchange's liquidity 
or to receive market data revenues).
    The Phlx states that Nasdaq's justifications for the proposed rule 
change are without merit. The Phlx believes that imposing a short time 
window within which Nasdaq market makers would be required to respond 
could solve Nasdaq's dual liability concern. Furthermore, the Phlx 
states that Nasdaq has offered no empirical data to substantiate the 
claim that non-automatic execution participation by UTP Exchanges 
results in deleterious order queuing.
    Finally, the Phlx asserts that requiring UTP Exchanges to 
participate in NNMS will funnel trading activity away from the UTP 
Exchanges, and, thus, remove the opportunity for price improvement, the 
hallmark of an auction market. The Phlx notes that requiring UTP 
Exchange participation in NNMS will expose UTP Exchange specialists to 
the same dual liability that Nasdaq currently seeks to avoid for its 
market makers. The Phlx proposes that an inter-market linkage plan for 
Nasdaq securities be developed, and, until such a plan is developed, 
the Phlx proposes that the status quo be maintained by allowing UTP 
Exchanges access to Nasdaq markets via SelectNet.

IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder,\10\ and, in particular, the requirements of 
Section 15A of the Act \11\ and the rules and regulations thereunder. 
The Commission finds specifically that the proposed rule change is 
consistent with Section 15A(b)(6) of the Act.\12\ Section 15A(b)(6) 
\13\ requires, among other things, that the NASD's rules be designed to 
facilitate 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.
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    \10\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \11\ 15 U.S.C. 78o-3.
    \12\ 15 U.S.C. 78o-3(b)(6).
    \13\ Id.
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    The Commission believes that the proposed rule change is not 
inconsistent with the objectives of this section of the Act. 
Specifically, requiring UTP Exchanges that choose to participate in the 
Nasdaq market also to participate in SuperSOES could help reduce the 
potential for order queuing and for system stoppages within the Nasdaq 
Stock Market, when a UTP Exchange's quote is alone at the best bid or 
best offer.
    Moreover, the Commission notes that Nasdaq is not required to grant 
competitors access to Nasdaq's proprietary systems. To the extent 
Nasdaq chooses to grant access to its proprietary systems, Nasdaq may 
impose reasonable terms and conditions, such as requiring use of 
SuperSOES for access to SelectNet. Nasdaq may not impose terms and 
conditions that place an unfair burden on competition or impose terms 
and conditions that result in unfair discrimination. Finally, UTP 
Exchanges may choose to participate in SuperSOES on a voluntary basis; 
nothing in this rule change would require them to accept automatic 
executions from Nasdaq.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (File No. SR-NASD-2001-69) be, 
and it hereby is, approved.
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    \14\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-8997 Filed 4-12-02; 8:45 am]
BILLING CODE 8010-01-P