[Federal Register Volume 67, Number 219 (Wednesday, November 13, 2002)]
[Notices]
[Pages 68895-68898]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-28746]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46774; File No. SR-NQLX-2002-2]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by Nasdaq Liffe Markets, LLC 
Relating to Listing Standards for Security Futures Products

November 5, 2002.
    Pursuant to section 19(b)(7) of the Securities Exchange Act of 1934 
(``Act''),\1\ and rule 19b-7 under the Act,\2\ notice is hereby given 
that on October 30, 2002, Nasdaq Liffe Markets, LLC (``NQLX'') filed 
with the Securities and Exchange Commission (``SEC'' or ``Commission'') 
the proposed rule change described in items I and II below, which items 
have been prepared by NQLX. The Commission is publishing this notice to 
solicit comments on the proposed rule changes from interested persons. 
NQLX also has filed the proposed rule change with the Commodity Futures 
Trading Commission (``CFTC''), together with a written certification 
under section 5c(c) of the Commodity Exchange Act \3\ (``CEA'') on 
October 30, 2002.
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    \1\ 15 U.S.C. 78s(b)(7).
    \2\ 17 CFR 240.19b-7.
    \3\ 7 U.S.C. 7a-2(c).
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I. Self-Regulatory Organization's Description of the Proposed Rules

    NQLX is proposing to adopt rules on listing standards for security 
futures contracts to comply with the requirements under section 6(h)(3) 
of

[[Page 68896]]

the Act \4\ and the criteria under section 2(a)(1)(D)(i) of the CEA,\5\ 
as modified by joint orders of the Commission and the CFTC.\6\
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    \4\ 15 U.S.C. 78f(h)(3).
    \5\ 7 U.S.C. 2(a)(1)(D)(i).
    \6\ See Joint Order Granting the Modification of Listing 
Standards Requirements (American Depository Receipts), Securities 
Exchange Act release no. 44725 (August 20, 2001) and Joint Order 
Granting the Modification of Listing Standards Requirements 
(Exchange Traded Funds, Trust Issued Receipts and shares of Closed-
End Funds), Securities Exchange Act release no. 46090 (June 19, 
2002), 67 FR 42760 (June 25, 2002).
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rules

    NQLX has prepared statements concerning the purpose of, and 
statutory basis for, the proposed rules, burdens on competition, and 
comments received from members, participants, and others. The text of 
these statements may be examined at the places specified in item IV 
below. These statements are set forth in sections A, B, and C below.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rules

1. Purpose
    The Commodity Futures Modernization Act of 2000 \7\ (``CFMA'') 
lifted the ban on trading futures on single stocks as well as narrow-
based stock indices (``security futures''). As part of this new 
regulatory framework, the CFMA amended the Act and the CEA by 
establishing the criteria and requirements for listing standards 
regarding the category of securities on which security futures can be 
based. NQLX has adopted these proposed rules on listing standards to 
comply with the requirements under section 6(h)(3) of the Act and the 
criteria under section 2(a)(1)(D)(i) of the CEA,\8\ as modified by 
joint orders of the Commission and the CFTC.
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    \7\ Pub. L. 106-554, 114 stat. 2763 (2000).
    \8\ 15 U.S.C. 78f(h)(3); 7 U.S.C. 2(a)(1)(D)(i).
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    NQLX is a board of trade, as that term is defined by the CEA,\9\ 
and has been designated as a contract market by the CFTC and its 
designation has not been suspended by order of the CFTC.\10\ On August 
26, 2002, NQLX registered with the SEC as a national securities 
exchange solely for the purposes of trading security futures.\11\ NQLX 
meets each of the requirements for listing standards and conditions for 
trading security futures.\12\ Specifically:
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    \9\ 7 U.S.C. 1a(2).
    \10\ See In the Matter of the Application of Nasdaq Liffe 
Markets, LLC for Designation as a Contract Market, CFTC Final Order 
of Designation (May 24, 2002); see also In the Matter of the 
Application of Nasdaq Liffe, LLC Futures Exchange for Designation as 
a Contract Market, CFTC Order of Conditional Designation (August 21, 
2001).
    \11\ 15 U.S.C. 78f(g)(1).
    \12\ 15 U.S.C. 78f(h)(2) and (3).
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    (1) Except as otherwise provided in a rule, regulation, or order 
issued jointly by the SEC and CFTC, NQLX's proposed rules 902(b)(2) and 
902(d)(2), which are part of this filing, require that any security 
underlying an NQLX security future (including each component security 
for a narrow-based security index) must be registered pursuant to 
section 12 of the Act.\13\
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    \13\ 15 U.S.C. 78f(h)(3)(A); see also 15 U.S.C. 78l.
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    (2) For any security futures listed by NQLX that are not cash-
settled, NQLX has arranged with the Options Clearing Corporation (which 
is a clearing agency registered pursuant to section 17A \14\ of the 
Act) for the payment and delivery of the security or securities 
underlying the security futures listed on NQLX.\15\
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    \14\ 15 U.S.C. 78qA.
    \15\ 15 U.S.C. 78f(h)(3)(B).
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    (3) NQLX believes that its proposed rules 902 and 903, which are 
listing standards for physically-settled security futures and are part 
of this filing, are no less restrictive than comparable listing 
standards for options traded on a national securities exchange or 
national securities association.\16\
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    \16\ 15 U.S.C. 78f(h)(3)(C).
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    (4) Except as otherwise provided in a rule, regulation, or order 
issued jointly by the SEC and CFTC, NQLX's proposed rule 902(b)(1), 
which is a part of this filing, requires that the security future be 
based upon a common stock or other equity securities as the SEC and 
CFTC jointly determine appropriate, which currently include American 
Depositary Receipts, shares of exchange-traded funds, trust-issued 
receipts, and shares of closed-end funds.\17\
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    \17\ 15 U.S.C. 78f(h)(3)(D); see Joint Order Granting the 
Modification of Listing Standards Requirements (American Depository 
Receipts), Securities Exchange Act release no. 44725 (August 20, 
2001) and Joint Order Granting the Modification of Listing Standards 
Requirements (Exchange Traded Funds, Trust Issued Receipts and 
Closed-End Funds), Securities Exchange Act release no. 46090 (June 
19, 2002), 67 FR 42760 (June 25, 2002).
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    (5) NQLX, through its clearing and settlement relationship with the 
Options Clearing Corporation, will have in place--within 165 days after 
the SEC and CFTC jointly publish in the Federal Register a compliance 
date--provisions for linked and coordinated clearing with other 
clearing agencies that clear security futures, which will permit 
security futures to be purchased on one market and offset on another 
market that trades the same product.\18\
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    \18\ 15 U.S.C. 78f(h)(3)(E).
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    (6) NQLX's proposed rule 328, which is part of this filing, only 
allows a broker-dealer subject to suitability rules comparable to those 
of a national securities association registered pursuant to section 
15A(a) \19\ of the Act to effect transactions in NQLX security 
futures.\20\
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    \19\ 15 U.S.C. 78oA(a).
    \20\ 15 U.S.C. 78f(h)(G).
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    (7) Section 4j of the CEA,\21\ and CFTC rule 41.27 \22\ promulgated 
thereunder, do not apply to NQLX because NQLX operates an electronic 
trading system that does not provide market participants with a time or 
place advantage or the ability to override a predetermined 
algorithm.\23\
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    \21\ 7 U.S.C. 4j.
    \22\ 17 CFR 41.45(b)(2).
    \23\ 17 CFR 41.27(b)(2); see also Regulation to Restrict Dual 
Trading in Security Futures Products, (March 1, 2002), 67 FR 11223, 
11225-11226 (March 13, 2002).
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    (8) NQLX believes that its proposed rules 902 and 903 meet the 
requirement that trading in the security futures are not readily 
susceptible to manipulation of their price, nor to causing or being 
used to cause the manipulation of the price of the underlying security, 
options on such security, or options on a group or index including such 
securities.\24\ In addition, NQLX proposed rule 304(c)(1), which is 
part of this filing, prohibits various manipulative and improper 
practices, including effecting a transaction in, or inducing the 
purchase or sale of, any NQLX contract through any manipulative, 
deceptive, or fraudulent device or contrivance. Proposed rule 304(c)(2) 
through (9), which are part of this filing, also specifically prohibits 
price manipulation or cornering the market, wash transactions, 
accommodation transactions, front-running, trading ahead, cherry 
picking, withdrawing, withholding, or disclosing a customer's order for 
the benefit of another person, taking advantage of a customer's order 
for the benefit of another person, and compensation trades.\25\
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    \24\ 15 U.S.C. 78f(h)(3)(H).
    \25\ NQLX proposed rule 304(c)(2) through (9).
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    (9) As to coordinated surveillance, NQLX's proposed rule 207, which 
is part of this filing, gives NQLX the authority to enter into 
information-sharing agreements or other arrangements or procedures to 
coordinate surveillance with other markets on which security futures 
trade, any market on which any security that underlies the security 
futures trade, and any other markets on which any related securities 
trade. Proposed rule 207 also allows NQLX to enter into any arrangement 
with, and provide information to, any person or body (including, 
without limitation, the

[[Page 68897]]

CFTC, SEC, National Futures Association, National Association of 
Securities Dealers, Inc. (``NASD''), any self-regulatory organization, 
any exchange, market, clearing organization, the Intermarket 
Surveillance Group, or foreign regulatory authority) that NQLX believes 
exercises a legal or regulatory function or a function comprising or 
associated with the enforcement of a legal or regulatory function. In 
addition to proposed rule 207, NQLX is an affiliate member of the 
Intermarket Surveillance Group and is a signatory of an information-
sharing agreement and its related addendum for security futures (dated 
October 18, 2002), which sets forth the agreement entered into between 
and among markets on which security futures are traded, any market on 
which any security underlying the security futures are traded, and 
other markets on which any related security is traded for coordinated 
surveillance to detect manipulation and insider trading.\26\
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    \26\ 15 U.S.C. 78f(h)(I).
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    (10) NQLX relies on its automated trading system (``ATS'') combined 
with specified proposed rules requiring the recording of trade 
information as well as books and records and record retention 
requirements to facilitate its obligation to conduct and coordinate 
market surveillance. As part of its ATS, NQLX will use a modified 
version of the LIFFE CONNECT TM trading platform, which is 
the same trading platform currently used by the London International 
Financial Futures and Options Exchange (``LIFFE'') to trade financial 
derivatives. The ATS is a fully-transparent, open architecture trading 
system that users access through non-NQLX front-end trading 
applications. The ATS performs price reporting and dissemination, 
displaying the prices of trades executed in the matching engine 
together with the aggregate size of all orders to buy and sell above 
and below the market, updated on a real-time basis. In addition, the 
ATS creates audit trails for trades executed within the central order 
book, as well as three discrete types of trades allowed to be executed 
outside the central order book (i.e., certain cross transactions for 
market makers, block trades, and exchange for physical trades).
    As to market surveillance, NQLX's capabilities are two-fold: First, 
under the oversight and supervision of NQLX, designated LIFFE staff at 
NQLX's ATS will conduct real-time, front-line market surveillance. This 
includes monitoring real-time trading activity for compliance with 
NQLX's rules. Second, under the oversight and supervision of NQLX, NASD 
will conduct post-trade market surveillance for NQLX. Post-trade, NASD 
will monitor all trading activity to detect actual and potential 
abusive trading activities, unusual trading patterns, and violations of 
NQLX's rules and federal law using proven systems currently used by 
NASD for market surveillance of The NASDAQ Stock Market, Inc.
    As to the audit trail itself, it begins with NQLX assigning one or 
more unique individual trading mnemonics (``ITMs'') to specified 
responsible persons at each member. Orders will not be accepted into 
the ATS without an ITM identifier attached to the order. And, pursuant 
to NQLX's rules, the responsible persons must have the ability to 
identify immediately for NQLX the source of all orders submitted under 
any ITM assigned to the responsible persons.\27\ In turn, NQLX's 
proposed rule 408, which is part of this filing, specifies the types of 
information that each order entered into the ATS must contain, 
including customer type indicator (or ``CTI'' code) as prescribed by 
CFTC regulation; customer account number or identifier; clearing 
account indicator; the exchange contract; delivery or expiration month; 
quantity; buy or sell; price or price limit or range; put or call and 
exercise price (if applicable); open or close position indicator (if 
applicable); order instructions (e.g., good ``til cancelled, minimum 
volume, etc.) (if applicable); strategy type indicator (if applicable); 
and code indicator for a cross transaction, block trade, or exchange 
for physical trade (if applicable).
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    \27\ See NQLX rule 309(a) and (b).
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    The three discrete types of transactions that are allowed under 
NQLX's rules to be executed outside of the central order book (i.e., 
certain cross transactions for market makers, block trades, and 
exchange for physical trades) are still submitted to the ATS and, in 
turn, captured by the audit trail. NQLX proposed rules 418(d), 419(g) 
and 420(b), which are part of this filing, indicate the types of 
information that must be submitted to the ATS for certain cross 
transactions for market makers, block trades, and exchange for physical 
trades, respectively.
    In addition to the audit trial created by the ATS, NQLX has several 
other proposed rules that will enhance market surveillance by (1) 
requiring members to make and maintain adequate books and records 
(proposed rules 320 and 321), (2) giving NQLX the authority to require 
the recording of conversations (proposed rule 322), (3) giving NQLX the 
authority to require the filing of daily trading information (proposed 
rule 324), and (4) requiring the reporting of reportable positions 
(proposed rule 325).\28\
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    \28\ NQLX proposed rules 320, 321, 322, 324 and 325 are part of 
this filing.
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    (11) NQLX proposed rule 425, which is part of this filing, requires 
NQLX to halt trading of a security futures contract based on a single 
security during any regulatory halt (as defined in CFTC regulation 
41.1(l) \29\ and SEC rule 240.6h-1(a)(3) \30\) imposed on the 
underlying security. Proposed rule 425 also requires NQLX to halt 
trading of a security futures contract based on a narrow-based security 
index (as defined by section 1a(25) \31\ of the CEA and section 
3(a)(55) \32\ of the Act) during any regulatory halt of one or more 
underlying securities that constitute 50 percent or more of the market 
capitalization of the narrow-based security index. NQLX also will have 
procedures in place to halt trading of security futures that are based 
on single securities during regulatory halts imposed on the underlying 
security. Before commencing trading in any narrow-based security 
indices, NQLX will have procedures in place to halt trading in the 
narrow-based security indices during any regulatory halt of one or more 
underlying securities that constitute 50 percent or more of the market 
capitalization of the narrow-based security index.
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    \29\ 17 CFR 41.41.1(l).
    \30\ 17 CFR 240.6h-1(a)(3).
    \31\ 7 U.S.C. 1a(25).
    \32\ 15 U.S.C. 78c(a)(55).
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    (12) NQLX has submitted proposed customer margin rules for 
publication and approval by the SEC,\33\ which it believes complies 
with the provisions jointly established by the SEC and CFTC pursuant to 
section 7(c)(2)(B) \34\ of the Act and set forth in SEC rules 400 
through 406 \35\ and CFTC rules 41.43 through 41.49.\36\ The SEC has 
approved NQLX's customer margin rules.\37\
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    \33\ Securities Exchange Act release no. 46548 (September 25, 
2002), 67 FR 61361 (September 30, 2002).
    \34\ 15 U.S.C. 78g(c)(2)(b).
    \35\ 17 CFR 240.400 through 406.
    \36\ 17 CFR 41.42 through 41.49.
    \37\ Securities Exchange Act release no. 46771 (November 5, 
2002).
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2. Statutory Basis
    NQLX files these proposed rules pursuant to section 19(b)(7) of the 
Act.\38\ NQLX believes that these rules are necessary to implement the 
requirements of the CFMA, including the requirement that trading in a 
listed security futures is not readily susceptible to manipulation of 
its price

[[Page 68898]]

nor to causing or being used to manipulate the price of the underlying 
security, options on the security, or options on a group or index 
including the security.\39\ NQLX also believes that these proposed 
rules are necessary to establish listing standards that: (1) Will 
foster the development of fair and orderly markets in security futures, 
(2) are necessary or appropriate in the public interest, and (3) are 
consistent with the protection of investors.
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    \38\ 15 U.S.C. 78s(b)(7).
    \39\ See Section 6(h)(3)(H) of the Exchange Act, 5 U.S.C. 
78f(h)(3)(H).
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    NQLX believes that its proposed rules comply with the requirements 
under section 6(h)(3) of the Act and the criteria under section 
2(a)(1)(D)(i) of the CEA,\40\ as modified by joint orders of the 
Commission and the CFTC. In addition, NQLX believes that its proposed 
rules are consistent with the provisions of section 6 of the Act,\41\ 
in general, and section 6(b)(5) of the Act,\42\ in particular, which 
requires, among other things, that the rules of an exchange be designed 
to prevent fraudulent and manipulative acts and practices, and, in 
general, to protect investors and the public interest.
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    \40\ 15 U.S.C. 78f(h)(3); 7 U.S.C. 2(a)(1)(D)(i).
    \41\ 15 U.S.C. 78f.
    \42\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NQLX does not believe that the proposed rules 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 Proposed 
Rules Received From Members, Participants, or Others

    NQLX neither solicited nor received written comment on the proposed 
rules.

III. Date of Effectiveness of the Proposed Rules and Timing for 
Commission Action

    Concurrent with the filing of the proposed rule change with the 
SEC, NQLX has filed a written certification with the CFTC under section 
5c(c) \43\ of the CEA and CFTC regulation part 38.4 \44\ in which NQLX 
certifies that its filed listing standards in proposed rules 902 and 
903 comply with the CEA. While proposed rule 902 and 903 are effective 
the day after their filing with the CFTC, NQLX intends to implement 
these rules immediately before its market launch.
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    \43\ 7 U.S.C. 7a-2(c).
    \44\ 17 CFR 38.4.
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    Within 60 days of the date of effectiveness of the proposed rules, 
the Commission, after consultation with the CFTC, may summarily 
abrogate the proposed rules and require that the proposed rules be 
refiled in accordance with the provisions of section 19(b)(1) of the 
Act.\45\
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    \45\ 15 U.S.C. 78s(b)(1).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed 
rules conflict with the Act. Persons making written submissions should 
file nine copies of the submission with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 
Comments also may be submitted electronically to the following e-mail 
address: [email protected]. Copies of the submission, all 
subsequent amendments, all written statements with respect to the 
proposed rules that are filed with the Commission, and all written 
communications relating to the proposed rules 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 these filings will also be available for inspection and 
copying at the principal office of NQLX. Electronically submitted 
comments will be posted on the Commission's internet website (http://www.sec.gov). All submissions should refer to file no. SR-NQLX-2002-02 
and should be submitted by December 4, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\46\
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    \46\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-28746 Filed 11-12-02; 8:45 am]
BILLING CODE 8010-01-P