[Federal Register Volume 68, Number 97 (Tuesday, May 20, 2003)]
[Proposed Rules]
[Pages 27722-27726]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-12604]



[[Page 27721]]

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

Part IV





Securities and Exchange Commission





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



17 CFR Part 240



Request for Comment on Nasdaq Petition Relating to the Regulation of 
Nasdaq-Listed Securities; Proposed Rule

  Federal Register / Vol. 68, No. 97 / Tuesday, May 20, 2003 / Proposed 
Rules  

[[Page 27722]]


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

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-47849; File No. S7-11-03]
RIN 3235-AI86


Request for Comment on Nasdaq Petition Relating to the Regulation 
of Nasdaq-Listed Securities

AGENCY: Securities and Exchange Commission.

ACTION: Concept release; request for comment.

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

SUMMARY: The Securities and Exchange Commission (``Commission'') seeks 
comment on a petition submitted by the Nasdaq Stock Market, Inc. 
(``Nasdaq'') concerning the regulation of Nasdaq-listed securities. 
Specifically, Nasdaq requests that the Commission amend the rules of 
all markets that trade Nasdaq-listed securities to establish uniform 
trading rules, and to ensure equal surveillance and enforcement of 
those rules; order that the exchanges' costs of regulation, including 
costs associated with proper data collection, surveillance, and 
enforcement, be aggregated and deducted from the market data revenue 
collected pursuant to the Nasdaq Unlisted Trading Privileges Plan 
(``UTP Plan''); and prohibit the launch or continuation of Nasdaq 
trading by any market that fails to protect investors as required under 
the Securities Exchange Act of 1934 (``Act''). In addition, the 
Commission requests comment on whether the same actions would be 
appropriate for the regulation and trading of exchange-listed 
securities.

DATES: Comments must be received on or before June 19, 2003.

ADDRESSES: To help us process and review your comments more 
efficiently, comments should be sent by one of the two methods 
specified below. Persons wishing to submit written comments should send 
three copies to Jonathan G. Katz, Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Comments 
also may be submitted electronically at the following E-mail address: 
[email protected]. All comment letters should refer to File No. S7-
11-03. Comments submitted by E-mail should include this file number in 
the subject line. Comment letters received will be available for public 
inspection and copying in the Commission's Public Reference Room, 450 
Fifth Street, NW., Washington, DC 20549-1001. Electronically submitted 
comment letters will be posted on the Commission's Internet Web site 
(http://www.sec.gov).\1\
---------------------------------------------------------------------------

    \1\ Personal identifying information, such as names or e-mail 
addresses, will not be edited from electronic submission. Submit 
only information that you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Terri L. Evans at (202) 942-4162 or 
Ian K. Patel at (202) 942-0089 in the Division of Market Regulation, 
---------------------------------------------------------------------------
Commission, 450 Fifth Street, NW., Washington, DC 20549-1001.

SUPPLEMENTARY INFORMATION: 

I. Introduction

    On April 14, 2003, the Commission received a petition from Nasdaq 
requesting that the Commission take certain actions (``Nasdaq 
Petition'') to respond to the greater fragmentation of trading in 
Nasdaq-listed securities across markets. The Commission is publishing 
Nasdaq's Petition to expedite and facilitate dialogue among all market 
participants on the issues raised by Nasdaq. The Commission is not 
endorsing Nasdaq's characterization of the regulation of Nasdaq-listed 
securities or its proposed solutions. Rather, the Commission is seeking 
comment on Nasdaq's Petition and, more generally, the issues raised by 
the Nasdaq Petition.

II. Background

A. Duties of a Self-Regulatory Organization

    In fashioning the Act, Congress chose to develop a unique pattern 
of regulation combining both industry and government responsibility.\2\ 
This pattern calls upon the exchanges and the National Association of 
Securities Dealers, Inc. (``NASD'') to exercise delegated governmental 
power to enforce at their own initiative compliance by members of the 
securities industry with both the legal requirements laid down in the 
Act and ethical standards which go beyond those requirements.\3\ As a 
result, the regulatory roles that self-regulatory organizations 
(``SROs'') play are a vital element in the regulation of the securities 
industry. An SRO is required to carry out the purposes of the Act, as 
well as enforce compliance by its members, and persons associated with 
its members, with the federal securities laws and the SRO's rules.\4\
---------------------------------------------------------------------------

    \2\ H.R. Doc. No. 123, 94th Cong., 1st Sess. 48 (1975), 
Legislative History of the Securities Reform Act of 1975.
    \3\ Id. The Commission is charged with supervising the exercise 
of this regulatory power to assure that it is used effectively to 
fulfill the responsibilities assigned to the self-regulatory 
organizations and that it is not used in a manner inimical to the 
public interest.
    \4\ See section 6(b)(1) of the Act, 15 U.S.C. 78f(b)(1) and 
section 15A(b)(2), 15 U.S.C. 78o-3(b)(2).
---------------------------------------------------------------------------

    An SRO is required to have rules designed, among other things, to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, and to refrain from imposing any 
unnecessary or inappropriate burdens on competition.\5\ For example, an 
SRO must maintain procedures to surveil against rule violations, 
including insider trading and market manipulation. While different 
market structures may imply different procedures for accomplishing this 
task, SROs are required to expend sufficient resources, in terms of 
both staff and technology, to support their surveillance functions. 
This includes having officers with expertise in monitoring for 
compliance with federal securities laws and SRO rules, and an 
understanding of the role of a registered exchange or association as an 
SRO. An SRO must deploy adequate examination and surveillance systems 
and maintain an audit trail of the transactions in its system. And SROs 
must have adequate measures in place to maintain listing and 
maintenance standards. SROs' regulatory programs, including those 
related to the trading of Nasdaq securities, are periodically inspected 
by the Commission.
---------------------------------------------------------------------------

    \5\ See section 6(b)(5) of the Act, 15 U.S.C. 78f(b)(5); section 
6(b)(8) of the Act, 15 U.S.C. 78f(b)(8); section 15A(b)(6), 15 
U.S.C. 78o-3(b)(6); and section 15A(b)(9), 15 U.S.C. 78o-3(b)(9). 
For example, an SRO must also have written listing and maintenance 
standards, as well as an adequate regulatory staff to apply those 
standards. See section 12(d) of the Act, 15 U.S.C. 78l(d); Rule 
12d2-2, 17 CFR 240.12d2-2 (requiring national securities exchanges 
to file an application with the Commission to strike a security from 
listing and registration). In addition, an SRO must have rules that 
ensure that no member's order is unfairly disadvantaged and all 
members are treated fairly. An SRO also is expected to have rules 
establishing procedures for the clearance and settlement of trades 
effected on the exchange. See Regulation of Exchanges and 
Alternative Trading Systems, Exchange Act Release No. 40760 
(December 8, 1998), 63 FR 70844 (December 22, 1998), at section 
IVB(1).
---------------------------------------------------------------------------

    An SRO also is required to enforce compliance with applicable laws 
and rules, and discipline members for violations relating to 
transactions executed in its market.\6\ This responsibility includes 
the establishment of a disciplinary process including appropriate 
sanctions for violations of the rules and a fair procedure for 
administering the

[[Page 27723]]

disciplinary process.\7\ The Commission has previously permitted SROs 
to agree, with Commission approval, with each other on how to allocate 
regulatory responsibilities. Rule 17d-2 under the Act permits SROs to 
establish joint plans for allocating the regulatory responsibilities 
imposed by the Act with respect to common members.\8\ An SRO 
participating in a regulatory plan is relieved of regulatory 
responsibilities with respect to a broker-dealer member of such SRO, if 
those regulatory responsibilities have been designated to another SRO 
under the regulatory plan. In addition, the Commission recognizes that 
an SRO can contract with other SROs, pursuant to a regulatory service 
agreement, to perform certain of these oversight activities. 
Nonetheless, an SRO retains ultimate responsibility for its self-
regulatory responsibilities, even if it has contracted with another SRO 
to perform oversight activities.
---------------------------------------------------------------------------

    \6\ See 19(g)(1) of the Act, 15 U.S.C. 78s(g)(1); See also 
Regulation of Exchanges and Alternative Trading Systems, Exchange 
Act Release No. 40760 (December 8, 1998), 63 FR 70844 (December 22, 
1998), at section IVB(1).
    \7\ See section 6(b)(6) of the Act, 15 U.S.C. 78f(b)(6); section 
6(b)(7) of the Act, 15 U.S.C. 78f(b)(7); section 15A(b)(7), 15 
U.S.C. 78o-3(b)(7); and section 15A(b)(8), 15 U.S.C. 78o-3(b)(8). 
While exchanges are required to enforce compliance by their members, 
and persons associated with their members, with applicable laws and 
rules, the Commission has used its authority under sections 17 and 
19 of the Act to allocate to particular SROs oversight of broker-
dealers that are members of more than one SRO. See 15 U.S.C. 78q and 
78s. See also 17 CFR 240.17d-2; 17 CFR 240.19g2-1.
    \8\ 17 CFR 240.17d-2.
---------------------------------------------------------------------------

B. Trading in NASDAQ Listed Securities

    On April 14, 2003, Nasdaq submitted the Nasdaq Petition, requesting 
that the Commission address ``unequal and inadequate regulation by some 
markets that trade securities listed on Nasdaq.'' \9\ As discussed in 
Nasdaq's Regulation White Paper,\10\ Nasdaq believes that as trading in 
Nasdaq securities spreads to a greater number of venues, it becomes 
increasingly difficult for the NASD or any other individual SRO to 
oversee adequately trading in those securities. Moreover, Nasdaq 
contends that this difficulty is particularly true with respect to 
broker-dealers that quote on one market while printing trades to 
another market or those that quote and trade the same security in more 
than one market. Nasdaq believes that it is often unclear which market 
is responsible for regulating such broker-dealers' activities, and that 
no market is likely to have adequate information to effectively oversee 
that activity.\11\
---------------------------------------------------------------------------

    \9\ See letter to Jonathan G. Katz, Secretary, Commission, from 
Edward Knight, Executive Vice President and General Counsel, Nasdaq, 
dated April 11, 2003 at 2 (File No. 4-479).
    \10\ Nasdaq Regulation White Paper: A Call for a Fairer 
Allocation of Responsibilities and Costs in a Fragmented Market, 
dated January 24, 2003 (``Regulation White Paper'').
    \11\ See Regulation White Paper, supra note, at 1.
---------------------------------------------------------------------------

    Until recently, most trading in Nasdaq-listed securities was 
regulated by the NASD. With guidance from the Commission, the NASD 
developed a regulatory framework to provide investor protection in an 
open trading environment with multiple market makers. Nasdaq claims 
that when trading in Nasdaq stocks was almost exclusively limited to 
the Nasdaq system, NASD was able to view trading in Nasdaq stocks and 
respond quickly and effectively to protect investors.
    According to Nasdaq, the fragmentation of trading of securities 
listed on Nasdaq by various national and regional exchanges has caused 
the regulation of Nasdaq trading to become uncoordinated. Nasdaq states 
that there are harmful disparities in the markets' abilities to 
regulate the trading of Nasdaq-listed securities: for instance, Nasdaq 
states that several exchanges do not have rules approved by the 
Commission for gathering the detailed trading data necessary for the 
detection of fraud, manipulation, insider trading, and other 
violations.
    In addition, Nasdaq asserts that some markets are lowering their 
execution and reporting fees to compete for trades in Nasdaq-listed 
securities. Nasdaq also states that, to hold down costs, these markets 
avoid incurring new regulatory expenses, such as the costs of adapting 
their existing rules and surveillance systems to the unique structure 
and patterns of Nasdaq trading. According to Nasdaq, these markets use 
the savings from less regulation as an inducement to attract trading 
away from the NASD's highly regulated markets to less regulated 
markets, to the detriment of investors.
    Nasdaq initially raised many of these concerns in its Regulation 
White Paper prior to submitting its Petition. In response to the 
Regulation White Paper, The Cincinnati Stock Exchange, Inc. (``CSE'') 
asserted that ``the current surveillance infrastructure provides an 
effective means for the ongoing regulation of the markets. This 
infrastructure, which has been in place for over 20 years, is organized 
in a manner that fairly distributes responsibilities and costs among 
the various self-regulatory organizations.'' \12\ CSE also noted that 
the Intermarket Surveillance Group (``ISG'') was established for the 
purpose of coordinating regulatory efforts to address potential 
intermarket manipulations and trading abuses. As a result, CSE 
recommended, in part, that Nasdaq work with the ISG to address its 
concerns regarding intermarket surveillance methodologies and the 
allocation of intermarket responsibilities prior to abandoning the 
existing SRO and ISG infrastructure. In addition, CSE contended that 
Nasdaq is merely speculating about the adequacy of other markets' 
surveillance programs, the adequacy of which is subject to Commission 
oversight and generally kept confidential between the Commission and 
the respective regulator. And lastly, CSE noted that if the regulatory 
concerns raised by Nasdaq exist, they exist for all securities, 
including exchange-listed securities.
---------------------------------------------------------------------------

    \12\ See letter from Jeffrey T. Brown, Senior Vice President, 
Secretary and General Counsel, CSE, to Chairman Pitt, Commissioner 
Atkins, Commissioner Campos, Commissioner Glassman, and Commissioner 
Goldschmid, dated February 19, 2003, at 1 (``CSE Letter''). The CSE 
also stated that if ``weaknesses exist in the system, CSE supports 
efforts by all markets to work together and improve intermarket 
coordination of securities regulation to ensure that our markets are 
fair, orderly and protect investors.'' Id.
---------------------------------------------------------------------------

III. Summary of the NASDAQ Petition

    To address the regulatory issues identified by Nasdaq, Nasdaq 
requests that the Commission intercede in three ways. First, Nasdaq 
requests that the Commission exercise its authority under section 19(c) 
of the Act \13\ and Rule 192 of the Commission's Rules of Practice \14\ 
to amend the rules of all markets that trade Nasdaq-listed securities 
to establish uniform trading rules, and to ensure equal surveillance 
and enforcement of those rules. Second, Nasdaq requests that the 
Commission exercise its authority under section 11A(a)(3)(B) of the 
Act,\15\ and Rule 11Aa3-2(b)(2) \16\ to immediately order that the 
exchanges' costs of regulation--including audit trail collection, 
surveillance, and enforcement--be aggregated and deducted from the 
market data revenue collected pursuant to the UTP Plan.\17\ Finally, 
Nasdaq asks the Commission to identify markets that trade Nasdaq-listed 
securities without approved rules, order audit trails, surveillance, 
and examination programs that are sufficient to protect investors that 
buy and sell Nasdaq-listed securities on those markets. For those that 
do not, Nasdaq requests that the Commission exercise its authority 
under

[[Page 27724]]

section 12(f)(2) and (f)(3) of the Act \18\ to prohibit the launch or 
continuation of Nasdaq trading by any market that fails to protect 
investors as required under the Act.
---------------------------------------------------------------------------

    \13\ 15 U.S.C. 78s(c).
    \14\ 17 CFR 201.192.
    \15\ 15 U.S.C. 78k-1(a)(3)(B).
    \16\ 17 CFR 240.11Aa3-2(b)(2).
    \17\ The UTP Plan is the Joint Self-Regulatory Organization Plan 
Governing the Collection, Consolidation and Dissemination of 
Quotation and Transaction Information for Nasdaq Listed Securities 
Traded on Exchanges on an Unlisted Trading Privileges Basis.
    \18\ 15 U.S.C. 78l(f)(2), (f)(3).
---------------------------------------------------------------------------

    Each of Nasdaq's proposals is set forth in great detail below.

A. Uniform Trading Rules

    Nasdaq requests that the Commission act immediately to establish 
uniform trading rules and ensure equal surveillance and enforcement of 
those rules because of its concern that investors are potentially 
harmed by the lack of uniform trading rules and from unequal 
surveillance and enforcement of rules.\19\ Nasdaq states that it 
attempted, unsuccessfully, to persuade the other exchanges that trade 
Nasdaq stocks to act jointly to adopt uniform market rules and 
surveillance and enforcement mechanisms to eliminate these regulatory 
disparities. Specifically, Nasdaq asked that the UTP Plan be amended to 
prohibit certain defined conduct. Under that proposal, so-called 
Prohibited Conduct would have included, without limitation: any 
activity that is prohibited by any provision of the Act or rule adopted 
under the Act, market manipulation, illegal short selling, insider 
trading, fraud, front running, marking the open or the close, and non-
compliance with the limit order display rule, and firm quote rule.\20\ 
Nasdaq believes that to prevent regulatory arbitrage all SROs' 
rulebooks should contain uniform rules on these matters, and that each 
SRO should vigorously surveil and enforce those uniform rules.
---------------------------------------------------------------------------

    \19\ Nasdaq discussed in greater details its views about the 
harmful regulatory arbitrage that occurs when markets apply 
different trading rules to the same conduct in its Regulation White 
Paper.
    \20\ Most members of the UTP Operating Committee asserted that 
the Nasdaq UTP Plan was not the proper forum for resolving 
regulatory issues.
---------------------------------------------------------------------------

    For example, Nasdaq claims that although it has a short-sale rule, 
several UTP Exchanges trade Nasdaq issues with no short-sale price 
test. Nasdaq asserts that industry participants route short-sale orders 
to exchanges without short-sale rules specifically to avoid NASD and 
Nasdaq rule restrictions. Nasdaq claims that certain exchanges 
publicize this disparity to attract order flow to their markets.
    In addition, Nasdaq concludes, after review of the rulebooks of 
various markets, that no other market currently executing trades in 
Nasdaq-listed securities has rules requiring its members to report 
order audit trail information or operates a Commission-approved order 
audit trail. Nasdaq collects order audit trail information through its 
Order Audit Trail System (``OATS'') and through its Automated 
Confirmation Transaction service (``ACT''). Nasdaq asserts that the 
NASD uses this data to create a fully integrated audit trail of quotes, 
trades, and orders to run its surveillance programs to detect insider 
trading, fraud, best execution violations, spoofing, purposeful late 
trade reporting, short-sale violations, untimely execution of market 
orders, and a wide variety of other potential rule violations.
    For transactions reported away from Nasdaq, Nasdaq states that the 
NASD eventually receives the quotes and trade reports of the regional 
exchanges through the ISG. However, Nasdaq claims that the ISG audit 
trail only provides trade information at the clearing firm level (as 
opposed to both the clearing firm and the executing firm levels). In 
addition, according to Nasdaq, the time fields in the data are not 
generated by clocks subject to uniform synchronization protocols, as is 
the case with OATS data. Moreover, Nasdaq states that ISG data is not 
provided in a format that is conducive to integration into NASD's 
automated surveillance systems. As a result, manually processing this 
information can be time-intensive; furthermore, Nasdaq states that this 
data is not received until two days after the trade date. Nasdaq 
believes that such a delay can significantly hinder NASD's ability to 
investigate unlawful trading activity on a real-time basis and can 
prevent NASD from obtaining non-stale regulatory information in an 
ongoing investigation. The NASD uses this information to detect 
violations involving wash sales, fraud, insider trading, marking the 
close, best execution, riskless principal trade reporting, Regulation 
M, firm quote compliance, and limit order protection, among others.\21\
---------------------------------------------------------------------------

    \21\ Nasdaq states that on an average day, OATS processes 65 
million order reports and that NASD currently has six full time 
staff members dedicated to OATS compliance.
---------------------------------------------------------------------------

    At a more fundamental level, Nasdaq believes that consolidated 
regulation protects investors better than the coordinated regulation 
that ISG facilitates. In addition, Nasdaq believes that consolidated 
regulation should be crafted by the entities that will be governed. ISG 
is a voluntary organization whose membership includes SROs (only some 
of which trade Nasdaq-listed securities) and certain foreign entities 
that are not regulated as SROs by the Commission.
    To combat these perceived problems, Nasdaq asks the Commission, at 
a minimum, to add to the rules of all SROs that trade Nasdaq-listed 
securities, rules requiring an electronic audit trail identical to the 
NASD's OATS Rules \22\ and short-sale restrictions similar to NASD Rule 
3350. Nasdaq also asks that, if the Commission's review of other 
markets' rules, surveillance, or enforcement reveals inequalities that 
can be addressed through the adoption of uniform rules, the Commission 
add those rules as well, to ensure that there are no regulatory 
inconsistencies among SROs that trade Nasdaq-listed securities.
---------------------------------------------------------------------------

    \22\ See NASD Rules 6951 through 6957.
---------------------------------------------------------------------------

Request for Comments on the Need for Uniform Trading Rules and 
Surveillance
    The Commission welcomes comment on all aspects of Nasdaq's 
petition, including the following matters:
    Q1. Do commenters agree with Nasdaq that there is unequal 
regulation of trading in Nasdaq securities?
    Q2. Should all exchanges and associations trading Nasdaq securities 
have rules requiring detailed audit trail information?
    Q3. Should all exchanges and associations trading Nasdaq securities 
be required to automate their surveillance and examination of Nasdaq 
trading on their markets?
    Q4. Should all exchanges and associations trading Nasdaq securities 
have similar rules to regulate short selling?
    Q5. What other trading rules should be uniform across all markets?
    Q6. How should the Commission address any regulatory gaps that can 
arise when trading in the same security is fragmented across different 
SROs?
    Q7. To what extent is ISG a useful mechanism for coordinating 
intermarket regulatory efforts? Does ISG fully address the regulatory 
gaps Nasdaq contends exist? Does the fact that the Commission does not 
have direct oversight of ISG limit the sufficiency of the ISG framework 
in ensuring adequate regulation of violative conduct in the trading of 
Nasdaq securities that can occur across markets, such as insider 
trading or certain market manipulations?
    Q8. Are there models sufficient to address potential concerns 
raised by fragmentation of regulation by multiple SROs trading Nasdaq 
securities?
    Q9. Are there advantages or disadvantages to a single market 
regulator with regulatory oversight across all markets trading Nasdaq 
securities?

[[Page 27725]]

    Q10. Should a competitive bidding process be required to determine 
which entity will serve as the single regulator?

B. Allocation of Regulatory Costs

    Nasdaq urges the Commission to equitably allocate regulatory costs 
across markets that trade Nasdaq-listed securities to ensure that 
intermarket competition does not come at the cost of adequate 
regulation. As set forth in the Regulation White Paper, Nasdaq believes 
that all markets that trade the same securities should share the 
responsibility of equal regulation. In Nasdaq's view, these shared 
responsibilities include the uniform rules, surveillance, and 
enforcement discussed above.
    Nasdaq claims that in the absence of a framework for adopting 
uniform order audit trails and uniform enforcement of marketplace 
rules, Nasdaq is forced to subsidize other markets' regulatory costs, 
creating a classic free-riding dilemma. Nasdaq funds NASD's OATS to 
collect trading information from all NASD members, whether or not the 
trades are reported to Nasdaq. For example, Nasdaq claims that Island 
ECN (``Island''), an NASD member, reports 15 percent of all Nasdaq 
trades to the CSE, and then, where Island is the reporting party, 
Island sends detailed information about those trades to OATS. 
Therefore, according to Nasdaq, although CSE receives the market data 
revenue attributable to those trades, the NASD and Nasdaq bear the 
costs of receiving and storing Island's OATS data as well as the costs 
of regulating Island's conduct as an NASD member.
    Nasdaq believes that the fairest way to allocate the costs of 
supervising the trading of Nasdaq stocks is to aggregate the exchanges' 
costs of regulation, which include costs associated with surveillance 
and enforcement, and to deduct that amount from the market data revenue 
collected pursuant to the Nasdaq UTP Plan. Nasdaq believes that the 
Commission could apply this allocation method to today's regulatory 
environment, as well as in the future to the single regulator, ISG, and 
DEA regulatory models that Nasdaq has identified in its Regulation 
White Paper. Nasdaq believes that this means of funding aggregate 
regulatory costs will counter the existing economic incentives that are 
leading markets to reduce their regulatory costs to compete for order 
flow.
Request for Comments on the Allocation of Regulatory Costs
    The Commission welcomes comment on all aspects of Nasdaq's petition 
requesting the reallocation of regulatory costs, including the 
following matters:
    Q1. Should proceeds from the Nasdaq UTP Plan be withheld to pay for 
regulatory costs?
    Q2. Would Nasdaq's proposal to aggregate and deduct regulatory 
costs from market data revenue result in adequate regulation? If so, 
what costs would appropriately be considered regulatory costs and 
therefore, appropriately deducted from the market data revenue?
    Q3. Should other methods of fairly allocating regulatory costs be 
considered?
    Q4. Should the NASD be required, as suggested by the CSE, to alter 
its systems to include more data from inter-market trading to improve 
inter-market surveillance? \23\ If so, who should pay for this 
enhancement?
---------------------------------------------------------------------------

    \23\ See CSE Letter, supra note at note 4.
---------------------------------------------------------------------------

    Q5. Who would determine what are legitimate regulatory costs? On 
what basis should such a determination be made?

C. Prohibition of Trading in Nasdaq-Listed Securities

    Finally, Nasdaq asks the Commission to identify the markets that 
trade Nasdaq-listed securities without approved rules, order audit 
trails, surveillance, and examination programs sufficient to protect 
investors that buy and sell Nasdaq-listed securities on those markets. 
Specifically, Nasdaq believes it is unclear whether SROs, other than 
the NASD, have comparable algorithmic systems and examinations focused 
on detecting violations of Commission and SRO investor protection and 
trading rules.\24\ In addition, while trading on Nasdaq is subject to a 
short-sale price test (NASD Rule 3350), several exchanges trade Nasdaq-
listed securities without being subject to a comparable price test.\25\ 
As a result of such disparities, Nasdaq believes that the level of 
regulatory protection an investor receives depends almost entirely on 
the market to which the investor's order is routed. For those markets 
that in Nasdaq's view do not have adequate regulatory protections, 
Nasdaq asks the Commission to exercise its authority under section 
12(f)(2) and (f)(3) of the Act \26\ to prohibit the launch or 
continuation of Nasdaq trading by any market that fails to protect 
investors as required under the Act.
---------------------------------------------------------------------------

    \24\ Nasdaq represented that while the CSE has asserted that its 
Firm Order Submission system is an order audit system for the 
surveillance of trading on the CSE, it was Nasdaq's understanding 
that FOS is a voluntary system used primarily for settling 
commercial disputes between traders rather than an integrated, 
comprehensive means for surveilling trading on the CSE.
    \25\ The Commission notes, however, that short sales in Nasdaq 
securities would be subject to borrowing requirements, pursuant to 
an NASD or UTP exchange rule. See, e.g, NASD Rule 3370.
    \26\ 15 U.S.C. 78l.
---------------------------------------------------------------------------

IV. Exchange-Listed Securities and Exchange-Listed Options

    In response to the Regulation White Paper, CSE asserted that Nasdaq 
ignored that ``the same cross-market manipulation issues that form the 
predicate for the regulatory solution it advocates in the Nasdaq world 
apply equally to all other securities, including the NYSE-listed stocks 
in which Nasdaq trades over 10% of the volume.''\27\ The CSE noted 
that, contrary to its position on the regulation of Nasdaq securities, 
Nasdaq did not appear to be arguing that the same surveillance programs 
were inadequate as applied toward NYSE-listed securities.\28\ 
Subsequently, in its Petition, Nasdaq expressly stated that it was not 
addressing the application of the principles expressed in its Petition 
to exchange-listed securities.\29\
---------------------------------------------------------------------------

    \27\ See CSE Letter, supra note 12, at 2.
    \28\ Id.
    \29\ See Nasdaq Petition at note 11.
---------------------------------------------------------------------------

    The Commission notes that exchange-listed securities and securities 
options may be traded on more than one market and, therefore, the same 
regulatory issues raised by Nasdaq could arise. At present, trading in 
exchange-listed securities is more concentrated than the trading in 
Nasdaq securities.\30\ In addition, the options markets are in the 
process of implementing a consolidated options audit trail system that 
will enable the options exchanges to reconstruct markets promptly, 
effectively surveil them and enforce order handling, firm quote, trade 
reporting and other rules.\31\
---------------------------------------------------------------------------

    \30\ See Table 12, Share Volume by Exchanges, SEC Annual Report 
2002 at 175. In 2001, the NYSE had 84.31 percent of the share volume 
for exchanges. Share volume for exchanges includes stocks, rights, 
and warrants.
    \31\ See Exchange Act Release No. 43268 (September 11, 2000) 
(order requiring, in part, the options markets to design and 
implement a consolidated options audit trail system that provides an 
accurate, time-sequenced record of electronic orders, quotations, 
and transactions). The International Securities Exchange (``ISE'') 
was not a respondent in the proceedings instituted by this order and 
therefore has not been ordered to comply with the undertaking. 
Nevertheless, the ISE has agreed to participate in the audit trail.
---------------------------------------------------------------------------

Request for Comments on the Application of Nasdaq's Recommendations to 
Exchange Listed Securities

    The Commission requests comment on whether the same regulatory 
concerns raised by Nasdaq for Nasdaq securities, such as regulatory

[[Page 27726]]

fragmentation and arbitrage, exist for exchange-listed stocks and 
options. In addition, the Commission specifically requests comment on 
the following:
    Q1. Do commenters believe that there is unequal regulation of 
exchange-listed securities among the markets trading such securities? 
If so, do commenters believe that the proposals made by Nasdaq with 
respect to Nasdaq securities would address such unequal regulation in 
the listed markets? If not, what other approaches do commenters 
recommend?
    Q2. Should the Commission require an intermarket consolidated order 
audit trial system for Nasdaq-listed and exchange-listed securities, 
other than options?

V. General Request for Comments

    In addition to the questions above, the Commission seeks comment on 
issues presented in the Nasdaq Petition. More specifically, how should 
the Commission make sure that each SRO that trades Nadsaq securities 
fulfills its statutory obligations to surveil trading in such 
securities?

    By the Commission.

    Dated: May 14, 2003.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-12604 Filed 5-19-03; 8:45 am]
BILLING CODE 8010-01-P