[Federal Register Volume 68, Number 127 (Wednesday, July 2, 2003)]
[Notices]
[Pages 39605-39608]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-16712]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48088; File No. SR-NASD-2003-85]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. and 
Amendments No. 1 and 2 Thereto Relating to a Post-Trade Anonymity 
Feature in SuperMontage

June 25, 2003.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on May 22, 2003, the National Association of Securities Dealers, Inc. 
(``NASD''), through its subsidiary, The Nasdaq Stock Market, Inc. 
(``Nasdaq''), filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Nasdaq has prepared. On June 2, 2003, Nasdaq filed 
Amendment No. 1 to the proposed rule change.\3\ On June 23, 2003, 
Nasdaq filed Amendment No. 2 to the proposed rule change.\4\ The 
Commission is publishing this notice, as amended, to solicit comments 
on the proposed rule change from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Peter R. Geraghty, Associate Vice President 
and Associate General Counsel, Nasdaq, to Terri Evans, Assistant 
Director, Division of Market Regulation (``Division''), Commission, 
dated May 29, 2003 (``Amendment No. 1''). In Amendment No. 1, the 
Nasdaq added rule language in paragraph (c) of NASD Rule 4719 that 
states that the Nasdaq staff can limit a member's ability to submit 
anonymous orders upon request of the member's firm. This provision 
was subsequently withdrawn in Amendment No. 2.
    \4\ See Letter from Peter R. Geraghty, Associate Vice President 
and Associate General Counsel, Nasdaq, to Terri Evans, Assistant 
Director, Division, Commission, dated June 20, 2003 (``Amendment No. 
2''). In Amendment No. 2, the Nasdaq withdrew the provision to 
restrict a member's ability to submit anonymous orders upon request 
of the member's firm in paragraph (c) of NASD Rule 4719. Nasdaq also 
codified the proposal, through proposed paragraph (c) of NASD Rule 
4719, to indicate that a member's identity may be revealed: (1) When 
the National Securities Clearing Corporation (``NSCC'') ceases to 
act for a member or the member's clearing firm; (2) for regulatory 
purposes, or upon the order of a court or arbitrator; and (3) after 
4 p.m. on trade date on an aggregate basis. Nasdaq also represented 
that it will retain the identities of the members that execute 
anonymous trades through SuperMontage for six years in order to 
satisfy members' record keeping obligations under Securities 
Exchange Act Rules 17a-3(a)(1) and 17a-4(a).
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq is seeking to add a post-trade anonymity feature to its 
SuperMontage trading system.
    The text of the proposed rule change is below. Proposed new text is 
italicized and proposed deleted text is [bracketed].
* * * * *

4712. Obligation To Honor System Trades

    (a) If an NNMS Participant, or clearing member acting on his 
behalf, is reported by NNMS to clearing [at the close of any trading 
day], or shown by the activity reports generated by NNMS as 
constituting a side of a System trade, such NNMS Participant, or 
clearing member acting on his behalf, shall honor such trade on the 
scheduled settlement date.
    (b) Nasdaq shall have no liability if an NNMS Participant, or a 
clearing member acting on his behalf, fails to satisfy the obligations 
in paragraph (a).

4719. Anonymity

    (a) Transactions executed in NNMS in which at least one member 
submits a Non-Attributable Quote/Order will be processed anonymously. 
The transaction reports will indicate the details of the transactions, 
but will not reveal contra party identities.
    (b)(1) The processing described in paragraph (a) shall not apply to 
transactions executed in NNMS when the member whose Quote/Order is 
decremented is an Order-Delivery ECN that charges an access fee.
    (2) Except as required to comply with the request of a regulator, 
or as ordered by a court or arbitrator, Order-Delivery ECNs shall not 
disclose the identity of the member that submitted a Non-Attributable 
Quote/Order that decremented the Order-Delivery ECN's Quote/Order.
    (c)(1) The Association may reveal a member's identity when the 
National Securities Clearing Corporation (``NSCC'') ceases to act for a 
member, or the member's clearing firm, and NSCC determines not to 
guarantee the settlement of the member's trades.
    (2) The Association may reveal a member's identity for regulatory 
purposes or to comply with an order of an arbitrator or court.
    (3) The Association may reveal a member's identity on risk 
management reports provided to the member's contra parties each day 
after 4 p.m., which disclose trading activity on an aggregate dollar 
value basis.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

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

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

1. Purpose
    Nasdaq proposes to add a post-trade anonymity feature to 
SuperMontage in response to demand from members. Today, systems that 
provide automatic executions of orders for Nasdaq stocks are 
commonplace and often it is the additional features offered by a system 
that determines whether market participants send orders to that system 
or a competing system. One such feature valued by market participants 
today is the ability to trade anonymously. When a member seeks to trade 
anonymously, it wants to prevent its contra party from knowing its 
identity.
    Anonymity is important to market participants because sometimes the 
identity of a party can reveal important ``market intelligence'' and 
complicate a member's ability to execute its customer orders. For 
example, if members see a pattern in which a particular member is 
actively buying a security, and it is commonly known that this member 
handles the orders of several very large institutional customers, such 
as pension funds or mutual funds, the other members can adjust their 
trading strategy for that security in anticipation of the strong demand 
that should develop as the member attempts to fill the order of one or 
more of its large institutional customers. In such a scenario, the 
natural result is that the price of the security increases and it 
becomes more expensive to fill the order. This result commonly is 
referred

[[Page 39606]]

to as ``market impact.'' Nasdaq believes post-trade anonymity 
diminishes market impact, which can help members satisfy their duty of 
best execution.
    Presently, SuperMontage only offers a pre-trade anonymity feature 
for certain trades, which means market participants do not know the 
identities of the members entering orders, but their identities are 
revealed to each other once a trade is executed.\5\ The post-trade 
anonymity feature, or ``full anonymity'' feature, Nasdaq is proposing 
would reveal the members' identities to each other on a trade-by-trade 
basis in two circumstances: (1) if the member whose quote is hit (i.e., 
the party providing the liquidity in the trade) is an ECN that 
participates in SuperMontage as an NNMS Order-Delivery ECN that charges 
an access fee;\6\ or (2) the NSCC has ceased to act for the member 
involved in the trade, or for the clearing firm of the member involved 
in the trade, and the NSCC has decided not to guarantee the trades by 
the failed firm.\7\ The reasons and process for revealing the members' 
identities in these circumstances is different and will be discussed in 
detail later. Nasdaq also proposes to provide members with additional 
risk management tools to complement the full anonymity feature.
---------------------------------------------------------------------------

    \5\ Members seeking pre-trade anonymity submit ``Non-
Attributable Quotes/Orders'' to SuperMontage. The term ``Non-
Attributable Quote/Order'' is defined in Rule 4701(o) as ``a bid or 
offer Quote/Order that is entered by a Nasdaq Quoting Market 
Participant or NNMS Order Entry Firm and is designated for display 
(price and size) on an anonymous basis in the Nasdaq Order Display 
Facility.''
    \6\ The term ``NNMS Order-Delivery ECN'' is defined in Rule 
4701(t)(2).
    \7\ A member's identity will be available to other members on 
certain compliance report cards issued by NASD's Market Regulation 
Department. However, the report cards normally are not issued until 
at least twenty-four days after trade date. In addition, NASD may 
reveal a member's identity to other members or others during a 
regulatory investigation or a routine oversight exam.
---------------------------------------------------------------------------

    Nasdaq's current pre-trade anonymity feature allows market makers, 
ECNs and Order Entry Firms to submit anonymous orders to SuperMontage 
for display under the ``SIZE'' market participant identifier 
(``MPID'').\8\ When a trade is executed with an order that resides 
under the SIZE MPID, the identity of the member that anonymously 
submitted the order is revealed immediately to the other member 
involved in the trade--meaning anonymity is lost.\9\
---------------------------------------------------------------------------

    \8\ Market makers and ECNs may also display Attributable Quotes/
Orders under the market participant's MPID. However, Order Entry 
Firms can only post Non-Attributable Quotes/Orders for display in 
SuperMontage. See Securities Exchange Act Release No. 47830 (May 12, 
2003), 68 FR 27126 (May 19, 2003).
    \9\ For the purpose of execution reports, Order Entry Firms have 
distinct MPIDs. Telephone conversation with Peter R. Geraghty, 
Associate Vice President and Associate General Counsel, Nasdaq, and 
Marc McKayle, Special Counsel, Division, Commission, on June 24, 
2003.
---------------------------------------------------------------------------

    The new full anonymity feature Nasdaq is proposing builds upon the 
pre-trade anonymity feature available today using the Non-Attributable 
Quote/Order feature and extends the anonymity beyond the time of 
execution by masking the identities of the members executing the trade. 
As discussed above, currently a member's identity is revealed 
immediately when a Non-Attributable Quote/Order is executed. 
SuperMontage produces an execution report that is sent to the parties 
to the trade and also creates a report in Nasdaq's Automated 
Confirmation Transaction Service (``ACT''). These reports contain the 
MPIDs for the members that executed the trade. Under the new proposal, 
when a member uses the Non-Attributable Quote/Order feature, instead of 
revealing the members' MPIDs, SuperMontage will substitute a four-
letter identifier that indicates the trade is anonymous (i.e., 
SIZE).\10\ Therefore, instead of seeing its contra party's MPID on the 
reports, the reports will indicate SIZE as the contra party.\11\ 
Replacing the members' MPIDs with SIZE does not alter how information 
is reported to the consolidated tape or Nasdaq's surveillance systems 
or the type of information reported to the consolidated tape or 
Nasdaq's surveillance systems. In addition, clearing firms will 
continue to receive immediate notification of trades executed by their 
correspondent firms,\12\ and, except as described below, the new 
anonymity feature does not change how trades will be processed and 
settled through the NSCC.\13\
---------------------------------------------------------------------------

    \10\ With one exception, trades will be processed anonymously if 
one of the parties submits a Non-Attributable Quote/Order. Thus, a 
member's trade can be processed anonymously even if it did not 
request anonymity. As discussed in detail later, the one exception 
is when the member whose quote is hit is an NNMS Order-Delivery ECN 
that charges a quote access fee.
    \11\ Nasdaq will know the identities of the members executing an 
anonymous trade and will provide a ``help desk'' that members can 
call to assist them in resolving disputed anonymous trades. 
Currently, members would contact each other and directly resolve 
disputed trades.
    \12\ When a correspondent firm executes an anonymous order in 
SuperMontage, its clearing firm will continue to receive a real-time 
SuperMontage report and ACT report containing all the trade details 
(e.g., the number of shares and the price of the trade), except the 
identity of the correspondent's contra party. The details of 
anonymous trades also will be included in ACT's risk management 
tools. For example, anonymous trades will be included in the 
aggregate purchase and sales calculations performed by ACT and will 
be included in calculations for determining whether a correspondent 
firm is approaching the trading thresholds defined by the clearing 
firm.
    \13\ Nasdaq will not assume any responsibility to settle 
anonymous trades and the NSCC's settlement guarantee and close-out 
procedures for failed firms will not be affected by Nasdaq's 
anonymity proposal. Therefore, as required today by NASD Rules 4712 
and 6160, members will be obligated to settle matched trades 
reported to the NSCC, including trades executed anonymously that 
have been matched and reported to the NSCC, but not yet guaranteed 
by the NSCC. Nasdaq will provide members several tools to manage 
their exposure prior to the NSCC's settlement guarantee attaching. 
These tools are described in detail later.
---------------------------------------------------------------------------

    The ACT reports that the NSCC receives from Nasdaq for anonymous 
trades will contain the identities of the parties to the trade. This 
measure will enable the NSCC to continue its normal risk management 
functions and settle anonymous trades just the same as those that are 
executed without the anonymity feature, with one exception. The ACT 
report sent to the NSCC will contain an indicator noting that the trade 
is anonymous. The effect of this indicator is that, on the contract 
sheets the NSCC issues to its participants, the NSCC will substitute 
SIZE for the MPID of the contra party, in effect masking from members 
the identities of their contra parties.\14\ The purpose of this masking 
is to preserve anonymity through settlement. If the NSCC did not mask 
the contra party identities, the contract sheets would reveal the 
identities of the parties to the trade and thus eliminate the full 
anonymity feature. With this minor change, anonymity is preserved 
through settlement.
---------------------------------------------------------------------------

    \14\ The NSCC issues contract sheets throughout the day.
---------------------------------------------------------------------------

    Nasdaq also proposes to offer additional risk management tools to 
members to assist them in monitoring their exposure to members they 
have traded with on an anonymous basis. Nasdaq has discussed its 
proposed full anonymity feature with several clearing firms in an 
attempt to balance members' competing desires to trade anonymously and 
monitor their exposure to other members. An execution system that 
reveals a contra party's identity immediately when a trade is executed 
provides the maximum amount of information for risk management, but, of 
course, such a system does not provide the degree of anonymity desired 
to lessen market impact. On the other hand, a system that does not 
provide any information with respect to the identity of contra parties, 
which is desirable for minimizing market impact, withholds useful risk 
management information. Ultimately, the information that provides 
market intelligence and creates market impact is one and the same as 
the information used in risk

[[Page 39607]]

management. Therefore, Nasdaq's proposal provides anonymity but also 
provides members with information that will allow members to continue 
to manage their risk.
    Nasdaq is proposing to add four new measures that should help 
members monitor their exposure to other members and take action quickly 
if a contra party ceases operation. Nasdaq believes that the first and 
second measures will assist members directly in their efforts to assess 
the risk associated with their anonymous trading, whereas the third and 
fourth measures involve closer coordination between Nasdaq and the 
NSCC, which indirectly should benefit members trading anonymously.
    First, Nasdaq will provide members with an intra-day concentration 
report that will disclose a member's aggregate dollar value of 
purchases and sales with other members with whom it has traded 
anonymously. This information will help members quantify their ``worst 
case scenario,'' which would occur if one or all of their contra 
parties failed to settle all trades executed anonymously. With this 
information, members can determine whether any risk-limiting actions 
should be taken.
    Second, Nasdaq will reveal after 4 p.m. Eastern Time the identities 
of the members listed on the intra-day concentration report.\15\ With 
this information, members will know the exact dollar value of their 
aggregate purchases and sales with individual contra parties. This 
information then can be incorporated into a member's risk management 
system and analyzed on a contra party-by-contra party basis. If a 
member is concerned about trading with a particular member, the member 
will possess information that can help it assess whether any risk-
limiting actions should be taken.
---------------------------------------------------------------------------

    \15\ See Amendment No. 2, supra note 4.
---------------------------------------------------------------------------

    Third, Nasdaq will begin providing trade information to the NSCC in 
real time as trades are executed in SuperMontage. In comparison, today 
Nasdaq collects trade information and sends it to the NSCC at five pre-
determined intervals throughout the day. With real time submission, the 
NSCC will possess trade information within seconds after a trade is 
executed and it can incorporate this information into its risk analysis 
of its participants. Ultimately, this could result in the NSCC reaching 
a decision earlier to cease to act for a participant, which would 
prevent other members from executing any additional trades with the 
firm or a firm that clears through that participant. Once the NSCC 
ceases to act for a participant, that firm, and any other firm that 
clears through the participant, will not be able to continue trading.
    Fourth, once the NSCC has ceased to act for a participant and 
determined not to guarantee the settlement of the participant's trades, 
Nasdaq will coordinate with the NSCC and promptly disclose to members 
each trade executed anonymously with the firm the NSCC ceased to act 
for and any firms that cleared through that the NSCC participant.\16\ 
As described earlier, when the NSCC ceases to act for a participant is 
one of the two general scenarios in which Nasdaq will reveal contra 
party identities on a trade-by-trade basis. This measure will allow 
members to determine quickly their potential exposure from anonymous 
trades with the failed firm and its correspondents and take any 
necessary risk-reducing actions.
---------------------------------------------------------------------------

    \16\ Id.
---------------------------------------------------------------------------

    The second scenario in which Nasdaq will reveal contra party 
identities on a trade-by-trade basis is when a member whose Quote/Order 
is decremented (i.e., the liquidity providing member) is an Order-
Delivery ECN that charges an access fee. The ultimate result is that 
members cannot trade with complete anonymity when accessing liquidity 
provided by Order-Delivery ECNs that charge access fees. Trades 
executed with these ECNs are processed differently because they have 
the discretion to reject trades with certain contra parties if the ECN 
is in dispute with the contra party concerning the ECN's quote access 
fee. Therefore, to provide fee-charging Order-Delivery ECNs with the 
opportunity to reject trades with certain members, Nasdaq must disclose 
each contra party's identity. Nasdaq believes that this process also 
will benefit members that execute trades with these ECNs because the 
members will be able to track the access fee charges accumulated with 
each ECN.
    To preserve some degree of anonymity, while also accommodating the 
unique rights and needs of these ECNs, Nasdaq is proposing a rule that 
would prohibit fee-charging Order-Delivery ECNs from disclosing the 
identity of the member that submitted the Non-Attributable Quote/Order 
that decremented their Quote/Order.\17\ The prohibition contains an 
exception, however, if the ECN is requested to provide such information 
to regulators or is ordered to disclose the information by a court or 
arbitrator. Based on conversations with ECNs, Nasdaq understands that 
ECNs do not normally disclose contra party identities for any trades 
executed through their systems because such a practice would diminish 
the anonymity features they provide. Therefore, Nasdaq believes the 
proposed rule prohibiting disclosure of this information is consistent 
with existing practices.
---------------------------------------------------------------------------

    \17\ Non-Attributable Quotes/Orders contain an indicator noting 
that the order is to be processed anonymously. As such, Order-Entry 
ECNs will be able to distinguish Non-Attributable Quotes/Orders from 
those orders for which the prohibition will not apply.
---------------------------------------------------------------------------

2. Statutory Basis
    Nasdaq believes that the proposed rule change, as amended, is 
consistent with the provisions of section 15A(b)(6) of the Act.\18\ 
Section 15A(b)(6) requires the rules of the NASD to be designed to 
foster cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and, in general, to protect investors and the public interest. 
Nasdaq believes the proposal is consistent with this standard because 
it balances two competing needs with respect to disclosure of contra 
party information. Masking contra party identities will help members in 
obtaining the best execution for their customer orders by limiting the 
market intelligence that is obtained, and the market impact that 
results, when a seller's or buyer's identity is revealed. Recognizing, 
however, that this same information is helpful to members in assessing 
contra party risk, Nasdaq has responded by proposing additional risk 
management features that should help members in monitoring trades 
executed anonymously.
---------------------------------------------------------------------------

    \18\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    Nasdaq also believes that the proposal balances the need to provide 
an anonymity feature in SuperMontage and the unique needs of Order-
Delivery ECNs that charge quote access fees. The proposal will continue 
to provide fee-charging Order-Delivery ECNs with the identities of 
their contra parties so that they have the information necessary to 
decide whether to trade with an individual member or reject an order 
because of a dispute regarding the payment of fees. However, to limit 
the effect of the special processing on the anonymity provided by 
SuperMontage, Nasdaq is proposing to prohibit these ECNs from 
disclosing the identities of their contra parties for anonymous trades, 
which Nasdaq understands is consistent with existing practices. Fee-
charging Order-Delivery ECNs would be permitted to disclose this 
information if

[[Page 39608]]

requested by a regulator or ordered by a court or arbitrator.

B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

    Written comments were neither solicited nor received.

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing also will be available for inspection and copying at the 
principal office of the NASD. All submissions should refer to File No. 
SR-NASD-2003-85 and should be submitted by July 23, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
---------------------------------------------------------------------------

    \19\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-16712 Filed 7-1-03; 8:45 am]
BILLING CODE 8010-01-P