[Federal Register Volume 68, Number 189 (Tuesday, September 30, 2003)]
[Notices]
[Pages 56361-56367]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-24757]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48527; File No. SR-NASD-2003-85]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the National Association of Securities Dealers, Inc. and 
Amendments No. 1 and 2 Thereto, and Notice of Filing and Order Granting 
Accelerated Approval to Amendment Nos. 3, 4, 5, and 7 Thereto Relating 
to a Post-Trade Anonymity Feature in SuperMontage

September 23, 2003.

I. Introduction

    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 
(``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 to add a post-trade anonymity 
feature to SuperMontage. 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 proposed rule 
change, as amended, was published for comment in the Federal Register 
on July 2, 2003.\5\ The Commission received five comment letters on the 
proposal, as amended by Amendment Nos. 1 and 2.\6\ On August 6, 2003, 
Nasdaq filed a response to the comment letters.\7\ On August 11, 2003, 
Nasdaq filed Amendment No. 3 to the proposed rule change.\8\ On 
September 8, September 16, September 17, and September 22, 2003, Nasdaq 
filed Amendment Nos. 4,\9\ 5,\10\ 6,\11\ and 7\12\ respectively, to the 
proposed rule change. This order approves the proposed rule change, as 
amended, and issues notice of, and grants accelerated approval to, 
Amendment Nos. 3, 4, 5, and 7.
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    \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'').
    \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'').
    \5\ See Securities Exchange Act Release No. 48088 (June 25, 
2003), 68 FR 39605 (July 2, 2003) (``Notice'').
    \6\ See Letters to Jonathan G. Katz, Secretary, Commission, from 
Jim Dyer, Senior Vice President & Trading Room Manager, Brokerage 
America, LLC, dated July 24, 2003 (``BAMM Letter''); Kim Bang, 
Bloomberg Tradebook LLC, dated July 24, 2003 (``Bloomberg Letter''); 
William O'Brien, Chief Operating Officer, Brut, LLC, dated July 29, 
2003 (``Brut Letter''); C. Thomas Richardson, Managing Director, 
Citigroup Global Capital Markets, Inc., dated July 25, 2003 
(``Citigroup Letter''); and John Hughes, Chairman, and John C. 
Giesea, President and Chief Executive Officer, Security Traders 
Association, dated July 23, 2003 (``STA Letter''). The letters are 
described in Section III, infra.
    \7\ See Letter from Edward S. Knight, Executive Vice President, 
Nasdaq, to Jonathan G. Katz, Secretary, Commission, dated August 4, 
2003 (``Nasdaq Response Letter'').
    \8\ See Letter from Peter R. Geraghty, Associate Vice President 
and Associate General Counsel, Nasdaq, to Terri Evans, Assistant 
Director, Division, Commission, dated July 31, 2003 (``Amendment No. 
3''). In Amendment No. 3, Nasdaq clarified in certain NASD rules 
that Nasdaq will remove a member from Nasdaq's systems when the 
member loses its clearing relationship. Members removed from a 
Nasdaq system can invoke their right to seek redress under the NASD 
Rule 9700 Series. The amendment also contains non-substantive 
changes to NASD Rules 4705, 5012, and 6120 to reflect that indirect 
participation in a clearing agency occurs through a ``participant,'' 
as such term is defined in Section 3(a)(24) of the Act.
    \9\ See Letter from Peter R. Geraghty, Associate Vice President 
and Associate General Counsel, Nasdaq, to Marc McKayle, Special 
Counsel, Division, Commission, dated September 4, 2003 (``Amendment 
No. 4''). In Amendment No. 4, Nasdaq created an additional exception 
to the anonymous processing of orders; made technical corrections in 
its rule text clarifying that Nasdaq must reveal member's identity 
in certain circumstances; explained how the help desk will operate 
to assist members with anonymous trades; and clarified Nasdaq's 
record keeping obligations.
    \10\ See Letter from Peter R. Geraghty, Associate Vice President 
and Associate General Counsel, Nasdaq, to Terri Evans, Assistant 
Director, Division, Commission, dated September 15, 2003 
(``Amendment No. 5''). In Amendment No. 5, Nasdaq codified its 
earlier representations regarding retention of information on behalf 
of its members to satisfy the members' books and records obligation. 
See Amendments 2 and 4, supra notes 4 and 9, respectively.
    \11\ See Letter from Peter R. Geraghty, Associate Vice President 
and Associate General Counsel, Nasdaq, to Thomas McGowan, Assistant 
Director, Division, Commission, dated September 16, 2003 
(``Amendment No. 6''). In Amendment No. 6, Nasdaq made a technical 
correction to its rule text to clarify those circumstances when 
members would be required to retain their recordkeeping obligations.
    \12\ See Letter from Peter R. Geraghty, Associate Vice President 
and Associate General Counsel, Nasdaq, to Thomas McGowan, Assistant 
Director, Division, Commission, dated September 17, 2003 
(``Amendment No. 7''). In Amendment No. 7, Nasdaq, in essence, 
withdrew Amendment No. 6 since it replaced in its entirety proposed 
Rule 4719(e)(ii), which was initially proposed in Amendment No. 5 
and subsequently amended by Amendment No. 6.
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II. Description of the Proposed Rule Change

    Nasdaq's current pre-trade anonymity feature allows market makers, 
electronic communication networks (``ECNs'') and order entry firms 
(``OE Firms'') to submit anonymous orders to SuperMontage for display 
under the ``SIZE'' market participant identifier

[[Page 56362]]

(``MPID'').\13\ 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.\14\ 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.
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    \13\ Market makers and ECNs may also display Attributable 
Quotes/Orders under the market participant's MPID. However, OE 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).
    \14\ For the purpose of execution reports, OE Firms have 
distinct MPIDs. Telephone conversation between Peter R. Geraghty, 
Associate Vice President and Associate General Counsel, Nasdaq, and 
Marc McKayle, Special Counsel, Division, Commission, on June 24, 
2003.
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    The proposed anonymity feature builds upon the pre-trade anonymity 
feature available today using the Non-Attributable Quote/Order feature 
and generally extends anonymity beyond the time of execution by masking 
the identities of the members executing the trade. Under the proposal, 
when a member uses the Non-Attributable Quote/Order feature, instead of 
revealing the members' MPIDs, SuperMontage will generally substitute a 
four-letter identifier that indicates the trade is anonymous (i.e., 
SIZE). Therefore, instead of seeing its contra-party's MPID on the 
reports, the reports will indicate SIZE as the contra-party.\15\ 
Replacing the members' MPIDs with SIZE would 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 would 
continue to receive immediate notification of trades executed by their 
correspondent firms,\16\ and, except as described below, the new 
anonymity feature would not change how trades would be processed and 
settled through the National Securities Clearing Corporation 
(``NSCC'').\17\
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    \15\ 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. Nasdaq 
staff's role will be limited to helping members resolve disputes, 
such as erroneous trades, when the members choose not to utilize the 
clearly erroneous trade adjudication process provided in NASD Rule 
11890. See Amendment No. 4, supra note 9.
    \16\ When a correspondent firm executes an anonymous order in 
SuperMontage, its clearing firm would continue to receive a real-
time SuperMontage execution 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 would be included in ACT's risk 
management tools.
    \17\ Nasdaq would not assume any responsibility to settle 
anonymous trades and the NSCC's settlement guarantee, and close-out 
procedures for failed firms, would not be affected by Nasdaq's 
anonymity proposal. Therefore, as required today by NASD Rules 4712 
and 6160, members would 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.
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    The ACT reports that the NSCC receives from Nasdaq for anonymous 
trades would contain the identities of the parties to the trade. This 
measure would enable the NSCC to continue its normal risk management 
functions and settle anonymous trades in the same manner as trades that 
are executed without the anonymity feature with one exception. The ACT 
report sent to the NSCC would 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 would 
substitute SIZE for the MPID of the contra-party. The purpose of this 
masking is to preserve anonymity through settlement.
    Nasdaq also proposes to offer members additional risk management 
tools for monitoring their exposure to members they have traded with on 
an anonymous basis. First, Nasdaq would provide members with an intra-
day concentration report that would disclose a member's aggregate 
dollar value of purchases and sales with other members with whom it has 
traded anonymously. Second, Nasdaq would reveal after 4 p.m. Eastern 
Time the identities of the members listed on the intra-day 
concentration report. With this information, members would know the 
exact dollar value of their aggregate purchases and sales with 
individual contra-parties Third, Nasdaq would begin providing trade 
information to the NSCC in real-time as trades are executed in 
SuperMontage. With real-time submission, the NSCC would possess trade 
information within seconds after a trade is executed and can 
incorporate this information into its risk analysis of its 
participants. Once the NSCC ceases to act for a participant, that firm, 
and any other firm that clears through the participant, would not be 
able to continue trading.\18\ Fourth, once the NSCC has ceased to act 
for a participant and determined not to guarantee the settlement of the 
participant's trades, Nasdaq would coordinate with the NSCC and Nasdaq 
would promptly disclose to members each trade executed anonymously with 
the firm the NSCC ceased to act for and any firms that cleared through 
that NSCC participant.\19\
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    \18\ See Amendment No. 3, supra note 8. In Amendment No. 3, 
Nasdaq clarified the process through which its members may be 
removed from SuperMontage for failure to maintain a clearing 
relationship. Members who are removed from a Nasdaq system can 
invoke their right to seek redress under the NASD 9700 series.
    \19\ Telephone conversation between Peter R. Geraghty, Associate 
Vice President and Associate General Counsel, Nasdaq, and Marc 
McKayle, Special Counsel, Division, Commission, on September 11, 
2003.
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    Nasdaq would also reveal contra-party identities on a trade-by-
trade basis 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 would not trade with 
complete anonymity when accessing liquidity provided by Order Delivery 
ECNs that charge access fees. Order Delivery ECNs would generally be 
prohibited, however, from disclosing the identity of the member that 
submitted the Non-Attributable Quote/Order that decremented their 
Quote/Order.\20\
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    \20\ Under the proposed rule change, Non-Attributable Quotes/
Orders would contain an indicator noting that the order is to be 
processed anonymously. As such, Order Delivery ECNs would be able to 
distinguish Non-Attributable Quotes/Orders from those orders for 
which the prohibition would not apply. 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. NASD would also be entitled to reveal a 
members' identity for regulatory purposes, including enabling a 
member to pursue arbitration, or to comply with an order of an 
arbitrator or a court. See Amendment No. 4, supra note 9.
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    Nasdaq would also disclose contra-party information when a member 
executes an order by matching against other trading interest it has in 
the system on the other side of the market (e.g., internalizes) on a 
trade-by-trade basis,\21\ including if a member executes a Preferenced 
Order \22\ sent to the same or another MPID used by that member.\23\ If 
the buying and selling interest submitted under the same MPID matches, 
Nasdaq would reveal, in all cases, to the member at the time of

[[Page 56363]]

execution, that it has internalized a trade through SuperMontage. 
Nasdaq would also reveal to the member at the end of the day when it 
has internalized across MPIDs.\24\
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    \21\ See Amendment No. 4, supra note 9.
    \22\ See NASD Rule 4701(aa).
    \23\ Telephone conversation between Thomas Moran, Associate 
General Counsel, Nasdaq, and Marc McKayle, Special Counsel, 
Division, Commission, on September 10, 2003, clarifying that a 
Preferenced Order may be sent to the same MPID or another MPID of 
the member. Members cannot submit anonymous orders through the 
SuperMontage Directed Order process. Telephone conversation between 
Peter R. Geraghty, Associate Vice President and Associate General 
Counsel, Nasdaq, and Terri Evans, Assistant Director, Division, 
Commission, on September 18, 2003. See also Letter from Edward S. 
Knight, Executive Vice President, Nasdaq, to Catherine McGuire, 
Associate Director and Chief Counsel, Division, Commission, dated 
September 15, 2003 (``Rule 10b-10 Exemption Request'').
    \24\ See Amendment No. 4, supra note 9. Nasdaq also is studying 
the feasibility of immediately revealing to members when they 
internalize across MPIDs.
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    Nasdaq also committed to retain, for the period specified in Rule 
17a-4(a), the actual identities of the members that executed anonymous 
trades through SuperMontage in its original form or a form approved 
under Rule 17a-6.\25\ For anonymous trades, Nasdaq would possess the 
information necessary under Rule 17a-3(a)(1) and would retain member 
identities for the period of time that broker-dealers are required to 
by Rule 17a-4(a) under the Act. However, for the universe of trades for 
which Nasdaq reveals to members the identities of the contra-parties, 
including when the contra-party is themselves, members would retain the 
record keeping obligation because the members would have the 
information to comply with Rule 17a-3(a) under the Act.\26\ In 
addition, members that submit, and receive an execution of, a Non-
Attributable Quote/Order that is a Preferenced Order would have to 
comply with Rules 17a-3(a)(1) and 17a-4(a) since they would possess the 
identity of their contra-party.\27\
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    \25\ See Amendment Nos. 2 and 5, supra notes 4 and 10.
    \26\ See Amendment Nos. 4 and 7, supra notes 9 and 12.
    \27\ Id.
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III. Summary of Comments and Nasdaq's Response

    The Commission received five comment letters on the proposed rule 
change.\28\ BAMM, Citigroup and STA supported the proposed rule change. 
Bloomberg expressed support for Nasdaq's goals, but expressed 
reservations regarding the proposal in its current form. Brut did not 
explicitly state whether it supported or opposed the proposal, but 
advised the Commission to review compliance, risk management and 
administrative issues carefully prior to taking action.
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    \28\ See supra note 6. Citigroup and STA also commented on ECN 
access fees in general. STA reiterated its view that ECN access fees 
should be abolished. Citigroup stated that ``either all broker/
dealers that represent orders as agent or riskless principal in the 
public market should be permitted to charge an access fee, or none 
should.'' The Commission notes that ECN access fees are not at issue 
in the current proposal, instead what is at issue is whether post-
trade anonymity feature, as proposed herein, is consistent with the 
Act.
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    BAMM, Citigroup and STA generally believed that post-trade 
anonymity is commonplace today. Specifically, Citigroup noted that 
exchanges and ECNs currently offer anonymity through execution and BAMM 
stated that anonymity has become a core feature of execution systems. 
As a result, these commenters believed that allowing Nasdaq to provide 
post-trade anonymity would level the competitive playing field.\29\ 
Citigroup also suggested that the proposal would improve the Nasdaq 
market because the current pre-trade anonymity feature does not 
adequately minimize market impact, and post-trade anonymity would 
assist brokers and dealers in obtaining better executions for their 
customers. \30\ According to Citigroup, ``Nasdaq's proposal should 
promote efficiency, reduce trading costs, and increase competition in 
the market, as broker/dealers will now be able to represent and execute 
their customer orders on an anonymous basis directly through a Nasdaq 
facility.'' BAMM stated that by increasing choice and competition, the 
proposal would increase liquidity in the marketplace, reduce 
fragmentation, and further reduce transaction costs.
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    \29\ See BAMM Letter and Citigroup Letter. See also STA Letter.
    \30\ See also BAMM Letter.
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A. ECN Participation

    Bloomberg believed that the proposal ``unnecessarily denies [ECNs] 
the opportunity to use SuperMontage's facilities in the way all other 
market participants can use them.'' The basis of Bloomberg's assertion 
was that market makers and OE Firms receive post-trade anonymity when 
taking and posting liquidity, but ECNs benefit from post-trade 
anonymity only when taking liquidity and not when posting liquidity. 
Bloomberg suggested that a viable solution would be to keep the 
execution report anonymous while providing broker-dealers with 
information after settlement disclosing an aggregate total of fees a 
broker-dealer had accumulated through an ECN. Bloomberg also opined 
that the disparate treatment puts ECNs at a competitive disadvantage, 
which is in contravention of sections 15A(b)(6) and 15A(b)(9) of the 
Act.\31\
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    \31\ Furthermore, Bloomberg noted that they are not currently 
able to use the SIZE facility, because SuperMontage does not provide 
a ``locked/crossed'' warning message as SuperMontage does for 
quotations entered by Order Delivery ECNs under their own acronyms. 
Without such warning, Bloomberg stated they will not be able to 
avoid the possibility of double execution. See Bloomberg Letter. 
Nasdaq, in its response, stated that it would be implementing a 
systems change to address the double execution issue. See Nasdaq 
Response Letter.
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    Nasdaq responded to Bloomberg's concerns regarding the disparate 
treatment of ECNs.\32\ Nasdaq stated that the proposal balances the 
need for post-trade anonymity with an ECN's ability to charge quote 
access fees and not accept automatic executions in SuperMontage. Nasdaq 
opined that there is a reasonable distinction between how ECNs and 
other members participate in SuperMontage, and that the special 
accommodations that have been made to allow ECNs to participate in 
SuperMontage are not discriminatory. According to Nasdaq, the anonymity 
feature is designed to provide ECNs the information they need to 
administer their access fees. Similarly, revealing the ECN's identity 
provides other members information they desire to monitor these fees. 
In contrast, market makers and OE Firms are not permitted to charge 
quote access fees, and they must accept automatic executions in 
SuperMontage. Accordingly, similar accommodations are not necessary 
when these parties execute trades with each other in SuperMontage.
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    \32\ See Nasdaq Response Letter.
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    Furthermore, Nasdaq asserted that its proposal cannot be deemed 
discriminatory when it is the ECN's decision that would result in the 
inability to remain anonymous. In Nasdaq's view, an ECN's ability to 
retain anonymity when its quote is hit through SIZE is a result of the 
way the ECN chooses to participate in SuperMontage (charging a quote 
access fee and not accepting automatic executions), and not a result of 
Nasdaq's unfair discrimination. Nasdaq stated that Bloomberg's 
suggestion to preserve the contra-party anonymity for SIZE trades that 
hit the quote of Order Delivery ECNs, would ``impose additional costs 
and burdens on other members and Nasdaq, not to mention that it would 
be unfair to those members that traded with Bloomberg to expose their 
identities immediately while masking Bloomberg's identity until the end 
of the day. Nasdaq believes these costs and burdens are unnecessary in 
light of the other options available to ECNs seeking full anonymity.''

B. Risk Management

    BAMM and Citigroup believed that Nasdaq adequately addressed 
certain operational or regulatory issues in its proposal, such as back 
office processing \33\ and risk exposure.\34\ For example, Citigroup 
believed that the intra-day concentration report would assist members 
with measuring their exposure if one or all of their contra-parties 
failed to settle all trades

[[Page 56364]]

executed anonymously. According to Citigroup, members could then 
determine whether any risk-limiting actions should be taken. 
Additionally, by revealing the identities of those listed on the intra-
day concentration report, members would know the exact dollar value of 
their aggregate purchases and sales with individual contra-parties. 
Citigroup believed that this added level of information about risk 
concentration and exposure should give members and their clearing firms 
better tools to limit their risk. Citigroup also believed that risk to 
clearing member firms should be reduced substantially because 
SuperMontage would provide trade information to the NSCC on a real-time 
basis.
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    \33\ See BAMM Letter.
    \34\ See Citigroup Letter.
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    Bloomberg and Brut expressed concern, however, that the proposal 
imposes new or increased financial risk on market participants. The 
commenters noted that from the time of the transaction until midnight 
of T+1, when the NSCC steps in as guarantor, the broker-dealer would be 
exposed to the risk of the anonymous contra-party's failure to settle a 
transaction. Brut questioned whether the proposal was worth such 
incremental risk, and whether Nasdaq should assume fiscal 
responsibility for such trades like ECNs and other providers of 
anonymous transaction services. Bloomberg also noted that specialists 
stand as guarantors of trades on SuperDot on the New York Stock 
Exchange (``NYSE''), and ECNs stand as the guarantors of anonymous 
trades within their internal systems.
    In response to comments that the proposal increases risk, Nasdaq 
stated that there would be ``little, if any, effect on a clearing 
firm's ability to monitor trading by itself or its correspondents.'' 
\35\ Specifically, Nasdaq asserted that Nasdaq and the NSCC would know 
the identities of the members who traded using the anonymity feature. 
Furthermore, Nasdaq noted that members trading anonymously and 
individual trades executed anonymously, would be subject to NSCC's full 
risk management systems and included in ACT's risk management 
calculations. Nasdaq stated that a member's ability to assess its 
contra-party risk through the use of intra-day reports would be 
affected only to the degree the member uses its contra-parties' 
identities on a trade-by-trade intra-day basis. Nasdaq also disagreed 
with the assertion that a systemic risk is created by Nasdaq's 
unwillingness to guarantee settlement of anonymous trades in the period 
between execution and the attachment of the NSCC guarantee. Nasdaq 
asserted that currently members are subject to the same risk that their 
contra-party, including ECNs, will default before the NSCC guarantee 
attaches.
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    \35\ See Nasdaq Response Letter.
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C. Books and Records

    Brut also commented that broker-dealers have certain recordkeeping 
requirements, such as recording the name or other designation of the 
person that is the contra-party to the transaction. Brut recommended, 
notwithstanding Nasdaq's representation that it would retain records to 
satisfy the recordkeeping requirements under Rule 17a-3 under the Act, 
that the Commission explicitly grant broker-dealers relief from the 
rule for transactions effected through SIZE. With regard to Brut's 
concerns regarding a broker-dealers obligations under Rule 17a-3, 
Nasdaq stated that it was a matter for the Commission to resolve.\36\
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    \36\ Id. See infra discussion at note 56 and accompanying text.
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D. Operation of Help Desk

    Brut also expressed concern that completely anonymous trades 
between broker-dealers could create difficulties in resolving erroneous 
or disputed trades, which typically are resolved through direct broker-
to-broker communication. Brut suggested that the Commission should 
ensure that the help desk has adequate resources and procedures to 
prevent unfair discrimination by Nasdaq in the resolution of disputes 
among SIZE users.
    In response to Brut's concerns regarding the resolution of disputed 
trades, Nasdaq noted that erroneous trades, whether anonymous or not, 
may be resolved in accordance with NASD Rule 11890.\37\ Further, Nasdaq 
clarified that the Market Operations Department would also be 
responsible for responding to requests from members.\38\ Nasdaq staff 
would resolve disputes when the members choose not to utilize the 
clearly erroneous trade adjudication process provided in NASD Rule 
11890. According to Nasdaq, Nasdaq staff would only effectuate the 
resolutions agreed to by the members who are the parties to the trade; 
Nasdaq staff will not issue independent decisions.\39\
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    \37\ Id.
    \38\ See Amendment No. 4, supra note 9.
    \39\ According to Nasdaq, the existence of the help desk does 
not preclude members from pursuing other means to resolve disputed 
anonymous trades. For example, a member can seek arbitration to 
resolve a disputed trade. Nasdaq would reveal a contra-party's 
identity upon receiving a written request from a member, who is a 
party to the disputed trade, which indicates the information is 
being requested for the purposes of pursuing a claim in arbitration. 
According to Nasdaq, revealing a contra-party's identity so that a 
member can pursue its right to arbitrate is consistent with Nasdaq's 
authority, under proposed Rule 4719(c)(2), to reveal a contra-
party's identity for regulatory purposes. See Amendment No. 4, supra 
note 9.
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IV. Discussion

    The Commission has carefully reviewed the proposed rule change, the 
comment letters, and Nasdaq's response and finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities association.\40\ In particular, the Commission finds that 
the proposed rule change, as amended, is consistent with section 15A of 
the Act.\41\ Specifically, the Commission finds that the proposed rule 
change is consistent with section 15A(b)(6) of the Act because it is 
designed to promote just and equitable principals of trade, 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.\42\
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    \40\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \41\ 15 U.S.C. 78o-3.
    \42\ 15 U.S.C. 78o-3(b)(6).
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    The Commission finds that Nasdaq's proposal to generally extend 
anonymity through clearance and settlement of a trade, subject to 
certain exceptions, to be consistent with the Act. The Commission notes 
that post-trade anonymity is not new \43\ and is offered by other 
market participants, including the Pacific Stock Exchange Equities 
(``PCXE'').\44\ As a result, the Commission does not believe that 
Nasdaq should be prohibited from offering similar services. The 
Commission believes that the SuperMontage post-trade anonymity feature 
should allow Nasdaq to offer some of the same benefits associated with 
anonymity, such as minimizing the market impact of institutional 
orders. As expressed by commenters, trading information can have an 
impact on the price of a security.\45\ For example, Citigroup stated 
that other market participants will adjust their trading

[[Page 56365]]

strategy, if they see a pattern in which they see Citigroup or another 
broker or dealer that normally handles institutional orders actively 
buying a stock, in anticipation of a strong buy demand. Citigroup 
compared this to the full anonymity offered by ECNs and exchanges that 
prevents market sensitive data from being disseminated on a real-time 
basis.
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    \43\ See Securities Exchange Act Release No. 37619A (September 
6, 1996), 61 FR 48290, 48310, note 243 and accompanying text 
(September 12, 1996) (adopting Rule 11Ac1-4 and amending Rule 11Ac1-
1) (discussing the benefits of anonymous trading).
    \44\ See PCXE Rules 7.7 and 7.36(b).
    \45\ See BAMM, Citigroup and STA letters.
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    The Commission recognizes that in certain securities, specific 
market makers may be viewed as price leaders, and other market 
participants may follow the quoting patterns of such market makers, 
which could result in price changes that frustrate a firm's ability to 
efficiently work large orders for its customers or obtain executions at 
improved prices. Therefore, the Commission believes that Nasdaq's 
proposal may reduce the type of market intelligence that can contribute 
to market impact. Further, the Commission believes that the proposal 
may assist broker-dealers in their efforts to satisfy their duty of 
best execution in working customer orders.
    The Commission notes that one commenter stated that the proposal 
``discriminates unfairly'' against ECNs because the execution reports 
would reveal contra-party identity when the quote of an Order Delivery 
ECN is decremented.\46\ Another commenter, however, expressed concern 
that Nasdaq and market participants must make special accommodation for 
fee-charging ECNs.\47\ The Commission believes that the contra-party 
identity exception does not unfairly discriminate against Order 
Delivery ECNs. Instead, the Commission believes that Nasdaq has 
attempted to accommodate the business models of ECNs and the manner 
that they participate in SuperMontage.
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    \46\ See Bloomberg Letter.
    \47\ See Citigroup Letter.
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    In the Notice, Nasdaq explained that trades executed with Order 
Delivery 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 its quote access fee.\48\ 
Thus, to provide fee-charging Order Delivery ECNs with the opportunity 
to reject trades with certain members, Nasdaq determined to continue to 
disclose each contra-party's identity in trades through SIZE where one 
of the contra-parties is a liquidity providing, fee-charging Order 
Delivery ECN. Nasdaq believes that this exception also benefits members 
that execute against the fee-charging Order Delivery ECN by enabling 
them to track the fee charges accumulated with each Order Delivery ECN. 
OE Firms and market makers must accept automatic executions in 
SuperMontage and do not charge access fees. Therefore, the same 
disclosure of contra-party information is not required.
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    \48\ See Notice, supra note 5.
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    As a result, the Commission believes that the proposed rule change 
reasonably accommodates the different entities; Order Delivery ECNs 
that charge access fees, market makers, OE Firms, and ECNs that do not 
charge a fee. As noted by Nasdaq, an ECN may alter the way it 
participates in SuperMontage to achieve full anonymity. Further, the 
Commission notes the original SuperMontage filing was amended, in 
response to ECN comments, to reveal the identity of Nasdaq market 
participants trading through SIZE by affixing the MPID of the sender on 
delivered orders and identifying the contra-parties in execution 
reports.\49\ With regard to trade reports, the system will essentially 
work in the manner that it does today for Order Delivery ECNs when 
their quote is hit, which permits them to evaluate their risk on a 
trade-by-trade basis.\50\ Accordingly, the Commission believes that 
Nasdaq has reasonably balanced the divergent interests of its members 
in a manner that is consistent with the Act.
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    \49\ Specifically, Nasdaq amended the original SuperMontage 
filing, in response to comments regarding credit risk by Bloomberg 
and Island, so that execution reports immediately revealed the 
identities of contra-parties for trades that occurred through SIZE. 
See Securities Exchange Act Release No. 43863 (January 19, 2001), 66 
FR 8020, 8033 (January 26, 2001) (``Original SuperMontage Approval 
Order'').
    \50\ Bloomberg suggested that Nasdaq could have opted to reveal 
the contra-party identity through an execution file at the end of 
the trading day. Nasdaq, however, believed it would be unfair to 
those members that traded with Bloomberg to expose their identities 
immediately while masking Bloomberg's identity until the end of the 
day. See Nasdaq Response Letter.
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    The Commission believes that Nasdaq has also adequately addressed 
concerns related to risk management. In particular, under the proposed 
rule change, Nasdaq will: (1) Provide 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; (2) 
report the identities of the members and the aggregated trading listed 
on the intra-day concentration reports after 4 p.m. Eastern Time; (3) 
provide the NSCC with real-time trade information for trades executed 
in SuperMontage; and (4) coordinate disclosure with the NSCC of trades 
executed anonymously with a firm that the NSCC has ceased to act for 
and any firms that cleared through that the NSCC participant.
    The Commission believes that this information will assist market 
participants in managing their risk. The Commission emphasizes that the 
NSCC and Nasdaq will continue to maintain the identities of all contra-
parties for trades that occur through SIZE. In particular, the NSCC 
will be able to continue its normal risk management functions and 
settle anonymous trades in the manner that it does today. The only 
difference will be that the NSCC will withhold the identities of the 
contra-parties on the contract sheets issued to participants to 
preserve anonymity through settlement.
    The Commission also believes that the proposal should enhance 
NSCC's ability to incorporate trade execution information into its risk 
analysis since Nasdaq will be providing this information on a real-time 
basis. The Commission believes that this may assist the NSCC in 
deciding sooner 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. The Commission notes that 
Nasdaq developed this process in conjunction with the NSCC and believes 
that it is consistent with section 15A(b)(6), which requires, in part, 
that the rules of the NASD foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities.\51\
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    \51\ See Securities Exchange Act Release Nos. 48122 (July 2, 
2003), 68 FR 41410 (July 11, 2003) (Notice of File No. NSCC-2003-14) 
and 48526 (September 23, 2003) (Order approving File No. NSCC-2003-
14 to allow NSCC to list an acronym instead of the actual contra-
side for a trade in its report of trade data to members).
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    The Commission notes that Bloomberg and Brut stated that the 
proposal created a systemic risk due to Nasdaq's failure to guarantee 
trades prior to the attachment of the NSCC guarantee at T + 1.\52\ 
After carefully considering these comments and Nasdaq's response, the 
Commission does not believe that the proposed rule change adds new risk 
that does not currently exist for Nasdaq market participants. 
Currently, Nasdaq does not act as a guarantor of trades prior to the 
NSCC guarantee attaching, \53\ and

[[Page 56366]]

Nasdaq members are obligated to settle all matched trades reported to 
the NSCC prior to the NSCC guarantee.\54\ This proposal does not change 
the responsibilities of Nasdaq, its members, or the NSCC. The 
Commission notes that, like today, a firm's primary exposure prior to T 
+ 1, when the NSCC guarantee attaches, would be its contra-party 
defaulting on the trade. This risk exists today. Further, to the extent 
that market participants are concerned with their ability to 
effectively monitor and manage their risk exposure as a result of 
anonymous trades, the Commission notes that Nasdaq will provide intra-
day concentration reports that will disclose a member's aggregate 
dollar value of purchases and sales with other members with whom it has 
traded anonymously. This information should assist members in 
calculating a worst-case scenario and allow them to take risk-limiting 
actions, if desired.
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    \52\ Generally, transactions are guaranteed as of the later of: 
(i) Midnight of T + 1, and (ii) midnight of the day they are 
reported as compared or as of midnight on the day they appear on T-
Contracts for locked-in trades See Addendum K to NSCC Rules and 
Procedures for additional explanation.
    \53\ See NASD Rule 4705(g). The Commission notes that other 
self-regulatory organizations expressly disclaim any liability that 
arises from the use of their facilities. See e.g., NYSE 
Constitution, Article II, Section 6, American Stock Exchange 
Constitution, Article 4, Section 1(e), and PCXE Rules 7.42 and 13.2.
    \54\ See NASD Rules 4712 and 6160.
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    The Commission has long held the view that competition and 
innovation are essential to the health of the securities markets. 
Indeed, competition is one of the hallmarks of the national market 
system. The Commission believes that the post-trade anonymity feature 
being proposed by Nasdaq is a reasonable effort by the NASD to enhance 
the quality of the Nasdaq market and provide market participants with 
the benefits of anonymity currently being offered by ECNs and PCXE. The 
Commission notes that to the extent that market participants are 
unwilling to trade in SuperMontage because of concerns regarding risk, 
broker-dealers may continue to use other alternative order routing and 
execution services such as ECNs, which guarantee trades executed 
through their systems, exchanges trading Nasdaq securities pursuant to 
unlisted trading privileges, and the NASD's alternative display 
facility.
    Brut also requested that the Commission clarify a broker-dealer's 
obligations under Rule 17a-3 under the Act with respect to completely 
anonymous transactions on SuperMontage. Rule 17a-3(a)(1) under the Act 
requires that broker-dealers make and keep current records of all 
purchases and sales of securities, including ``the name or other 
designation of the person from whom purchased or received or to whom 
sold or delivered.'' Rule 17a-4(a) under the Act requires that the 
records be preserved for six years, the first two years ``in an easily 
accessible place.'' Nasdaq has represented and codified in its rules 
that it will, except in limited circumstances, retain for the period 
specified in Rule 17a-4(a) a record of the identities of the members 
that execute anonymous trades through SuperMontage in its original form 
or a form approved under Rule 17a-6.\55\ Commission staff will not 
recommend enforcement action to the Commission if, in lieu of making 
and preserving a separate record, the broker-dealer relies on Nasdaq's 
retention of the identities of members that execute anonymous trades 
through SuperMontage to satisfy the requirements of Rules 17a-3(a)(1) 
and 17a-4(a) under the Act.\56\
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    \55\ See Amendment Nos. 2, 4, 5, and 7, supra notes 4, 9, 10, 
and 12, respectively.
    \56\ The Commission notes that a broker-dealer has the 
responsibility to make, keep current, and preserve records of all 
purchases and sales of securities in accordance with Exchange Act 
Rules 17a-3 and 17a-4 for trades through SuperMontage if the broker-
dealer knows the identity of the contra-party, including those 
instances where Nasdaq discloses the contra-party to a trade (e.g., 
internalized trades). Also, a member that submits a Non-Attributable 
Quote/Order that is a Preferenced Order to another member retains 
the recordkeeping responsibilities described above because that 
member would know the identity of the contra-party to which it sent 
the Preferenced Order. In addition, even where the broker-dealer 
does not know the identity of the contra-party, the broker-dealer 
retains the responsibility to maintain such records, except for a 
record of the identity of the contra-party.
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    Brut also suggested that the Commission review the procedures and 
resources that Nasdaq will dedicate to the help desk to coordinate the 
resolution of erroneous or disputed trades for anonymous contra-
parties. The Commission believes that Nasdaq has adequately responded 
to Brut's comments. As Nasdaq clarified, market participants involved 
in anonymous trades can use NASD Rule 11890 to resolve erroneous 
transactions, as well as the help desk. Further, market participants 
will continue to be able to arbitrate trades since Nasdaq will provide 
the identity of a contra-party in those instances where one party 
wishes to arbitrate a dispute.\57\ The Commission expects that Nasdaq 
will continue to monitor its procedures and the adequacy of the help 
desk resources as post-trade anonymity is utilized and, if necessary, 
provide additional resources to ensure the maintenance of a fair and 
orderly market.
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    \57\ See Nasdaq Response Letter.
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    The Commission finds good cause for accelerating approval of 
Amendment Nos. 3, 4, 5, and 7 prior to the thirtieth day after the date 
of publication of notice thereof in the Federal Register. Amendment No. 
3 merely clarifies the process by which the Nasdaq would remove a 
member from SuperMontage if the member failed to maintain a clearing 
relationship, and makes non-substantive conforming changes to NASD 
Rules 4705, 5012, and 6120. Amendment No. 4 merely: (1) Conforms its 
rule text to reflect the mandatory nature of certain disclosures as 
described in the Notice, (2) responds to comments regarding the 
operation of the help desk, (3) clarifies Nasdaq's commitment to retain 
certain records, and (4) ensures that members will be able to satisfy 
their obligations under Rule 10b-10.\58\ Amendment Nos. 5 and 7 merely 
codify Nasdaq's earlier representation in Amendment Nos. 2 and 4 
regarding its retention of information on behalf of its members. The 
Commission notes Amendment No. 2, which includes Nasdaq's general 
representation that it would retain contra-party information on behalf 
of its members, was published for notice and comment. Only one comment, 
that the Commission be explicit in granting relief, was received on the 
issue. The Commission believes that these amendments merely clarify the 
recordkeeping obligations of Nasdaq and its market participants, assist 
Nasdaq members in complying with their Rule 10b-10 obligations, and do 
not raise any substantive issues. The Commission finds specifically 
that Amendment Nos. 3, 4, 5, and 7 are consistent with section 
15A(b)(6) of the Act as they are designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest.\59\ Accordingly, pursuant to section 19(b)(2) of the 
Act,\60\ the Commission finds good cause to approve Amendment Nos. 3, 
4, 5, and 7 prior to the thirtieth day after notice of the Amendment is 
published in the Federal Register.
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    \58\ See also Rule 10b-10 Exemption Request, supra note 23. The 
Division, pursuant to delegated authority, granted limited exemptive 
relief from the contra-party identity requirement of Rule 10b-
10(a)(2)(i)(A) to NASD members using the post-trade anonymity 
feature. Letter from Brian A. Bussey, Assistant Chief Counsel, 
Division, Commission, to Edward S. Knight, Executive Vice President, 
Nasdaq, dated September 23, 2003.
    \59\ 15 U.S.C. 78o-3(b)(6).
    \60\ 15 U.S.C. 78s(b)(2).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 3, 4 5, and 7, including whether 
Amendment Nos. 3, 4, 5, and 7 are consistent with the Act. Persons 
making written submissions should file six copies thereof with the 
Secretary,

[[Page 56367]]

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 Amendment Nos. 3, 4, 5, and 7 that 
are filed with the Commission, and all written communications relating 
to Amendment Nos. 3, 4, 5, and 7 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 will also 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 October 21, 2003.

VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\61\ that the proposed rule change (SR-NASD-2003-85), as amended, 
be, and hereby is, approved.\62\
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    \61\ 15 U.S.C. 78s(b)(2).
    \62\ Nasdaq intends to implement the proposed rule change on 
September 29, 2003. Telephone conversation between Peter R. 
Geraghty, Associate Vice President and Associate General Counsel, 
Nasdaq, and Marc McKayle, Special Counsel, Division, Commission, on 
September 23, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\63\
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    \63\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-24757 Filed 9-29-03; 8:45 am]
BILLING CODE 8010-01-P