[Federal Register Volume 78, Number 129 (Friday, July 5, 2013)]
[Notices]
[Pages 40523-40525]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-16075]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69892]


Order Exempting Market Makers Participating in NASDAQ Stock 
Market LLC's Market Quality Program From Section 11(d)(1) of the 
Securities Exchange Act of 1934 and Rule 11d1-2 Thereunder

June 28, 2013.
    On March 13, 2013, the Securities and Exchange Commission 
(``Commission'') approved a proposed rule change of the NASDAQ Stock 
Market LLC (``Exchange'' or ``NASDAQ'') to add new

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NASDAQ Rule 5950 (``New Rule 5950'') to establish the Market Quality 
Program (``MQP'' or ``Program'').\1\ In connection with the Program, on 
a voluntary pilot basis, an MQP Company \2\ may list an eligible MQP 
Security \3\ on NASDAQ and in addition to the standard (non-MQP) NASDAQ 
listing fee, a sponsor may pay a fee (``MQP Fee'') \4\ that will be 
used for the purpose of incentivizing one or more market makers 
participating in the MQP (``MQP Market Makers'') to enhance the market 
quality of an MQP Security.
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    \1\ Securities Exchange Act Release No. 69195, (Mar. 20, 2013) 
(``Approval Order''). The Approval Order contains a detailed 
description of the MQP. On December 7, 2012, NASDAQ filed with the 
Commission, pursuant to Section 19(b)(1) of the Securities Exchange 
Act of 1934, as amended (``Act'' or ``Exchange Act'') and Rule 19b-4 
thereunder, a proposed rule change to establish the MQP. The 
proposed rule change, as modified by Amendment No. 1 thereto, was 
published for comment in the Federal Register on December 31, 2012. 
Securities Exchange Act Release No. 68515 (Dec. 21, 2012), 77 FR 
77141 (Dec. 31, 2012) (``Notice''). On February 7, 2013, NASDAQ 
submitted Amendment No. 2 to the proposed rule change. On February 
8, 2013 NASDAQ withdrew Amendment No. 2 due to a technical error in 
that amendment and submitted Amendment No. 3 to the proposed rule 
change. As noted in the Approval Order, Amendment No. 3 provided 
clarification to the proposed rule change and did not require notice 
and comment. On February 14, 2013, the Commission designated a 
longer period within which to take action on the proposed rule 
change. Securities Exchange Act Release No. 68925 (Feb. 14, 2013), 
78 FR 12116 (Feb. 21, 2013). The Approval Order grants approval of 
the proposed rule change, as modified by Amendment Nos. 1 and 3.
    \2\ The term ``MQP Company'' means the trust or company housing 
the exchange traded fund (``ETF'') or, if the ETF is not a series of 
a trust or company, then the ETF itself. New Rule 5950(e)(5).
    \3\ The term ``MQP Security'' means an ETF security issued by an 
MQP Company that meets all of the requirements to be listed on 
NASDAQ pursuant to Rule 5705. New Rule 5950(e)(1).
    \4\ The MQP Fee, as described more fully in New Rule 5950(b)(2), 
consists of an annual basic MQP Fee, and may include an additional 
annual supplemental fee.
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    Section 11(d)(1) of the Exchange Act \5\ generally prohibits a 
broker-dealer from extending or maintaining credit, or arranging for 
the extension or maintenance of credit, on shares of new issue 
securities, if the broker-dealer participated in the distribution of 
the new issue securities within the preceding 30 days. The Commission's 
view is that shares of open-end investment companies and unit 
investment trusts registered under the 1940 Act, such as ETF shares, 
are distributed in a continuous manner, and broker-dealers that sell 
such securities are therefore participating in the ``distribution'' of 
a new issue for purposes of Section 11(d)(1).\6\
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    \5\ 15 U.S.C. 78k(d)(1).
    \6\ See, e.g., Exchange Act Release Nos. 6726 (Feb. 8, 1962), 27 
FR 1415 (Feb. 15, 1962) and 21577 (Dec. 18, 1984), 49 FR 50174 (Dec. 
27, 1984).
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    The Division of Trading and Markets, acting under delegated 
authority, granted an exemption from Section 11(d)(1) and Rule 11d1-2 
thereunder for broker-dealers that have entered into an agreement with 
an ETF's distributor to place orders with the distributor to purchase 
or redeem the ETF's shares (``Broker-Dealer APs'').\7\ The SIA 
Exemption allows a Broker-Dealer AP to extend or maintain credit, or 
arrange for the extension or maintenance of credit, to or for customers 
on the shares of qualifying ETFs subject to the condition that neither 
the Broker-Dealer AP, nor any natural person associated with the 
Broker-Dealer AP, directly or indirectly (including through any 
affiliate of the Broker-Dealer AP), receives from the fund complex any 
payment, compensation, or other economic incentive to promote or sell 
the shares of the ETF to persons outside the fund complex, other than 
non-cash compensation permitted under NASD Rule 2830(l)(5)(A), (B), or 
(C). This condition is intended to eliminate special incentives that 
Broker-Dealer APs and their associated persons might otherwise have to 
``push'' ETF shares.
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    \7\ See Letter from Catherine McGuire, Chief Counsel, Division 
of Trading and Markets, Securities and Exchange Commission to 
Securities Industry Association (Nov. 21, 2005) (``SIA Exemption'').
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    The MQP will permit certain ETFs to voluntarily incur increased 
listing fees payable to the Exchange. In turn, the Exchange will use 
the fees to make incentive payments to market makers that improve the 
liquidity of participating issuers' securities, and thus enhance the 
market quality for the participating issuers. Incentives payments will 
be accrued for, among other things, executing purchases and sales on 
the Exchange. Receipt of the incentive payments by certain broker-
dealers will implicate the condition of the SIA Exemption from the new 
issue lending restriction in Section 11(d)(1) of the Exchange Act 
discussed above. The Commission's view is that the incentive payments 
market makers will receive under the proposal are indirect payments 
from the fund complex to the market maker and that those payments are 
compensation to promote or sell the shares of the ETF. Therefore, in 
the absence of an exemption from Section 11(d)(1) and rule 11d1-2 
thereunder, an MQP Market Maker that is also a Broker-Dealer AP for an 
ETF (or an associated person or an affiliate of a Broker-Dealer AP) 
that receives the incentives will not be able to rely on the SIA 
Exemption from Section 11(d)(1).\8\
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    \8\ See Approval Order, supra note 1, at 32-33.
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    NASDAQ has requested, on behalf of itself and those MQP Market 
Makers who are broker-dealers (or any associated person or affiliate of 
such broker-dealers), exemptive, interpretive or no-action relief from 
the requirements of Section 11(d)(1) of the Exchange Act and Rule 11d1-
2 thereunder, in connection with certain payments from the Exchange to 
certain Market Makers participating in the MQP, as discussed in its 
letter.\9\
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    \9\ Letter from David M. Lynn, Morrison & Foerster LLP to David 
Blass, Chief Counsel, Division of Trading and Markets, Securities 
and Exchange Commission (June 27, 2013) (``Request Letter'').
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    NASDAQ believes that the MQP Credit should not disqualify a Broker-
Dealer AP or Non-AP Broker-Dealer from relying on the SIA exemption. 
Among other things, NASDAQ notes that the MQP Credit is provided only 
to MQP Market Makers that meet or exceed MQP market quality standards 
and that it will not act as an incentive for Broker-Dealer APs or Non-
AP Broker-Dealers to ``push'' the MQP Securities. In addition, many 
features of the MQP seek to improve the quality of the market for MQP 
Securities, enhance liquidity in participating MQP Securities, and 
reduce spreads and decrease the effective cost of investing in MQP 
Securities. NASDAQ notes that the MQP Credit attributable to sales of 
MQP Securities by an MQP Market Maker is modest at approximately 25% of 
the total MQP Credit, with the remainder attributable to purchases by 
the MQP Market Maker and quotes. The Exchange also notes the ``the 
unprecedented transparency of the MQP through a dedicated MQP Web page, 
will enable investors to understand the MQP and the roles of MQP 
Companies, MQP Market Makers and the Exchange within the Program.'' 
\10\
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    \10\ Request Letter at 14. Several Exchange Rules are designed 
to provide comprehensive and accessible disclosure to investors 
about the MQP Program through the Exchange's Web site or product-
specific Web sites. New Rules 5950(a)(1)(C) and 5950(c)(3) require 
the Exchange to provide notification on its Web site regarding: (i) 
the acceptance of an MQP Company (on behalf of an MQP Security) and 
an MQP Market Maker into the MQP; (ii) the total number of MQP 
Securities that any one MQP Company may have in the MQP; (iii) the 
names of MQP Securities and the MQP Market Maker(s) in each MQP 
Security, and the dates that an MQP Company, on behalf of an MQP 
Security, commenced participation in and withdrew or was terminated 
from the MQP; and (iv) any limit on the number of MQP Market Makers 
permitted to register in an MQP Security. New Rule 5950(a)(2)(D) 
requires the Exchange to provide notification on its Web site when 
it receives notification that an MQP Company (on behalf of an MQP 
Security) or an MQP Market Maker intends to withdraw from the MQP, 
including the date of actual withdrawal or termination from the MQP. 
Rule 5950(b)(1) requires the MQP Company to disclose on a product-
specific Web site for each product, that the MQP Security is in the 
MQP and to provide a link to the Exchange's MQP Web site. The 
Exchange will also post monthly reports concerning the efficacy of 
the MQP program to its Web site.

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[[Page 40525]]

    NASDAQ also believes that the potential market quality improvements 
of the MQP will be reduced if Broker-Dealers APs and non-AP Broker-
Dealers do not receive the requested exemption. NASDAQ asserts that the 
MQP incentives are designed to encourage market markers to participate 
in the Program and that it is desirable for as many market participants 
as possible to participate in the Program. The Commission recognizes 
that broker-dealers that have to choose between participating in the 
MQP and having the ability to rely on the SIA Exemption may determine 
for business reasons that they would prefer to benefit from the SIA 
Exemption and thus would decline to participate in the MQP.\11\ 
Therefore, we understand how the absence of an exemption from Section 
11(d)(1) could serve to reduce the number of MQP Market Makers in the 
Program.
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    \11\ NASDAQ reports that Broker-Dealer APs and Non-AP Broker-
Dealers believe that participating in the MQP in the absence of 
requested relief may ``present an unacceptable level of risk that 
may keep some market participants out of the Program.'' Request 
Letter, note 82. We choose not to speculate about the risk that 
these broker-dealers perceive, but we note that, even in the absence 
of exemption granted herein, a broker-dealer that receives MQP 
credits derived from sales of MQP Securities but that does not 
extend or maintain credit, or arrange for the extension or 
maintenance of credit, on shares of new issue MQP Securities for 
which the broker-dealer participated in the distribution within the 
preceding 30 days would not violate Exchange Act Section 11(d)(1).
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    The Commission finds that it is appropriate in the public interest, 
and is consistent with the protection of investors, to grant a limited 
exemption from Section 11(d)(1) of the Exchange Act and Rule 11d1-2 
thereunder to Broker-Dealer APs and Non-AP Broker-Dealers who 
participate in the MQP. The Program is intended to improve market 
quality by promoting enhanced liquidity, reduced spreads, and reduced 
cost of investing in MQP Securities. The Commission believes that 
granting the exemption will encourage a larger number of MQP Market 
Makers to participate in the program and that a larger number of MQP 
Market Makers should create greater potential for the market quality 
improvements the Program aims for. The Exchange determines to pay an 
MQP Credit only if an MQP Market Maker maintains a quality market in an 
MQP Security meeting certain spread and liquidity standards and that 
MQP payments are not intended to promote the sale of MQP Securities. 
The Commission believes that the portion of the MQP Credit attributable 
to sales of MQP Securities--approximately 25% of the MQP Credit, with 
the remainder attributable to purchases and quotations--may create a 
modest incentive for MQP Market Makers to promote the sale of MQP 
Securities, while creating an overall incentive for MQP Market Makers 
to enhance market quality. The Commission does not believe that this 
combination of incentives will provide the kind of ``share-pushing'' 
incentive with which Congress was concerned when it enacted Section 
11(d). The required Web site disclosures \12\ will also help Market 
Makers' customers understand the Program's effect on MQP Market Makers' 
incentives and thus will help investors to make informed decisions 
despite the potential additional sales pressure Market Makers may 
assert as a result of the MQP.
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    \12\ See note 10, supra.
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Conclusion

    It is therefore ordered, that Broker-Dealer APs and Non-AP Broker-
Dealers who participate in the MQP, may rely on the SIA Exemption 
pertaining to Section 11(d)(1) and Rule 11d1-2 thereunder,\13\ subject 
to the conditions provided in that exemption, notwithstanding that 
Broker-Dealer APs and Non-AP Broker-Dealers may receive MQP Credits 
derived in part from the sale of MQP Securities as described in your 
request.
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    \13\ See note 7, supra.
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    This exemption expires when the Program terminates, and is subject 
to modification or revocation at any time the Commission determines 
that such action is necessary or appropriate in furtherance of the 
purposes of the Exchange Act. This order does not represent Commission 
views with respect to any other question that the proposed activities 
may raise or the applicability of other federal or state laws and rules 
to the proposed activities.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(62).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-16075 Filed 7-3-13; 8:45 am]
BILLING CODE 8011-01-P