June 22, 2001
Richard G. Ketchum
Re: Request for Interpretive Guidance and Exemptions Under Rule 11Ac1-5
Dear Mr. Ketchum:
In your letter dated June 20, 2001 ("Letter") on behalf of the Nasdaq Stock Market, Inc. ("Nasdaq"), you requested that the Division of Market Regulation ("Division") issue interpretive guidance and that the Commission exempt certain orders from Rule 11Ac1-5 ("Rule") under the Securities Exchange Act of 1934 ("Exchange Act"). Specifically, given the significant changes to Nasdaq's SelectNet system that will accompany the phase-in of the SuperSOES rules in July 2001,1 your request relates to the application of the Rule to SuperSOES and SelectNet in light of these changes. This letter responds to your request.
Adopted in November 2000,2 the Rule generally requires a "market center" (as defined in the Rule) that trades national market system securities to make available to the public monthly electronic reports that include uniform statistical measures of execution quality. On April 12, 2001, the Commission issued a temporary exemption from the reporting requirements of the Rule until July 31, 2001 for Nasdaq securities.3 Accordingly, the first monthly reports (for August 2001) under the Rule for the 2000 most actively traded Nasdaq securities must be made available to the public by no later than the end of September 2001.4
The Letter notes that the quotes of Nasdaq market makers currently can be accessed both through SOES for limited types of orders and, more generally, through SelectNet preferenced orders. The implementation of the SuperSOES rules, among other things, will replace SelectNet and establish SuperSOES as the primary means for accessing, through automatic execution, the quotes of market makers, as well as the quotes of other types of market participants that agree to accept automatic executions through SuperSOES (collectively, "SuperSOES Participants"). Nasdaq intends and believes that all Nasdaq securities subject to the Rule will be phased into SuperSOES by July 30, 2001, contingent upon successful testing of the new system.
Under Nasdaq rules, when SuperSOES is phased in for a security any SelectNet participant (with one exception discussed below) that wishes to preference a SuperSOES Participant through SelectNet may do so only by sending orders that are all-or-none ("AON") orders or minimum acceptable quantity ("MAQ") orders, either of which must be for a size that is at least 100 shares greater than the displayed amount of the preferenced participant's quoted size. Firms participating in SelectNet that are not SuperSOES Participants, however, would continue to received preferenced orders through SelectNet for sizes equal to or less than their quoted size. The Letter requests an interpretation that the AON and MAQ orders received by SuperSOES Participants through SelectNet would not be a "covered order" as defined in paragraph (a)(8) of the Rule.
The sole exception to the general rule that SuperSOES Participants will not receive preferenced orders through SelectNet for sizes equal to or less than their displayed quoted size relates to exchanges that trade Nasdaq securities pursuant to unlisted trading privileges that are not SuperSOES Participants ("UTP Exchanges"). Such UTP Exchanges may continue to use SelectNet to access the quotes of SuperSOES Participants. To spare SuperSOES Participants the expense of developing systems to capture this small subset of orders, the Letter requests an exemption from the Rule's definition of covered order for preferenced SelectNet orders received by SuperSOES Participants from UTP Exchanges that are not SuperSOES Participants.
The Letter also notes that the SuperSOES rules will modify SOES, which will be recast as the Nasdaq National Market Execution System and deliver automatic executions pursuant to the SuperSOES rules. Accordingly, Nasdaq believes that it should be considered the market center, as defined in the Rule, for SuperSOES orders, rather than the SuperSOES Participant whose quotes are accessed by the orders.
Finally, the Letter states that it is possible that unforeseen events could delay the successful testing and full implementation of SuperSOES. Given that market centers are required to begin reporting on transactions in Nasdaq securities on August 1, Nasdaq requests a temporary exemption for SuperSOES Participants from reporting on SelectNet preferenced orders in the event that SuperSOES is not fully implemented by August 1.
The Division previously has addressed the application of the Rule to SOES and SelectNet, as they currently operate.5 It expressed the view that SOES, which delivers automatic executions for limited types of orders, is itself a market center for which Nasdaq must issue monthly reports.6 SelectNet, in contrast, is merely an order routing system that does not deliver automatic executions and is not a separate market center. Consequently, market centers that receive preferenced orders through SelectNet to access their displayed quotes must report on those orders under the Rule.
The basis for the Division's view is the need for public information concerning the quality of executions provided through systems that offer general access to public quotes. One of the major objectives of the Rule is to address problems associated with market fragmentation. Systems that link market centers and provide an important means of access to the public quotes of market centers help address fragmentation and maintain the integrity of the public quote stream.7 These vital functions will be furthered by the public availability of information on the execution of orders routed through these systems.
Given Nasdaq's intention and belief that significant changes to SelectNet and SOES will be phased in by July 30, however, it is necessary to update the views previously expressed by the Division. Most importantly, SuperSOES will replace SelectNet as the primary means of access to the public quotes of SuperSOES Participants, while SelectNet will remain an important means of general access to the quotes of firms that are not SuperSOES Participants.
The Division agrees with Nasdaq's view that SuperSOES (also referred to as the Nasdaq National Market Execution System) is a market center for which Nasdaq should issue monthly reports under the Rule. Consequently, the market centers against whose quotes SuperSOES delivers an automatic execution would not be required to report on these transactions. Importantly, however, a market center that first receives orders for execution and then chooses to route them away to SuperSOES for execution would continue to be required to report on these orders (including them, for example, in its monthly reports as "shares of covered orders executed at any other venue").
The Division also agrees with Nasdaq's view that AOL and MAQ orders routed through SelectNet to SuperSOES Participants for amounts at least 100 shares greater than the firm's displayed quote would not be covered orders, as defined in paragraph (a)(8) of the Rule. The definition excludes orders for which the customer requests special handling, including, but not limited to, orders to be executed only at their full size. Given the minimum size restrictions on AOL and MAQ orders routed through SelectNet, thereby eliminating SelectNet as a general means to access the firm's public quote, the Division believes that they are appropriately excluded from covered orders. For market centers that are not SuperSOES Participants (such as an ECN), however, SelectNet will remain an important means of general access to their quotes. Accordingly, such market centers must report on these orders under the Rule (assuming they are not otherwise excluded from the Rule).
Even SuperSOES Participants may continue to receive SelectNet preferenced orders from UTP Exchanges for a size equal to or less than the amount of the firm's quoted size. Given the ready access that automatic executions through SuperSOES will provide to the quotes of SuperSOES Participants, as well as the potentially significant costs associated with developing systems to report only on a small number of SelectNet orders, the costs necessary to implement reporting on the orders would outweigh the benefits of the reported information. Consequently, the Commission, by the Division pursuant to delegated authority,8 finds that an exemption for these orders is necessary or appropriate in the public interest, and is consistent with the protection of investors. It therefore is exempting from the definition of covered order in paragraph (a)(1) of the Rule the SelectNet preferenced orders routed to a SuperSOES Participant by a UTP Exchange.
Finally, in the event that the phase-in of SuperSOES, contrary to Nasdaq's current belief, is not completed by July 30, 2001, the Commission, by the Division pursuant to delegated authority, also is exempting all SelectNet preferenced orders routed to SuperSOES Participants in Nasdaq securities for which the phase-in has not been completed. Given the likely brief duration of the interim period before full phase in of SuperSOES, the Commission finds that the exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors.
The interpretive views expressed in this letter are those of the Division only. The Commission is not bound by these views and may interpret the Rule as it deems necessary or appropriate in the public interest or for the protection of investors. Because this position is based on the representations made to the Division, any different facts or conditions might require different conclusions.
In addition, the exemptions granted in this letter are subject to modification or revocation at any time if the Commission determines that such action is necessary or appropriate in the public interest or otherwise in furtherance of the purposes of the Exchange Act.
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.
Annette L. Nazareth