August 28, 2001
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Attention: Mr. Jonathan Katz, Secretary
Re: SEC File No. 10-131
Ladies and Gentlemen:
Bloomberg L.P.1 ("Bloomberg") and Bloomberg Tradebook LLC ("Bloomberg Tradebook)2 appreciate the opportunity to comment on the application by The Nasdaq Stock Market, Inc. ("Nasdaq") on Form 1 under the Exchange Act for registration as a national securities exchange (the "Form 1 Application") filed pursuant to Section 6(a) of the Exchange Act, which the Securities and Exchange Commission (the "Commission") published for comment in Securities Exchange Act Release No. 44396 (June 7, 2001). In connection with its Form 1 Application, Nasdaq also has filed a Form 10 under Section 12(g) of the Exchange Act for the purpose of registering its common stock for trading on Nasdaq.3 Where necessary, we have included below comments on Nasdaq's Form 10 and exhibits thereto.
The Commission's review of the Form 1 Amendment requires that it conduct a thoroughgoing, de novo review of the proposed operation of Nasdaq as an exchange independent of the National Association of Securities Dealers, Inc. (the "NASD").4 The principal substantive issues the Form 1 Application raises, and that we believe the Commission should require Nasdaq to resolve before granting its registration as a national securities exchange, include the following:
There are a number of bases on which the Commission should determine that it cannot conclude that the Form 1 Application, as currently filed, complies with the Exchange Act. We respectfully suggest that, before it can grant the registration, the Commission will have to require further amendment of the Form 1 Application and to resolve a number of policy issues. Several of these issues are discussed below.
Trade execution. Currently, there is no real alternative to Nasdaq's monopoly with respect to the execution of quotations/orders in securities traded via Nasdaq. Through a series of developments, starting with the inauguration of the Small Order Execution System ("SOES") in the 1980's and progressing through the development of SuperSOES and SuperMontage, Nasdaq has evolved from a decentralized, quotation- and telephone-based system into a screen-based, electronic communications network embodying an electronic limit order book. The interplay of SuperSOES and SuperMontage has transformed the previous quotation-driven market structure into a centralized, monopolistic market structure with an electronic central limit order book, producing a market center that permits far less competition than the former structure or even the New York Stock Exchange ("NYSE") during the heyday of Rule 390. NASD members can bypass SuperSOES through private wire connections between a market maker and a customer or dealer, but that means of avoiding SuperSOES is not on an equal competitive footing with the use of SuperSOES. Orders transmitted through SuperSOES impose obligations on the market maker to execute against its published quotation. Those obligations are not replicated by private wire connections. Only Nasdaq, with its Commission-approved SuperSOES rules, has the monopolistic power to execute transactions against market makers' quotations. Individual market participants do not have the market power to replicate that obligation through private contractual arrangements or other private ordering.
In the prior, decentralized, quotation-driven Nasdaq market, an NASD member could accept a market maker's bid or offer over the telephone or via private wire connections. SOES permitted a broker to transmit executions to market makers, regardless of time- and price-priority considerations. Today, however, in the SuperSOES/SuperMontage environment, the order entrant's ability to hit a bid or take an offer is limited to the market makers quoting prices at the National Best Bid and Offer, and then only in strict time priority. The order entrant's ability to "preference" market makers has been all but obliterated. It is true that an order-entry firm can negotiate with any Nasdaq market maker, but it does not have any ability to assign a "liability order" to the market maker outside of the SuperSOES/SuperMontage systems. As an ECN, Bloomberg Tradebook is obliged to live up to certain performance standards enforced by the Commission, including mandated response times for handling orders coming in through SelectNet. Market makers never have been subject to comparable, enforceable standards and were never given the choice of developing their own means of meeting those requirements. Instead, Nasdaq asked the Commission for the authority, and was granted the authority, to do it for them by turning quotations into executable orders. That step helped to transform the OTC market in Nasdaq-listed securities from a decentralized, competitive market to a centralized, monopolistic market. The resulting market power and revenue base position Nasdaq well for its intended initial public offering since it enjoys a captive audience, guaranteed revenues and a government-sponsored monopoly.
The competitive implications of that order-processing monopoly are significant and they substantially limit investor choice. Nasdaq has essentially succeeded in imposing through the SuperSOES/SuperMontage combination the equivalent of the very access fees to which market makers objected so strenuously when they were imposed by ECNs. These access fees go not to an ECN, but instead to another private company that is now proposing to go public, Nasdaq. Unlike ECN fees, to which market participants have several effective alternatives due to the expanding number of ECNs, there is no effective alternative to Nasdaq fees. Nasdaq retains through the consolidated limit order book an effective monopoly.
The Commission has previously approved both SuperSOES and SuperMontage.5 Of course, since those systems were presented piecemeal for decision, the implications of the combination and the accompanying restraints of trade were neither ventilated nor discussed at the time they were approved. Now that the Nasdaq Form 1 Application necessarily presents these pieces once again for de novo Commission consideration, in what should be an integrated mosaic, the interaction of these systems should be carefully evaluated.6 In our view, the application of those rules to Nasdaq's operation as a national securities exchange imposes inappropriate burdens on competition and impedes the mechanism of a free and open market and a national market system, in contravention of Sections 6(b)(5) and 6(b)(8) of the Exchange Act.
As filed, the Form 1 Application mentions only that SuperMontage will be implemented, but provides no detailed plan for its implementation. The filing does not currently provide an opportunity for review and comment regarding the SuperMontage system and does not allow the public or the Commission to determine whether factual predicates underlying the Commission's prior approval of the SuperMontage are or are not significantly changed by Nasdaq's becoming a national securities exchange. While SOES and the SuperMontage were, of course, the subject of extensive proceedings resulting in substantial changes before Commission approval of the pertinent rules, the related rules and facilities must be considered de novo in connection with their inclusion in Nasdaq's exchange application, particularly given the uncertainty as to how, for example, SuperMontage will interact with other facilities of the national securities exchanges, including but not limited to the Intermarket Trading System.
An alternative OTC market. Section 15A of the Exchange Act requires the NASD to maintain and monitor an active OTC market. Nasdaq's Form 10 notes that the "SEC has also indicated that the approval of Exchange Registration is linked to the NASD's obligation to provide an alternative facility to NASD members to trade exchange linked securities."7 According to Nasdaq, "it is likely that the NASD will be required to build a residual market for Nasdaq, NYSE and Amex listed securities."8 Neither Nasdaq's Form 1 Application nor Nasdaq's Form 10 addresses when such a market would be created. The Commission itself notes in the release publishing the Form 1 Application for comment that an alternative OTC market under the direction of the NASD, including a quotation- and transaction-reporting facility, must be operational upon Nasdaq's exchange registration.9
The Commission has correctly pointed to the need for the NASD to provide for an alternative OTC market that will compete with Nasdaq. Whether the NASD will be motivated to respond appropriately to that need remains to be seen, but the Commission has the tools to provide that motivation through its consideration of Nasdaq's Form 1 Application. Investors and the public interest are seriously affected by the lack of choice Nasdaq alone will provide in the absence of a vigorous third market in Nasdaq-listed securities. We respectfully request the Commission to press forward with its requirement that the NASD, in fact, provide for a competitive alternative to Nasdaq as a condition of approving Nasdaq's Form 1 Application. Such an alternative market should be so designed that it will provide market makers and order-entry firms a fair opportunity to obtain efficient execution of orders and that it will break the order-processing monopoly Nasdaq has perfected through the SuperSOES/SuperMontage combination, as more fully described below. The Commission should require the NASD to obtain Commission approval of the new market not later than the time the Commission approves the Nasdaq Form 1 Application.
There is today a scheme of regulation of OTC equity trading in securities that fall below the Nasdaq listing thresholds, such as "pink sheet" and "bulletin board" securities, but the NASD should establish a new system for the trading of securities that qualify for Nasdaq and are traded there. That system should apply a system of regulation of third-market trading in exchange-listed securities, and other aspects of OTC trading in equity and debt securities. If the requirement to provide for regulation of an appropriately configured OTC market is not fulfilled, the alternative OTC market to be supervised by the NASD would be inferior in all respects to the Nasdaq exchange. Perhaps by design, Nasdaq would have effectively orphaned the OTC market, particularly one that might compete with Nasdaq in "Nasdaq's" securities. As both a legal matter and a practical matter, the time to address those matters, the time when Nasdaq's energies and those of the NASD are likely to be most effectively mobilized to fulfill the statutory objectives identified by the Commission, is before Commission approval of Nasdaq's registration as a national securities exchange, not afterward.
Nasdaq itself has recognized the competitive implications of following the Commission's directive faithfully. In the Risk Factors section of the Nasdaq Form 10, it identifies the creation of a third market as a significant problem:
Nasdaq may face competition from the establishment of a residual market by the NASD.
In the SEC's January 2001 order approving SuperMontage, it noted that in order to address concerns that Nasdaq's position as an ESIP would compel participation in SuperMontage, the NASD has committed to provide NASD members with the ability to opt-out of SuperMontage by providing an alternative quotation and transaction reporting facility for NASD members. In addition, the SEC has also indicated that the approval of Exchange Registration is linked to the NASD's obligation to provide an alternative facility to allow NASD members to report trades and disseminate quotations in exchange listed securities. As a result, it is likely that the NASD will be required to build a residual market for Nasdaq, NYSE, and Amex listed securities. If this market becomes a viable alternative to Nasdaq, then Nasdaq faces the risk of reduced market share in transactions and market information services revenues, which would adversely affect Nasdaq's business, financial condition, and operating results.10
The very fact that Nasdaq views as a risk factor the NASD's obligation to comply with the Commission's requirement that it develop a third market in Nasdaq-listed securities underscores the importance that the NASD have the ability and resources to fulfill the obligation independently of Nasdaq. If the Nasdaq registration were declared effective without achieving the Commission's objective of providing for a viable and competitive OTC market that will compete with Nasdaq, the NASD would likely be placed in violation of the Exchange Act as construed by the Commission.11 Accordingly, we believe that the Commission should not approve Nasdaq's exchange registration without first satisfying itself that, immediately following Nasdaq's registration, the NASD itself will be in compliance with its obligations under the Exchange Act, the obligations that led the NASD in the late 1960's to create Nasdaq.12
The creation of such a market will not happen spontaneously. To make an alternative market possible, the Commission will have to insist that exclusionary rules in the SuperMontage/SuperSOES combination be modified so as to eliminate provisions that, in effect, impede third-market trading in Nasdaq-listed securities. Some 60 years ago, in the Multiple Trading Case, the Commission determined that rules of the NYSE that prohibited NYSE members from trading on regional exchanges in NYSE-listed stocks were against the public interest and illegal.13 Some 25 years ago, in enacting the Securities Acts Amendments of 1975 (the "1975 Amendments"), the Congress viewed with some skepticism the suggestion that the Commission should take action to bar third-market trading in exchange-listed securities. It permitted the Commission to take that action by rule only if the Commission found, on the record, that, among other things:
(1) As a result of transactions in such securities effected otherwise than on a national securities exchange the fairness or orderliness of the markets for such securities has been affected in a manner contrary to the public interest or the protection of investors;
(2) No rule of any national securities exchange unreasonably impairs the ability of any dealer to solicit or effect transactions in such securities for his own account or unreasonably restricts competition among dealers in such securities or between dealers acting in the capacity of market makers who are specialists in such securities and such dealers who are not specialists in such securities, and
(3) The maintenance or restoration of fair and orderly markets in such securities may not be assured through other lawful means under [the Exchange Act].14
The need to preserve free and open markets in the twenty-first century is no less important than it was in 1975 and the Commission's mandate under the Exchange Act remains unchanged. Unless the rules and systems of the Nasdaq market are adjusted to permit and encourage free movement back and forth between Nasdaq and the third market in Nasdaq-listed securities, the evils seen by the Commission in the Multiple Trading and PLOPR cases, and identified by the Congress in evaluating the pressures to kill the third market will come to pass. The strictures placed on Nasdaq members and Nasdaq market makers under the Nasdaq rules, unless the Commission relieves those strictures, are even more onerous and exclusionary than were imposed by the NYSE's now discarded and discredited Rule 390.15
The restrictions the SuperMontage/SuperSOES combination will impose on market makers and order-entry firms once SuperMontage goes into effect will create a market structure with no effective alternatives and, if unaltered by the Commission, with no effective outlet to the third market. Upon the advent of SuperSOES, market makers and order-entry firms lost their former ability to choose the firms with which they would trade, and they became unable to go outside of Nasdaq to obtain that choice because: (i) an order-entry firm cannot "preference" a market maker in SuperMontage because Nasdaq's SuperSOES chooses who the firm will trade with; (ii) the order-entry firm cannot use SelectNet to access a particular market maker's quoted size via a binding "liability order" that would be protected under the Commission's Quote Rule,16 which it otherwise might wish to do because of superior liquidity at a given price, superior service or other competitive factors; and (iii) market makers will not make third-market connections outside of the SuperMontage/SuperSOES combination because of the certainty of multiple execution against their quoted size resulting from the assignment of executions via SuperSOES at the same time as the market maker is filling orders for the same securities via private wire connections.
One significant reason for a securities firm to be a market maker in Nasdaq or the third market is the opportunity to gain publicity for its trading interest and the possible advantage of the imprimatur of the operator of the system. As noted above, one of the reasons an order-entry firm cannot preference market makers in the SuperMontage/SuperSOES combination is that Nasdaq assigns an execution to market makers. One reason for this restrictive feature may be Nasdaq's desire to compel market makers to continue to quote only in Nasdaq, rather than the third market. If the third market offered Nasdaq members an adequate opportunity to obtain publicity, in their own names, for their quotations and an effective means, without losing their ability to continue to make markets on Nasdaq itself, to opt out of taking Nasdaq executions and to obtain timely and efficient executions of their trades, the third market might well become viable.17 That would, in Nasdaq's words, adversely affect Nasdaq's business, financial condition, and operating results.
We note that the NASD has not identified even the barest outline of the third market it is supposed to create and that is supposed to offer a viable alternative to Nasdaq. Ensuring the establishment and maintenance of a strong and vigorous third market in Nasdaq-listed securities, with appropriate linkages and possibly a "virtual" Intermarket Trading System that actually works, would resolve many of the competitive and operational issues that will be presented if Nasdaq is allowed to preserve its hegemony as "the only game in town." The risk that Nasdaq's technology in effect is or will become a "single point of failure," and that Nasdaq, given its obligations to enhance share value for its shareholders, will resist Commission calls to spend the money necessary to augment its capacity or update its systems will be more effective if there are effective alternative venues for American and foreign investors to trade Nasdaq stocks. If the Commission takes action to foster the development of such alternative venues, by addressing the anticompetitive aspects of Nasdaq's rules, it will increase the choices open to investors and make the U.S. markets more competitive and make liquidity in U.S. stocks more resistant to capture by foreign market centers.
The markets should determine which market centers will survive and which will fail. The Commission should rely on those market forces and not permit a dominant player such as Nasdaq to erect barriers to the development of alternative venues. If U.S. brokers are blocked from trading in other venues, and if the "buy side" demands alternatives to Nasdaq, particularly given the monopolistic incentives Nasdaq currently enjoys, the competitiveness and attractiveness of the U.S. markets will suffer, to the detriment of investors and the public interest.
As Nasdaq itself notes, "[a]s market participants continue to establish automated trading links with one another and lock-in transactions externally from Nasdaq, the use of the ACT comparison function as a percentage of total trading volume will continue to decrease. This negatively affects revenue . . . ."18 Nasdaq's fears of alternatives to its SuperMontage/SuperSOES combination provide obvious incentives to stem any erosion of its market share. In other contexts, where a competitor does not have the dominant market position and the exclusionary machinery built into Nasdaq's rules, the fear of losing market share would normally produce a positive result, in terms of improved products and services. Given Nasdaq's arsenal of anticompetitive weapons and its current, dominant market share, however, a positive result is unlikely unless the Commission affirmatively intervenes to alter the status quo.
The components of a third market are already in place in the trading systems of the major brokers, in the ECNs and in the current private wire connections between order-entry firms, brokers, customers and market makers. Those components can readily be bound together, along with Nasdaq, into a commercially successful system of interlinked liquidity pools if the Nasdaq barriers to use of the third market are eliminated. Creating an effective third market would not create a risk of market fragmentation.
We submit that the most desirable response to concerns about fragmentation is not to contain securities markets within a closed and centralized framework but to foster competition in market architecture and to encourage linkage and integration among various liquidity pools. If fragmentation is the absence of communication and order interaction among market centers, fragmentation would not be a problem in a transparent, interlinked system of separate liquidity pools that afford ample opportunity for order interaction. Having separate pools that operate in competition with one another to attract order flow but that permit ready access by order entrants enhances the economic health and vitality of the markets.
Market data distribution and data fees. In addition to its government-granted monopoly over execution processing, Nasdaq enjoys special privileges not available to others that would compete in the distribution of market data. 19 Chief among those privileges is the unique access Nasdaq has without paying fees to market data generated by its members through use of its facilities. Nasdaq's special access to those data is reinforced by the Commission's own Rule 11Aa3-1(c)(2),20 which prohibits Nasdaq members from distributing data concerning trades outside the context of an approved data plan. The resulting monopoly enjoyed by Nasdaq gives it a unique, government-protected position, one it is unwilling to relinquish or share with others. Now that Nasdaq will be a for-profit exchange, it will have even greater incentives to enhance its revenues through market-data fees. In addition, it will enjoy a private treasure trove of the raw materials that are necessary to the construction of data analytics, order-management systems, and other value-added functionalities that are essential tools for market participants. Those raw materials are, of course, provided to Nasdaq by its members by force of law.
In view of its unique and privileged position, Nasdaq should not have any exclusive proprietary right that would afford it a unique opportunity to develop value-added products on the basis of market data that are otherwise undisclosed and then to charge what the traffic will bear for the products. Others should have a fair opportunity to develop their own value-added products with the same data as Nasdaq uses for its product-data which are provided to Nasdaq by force of law-and should not have to pay a royalty to the exchange for use of those data in such products beyond the prices charged for the data themselves. If Nasdaq sells a value-added product (such as a market indicator), it should have to make available on a timely basis in advance to all vendors at a minimum, for the same price and on equal terms, all the constituent data elements that were not otherwise available and that were used to create or nourish the value-added product, such as the data used to create or nourish the indicator. Nasdaq should not be able to compete in the creation and distribution of value-added products except through a separate legal entity that acquires the constituent data elements on the same terms and at the same prices as other vendors. In other words, Nasdaq should not be able to use its monopoly access to unpublished market data to obtain a unique competitive advantage in the competitive market in value-added products, such as data analytics. At no place in the Form 1 Application are these issues discussed.
A relevant precedent for the way in which Nasdaq's entry into data-distribution and data-analytics should be regulated is the exemption granted by the SEC to Nasdaq from Section 19(b)'s requirement for SEC review of rule and fee changes as to the activities of Nasdaq's proposed software development subsidiary, Financial Systemware, Inc. (the "FSI Exemption").21 In granting the FSI Exemption, the SEC pointed to the risks that are posed by a for-profit exchange acquiring a subsidiary that provides order management software. The SEC set four conditions on granting the exemption: (i) the continued presence of a high level of effective competition in providing order-management system ("OMS") services and software to market makers; (ii) use of the software marketed by the Nasdaq subsidiary is not and will not in the future be necessary to access Nasdaq or any other NASD market-related facility; (iii) full public access to Nasdaq must be available through the Application Programming Interface and the NASD and Nasdaq must maintain fair and equitable access to the Nasdaq system and encourage the development of software by NASD members and competing software vendors; and (iv) the NASD and Nasdaq agree not to provide their subsidiary with an informational advantage concerning Nasdaq market-data facilities. In addition, the SEC required that FSI not share employees with the NASD, Nasdaq or any other NASD affiliate, that FSI be housed in office space that is separate from that of the NASD or Nasdaq and that FSI be treated like any other third-party vendor with respect to the provision of information regarding planned or actual changes to Nasdaq.
Implicit in the FSI Exemption is the distinction between data and functionality, between raw material and a finished product. The OMS software produced by FSI is a functionality. The data that it manages are part of the raw material essential to creating the functionality. To the extent that OMS software produced by FSI is a delivery system for core market data, it is important that FSI be organized as a separate legal entity to foster competition from other software providers. The SEC clearly understood the anti-competitive potential of Nasdaq's software subsidiary and took steps to separate it from its parent. We would suggest that the SEC continue the work it has begun in the FSI Exemption by requiring that, whenever a subsidiary of an exchange proposes to produce a functionality, for example, OMS software, to use raw material that includes market data emanating from the regulated market, the exchange should have to provide the same raw material at the same time to the subsidiary's competitors on the same terms and for the same price and according to the same delivery schedules as contemplated for exchange use. The delivery, we suggest, should be in accordance with the same software protocols, specifications and parameters as the exchange provides to its vendor subsidiary.
Nasdaq is the sole source of data concerning quotations, unfilled limit orders, transactions and other information provided to it by its members, which together constitute the raw material for building the functionalities that facilitate the ways in which investors interact with the markets. The FSI Exemption stands for the proposition that, when the exchanges such as Nasdaq compete in the market for functionalities that are delivery systems for or are based upon core market data, they must do so through wholly separate legal entities that gain access to the data at the same time, for the same price and on the same terms as their competitors. In the absence of governmental action, Nasdaq will be a full-fledged competitor of information vendors without having to yield any of its monopoly powers. Particularly given the policies the Commission enunciated in the FSI Exemption, we believe the Commission should require, as suggested above, that Nasdaq spin-off its market-data functions into a separate and distinct legal entity that will provide data, analytics and other data-based functions as a without the advantages of monopoly cross-subsidies.
Nasdaq's Form 1 Application is the last step in Nasdaq's transition to an independent, for-profit national securities exchange. As a for-profit exchange primarily committed to enhancing shareholder value, Nasdaq would continue to enjoy a government-granted monopoly over key market data and would be in a position to vertically integrate into the market for the distribution of data and the development and marketing of value-added market-data products in direct competition with Bloomberg, Reuters plc, Thomson Financial and other third-party vendors.
For-profit status. The Commission has stated that the Exchange Act does not require national securities exchanges to be not-for-profit organizations and that it is possible for a for-profit exchange to meet the standards set forth in Section 6(b) of the Exchange Act.22 In considering Nasdaq's exchange registration under Section 6(b) of the Exchange Act, we believe the Commission must closely scrutinize the impact upon investors and the market-data industry of a for-profit exchange that would enjoy all the advantages of monopoly control over an essential resource of the national market system and could be in a position to exert unfair leverage on the basis of that monopoly in its activities within the currently competitive market-data analytics and distribution sphere.
The Nasdaq Form 10 states that the Commission "is reviewing concerns by industry members that the present level of data fees do not properly reflect the costs associated with their collection, processing and distribution."23 Those industry concerns appear well justified. For the year ended December 31, 2000, the sale of market data was Nasdaq's second largest revenue source and accounted for 29.8% of its revenues,24 a substantial increase over the 22% of Nasdaq revenues reported by the Commission in 1999.25 Historically, we note, the Commission has required that Nasdaq's market-data fees be cost-based and that costs associated therewith not include items other than the costs of data collection and transmission and market regulation.26 The fact that the percentage of its aggregate revenues Nasdaq extracts from the industry and the investing public through data fees is as high as it is today, and apparently is increasing, suggests the levels of data fees are far too high.
We note that on August 21, 2001, Nasdaq reported a 57% decline in net income for the second quarter of 2001, to $19.6 million, compared with $45.3 million in the second quarter of 2000.27 Nasdaq reported that the decline in its revenues was due exclusively to a decline in market information fees, which dropped 14% to $55.5 million from $74 million in the second quarter of 2000 and was contrasted with increases in Nasdaq's other revenues. Nasdaq attributed the decline in market-data revenue to a decline in the demand for "nonprofessional data services, which previously were supported by online individual investors."28 That decline, of course, underscores the extent to which Nasdaq's data fees are borne directly by retail investors, which in turn demonstrates the need for special Commission vigilance in this area.
The substantial revenue that Nasdaq has derived from the sale of market data is a strong indication that the fees Nasdaq charges for its market data are not cost-based and indeed may involve an unconscionable mark-up over cost. We would submit that the Nasdaq fee levels and fee structure for market data may well violate the following requirements in Section 6(b):
The excessive fees that Nasdaq would levy as an exchange for market data would benefit Nasdaq's shareholders at the expense of its members and the investing public, to whom the excessive fees would be passed on in one form or another. The virtual monopoly that Nasdaq would enjoy over the market data its members are required to turn over to it for free would stifle competition in the development of value-added market functionalities. If the Commission were to approve Nasdaq's application for exchange registration without a de novo review of its rules, including its market-data fee structure, what is, in effect, a government-granted monopoly in market data would be incorporated into the rules and structure of a new for-profit entity. We therefore advise the Commission that, given the standards against which Nasdaq's proposed rules must be measured and the Commission's interpretation of how those standards must be applied, the Commission cannot lawfully make the requisite statutory finding that Nasdaq's proposed rules are consistent with the Exchange Act.
Under the Exchange Act, the Commission must find that all dues, fees and other charges of the Nasdaq exchange for the use of its facilities, including market data, are reasonable and equitably allocated. The Commission must further conclude that the rules of the Nasdaq exchange are not designed to permit unfair discrimination and that they do not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. With respect to market data, the Commission stated in its release on the regulation of market information fees and revenues that it has not applied any rigorous method in assessing data fees.29 The Commission has previously considered the rule changes of the NASD that impose fees for data and other services, but its review of Nasdaq's application for registration as an exchange necessitates a de novo review of the entire fee structure. It also is true, however, that the Commission must make a de novo finding concerning the fees in passing on the Form 1 Application, a finding that cannot simply "piggyback" on findings made in earlier periods.30 The economics have changed and Nasdaq's circumstances have changed, as is witnessed by the steadily increasing transactional volume on Nasdaq, by the substantially increased percentage of Nasdaq revenues attributable to market-data fees and the very fact that Nasdaq soon will be a public company independent of the NASD. Given the significantly different context in which the Commission will be reviewing the Nasdaq fees, its de novo review of the fees will need to be thorough and searching and will not be able to rely to any significant extent on findings made under substantially different circumstances.
NASD as an exclusive securities information processor. The competitive implications of Nasdaq's market-data monopoly requires that the Commission take a more aggressive position than it has in the past in regulating Nasdaq's conduct as, in effect, an exclusive securities information processor. In reviewing the Form 1 Application, the Commission should require Nasdaq to provide a detailed and exacting, cost-based justification for its fees for market data and the Commission should take a close look at Nasdaq's policies and procedures to ensure the provision of data is not discriminatory. The Congress, in enacting the Securities Acts Amendments of 1975, warned particularly against possible abuses of market power by market centers such as Nasdaq that also operate as an exclusive central processor:
The Committee believes that if economics and sound regulation dictate the establishment of an exclusive central processor for the composite tape or any other element of the national market system, provision must be made to insure that this central processor is not under the control or domination of any particular market center. Any exclusive processor is, in effect, a public utility, and thus it must function in a manner which is absolutely neutral with respect to all market centers, all market makers, and all private firms. Although the existence of a monopolistic processing facility does not necessarily raise antitrust problems, serious antitrust questions would be posed if access to this facility and its services were not available on reasonable and nondiscriminatory terms to all in the trade or if its charges were not reasonable. Therefore, in order to foster efficient market development and operation and to provide a first line of defense against anti-competitive practices, Sections 11A(b) and (c)(1) would grant the SEC broad powers over any exclusive processor and impose on that agency a responsibility to assure the processor's neutrality and the reasonableness of its charges in practice as well as in concept [emphasis added].31
Advisory Committee report. As the Commission knows, its Advisory Committee on Market Information, formed last year, has been studying the issue of market-data fees and is due to issue a report on or about September 15, 2001.32 At a minimum, the issues that have been debated publicly by the Advisory Committee will deserve careful Commission scrutiny upon its receipt of the report and may be the subject of Commission and congressional hearings and Commission rulemaking or congressional legislation. Those issues, which are substantial and go to the heart of market transparency and the financing of self-regulatory organizations ("SROs"), will take considerable time to resolve. We suggest that, given the extensive controversy surrounding the level of the fees Nasdaq and other SROs charge for market data, the Commission should await its further public consideration of those issues before attempting to determine, in the context of the Form 1 Application, whether the proposed Nasdaq fees are in fact consistent with the Exchange Act.
IV. ADDITIONAL CONCERNS
Role of NASD-R. Nasdaq's Form 1 Application raises additional concerns since it fails to define how the rulemaking authority will be divided between Nasdaq and its current affiliate, NASD Regulation, Inc. ("NASD-R") and does not specify which of the NASD rules will remain with the NASD after the registration of Nasdaq as an exchange is made effective. Nasdaq proposes to delegate certain regulatory powers to the NASD and NASD-R. Nasdaq's filing leaves unanswered, however, exactly how the existing NASD rules will be allocated between Nasdaq and the NASD. We think a parallel filing by the NASD to propose for comment the amendment of its rules, where that is to be done effective upon Nasdaq's exchange registration, should be made so that the public and the Commission can consider the entire arrangement rather than to be confronted by the several filings piecemeal.
Illegal membership requirement. The new proposed Nasdaq member rules would require a Nasdaq member to be a member of at least one other self-regulatory organization ("SRO") before applying for membership in Nasdaq. That proposed membership requirement violates Sections 6(b)(2) and 6(c)(1) of the Exchange Act, which provide, in relevant part, that any registered broker or dealer may become a member of an exchange.33 We note that, soon after the 1975 Amendments were enacted, the Commission disapproved proposed rules of the NYSE that would have imposed membership requirements not permitted by the Exchange Act.34 In any event, the proposed requirement has some curious aspects. If all the SROs adopted the same requirement, the result would be that no new broker-dealer could join any SRO because it would not first have been a member of another SRO.
Shareholders vs. members of a for-profit exchange. The directors of Nasdaq, under Delaware law, will be conflicted in their duties of due care and absolute loyalty to Nasdaq's shareholders,35 on the one hand, and its members, on the other. As a for-profit exchange, the conflict between the interests of shareholders and the interests of exchange members will be sharpened, particularly with respect to the profits the new exchange may anticipate from the sale of market data and market-data products and services.
If its application to become registered as a national securities exchange is approved, Nasdaq will have two sets of constituents. It will owe duties to its shareholders, primarily driven by a desire to increase profits and maximize share value, and under the Exchange Act it will owe duties to its members and to investors. These interests could easily become adverse.
The Form 1 Application must be considered in light of the Exchange Act goals in Section 6 of ensuring that exchange members have fair representation in administering the affairs of the exchange (Section 6(b)(3)), in removing impediments to and perfecting the mechanism of a free and open market and a national market system (Section 6(b)(5)) and appropriate protection of competition (Section 6(b)(8)) and in Section 11A(a)(1)(C), to ensure economically efficient execution of securities transactions, the availability to brokers, dealers, and investors, of information with respect to quotations for and transactions in securities, the practicability of brokers executing investors' orders in the best market, and an opportunity, to the extent consistent with those other goals, for investors' orders to be executed without the participation of a dealer. While the Commission has previously expressed the broad policy judgment that an SRO can be a for-profit entity without necessarily contravening the Exchange Act, that broad judgment must now be examined closely in light of the case at hand. The Commission did indeed reach the judgment that the International Securities Exchange, LLC (the "ISE"), a for-profit entity, met the Exchange Act standards for registration, but that determination was based on the particular facts pertaining to the ISE, which are quite different from those presented by Nasdaq. In granting the ISE's registration, the Commission drew attention to the fact that ISE's corporate structure was substantially different from that of a customary public company such as Nasdaq proposes to become:
Although ISE's expectation is to have net income, and it will create a budget and set fees based upon that expectation, it will not distribute profits to its owners. Net income will be used by the ISE to finance capital improvements and to provide for financial reserves. Generally, existing exchanges control the amount of annual net income by adjusting their fees. Some exchanges rebate fees collected, or reduce or eliminate fees temporarily when they exceed projected earnings. ISE's LLC structure provides for a similar financial model as the existing exchanges with the exception of the manner in which taxes are paid.36
Given Nasdaq's status as a for-profit entity, Nasdaq's shareholders may well have an interest in extracting monopoly rents from market participants, with a view to maximizing profits and shareholder value. Given the Delaware law applicable to Nasdaq's directors, the Commission should take an affirmative position under the Exchange Act to limit Nasdaq's ability to charge monopoly rents and to maximize shareholder value at the expense of investors and other market participants. At a minimum, the fact that Nasdaq will be a stand-alone, for-profit entity that will enjoy unchecked market power should give the Commission pause as it considers the Form 1 Application. At a minimum, special scrutiny will be required to evaluate the potential for abuse and whether it can be effectively controlled if Nasdaq is allowed to go forward with its private corporate objectives as a for-profit exchange.
The NYSE recently argued to the SEC Advisory Committee on Market Information that Section 6(b)(3) of the Exchange Act protects the interests of members of an exchange in ensuring equal access and non-discriminatory pricing with respect to the provision of market data,37 but the NYSE argument did not take into account that (i) the representation of exchange members on exchange boards does not necessarily protect investors to whom net profits from data fees are passed on, and (ii) the representation of exchange members on the exchange boards, while substantial in the period leading up to the enactment of the 1975 Amendments, has been substantially diluted since then, primarily because of pressure exerted by the Commission for the exchanges to have a majority of "public" members on their boards. Thus, whatever protection the Congress may have thought was being provided by having knowledgeable industry members control exchange boards has been largely vitiated in the ensuing years. The "public" members of exchange boards consist largely of representatives of listed companies, who may have only passing knowledge of exchange markets and related issues. The exchange boards are likely to be even less effective as guardians of the reasonableness of fees as the exchanges become private, for-profit entities and their boards owe single-minded fiduciary obligations to their shareholders rather than to investors, their own members or the public at large. Even if having a majority of non-industry board members meets other objectives under the Exchange Act and may barely avoid violating the "fair representation" standard in Section 6(b)(3), as the Commission found in the ISE's case, it does not provide the kind of protection the Congress envisioned when it enacted the 1975 Amendments.38
Serious questions are raised by the remaining affiliation between the NASD, a registered securities association, and Nasdaq. Will the NASD be able, and motivated, to operate independently of Nasdaq?39 As Nasdaq notes, there remains an interlocking directorate between the NASD and Nasdaq.40 Also, many of the key officers of Nasdaq are current or former NASD officers who retain close ties to those left behind in the NASD. It remains to be seen when, if ever, Nasdaq will be truly independent of the NASD, and vice versa.
Does the NASD have a plan for the design and implementation, independent of Nasdaq, of a third market in Nasdaq-listed securities? Who will put together a workable third market, particularly since the key officers of Nasdaq have significant restricted stock positions in Nasdaq and have their personal fortunes tied to its success? The NASD has not put forward any blueprint for addressing that issue. Will the NASD will have little internal recourse but to turn to Nasdaq for the technology and technical expertise?.41
The public trust that resides in the NASD and in its board to manage and improve the markets resides in a group of individuals many of whom have significant, personal financial stakes in the value of the Nasdaq shares they and their member firms hold. To whom would a young, enterprising employee of the NASD appeal with the idea of creating a third market that would be a vigorous competitor of the enterprise in which the senior officers and board members of the NASD were significant shareholders?42 The NASD, with the Commission's guidance, must provide an answer to that question.
V. STANDARDS FOR COMMISSION REVIEW
As the Commission knows, Section 19(a)(1) of the Exchange Act provides that, in reviewing an application for registration as a national securities exchange, the Commission "shall grant such registration if it finds that the requirements of [the Exchange Act] and the rules and regulations thereunder with respect to the applicant are satisfied. The Commission shall deny such registration if it does not make such finding." In its order granting the ISE's application, the Commission described its role as follows:
Under Sections 6 and 19(a) of the Exchange Act, the Commission will grant an order for registration as a national securities exchange if it finds that the exchange is so organized and has the capacity to carry out the purposes of the Exchange Act and can comply, and can enforce compliance by its members and persons associated with its members, with the provisions of the Exchange Act, the rules and regulations thereunder, and the rules of the exchange. The rules of the exchange must be adequate to ensure fair dealing and to protect investors, and may not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.43
The Commission's review of the proposed rules of an applicant for registration as a national securities exchange is a necessary part of its review of the application itself. Section 6(b) of the Exchange Act sets forth a number of detailed requirements for exchange rules. Section 6(b)(1) provides that no exchange shall be registered unless the Commission affirmatively determines that "[s]uch exchange is so organized and has the capacity to be able to carry out the purposes of" the Exchange Act. Section 6(b)(4) states that the rules of an exchange must provide for "the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons for using its facilities."44 Section 6(b)(5) requires that the rules of an exchange be designed "to remove impediments to and perfect the mechanism of a free and open market and a national market system . . . and are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers . . . ." Perhaps most importantly in this context, Section 6(b)(8) requires that the rules of an exchange "not impose any burden on competition not necessary or appropriate in furtherance of the purposes" of the Exchange Act.
In effect, Section 6(b) specifies certain objectives that an SRO's rules, as a group, must affirmatively foster and certain negative injunctions the rules, individually or in conjunction with each other, must not violate. The Commission has noted that while an individual SRO rule need not fulfill all the objectives set forth in, e.g., Section 6(b) of the Exchange Act, it must not, considered alone or together with other rules of the SRO, violate even one of the negative injunctions, such as the requirement under Section 6(b)(8) that a Nasdaq rule not impose "any burden on competition not necessary or appropriate in furtherance of the purposes of the [Exchange Act]."45 Accordingly, even if Nasdaq's rules comply in a broad sense with all the affirmative purposes of the Exchange Act, the Commission will not be able to find that Nasdaq's registration is consistent with the Exchange Act and the Commission will be obliged to deny the registration if the Commission determines that even a single Nasdaq rule does not comply with any one or more of the negative injunctions set forth in, e.g., Sections 6(b)(5) and 6(b)(8).
Implications of de novo review. The Congress commanded the Commission, in passing on exchange rules, to apply the full panoply of administrative procedure that it is required to follow in adopting rules under the Administrative Procedure Act. Compliance with the congressional requirements is a necessary predicate to Commission approval of the Form 1 Application. Whether proposed rules are considered in the context of a Section 19(b) filing by an existing SRO or in the context of an application for registration by an entity seeking to become an SRO, the standards of, e.g., Section 6(b) of the Exchange Act, are the same, as are the procedural requirements. The Commission must weigh each rule of an applicant for registration as an exchange with the same deliberate care as it would a rule change of an existing exchange. In its Form 1 Application, however, Nasdaq has not even attempted to provide a rule-by-rule justification for the rules it has filed as part of the application and it has thus deprived the Commission and the public of the basis the Congress intended they should have to evaluate the rules.
This is particularly a problem in the case of an exchange that will enjoy the dominant competitive position of Nasdaq. The Form 1 Application in its current form does not put the Commission in a position to determine whether the burdens on competition imposed by Nasdaq's rules would or would not be necessary or appropriate in furtherance of the purposes of the Act.46 As the Commission is aware, the courts have applied strict scrutiny to rule filings that do not meet the statutory standards. The scope of this obligation is explained in Timpinaro v. SEC,47 in which the U.S. Court of Appeals for the District of Columbia Circuit remanded an SEC-approved rule to the Commission for failure to substantiate its belief that the rule would achieve a stated objective.48
In a context where the competitive impacts of Nasdaq's rules are certain to be trivial, an elaborate discussion is not warranted. Given the significant competitive implications of Nasdaq's proposed registration as a national securities exchange and its market power as the dominant market center for Nasdaq-listed securities, the competitive issues here are by no means trivial. The Nasdaq Form 1 Application does not elucidate the issue and, as a result, the filing does not provide a sufficient basis for public comment on, or Commission approval of, a large number of Nasdaq's proposed rules.49 Given the inadequacy of the record, the public is effectively deprived of a meaningful opportunity for comment on the proposed rule change. The Commission, in turn, is denied the benefit of the comments that could arise from the fully informed dialogue and genuine interchange of data, views and arguments the Congress envisioned in fashioning the processes by which applications for registration as a national securities exchange are to be evaluated.50 That is particularly the case where a valuable franchise or privilege such as exchange registration would be awarded, one that would give the newly privatized Nasdaq a government-granted monopoly over an important article of interstate commerce.51
Insufficient disclosure and absence of justification. In view of the unique and privileged position enjoyed by Nasdaq in relation to trade execution and market data, we believe that the Commission's review of Nasdaq's exchange registration requires its consideration of the burdens on competition and related problems arising out of Nasdaq's monopoly power. We also believe that, as filed, Nasdaq's Form 1 Application and the complementary information filed in Nasdaq's Form 10 do not provide an adequate basis for the public to provide meaningful comments with respect to a number of other areas. The Form 1 Application does not provide sufficient information regarding Nasdaq's proposed implementation of the SuperMontage system in conjunction with SuperSOES, does not provide sufficient detail as to how an alternative OTC market will be implemented for NASD members to trade exchange linked securities and does not sufficiently address the relationship that will exist among the NASD, NASD-R and Nasdaq after the proposed registration is effected. In addition, as noted below, in a number of substantial respects, the Form 1 Application is not in compliance with applicable provisions of the Exchange Act, particularly Section 6(b).
Nasdaq's refusal to describe how its more important rules would comply with the standards embodied in Section 6(b), as amplified by the goals of a national market system outlined in Section 11A(a)(1)(C), not only deprives the public of a basis to understand many important impacts Nasdaq's new status as a securities exchange would have on the markets and on investors, but it also deprives the Commission of a legally sufficient basis on which to determine whether the Form 1 application would or would not be consistent with the provisions of the Exchange Act, particularly Sections 6(b)(3), 6(b)(4), 6(b)(5) and 6(b)(8), applicable to Nasdaq. The approach taken by Nasdaq in the Form 1 Application is not, in our view, consistent with the Commission's own rulemaking approach during its long and distinguished history. In matters of this kind, particularly where valuable franchises would, in effect, be awarded and the public interest would be vitally affected, sunlight is indeed the best disinfectant.52 Nowhere is this more important than in assessing burdens on competition, particularly given the dominant market position of Nasdaq.53 To hold otherwise would be to frustrate the very congressional purposes that underlie the requirement under Section 19(a) of the Exchange Act that an application to become a national securities exchange be searchingly evaluated in light of the purposes of the Exchange Act and the requirements imposed on exchanges.
The substantive and procedural defects in the Form 1 Application go to the essence of the Commission's adjudicatory process with respect to this application. They have effectively undermined the purpose of the notice-and-comment process. In and of themselves, the defects would make it legally impermissible for the Commission to approve the application on the basis of the current record. In discussing the substantively analogous requirements of Rule 19b-4 under the Exchange Act, for example, the Commission has stated:
The Commission notes . . . that notices of proposed rule changes need to be clear in order to elicit meaningful public comment. Although a proposed rule change may be accepted as filed, the Commission believes that it should not be published until it has reached an adequate level of clarity regarding the issues raised by the filing. For complex filings, this can require more extensive review. Filings of rule changes also need to include information necessary to enable the Commission's staff to conduct a complete review. Any filings that fail to comply with the requirements of Form 19b-4 may be returned to the SRO and will be deemed not to have been filed with the Commission.54
Section 6 of the Exchange Act requires the Commission, in connection with its review of Nasdaq's proposed registration as a national securities exchange, to conduct a de novo review of Nasdaq's role as the central, monopolistic operator of the market in Nasdaq-listed securities, its monopoly role as an exclusive processor and distributor of market data and the NASD's obligation to foster the development and regulation of a competitive OTC market in Nasdaq and other securities. This is perhaps the best chance the Commission will have-certainly the opportunity during which the Commission will have the greatest leverage as a practical matter over Nasdaq and the NASD-to revisit the issue of Nasdaq's trade-execution and market-data monopolies before the Commission allows Nasdaq, as the first truly for-profit national securities exchange, to attain registration independent of the NASD. Section 6 requires a careful and painstaking review to make sure that not even one negative injunction contained in the Exchange Act is contravened. We request that the Commission consider the very serious concerns described above, analyze the proposals contained in the Form 1 Application and require substantial revisions to the Form 1 Application before giving further consideration to permitting Nasdaq's registration as a national securities exchange to become effective.
* * *
We appreciate the opportunity to make our views known to the Commission and the staff and we hope that our letter is helpful. If members of the Commission or of the staff believe we may be of further assistance in these matters, please let us know.
Very truly yours,
BLOOMBERG TRADEBOOK LLC
By: Kevin M. Foley by RDB
Kevin M. Foley
cc(w/att.): The Hon. Harvey L. Pitt, Chairman
The Hon. Isaac C. Hunt, Jr., Commissioner
The Hon. Laura S. Unger, Commissioner
Annette L. Nazareth, Esq., Director,
Division of Market Regulation
Robert L. D. Colby, Esq., Deputy Director,
Division of Market Regulation
Belinda Blaine, Esq., Associate Director,
Division of Market Regulation
David M. Becker, Esq., General Counsel
|1||Bloomberg is a worldwide, finance-oriented information and media company that provides data, news and analytics (the "BLOOMBERG PROFESSIONAL service") to investment firms and other professionals via more than 150,000 BLOOMBERG PROFESSIONAL terminals worldwide. Bloomberg is a Delaware (U.S.) limited partnership, headquartered in New York. Bloomberg serves its broker-dealer and institutional customers' communications needs and facilitates their transaction of business by offering various additional services, including electronic messaging, non-anonymous offerings, bids wanted and equity order-routing and indications of interest, and linkages to certain exchanges within and outside the United States. Approximately two million text messages and transaction messages involving billions of dollars of securities are sent and received by Bloomberg customers across the BLOOMBERG PROFESSIONAL service every business day.|
|2||Bloomberg Tradebook operates a proprietary electronic communications network (an "ECN") pursuant to Regulation ATS under the Securities Exchange Act of 1934 (the "Exchange Act") and a no-action letter from the staff of the Securities and Exchange Commission's Division of Market Regulation. Letter from Dr. Richard R. Lindsey to Roger D. Blanc (January 17, 1997), SEC No-Action Letter, 1997 SEC No-Act. LEXIS 55 (the "Bloomberg Tradebook No-Action Letter"). The Bloomberg Tradebook No-Action Letter was extended on several occasions, most recently on June 14, 2001. Bloomberg Tradebook is a registered broker-dealer and a member of the National Association of Securities Dealers, Inc. Bloomberg Tradebook offers its institutional and broker-dealer customers, and other broker-dealers that access the Tradebook System via private connections and Nasdaq's SelectNet, the opportunity to buy and sell equity securities through use of the BLOOMBERG PROFESSIONAL service (as defined below). Bloomberg Tradebook is a wholly owned subsidiary of Bloomberg.|
|3||See Amendment No. 2 to Form 10, File No. 000-32651, as filed with the Commission on June 29, 2001 (the "Nasdaq Form 10").|
|4||See Section V. STANDARDS FOR COMMISSION REVIEW, infra.|
|5||See Securities Exchange Act Release Nos. 42344 (January 14, 2000) and 43863 (January 19, 2001).|
|6||Without explanation, Nasdaq did not include in its proposed rules, submitted as Exhibit A to the Form 1 Application, its recently approved rules governing SuperMontage, nor did Nasdaq's filing include the technical specifications of the SuperMontage system, notwithstanding extensive general descriptions in the Form 10 of the SuperMontage system.|
|7||Amendment No. 2 to Nasdaq Form 10, Item 1, Business, "Nasdaq's Relationship to the NASD and its Affiliates."|
|9||Securities Exchange Act Release No. 44396 (June 7, 2001), Notice of Filing: II. Nasdaq's Exchange Registration.|
|10||Nasdaq Form 10 at Item 1, Business, "Risk Factors".|
|11||Section 15A(b)(6) of the Exchange Act requires the NASD's rules to be designed to, inter alia, "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 . . . ."|
|12||See, e.g., Securities Exchange Act Release Nos. 8470 (December 16, 1968) and 8661 (August 4, 1969).|
|13||Matter of The Rules of the New York Stock Exchange, 10 SEC 270 (October 4, 1941) (NYSE rule prohibiting dealings on other markets declared to be against public interest and illegal). In 1976, the Commission rejected on similar grounds the NYSE's proposed Public Limit Order Protection Rule (the "PLOPR"), which would have required NYSE members to clear limit orders on the NYSE before taking trades to another exchanges. Matter of New York Stock Exchange, Inc., Notice of Proceeding to Consider Disapproval of Proposed Rule Change, Securities Exchange Act Release No. 12249 (SR-NYSE-76-5) (March 23, 1976), in text following n.8.|
|14||Section 11A(c)(3)(A)(1) - (3).|
|15|| Indeed, the argument that market centrality would usefully resolve problems of "fragmentation" has a close resemblance to arguments in favor of former NYSE Rule 390. As former Chairman Levitt observed:
I can't think of a more propitious time to reconsider other restrictions that distort competition and introduce artificial costs. One, in particular, comes to mind-NYSE Rule 390.
Chairman Arthur Levitt, "Dynamic Markets, Timeless Principles," Speech at Columbia Law School (September 23, 1999).
|16||Rule 11Ac1-1 under the Exchange Act. That feature of Nasdaq's technology, which forces the order-entry firm to enter its orderon an all-or-none or minimum-fill basis in a size at least one round lot larger than the market maker's quotation, is designed specifically to ensure that the order is not a binding liability order and, therefore, that the market maker can ignore the order with impunity. See NASD Rule 4706(b)(1)(A). Effectively, Nasdaq has avoided the application of the mandatory-fill provision in the Commission's Quote Rule, Rule 11Ac1-1 under the Exchange Act, since the orders delivered via SelectNet either are converted into trades or are in a size above the market maker's published size and thus are not subject to the mandatory-fill requirement.|
|17||One effect of the Quote Rule, Rule 11Ac1-1 under the Exchange Act, is that, while the Commission never adopted its proposed amendment that would have subjected dealers that account for more than 1% of the trading volume in Nasdaq securities to have to register as Nasdaq market makers, upon Nasdaq's becoming an exchange, dealers in Nasdaq-listed securities will automatically become subject to the existing 1% requirement under the Quote Rule. See Securities Exchange Act Release No. 37620 (August 29, 1996).|
|18||Nasdaq Form 10, Item 1, Business, "Risk Factors-Nasdaq may lose trade reporting revenues if more market participants bypass the comparison feature of its trade reporting system."|
|19||We have made a number of these points in our letter of July 12, 2001 to Joel Seligman, Chairman of the Commission's Advisory Committee on Market Information, copies of which were provided to the Commissioners and certain senior staff members.|
|20||17 CFR 240.11Aa3-1(c)(2).|
|21||Securities Exchange Act Release No. 44201 (April 18, 2001).|
|22||Securities Exchange Act Release No. 40760 (December 8, 1998), in text following n. 325.|
|23||Nasdaq Form 10, Item 1, Business, "Risk Factors-Certain Congressional and SEC reviews could result in a reduction in data fees that could reduce Nasdaq's revenues."|
|24||Nasdaq's Form 10, Item 1, Business, "Products and Services".|
|25||Securities Exchange Act Release No. 42208 (December 9, 1999), in text following n.110.|
|26||Id. in text following n.120.|
|27||Kelly, "Nasdaq Reports Profit Fell 57% to $19.6 Million in 2nd Quarter, The Wall. St. J., Aug. 22, 2001 at C-1.|
|28||Id. at C-13.|
|29|| Securities Exchange Act Release No. 42208 (December 9, 1999), in text following n.81:
|30|| See Securities Exchange Act Release No. 42455 (February 24, 2000) in text following n.144:
The Commission must find that the ISE's proposed fees are consistent with Section 6(b) of the [Exchange Act], in general, and further the objectives of Section 6(b)(4) in particular, in that they will provide for the equitable allocation of reasonable dues, fees, and other charges among the Exchange's members and other persons using its facilities.
|31||Securities Acts Amendments of 1975, Report of the Senate Comm. on Banking, Housing and Urban Affairs to Accompany S.249, S. Rep. No. 94-75, 94th Cong., 1st Sess. 11-12 (1975).|
|32||See Securities Exchange Act Release No. 43313 (September 20, 2000), announcing formation of the Advisory Committee on Market Information.|
|33||As the Commission knows, many floor members of existing exchanges are members of only that SRO. See also, Rule 15b9-1 under the Exchange Act.|
|34||In disapproving NYSE Rules 309 and 310, which would have conditioned exchange membership on grounds not found in the Exchange Act, the Commission held that the NYSE's proposed rules could not be found to be consistent with the Exchange Act. Securities Exchange Act Release No. 12737 (August 25, 1976).|
|35||See, e.g., Smith v. Van Gorkom, 488 A.2d 858 (1985), Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (1986) and Paramount Communications v. Time, Inc., 571 A.2d 1140 (1990)|
|36||Securities Exchange Act Release No. 42455, supra¸ in text following n.7.|
|37||Letter of Robert G. Britz, Group Executive Vice President, NYSE., to Joel Seligman, Chairman, SEC Advisory Committee on Market Information, July 6, 2001, n.3.|
|38||Securities Exchange Act Release No. 42455, supra¸ in text following n.9.|
|39||Typically, the question has been asked whether Nasdaq is independent of the NASD. The reverse question is equally important.|
|40||As of June 29, 2001, the date the Nasdaq Form 1 was filed, Frank G. Zarb was both Chairman of Nasdaq and Chairman of the NASD board and Messrs. H. Furlong Baldwin, Frank E. Baxter, John D. Markese, David S. Pottruck, Arthur Rock, Richard C. Romano, and Arvind Sodhani were members of both the NASD board and the Nasdaq board. Nasdaq Form 10, Item 7, Certain Relationships and Related Transactions, "The NASD". In addition, Nasdaq notes that, "Conflicts of interest may arise between Nasdaq and the NASD, or its affiliates, in a number of areas relating to their past and ongoing relationships, including the nature, quality, and pricing of services rendered; shared marketing functions; tax and employee benefit matters; indemnity agreements; sales or distributions by the NASD of all or any portion of its interest in Nasdaq; or the NASD's ability to influence certain affairs of Nasdaq prior to Exchange Registration." Nasdaq Form 10, Item 1, Business "Risk Factors-Nasdaq faces potential conflicts of interest with related parties."|
|41||The NASD will face a similar problem in trying to implement the TRACE proposal with respect to debt securities. As we noted earlier, the fact that TRACE is owned and operated by the NASD instead of Nasdaq does not make TRACE any less a monopoly. In addition, there is no indication in the Approval and Amending Release that the NASD will solicit open bidding for the technology service provider for TRACE. Instead, the NASD has stated that it will award what is apparently an exclusive contract to Nasdaq to act as its vendor of information-processing services for TRACE. As a result, having the NASD rather than Nasdaq control TRACE will not resolve the anti-competitive concerns previously raised by Bloomberg and other commenters. Letter from Bloomberg dated March 14, 2001, in Commission File No. SR-NASD-99-65.|
|42||See Nasdaq Form 10, Item 7, Certain Relationships and Related Transactions, "The NASD".|
|43||Id. in text following n.6.|
|44||As defined in Section 3(a)(2) of the Exchange Act, the term "facility", when used with respect to an exchange, includes tangible or intangible property and "any right to the use of such premises or property or the service thereof for the purpose of effecting or reporting a transaction on an exchange (including . . . any system of communication to or from the exchange by ticker or otherwise . . . ) . . . . " An exchange's distribution of market data is thus within Section 3(a)(2) and the fees are subject to the test in Section 6(b)(4).|
|45||As the Commission noted in Securities Exchange Act Release No. 17371 (December 12, 1980), with respect to the virtually identical provisions applicable to the NASD under Section 15A(b) of the Exchange Act, "Section 15A(b) of the Act specifies certain objectives that the NASD's rules, as a group, must affirmatively foster and certain objectives that its rules must not be designed to achieve." Id. in text following n.71.|
|46|| As the Commission is aware, in the analogous case of rule filings by SROs that are already registered, the General Instructions to Form 19b-4, 5 Fed. Sec. L. Rep. (CCH) ¶ 32,356, are explicit on the point. They provide, for example, with respect to "Information to be Included in the Completed Form," as follows:
4. Self-Regulatory Organization's Statement on Burden on Competition
Id. at p. 22,318.
|47||2 F.3d 453 (D.C. Cir. 1993).|
|48||See also Section 3(f) of the Exchange Act.|
|49||To assist the Commission in its adjudicatory proceedings under the Exchange Act, the NASD must provide an adequate basis for comment on its rule proposals and, where significant competitive issues are involved, must provide an opportunity for the public to comment meaningfully on the issues involved. Perfunctory recitals do not provide that basis. See Connecticut Light and Power Co. v. NCR, 673 F.2d 525, 530-31 (DC Cir. 1982).|
|50|| As noted above, the review of an applicant for registration as an exchange requires exacting procedures, procedures no less demanding than the procedures for review of proposed rule changes by an existing registrant, which the Congress described in Securities Acts Amendments of 1975, Report of the Senate Comm. on Banking, Housing and Urban Affairs to Accompany S.249, S. Rep. No. 94-75, 94th Cong., 1st Sess. 29-30 (1975):
In order to facilitate expeditious Commission review and evaluation of [proposed rule changes] and to assure informed public comment on them, Section 19(b)(1) would require all self-regulatory organizations to file with the SEC in connection with any proposed rule change a "concise general statement of the basis and purpose" of the proposed rule change. It is the Committee's intention in adopting this standard to hold the self-regulatory organizations to the same standards of policy justification that the Administrative Procedure Act imposes on the SEC.
|51||Cf. Home Box Office, Inc. v. FCC, 567 F.2d 9 (1977).|
|52||Cf. L. Brandeis, Other People's Money and How the Bankers Use It 62 (1914): "Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman."|
|53||The Commission often has had to take action to curb the anti-competitive tendencies of the NASD and other self-regulatory organizations. See, e.g., the Ætna proceeding, Securities Exchange Act Release No. 9632 (June 7, 1972) (Commission partially abrogated, as in excess of NASD authority and anti-competitive, part of former Art. III, Sec. 25 of NASD Rules of Fair Practice [now NASD Conduct Rule 2420]); Plaza Securities Corporation, Securities Exchange Act Release No. 10643 (February 14, 1974) (NASD disciplinary order under former section 25 set aside); Securities & Exch. Comm'n, Report Pursuant to Section 21(a) of the Securities Exchange Act of 1934 Regarding the NASD and the Nasdaq Market, (August 8, 1996); "Multiple Trading Case, supra; PLOPR case, supra; and Matter of Applications of William J. Higgins and Michael D. Robbins, Securities Exchange Act Release No. 24429 (May 6, 1987) (NYSE action denying access on basis of policy not reasonably and fairly implied by existing rule set aside). See also Securities Exchange Act Release No. 12994 (November 18, 1976) in text accompanying nn. 14-23, and authorities cited therein. Cf. Silver v. New York Stock Exch., Inc., 373 U.S. 341 (1963).|
|54||Securities Exchange Act Release No. 35123 (December 20, 1994), in text following n.35.|