August 30, 2001

By Hand and Via Electronic Mail

Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: The Nasdaq Stock Market, Inc.; Notice of Filing of Application for Registration as a National Securities Exchange Under Section 6 of the Securities Exchange Act of 1934, Release No. 34-44396, File No. 10-131

Dear Mr. Katz:

The Securities Industry Association ("SIA")1 is pleased to provide the U.S. Securities and Exchange Commission ("Commission") with comments on The Nasdaq Stock Market, Inc.'s ("Nasdaq") application to register as a national securities exchange ("Form 1") under Section 6 of the Securities Exchange Act of 1934 ("Exchange Act").2 As you are aware, the Commission initially requested comment by July 30, 2001, but extended the comment period until August 29, 2001 at the request of several members of the public, including the SIA.3 The Commission is required to take action on Nasdaq's application by September 11, 2001, unless Nasdaq consents to an extension of time.4

As stated in the Commission's release issuing notice of Nasdaq's application to register as an exchange, "[t]he Commission shall grant such registration if it finds that the requirements of the Exchange Act and the rules and regulations thereunder with respect to Nasdaq are satisfied." Accordingly, the SIA first offers certain general observations on Nasdaq's application, and then raises important issues that we believe the Commission should consider in its deliberations to determine whether the application meets the requirements of the Exchange Act and the rules and regulations thereunder.

General Comments

The Form 1 represents a major restructuring of the U.S. securities markets that transfers much of the key facilities of the nation's over-the-counter ("OTC") market to a for-profit exchange market. Because of the far-reaching implications of this application, SIA member firms consider the filing to be of great importance and one that requires considerable thought and review by member firms and other interested parties. Although the SIA is pleased to offer general observations on this application and to raise a number of issues for the Commission's consideration, the SIA cannot provide at this time any final determinations as to whether the Form 1 satisfies the requirements of the Exchange Act for the following reasons:

(1) The comment period, although extended for one month, was too limited in view of the size, complexity, and importance of the filing.5 Nasdaq's provision of a guideline or meaningful comparison between the Nasdaq and National Association of Securities Dealers, Inc. ("NASD") rulebooks at an early date would have facilitated the review of this filing; however, the SIA did appreciate receiving the "red-lined" version of the Form 1 trade reporting rules provided by Nasdaq on August 7, 2001.6

(2) Certain critical pieces of information related to the filing are unavailable or lack clarity. This information is essential to analyzing the impact of this application on the securities markets and to determining whether the Form 1 satisfies the requirements of the Exchange Act. This information includes:

Many SIA member firms advocate not approving Nasdaq's exchange application until the alternative display facility for the residual OTC market is operational, and strongly believe that, given the record before it, the Commission cannot at this time make the necessary findings to approve Nasdaq's exchange application.

Many other firms believe, however, that approval of Nasdaq's application should not be held up because the NASD's residual facility is not yet operational. These firms would support the Commission's approving Nasdaq's application if the Commission finds that it otherwise satisfies the requirements of the Exchange Act, but with the condition that the NASD facility be operational before Nasdaq actually begins operation as an exchange. 

Either way, SIA believes that the Commission should address the residual facility before Nasdaq becomes an operating, for-profit exchange.

Discussion of Issues

We note that the Commission raised certain issues in its release issuing notice of the Form 1 that it believed warranted particular attention. Specifically, the Commission stated that "[t]here are a number of implications to Nasdaq's separation from the NASD and application to register and operate as an exchange. For example,

SIA member firms focused on these issues in their review of the Form 1, and also identified several other critical issues that they believe the Commission should consider in its deliberations. The list of issues below should not be considered exhaustive; it contains only those issues identified by member firms to date in the limited amount of time they had to review the application. The SIA appreciates the opportunity to discuss these important concerns, and trusts that the Commission will find this discussion helpful in their deliberations to determine whether the application satisfies the requirements of the Exchange Act and the rules and regulations thereunder.

1. Form 1: Proposed Rules and Exhibits

Nasdaq has stated that it relied heavily upon the NASD rulebook in formulating its proposed rules, and that the only substantive changes made were in the trade reporting rules, specifically Rules 4630-4633 and the Rule 6400 series.8 SIA member firms concentrated their review on the trade reporting rule sections because of Nasdaq's representations, the initial lack of any guideline or meaningful comparison between the two rulebooks, and the limited amount of time to review the entire filing. A few firms, however, did briefly review the other sections of the application, and their concerns and questions are also presented below.

A. Trade Reporting Rules: Rules 4630-4633 and Rule 6400 Series

The new trade reporting rules will impact broker-dealers and self-regulators in different ways. The Commission should consider carefully the rules' impact when determining whether they meet the Exchange Act's requirements, particularly those in Sections 6(b)(5) and 6(b)(8). These sections require that the Commission determine that:

When Nasdaq becomes an exchange, it will no longer be able to deem any trade of a Nasdaq security as a "Nasdaq trade," as it does today. Since Nasdaq will no longer be both a quasi-exchange and the OTC market, a definition must be created to determine when a trade has actually taken place "on Nasdaq" or in the OTC market, which will be operated by the NASD.9 Rules 4630-33 (which include interpretations IM-4630-1 and IM-4633-1, 2, 3 and 4) cover the reporting of trades of Nasdaq securities, and the Rule 6400 series of rules addresses the reporting of trades in securities listed on another exchange but traded on Nasdaq pursuant to unlisted trading privileges.

IM-4630-1 attempts to define a Nasdaq transaction.  Section (1) of that rule codifies as Nasdaq trades those trades made on one of its systems, such as via SuperSoes, SelectNet or, eventually, SuperMontage. Sections (2) and (3) of the rule, however, define a Nasdaq transaction as any transaction involving a Nasdaq registered member or Nasdaq registered ECN.  This part of the rule is intended to capture as Nasdaq trades all transactions internally crossed or matched by market makers or electronic communication networks ("ECNs").

Many member firms are concerned over this broad definition in IM-4630-1 of a Nasdaq exchange trade, which could classify certain OTC transactions as Nasdaq exchange transactions. They believe that this definition inappropriately extends Nasdaq's regulatory jurisdiction into their member firms' OTC activity in contravention of Section 11A of the Exchange Act, Rule 19c-3 thereunder, and recent Commission policy regarding exchange off-board trading rules. Other firms, however, do not have these concerns and, indeed, support the definition.

Rule 4633 attempts to define the various possible scenarios of executions and how each transaction will be reported.  On its face, this rule may not present any problems for broker-dealers, but it could perhaps cause some confusion.  For example, Rule 4633(a)(2) allows non-registered reporting members to voluntarily report transactions in Nasdaq securities to Nasdaq, even though NASD trade reporting rules (which must be drafted to complement the new Nasdaq reporting rules) would most likely mandate reporting of such transactions to the NASD.  Rule 4633(c) expands on 4633(a)(2) by describing the various executions and reporting scenarios.  Also, IM-4633-4 again allows for a choice, on a transaction-by-transaction basis, to report to either Nasdaq or the NASD. Giving participants the ability to choose where to report transactions could cause not only confusion, but also perhaps reports inadvertently not being made in some cases.

IM-4633-3 explains trade reporting for ECNs and attempts to standardize such trade reporting. The proposed changes will certainly require reprogramming for everyone, ECNs and market makers alike, but it will particularly affect certain ECNs with respect to volume calculations as a percentage of Nasdaq's overall volume.

Most of the comments just made regarding Rules 4630-33 are applicable to the Rule 6400 series, as the changes made by Nasdaq in the Rule 6400 series essentially parallel those made in the Rules 4630-33 series. Therefore, what may be somewhat confusing in Rules 4630-33 is also confusing in the Rule 6400 series, such as the ability of non-registered reporting members to report to Nasdaq voluntarily. This lack of clarity could result in trade statistics that are not meaningful.

The SIA recommends that the Commission review these important rules carefully to ensure that they are written clearly, will not create confusion as to their trade reporting requirements,10 are appropriate in the public interest, and otherwise meet the requirements of the Exchange Act to, among other things, promote just and equitable principles of trade, facilitate transactions in securities, and not go beyond the "administration of an exchange."11

B. Membership Provisions

Nasdaq's for-profit status heightens the need for Commission scrutiny of the rules and regulatory burdens Nasdaq imposes on members and of the fees Nasdaq charges firms. In this regard, the SIA understands that Nasdaq has submitted to the Commission a list of proposed rules pertaining to governing members that, if the Commission approves, the text of such rules will be deleted from the proposed Nasdaq rulebook, and the corresponding NASD rules and any interpretive material issued thereunder will be incorporated by reference. Nasdaq believes that this is the most expedient way to ensure that the latest NASD rules and interpretations will apply to Nasdaq members, as the NASD has agreed to act as Nasdaq's regulatory authority. Although SIA member firms may not have any concerns with this action, they would have appreciated the opportunity during the Form 1 comment period to review the list of affected rules and the implications of incorporating by reference the NASD's rules.

The SIA recommends that the Commission determine whether the affected rules and the implications of this action are consistent with the Exchange Act, particularly Sections 6(b)(2), 6(b)(5), 6(b)(6) and 6(b)(7). According to these provisions, the Commission must ensure, respectively, that:

With regard to membership fees and dues, there appears to be no mention of what fees or dues will be assessed for the initial membership application or annually, even though the membership application grants Nasdaq the authority to assess fees on members.12 The only fee discussion appears to be in the 7000 rule series in Exhibit E (transaction fees). The SIA suggests to the Commission that it review this subject with Nasdaq to ensure that they meet the requirements of the Exchange Act, particularly Section 6(b)(4) which states that the rules of the exchange "...provide for the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities."

Finally, once Nasdaq is registered as an exchange, it intends for member firms to file slightly revised Form B-Ds and Form U-4s after a 90-day "grandfather" period.13 Member firms strongly recommend to the Commission that they work with Nasdaq to streamline, where possible, this enormous administrative task. In addition, Nasdaq should clarify the examination requirements for associated persons of members; for example, it is unclear whether an individual will be required to take multiple examinations if he/she wishes to be associated with a firm with multiple exchange memberships.

C. Bulletin Board Rules

Nasdaq proposes in its Rule 6500 series to operate the Bulletin Board as an exchange facility, and is or will be submitting an exemption request to the Commission under Section 12 of the Exchange Act in order to do so. As explained later in section 2.D. of this letter, SIA member firms have not had an opportunity to review any such exemption request, and also have differing opinions on Nasdaq's intentions with the Bulletin Board and whether this should even be an issue for the Commission to consider in its deliberations on the Form 1.

D. Affiliations

Section 6(b)(1) of the Exchange Act requires that the Commission determine that Nasdaq is " organized and has the capacity to be able to carry out the purposes of this title and to comply, and (subject to any rule or order of the Commission pursuant to Section 17(d) or 19(g)(2) of this title) to enforce compliance by its members and persons associated with its members, with the provisions of this title, the rules and regulations thereunder, and the rules of the exchange."

Exhibit C to the Form 1 shows that Nasdaq is involved in a substantial number of business ventures with numerous financial partners, particularly those pertaining to their global expansion objectives. The SIA is not taking a position on these affiliations, but assumes that the Commission will carefully review Nasdaq's outside activities to ensure the viability of the core market.

E. Trading Systems: Rules and User Guides

The SIA recommends that the Commission ensure that all of Nasdaq's systems are described adequately in the Form 1, and otherwise meet the requirements of Section 6(b)(5) of the Exchange Act. The SIA notes that the rules for Nasdaq's recently-approved system, SuperMontage, are not included in Form 1 and yet Nasdaq maintains that this will be the primary trading platform once Nasdaq's exchange application is approved. Since these rules will significantly change the core of Nasdaq's exchange trading facilities, some firms believe that their absence is a material deficiency in the filing that precludes an assessment of their impact on the application and the provisions of the Exchange Act.

Exhibit E to the Form 1 contains the Nasdaq user guides. The SIA recommends to the Commission that it ensure, before it takes final action on the application, that this section includes descriptions of SuperSoes (the system currently in use) and SuperMontage, and is otherwise up-to-date.

F. Recent NASD Rule Changes

Nasdaq has informed the SIA that approximately 75 of the NASD's rules, upon which they based their Nasdaq rules, have been amended since the filing of the Form 1 with the Commission. The SIA recognizes that it would be difficult for the NASD and Nasdaq, in its present form as a NASD subsidiary, to remain completely static through the Form 1 approval process, and also that there will be opportunity for public comment on any amendments proposed to the Nasdaq rules to conform with the NASD rule amendments.14 Nevertheless, SIA member firms believe that, short of an amendment at this time to the Form 1, a list or other information noting those NASD amendments that impact Nasdaq's proposed rules would have been useful to review during the Form 1 comment period and would have facilitated any determination as to whether the Form 1 satisfies the requirements of the Exchange Act.

G. NASD Rule Modernization Project

The NASD is undergoing a major NASD rule modernization project, for which the SIA provided comment.15 In that Nasdaq's proposed rulebook is based almost entirely on the NASD's rulebook, it is necessary to understand the potential impact of this project on Nasdaq's proposed rules in order to perform a complete analysis of this application. Any relevant information on this project would have facilitated member firms' review of the application and their determination of whether the Form 1 satisfies the requirements of the Exchange Act.

2. Form 1: Impact on the Securities Exchange Act of 1934

Nasdaq's application to register as an exchange impacts a great number of statutory and regulatory provisions that govern the trading of securities on an exchange. The SIA understands that, in some cases, Nasdaq has filed, or intends to file, with the Commission requests for exemption from certain Exchange Act provisions. In other cases where an exemption may be warranted, firms are unclear whether Nasdaq intends to file an exemption request. The SIA understands that no exemption requests have been made public by the Commission at this time. SIA member firms, therefore, have not had an opportunity to review any such requests or to evaluate Nasdaq's justifications for such exemptions. As a result, firms do not have a complete picture of how Nasdaq intends to comply with the statutory requirements applicable to other exchange markets, nor why it should be exempted from certain requirements. The unavailability of this information, which many SIA member firms consider critical to their review of Nasdaq's application, contributed to those firms' difficulty in reaching any final determinations on whether the Form 1 satisfies the requirements of the Exchange Act.

A. Sections 6, 11A and 15A of the Exchange Act

The following sections of the Exchange Act mandate that there be fair competition between exchange markets and markets other than exchange markets, and give specific direction to the NASD: