July 30, 2001
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. 10-131
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
Dear Mr. Katz:
The Member Associations of the American Stock Exchange1 (the "Amex Member Associations") have spent considerable time reviewing the application of the Nasdaq Stock Market, Inc. (the "Nasdaq") to register as a national securities exchange under Section 6 of the Securities Exchange Act of 1934 (the "Exchange Act"). We support, in concept, the separation of the Nasdaq trading facility from the National Association of Securities Dealers, Inc. ("NASD") and Nasdaq's registration as a national securities exchange. However, we are not in a position to comment upon their specific proposal at this time because there are far too many gaps in the available information to allow a reasoned analysis.
In light of the deficiencies in the public record, the Amex Member Associations request that the Commission: (1) seek a waiver from Nasdaq of the statutory 90 day deadline by which the Commission must act upon Nasdaq's application; 2 (2) require Nasdaq and the NASD to provide additional information needed to review the application as soon as reasonably possible; and (3) extend the comment deadline until the later of October 31, 2001 or 60 days following the date on which a materially complete current record is available to the public. We believe that extending the comment deadline to 60 days following the publication of a complete record is appropriate given the complexity and voluminous nature of the filing. These steps are intended to provide all interested parties with a meaningful opportunity to evaluate and comment upon the application on the basis of materially complete and up-to-date information.
1. Lack of a Complete and Current Public Record
The Amex Member Associations have been unable to conduct a complete evaluation of Nasdaq's application due to material gaps in the available public record, and we believe the same this is true for other interested parties. First and foremost, it is impossible to understand the full implications of Nasdaq's proposal without information on the NASD's plans for the residual OTC markets. In particular, to fully understand Nasdaq's exchange application, it is necessary to know how the NASD proposes to modify its rules, as a national securities association, for the OTC markets under its self-regulatory jurisdiction and how it plans to provide for the alternative quotation and transaction reporting facilities that the Commission has directed it to have in place "upon Nasdaq's exchange registration."3
We also believe more information is necessary on how Nasdaq and the NASD are proposing to define their future on-going relationship to one another. For example, features of Nasdaq's application seem to blur distinctions between Nasdaq's proposed exchange operations and the NASD's operations with respect to the residual OTC market, including in such significant areas as trade reporting and membership, raising the concern that Nasdaq's proposed separation from the NASD could prove to be more form than substance.4 In particular, the proposed trade reporting rules raise a myriad of questions regarding how OTC trades will be reported in the future and whether membership is an appropriate factor in determining where to report a trade.
As a second area where information is deficient, it appears that the rules Nasdaq included as part of its application are outdated. Nasdaq's proposed rules for operating as an exchange duplicate in substantial part its current rules as an OTC market facility of the NASD. However, they do not include a number of recent changes that Nasdaq has made to its rules, most notably, the SuperMontage rules approved last January by the Commission. Since the SuperMontage rules would significantly alter the self-described centerpiece of Nasdaq's exchange trading facilities - the "Nasdaq National Market Execution System" (the "NNMS") - this discrepancy represents a material difficulty in commenting on the filing. 5
We recognize that Nasdaq, as an existing market, and the NASD, as the current SRO for Nasdaq's markets, do not operate in a static environment and should have the flexibility to amend their rules while the Commission's review of Nasdaq's application is pending. We also understand that their rule changes are generally subject to public comment. However, it is not clear whether rule changes adopted during this interim period will ultimately be reflected in Nasdaq's rules as an exchange, in the NASD's future standalone rules for the OTC markets or in both places or neither. Moreover, an interested party's comments may well vary depending upon whether it evaluates an NASD/Nasdaq rule filing from the perspective of Nasdaq as a national securities exchange or as an OTC market facility of the NASD. As a further complication, under the current state of affairs it is impossible to know whether Nasdaq is considering changes to any of the recent rule amendments in light of its prospective status as a registered exchange.
We ask the Commission to request Nasdaq to provide a current set of its proposed rules for interested parties to evaluate. In addition, we recommend that the Commission ask the NASD and Nasdaq to clarify in their future rule filings how, if at all, the proposed changes will be reflected in their respective rules following Nasdaq's exchange registration. For rule filings that will affect Nasdaq's proposed exchange rules in any material way, we recommend that the Commission invite comments on the changes in terms of their implications both before and after Nasdaq becomes an exchange.
Finally, the application contains no clear explanation of how Nasdaq plans to meet its obligations as an exchange under SEC Rule 11Aa3-1 to have one or more transaction reporting plans in place with respect to Nasdaq securities. Nasdaq proposed Rule 4400 includes a cross-reference from the existing NASD/Nasdaq rule to a transaction reporting plan "filed with the Commission," which we assume is a reference to the existing OTC/UTP Plan. What is unclear, however, is whether Nasdaq kept this language because it intends to join the OTC/UTP Plan or as an oversight. Moreover, in recent conversations with participants in the OTC/UTP Plan, Nasdaq has indicated that it may form its own securities information processor to disseminate Nasdaq-only quotations away from the inside market. A UTP Participant's ability to ascertain possible conflicts surrounding the exchange filing and the OTC/UTP Plan is limited by the uncertainty surrounding Nasdaq's intention to create a competing securities information processor.
2. General Areas of Concern with the Application
Even on the basis of an incomplete record, it is evident that Nasdaq's application raises a number of difficult issues requiring the Commission's careful deliberation. The complexity of these issues alone warrants an extension of the comment period. The following are a few of the general areas that need to be addressed:
A. What features should the Commission require Nasdaq and the NASD to adopt as a precondition to Nasdaq's registration as an exchange to differentiate Nasdaq as an exchange from the NASD and the OTC market? (i.e., how separate must they become from one another?) More specifically:
i. What should the residual OTC market look like after Nasdaq's separation from the NASD?
ii. What Nasdaq facilities should appropriately be treated as exchange facilities? We are not convinced that the SelectNet facility for Nasdaq securities constitutes an exchange facility, but this is an area where our analysis is compromised by the lack of information on Nasdaq's current plans for the NNMS.
iii. What trades are appropriately Nasdaq exchange trades? We believe that Nasdaq's proposed trade reporting rules may overstep the bounds of exchange administration contrary to Section 6(b)(5) of the Exchange Act6 by seeking to classify OTC transactions as Nasdaq exchange transactions. If the Commission permits Nasdaq the privilege of claiming print reports for OTC transactions, other exchanges should be granted the same privilege.
iv. How will the Commission implement trade-through protection with respect to trading on Nasdaq? We believe the Commission should require Nasdaq to implement trade-through restrictions as a precondition to exchange registration. We can see no policy reason for excluding Nasdaq from this fundamental aspect of what it means to be an exchange within the national market system.
B. Should Nasdaq be permitted to operate the Over-The-Counter Bulletin Board Service ("OTCBB") as an exchange facility? Nasdaq has announced that it plans to submit an exemption request to the Commission to allow it to operate the service. The OTCBB is clearly an OTC market facility and if the Commission allows Nasdaq to operate the OTCBB as an exchange facility, Member Associations expects that other exchanges may request and should be entitled to operate OTC quoting facilities.
We have other, more specific areas of concern. However, we believe it is premature to offer any comments at this time since our analysis is, of necessity, incomplete due to the material incompleteness of the public record.
3. Need for the Commission to Reevaluate Certain of Its Rules
There are a number of Exchange Act provisions and SEC rules that impose different standards on OTC markets and their participants, on the one hand, and exchange markets and their members, on the other hand. 7 In many cases, they expressly refer to Nasdaq as shorthand for the OTC market and provide Nasdaq with greater latitude in the rules it may adopt.
Before acting upon Nasdaq's application, we believe that the Commission should reevaluate its rules and amend them as necessary or appropriate to ensure that they apply consistently to all of the exchanges, including Nasdaq, and clearly set out how they apply to the NASD and the residual OTC market. These rules include, among others, SEC Rule 10a-1 (short sales); rules that differentiate between "automated interdealer quotation systems" and exchanges, e.g., Rules 11Ac1-1 through 11Ac1-4, 11Aa3-1 and 15c2-11; Regulation M (market stabilization quotes); Rule 10b-18 (issuer repurchases); Rule 3a51-1 (penny stocks); Rule 11b-1 (affirmative and negative obligations of specialists); Rule 10b-10 (confirmations) and SEC rules under Section 12 of the Exchange Act (extension of unlisted trading privileges).
In certain cases, Nasdaq, as an exchange, would receive unfair preferential treatment if the existing rules are applied to it, contrary to the principles of fair competition and equal regulation embodied in Section 11A of the Exchange Act. We wish to highlight two areas, in particular, where Nasdaq would receive unfair preferential treatment under existing SEC rules, literally applied: short sale restrictions and market stabilization quotes. SEC Rule 10a-1, in the case of short sale restrictions, and Regulation M, in the case of market stabilization activities, provide Nasdaq, as an OTC market, with greater latitude in the rules it may adopt in these areas than exchange markets. Nasdaq is seeking to preserve that beneficial treatment by re-proposing as exchange rules the rules it currently has in place as an OTC market facility of the NASD. These proposed Nasdaq rules, Rules 3350 and 4614, respectively, would seem to comply with the literal terms of the Commission's rules, because the Commission's rules specifically refer to Nasdaq as a surrogate for the OTC markets. We doubt, however, that when the Commission adopted its rules it was based on an assessment of their implications were Nasdaq to change its market status from an OTC market to an exchange market.
Nasdaq's proposal to register as a national securities exchange is a watershed event in the development of the national market system. It changes a pattern of market operation that dates back at least to the start-up of Nasdaq in 1971, if not to the formation of the NASD in 1939. Given the significance of this event, prudence dictates that the Commission proceed cautiously - and on the basis of a complete record - in its legal analysis of Nasdaq's application and the many difficult issues that it raises. Interested parties should also be given a meaningful opportunity to formulate comments on the basis of a materially complete and up-to-date record.
Accordingly, we urge the Commission to seek Nasdaq's waiver of the statutory 90 day deadline and to ask Nasdaq and the NASD to provide additional information in the areas we (and other commenters) identify. We also urge the Commission to extend the comment deadline until the later of October 31, 2001 or 60 days following the date on which a materially complete and up-to-date record is available so that interested parties have a meaningful opportunity to conduct a thorough and reasoned evaluation of Nasdaq's proposal.
|1||The Amex Member Associations include the Options Market Makers Association, the Floor Brokers Association and the Specialists Association.|
|2||If Nasdaq is opposed to granting an extension, the Commission should institute proceedings to determine whether the application should be denied on the grounds that Nasdaq and its parent, the NASD, have provided insufficient information to demonstrate that Nasdaq meets the legal standards for exchange registration.|
|3||Release No. 34-44396, 66 FR 31952 at 31953 (June 13, 2001). The Commission also set this out as preconditions to Nasdaq's implementation of SuperMontage in its order approving SuperMontage. Release No.34-43863, 66 FR 8020 at 8053-8054 (Jan. 26, 2001).|
|4||We plan to address these concerns in detail in a follow-up submission with the benefit, we hope, of more complete information.|
|5||The NNMS, which Nasdaq describes as its "primary trading and execution medium." See "The Nasdaq Stock Market," at Exhibit E, Tab 1, p. 13 of Nasdaq's Form 1 filing. The SuperMontage rules materially build upon SuperSOES and were subject to a protracted and contentious public comment process during which Nasdaq made numerous amendments to its original rule filing.|
|6||Section 6(b)(5) provides that an exchange's rules may not be "designed to . . . regulate by virtue of any authority conferred by this title matters not related to . . . the administration of the exchange."|
|7||The Commission recognizes that Nasdaq and its market users should be subject to different standards in its notice of Nasdaq's application, when it highlights that Nasdaq members will become subject to Section 10(a) and 11(a) of the Exchange Act once Nasdaq registers as an exchange. Release No. 34-44396, 66 FR 31952 at 31953 (June 13, 2001).|