Electronic Traders Association
20 Greenway Plaza, Suite 650
Houston, TX 77046
Telephone: (713) 403-4200
Fax: (713) 403-4221

December 4, 2001

Jonathan G. Katz
United States Securities and Exchange Commission<
450 Fifth Street, N.W.
Washington, D.C. 20549

Re: File Nos. SR-NASD-2001- 63, 2001-67, and 2001-71; and File No. S7-03-01. 

Dear Mr. Katz:

I am writing on behalf of the Electronic Traders Association ("ETA") in response to the rule changes filed by the NASD to: (1) modify the fees for use of SuperSOES; (2) modify Nasdaq's liquidity provider rebate; (3) institute a quotation update charge; and (4) introduce a mechanism for sharing market data revenue with NASD members that report substantially all of their trades through the ACT system (collectively, we refer to these proposals as the "Fee Increases"). ETA has a vital interest in the efficiency and integrity both of our capital markets and our system for regulating securities professionals. Our members generally operate from multiple offices across the country. Together, they account for a dominant portion of the orders executed each day on the Nasdaq marketplace and have a growing presence in the market for listed securities.

Because of our experience and dominant position in the securities markets, we believe that we can offer well-informed opinions on many issues of importance to investors and securities professionals. Transactions executed by our members generally are 400 shares or less. Often, these transactions provide liquidity to retail investors. Thus, we believe that our perspective mirrors the view of many retail investors that execute transactions through ECNs.

I. Overview

ETA has been concerned for some time with the ability of the NASD and Nasdaq to impose a fee structure on an accelerated basis without prior review by the Commission, when such fees are clearly inconsistent with the provisions of the Exchange Act. We believe that the Fee Increases will have a significant effect on market structure. Our objections to the proposed Fee Increases are based both on the inadequate process that fostered the changes, as well as on the discriminatory effect that the fees will have on competitors of Nasdaq.

Our interest in these proposals stems from the fact that any fees are likely to be passed on to our members, directly or indirectly, in the form of higher costs of execution or increased spreads, and because we anticipate that the fee structure is designed to increase the monopolistic control of Nasdaq. In this latter regard, we feel very strongly that the effect of the fees on ECNs needs to be examined closely by the Commission. Any decrease in competition among market centers as a result of the fee changes will adversely affect consumers.

We also agree with the comments of others who have noted that the accelerated approval process that Nasdaq utilized to implement its new fee proposals is a gross and obvious abuse of its stature as a government sponsored monopoly. We, and many others, have been perplexed for some time about the reluctance of the Commission to fulfill its legislative obligations under the Exchange Act and address the changes in the market that have occurred in recent years. It has been obvious to everyone, including we believe the Commission Staff, that fees are a significant issue that are not simply a matter to be decided by a monopolistic provider, or a cartel of providers - without the required government oversight.

II. Abuse of Power

"Who needs the law, we got the power. . . "

Jay Gould - 19th Century Robber Baron

At the outset of our comments, we feel compelled to exclaim the lack of notice that was provided to the industry regarding the Fee Increases, including those directly affected by the rule proposals. In our view, fundamental fairness demands that the significant changes proposed by Nasdaq be submitted for comment, at least among the Nasdaq membership. In this instance, there was no urgency associated with the rule proposals. Nevertheless, the initial rule filing apparently was made with the Commission on a Friday afternoon and became effective the next Monday. Because of this, many members of the industry, including many ETA members, were unaware of the fee proposals until they took effect on Monday morning. Moreover, even that Monday, after the rules had become effective, no filings were available in the Commission's public reference room.1

The conduct of Nasdaq in this instance is hardly a surprise. In the context of Super Montage, and the proposal to adopt new Rule 19b-62, we and others cautioned that the evolution of the securities markets and the privatization of Nasdaq required more, and not less, oversight by the Commission in areas in which monopolistic forces were permitted. Fees and trading rules that limit access are particularly powerful tools in thwarting the competition.

As the Commission is well aware, Nasdaq no longer is a mutual organization operating for the benefit of all of its members. Nasdaq now has substantial outside ownership by shareholders, to which it owes a fiduciary duty, whose interests may conflict with those of the market centers generally. Fee changes, while perhaps neutral when levied among members of a mutual organization with widespread representation, are no longer "non-controversial" filings. By and large, Nasdaq remains an organization controlled by traditional market makers who stand to benefit most from the fee changes. ETA members, who may pay a disproportionate share of the increase in fees proposed by Nasdaq, are not represented on the committees of Nasdaq that considered the fee increases.

In addition to the change in ownership structure, Nasdaq now operates in an arena in which it competes directly for order flow with alternative markets, such as ECNs, that are compelled by law to submit their quotes to Nasdaq. Nevertheless, Nasdaq remains protected from antitrust laws based in large measure on the Congressional assumption that the Commission's oversight of its activities, including the establishment of fees, will prevent discriminatory and anti-competitive practices. For this reason, we find it astonishing that the Commission and the Staff continue to permit the predictable behavior illustrated by the Fee Increases.3

We are aware, based upon a recent Nasdaq Head Trader Alert,4 that Nasdaq has agreed to delay implementation of Phase III of the Fees Increases. As indicated in the Alert, this will temporarily remove the distinction between Full and Partial Contribution members in connection with market data rebates and quote fees, and permit time for comment on these specific fee issues. We understand that Nasdaq's concessions are the result of concerns by the Commission and other market participants. Notwithstanding the concessions by Nasdaq, the process that it has used in this regard remains flawed and reflects fundamental unfairness. For this reason, we think that it is important for the Commission to send a strong message to Nasdaq by using its authority to abrogate each of the Fee Increases.

III. Proposed fee change is discriminatory

Because Nasdaq is a government sponsored monopoly, it is not subject to market forces other than competing SROs. Although we do not want to belabor a point that has been made by other commenters, fee issues are matters of central importance to the marketplace. The recent Report of the Advisory Committee on Market Information and the legislative debate on market structure are testimony to the growing concerns regarding the fee setting mechanisms of the NASD and Nasdaq.

Without the ability to conduct adequate analysis, we and others are not yet certain of the effects of the fee proposals on market structure. Our primary concern is with the impact that these changes will have on the prices available to retail traders and investors executing transactions through ECNs. Presently, ETA members and many retail investors have a choice in seeking a forum for execution. The growing volume in transactions effected on ECNs has been successful in reducing spreads in Nasdaq and demonstrated that these market centers offer value to investors beyond what is available in transacting business with market makers on Nasdaq. For this reason, we are concerned that our members and other retail investors may be deprived of access to competitive market centers if the Nasdaq proposal has the effect of forcing liquidity into a single centralized systems that favors market makers over ECNs.

A. Revenue Sharing

ETA, along with other commentators, is of the view that the proposed fee changes will discriminate against ECNs and alternative trading systems. One way in which we believe the Fee Increases are consciously designed to discriminate against ECNs and professional traders is the manner in which liquidity rebates are provided. ECNs operate on an agency basis and receive access fees and therefore cannot become "Full Contribution" members of Nasdaq. Consequently, they are not entitled to the liquidity provider rebates under the proposed rules. Moreover, we note that order entry firms, such as those operated by ETA members, and their customers, do not receive any payment for order flow and therefore are not likely to obtain any indirect benefit from the increased revenue received by market makers from rebates provided to this class of "Full Contribution" members.

Nasdaq has claimed in its proposing release that such discriminatory rebates are necessary to address competitive disparities in the marketplace between market makers and ECNs, which charge non-subscribers fees for accessing their quotes. We find this argument disingenuous. Unless Nasdaq is modifying its charter to become a trade association rather than a market center, it is difficult to take this argument seriously. At a minimum, Nasdaq should be required to submit support for its claim that the differences between ECN and market maker models produce negative competitive consequences for market makers that should be redressed by imposing, through its regulatory powers, a disparate fee structure.

Nasdaq also has stated that the purpose of these fees is to maintain Nasdaq's core of liquidity versus ECNs. The nature of ECN fees already has been addressed by the Commission in the context of the order handling rules and Regulation ATS. Once ECN fees are factored into a market price, competitive forces will determine the appropriate maximum fees. Moreover, the manner in which ECN quotes are displayed in the Nasdaq system was a matter of significant debate that was resolved in connection with the approval of SuperMontage. If Nasdaq wishes to reopen this debate, it should do so in a manner that permits full discussion. It is our expectation that the amendment to its current filing relating to Phase III will offer such an opportunity.

B. Quote Fees

A second source of discrimination will be evidenced in the form of the proposed quote fees. We understand that updated quotes and message traffic does place a burden on any system. However, we also note that a driver of this additional traffic is a combination of reduced liquidity at specific price points as a result of decimalization and of more efficient markets that have evolved as a result of the requirement that ECNs submit their quotes to Nasdaq. As the Commission is aware, the ECNs have become highly efficient means of conducting commodity-like transactions in securities. Spreads available in active stocks are often in no greater than one penny increments. Moreover, unlike market makers, ECN quotes are driven by their numerous customers, and not a conscious decision by a single market maker to raise or lower its quotes.

ECNs now compete directly against Nasdaq and UTP Exchanges for order flow. For this reason, we are skeptical of the reasons that Nasdaq has excepted UTP Exchanges from the quotation fees. As Nasdaq noted, such fees are not currently permissible under the UTP Plan, nor are they likely ever to be permitted because of the governance structure of the Plan. ECNs, on the other hand, while competing directly for market share and subject to similar quote submission requirements under the ATS Regulations, will bear the burden of the disparate fee structure. We believe that it is ironic that the ATS Regulations, and the order handling rules, which are designed to assure that the whole market has access to the national best bid or offer, will be distorted by Nasdaq to punish those market centers that offer open books and execute high volumes of transactions.

We also discount the need to impose fees on quotations as a means of supporting the Nasdaq infrastructure. ECNs, and ETA members, already contribute a significant amount of volume and transactions to the Nasdaq system and will bear a disproportionate share of fees due simply to the imposition of transaction execution charges. No further revenue stream is required by Nasdaq to assure an equitable allocation of expenses for maintaining the system. These charges will simply further serve to undermine the competitive position of ECNs.

IV. Conclusion

My colleagues and I at ETA have a strong interest in maintaining a fair and robust marketplace for securities, and we believe that the views expressed herein will further this goal. For the reasons that we outlined above, we urge the Commission to permit adequate comment and analysis of each of the "Anti-ECN Rules" by abrogating the new fee proposals. Alternatively, we suggest that Nasdaq, in connection with its announced amendments relating to Phase III, extend the period for which all members are considered Full Contribution Members until November 30, 2002. During this period, the Commission and commenters would have an opportunity to consider the effects of the Fee Increases.

We would be pleased to meet with members of the Commission at any time to discuss our views.


James H. Lee
Chairman and President, Electronic Traders Association

cc: Securities and Exchange Commission
The Honorable Harvey L. Pitt, Chairman
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Laura Simone Unger, Commissioner
Ms. Annette Nazareth, Director, Division of Market Regulation
Mr. Robert Colby, Deputy Director, Division of Market Regulation
Ms. Belinda Blaine, Associate Director, Division of Market Regulation
Ms. Elizabeth K. King, Associate Director, Division of Market Regulation
Ms. Katherine England, Assistant Director, Division of Market Regulation
Ms. Susie Cho, Attorney, Division of Market Regulation

United States Congress

The Honorable Paul S. Sarbanes
Committee on Banking, Housing and Urban affairs
United States Senate

The Honorable Phil Gramm
Ranking Member
Committee on Banking, Housing and Urban affairs
United States Senate

The Honorable Michael G. Oxley
Committee on Financial Services
United States House of Representatives

The Honorable John J. LaFalce
Ranking Member
Committee on Financial Services
United States House of Representatives

The Honorable Richard H. Baker
Subcommittee on Capital Markets
Committee on Financial Services
United States House of Representatives

The Honorable Paul E. Kanjorski
Ranking Member
Subcommittee on Capital Markets
Committee on Financial Services
United States House of Representatives


1 Separately, we want to express our frustration with the manner in which rule filings are communicated to the public. The Commission in recent years has forced issuers and securities professionals to file reports on Edgar, through the CRD, and on websites in order to provide more information to the public. Only a limited number of SRO rulemakings are available on the Commission's Website, however, while the majority, including many of the market data plans, are hidden from public view. It would be a simple matter for the Commission to encourage disclosure by requiring these sophisticated market participants to publish their rule filings in the Edgar system.
2 Securities Exchange Act Release No. 34-43860. We also are submitting a copy of this correspondence for the public files as our comment in connection with proposed Rule 19b-6. We believe that Nasdaq's actions in connection with the implementation of the Fee Increases provide an ample illustration of the potential danger inherent in permitting accelerated approval of SRO rules that may have an anti-competitive effect.
3 ETA generally supported the proposal of the NASD to modify SOES and SelectNet into the Nasdaq National Market Execution System ("NNMS"). However, it also was apparent at the time that the Commission was considering this proposal that the fee system for NNMS had the potential to operate in a discriminatory and anti-competitive fashion and in a manner inconsistent with the provisions of the Exchange Act. In proposing the NMMS, Nasdaq artfully avoided any discussion of the fee structure made the subject of the present NASD rule filings. As ETA pointed out at the time, it was predictable that any fee proposals would have the potential to be anti-competitive. In its May 28, 1999 comment letter to the Commission on the NNMS proposal, ETA stated as follows:

Finally, ETA continues to have substantial concerns that the fee system for NNMS may operate in a discriminatory and anti-competitive fashion. Section 11A of the Exchange Act provides, among other things, that it is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure economically efficient execution of securities transactions. In addition, Section 15A(b)(5) of the Exchange Act requires that the rules of the NASD provide for the equitable allocation of reasonable dues, fees and other charges among members and issuers and other persons using any facility or system which the NASD operates or controls. ETA cautions the Commission to pay special attention to the costs imposed on participants in NMMS, prior to approval, to ensure that such charges are in accordance with the provisions of Sections 11A and 15(b)(5) of the Exchange Act.

4 Head Trader Alert #2001-177 (November 29, 2001).