The X-Change Corporation
36 West 44th Street, Suite 1201
New York, New York 10036
June 27, 2002
United States Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
Attention: Mr. Jonathan G. Katz, Secretary
Re: SEC File No. SR-NASD-2001-90 (Amendment No. 2)
Dear Mr. Katz:
WEBIXTRADER.COM ("WEBIXTRADER")1 appreciates this opportunity to comment on Amendment No. 2 to the proposal by the National Association of Securities Dealers, Inc. (the "NASD") relating to the proposed separation of The Nasdaq Stock Market, Inc. ("Nasdaq") from the NASD and the establishment of an Alternative Display Facility (the "Proposal").
Like the majority of other commenters, WEBIXTRADER does not object to the concept of the ADF. However, WEBIXTRADER does object to many of the procedural and legal deficiencies contained in the various filings made by the NASD and Nasdaq relating to the ADF, Nasdaq's application for registration as a national securities exchange and other topics. We understand that comments on specific provisions of the applications or proposals discussed in these filings should be made in accordance with the comment process for each individual filing. However, like other commenters, we do not believe that these filings can be considered in isolation,2 and are concerned that the NASD's piecemeal approach to the filings has inhibited meaningful comment on them.
The NASD and Nasdaq have taken or are taking numerous actions which are interrelated and on which members of the public and the securities industry should have the full opportunity to comment, including the following:
Despite the flurry of filings and proposals by NASD on the above subjects, it has yet to issue a statement addressing these relationships between the proposals or the numerous issues which arise as a result of these relationships.7 We find it difficult to believe that the NASD does not have a master plan with regard to its and Nasdaq's future operations and structure. We respectfully request that the Commission require, as a condition to approval of any of the above filings, that the NASD file a statement setting forth its plan as it relates to the filings.
Deficiencies in Separation Plan
Section 15A(b)(6) of the Exchange Act requires that the rules of the NASD, among other things, "foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system . . . ."8 In approving the NASD's SuperMontage proposal, the Commission recognized the possibility that conflicts of interest between the NASD and Nasdaq would impair the NASD's ability to fulfill its statutory duty. Specifically, the Commission noted that:
[it] would be inconsistent with the NASD's self-regulatory responsibility for the NASD to use its regulatory power to advance Nasdaq's market interest to the detriment of its members, and the Commission intends to be vigilant to prevent this. As a result, the NASD will not be able to use its regulatory authority to act in any manner in preference to, or prejudice of, Nasdaq or any other stock market, marketplace, or market participant generally or specifically because of that entity's relationship to the SuperMontage or Nasdaq.9
The NASD has done little in the seventeen months since the Commission approved the SuperMontage proposal to separate itself from Nasdaq in any meaningful fashion. The conflicts which exist between the NASD and Nasdaq are numerous. Some of these conflicts are as follows:
We agree with the other commenters who have questioned whether the NASD can be considered fully committed to the ADF as long as these conflicts of interest exist.13 In addition, this conflict of interest raises a larger issue, namely whether the NASD can properly exercise its self-regulatory responsibilities with regard to Nasdaq and the alternative trading systems with which it competes. As is often the case with conflicts of interest, the appearance of the conflict of interest is enough to create a loss of confidence in the NASD's ability to perform these functions properly. Given the importance of a strong self-regulatory system and the importance of fair competition between security markets, this situation is intolerable.
As troubling as the clear conflict of interest between the NASD and Nasdaq is, the NASD is apparently indifferent to this conflict. These serious issues, which were the subject of extensive comment, are dealt with by the NASD in a brief section, entitled "Other Issues," within its statement of the purpose of the statutory basis for the Proposal.14 The NASD's only statement on the ownership issue is that it "no longer holds any common stock in Nasdaq, except the stock that underlines the warrants issued in the Nasdaq private placement."15 Warrants, as anyone involved in the securities industry knows, give the holder a real, not hypothetical, economic stake in an entity. In addition the NASD's statement that it no longer holds any common stock is disingenuous; the NASD does not state that it continues to own preferred stock. The NASD also responds to the conflict issue by pointing out that its "management" is completely independent from that of Nasdaq, and that its board of directors will be separate by the time the ADF becomes operational.16
The NASD responses to commenters' concerns on the conflicts of interest between it and Nasdaq miss the point. The issue is not purely one of the NASD's ability to control Nasdaq. Rather, the NASD's huge economic stake in Nasdaq gives it a powerful incentive to maximize the value of this stake, including preserving its large cash distributions, by making it difficult for Nasdaq's competitors to attract or retain business. One way the NASD can seek to preserve the value of its ownership interest in Nasdaq is through its direct regulation of Nasdaq's competitors, ECN's and other alternative trading systems. Another is by failing to ensure that the ADF is a meaningful alternative to Nasdaq, whether through rulemaking, by failing to devote sufficient resources to the facility's operation or making the pricing prohibitively expensive.
Given the serious conflicts of interest between the NASD and Nasdaq and NASD's apparent unwillingness to resolve these conflicts, we believe that only Commission action can resolve this problem. The solution is straightforward - the Commission should not approve Nasdaq's Form 1 application or the BBX Proposal until the NASD and Nasdaq are completely separate. Completely separate should be taken to mean that the organizations have no common officers or directors, and that the NASD has no ownership interest whatsoever in Nasdaq - no common stock, no preferred stock, no warrants and no other securities. Any Commission suggestion that the NASD and Nasdaq completely separate themselves would undoubtedly meet with the response from the NASD that there are numerous economic and procedural hurdles to such a step. However, the Commission is not the cause of this problem, nor are any of the other market participants. The NASD and Nasdaq have created the problem, and should be charged with its resolution.
Exclusion of Bulletin Board Securities
Much of the motivation for the creation of the ADF lies in the unfairness of requiring ECN's and other alternative trading systems to access the national market system through Nasdaq.17 The necessity of an effective ADF, as it exists with regard to securities currently traded on Nasdaq, has been adequately expressed by other commenters.18 However, an even more serious anticompetitive threat exists in the market for OTCBB stocks, which are not even included in the proposed ADF. As discussed in more detail below, the exclusion of OTCBB securities from the ADF, coupled with the BBX Proposal, have the effect of creating a monopoly in OTCBB securities which could be broken only by an alternative trading system's accessing the national market system through Nasdaq or another exchange. This situation runs counter to the basic principles of the National Market System. The preservation of monopolies will curb new initiatives and result in stagnation, rather than progress, in the securities markets.
ECN's and other alternative trading systems are not subject to all of the order display and execution access requirements of Regulation ATS with regard to transactions in OTCBB securities. This is because OTCBB securities do not currently meet the definition of "covered security." Regulation ATS largely incorporates the definition of "covered security" from Rule 11Ac1-1(a)(6), which defines "covered security" to include "any reported security and any other security for which a transaction report, last sale data or quotation information is disseminated through an automated quotation system as described in Section 3(a)(51)(A)(ii) of the [Exchange] Act."19 The term "reported security" includes securities for which transaction reports are collected under an effective transaction reporting plan.20 Reported securities therefore include only Nasdaq securities or exchange-listed securities.21 OTCBB Securities also do not fall within the second portion of the definition of "covered security" in Rule 11AC1-1(a)(6) because the OTCBB is not considered an automated quotation system within the meaning of Section 3(a)(51)(A)(ii) of the Exchange Act.22 The fact that OTCBB securities do not fall within the definition of "covered security" means that these securities are not subject to the order display and execution access requirements of Rule 301(b)(3) of Regulation ATS, which apply only to covered securities whose volume on a system exceeds the threshold specified in the rule.23
The BBX Proposal will have the effect of causing OTCBB securities to fall within the definition of covered securities. It is unclear from the NASD's filings relating to the BBX and to its public statements whether the BBX will be a "tier" within Nasdaq; it does appear that it will be somehow part of Nasdaq.24 Once the BBX becomes either an exchange or part of an exchange, securities listed on the BBX will have to be subject to an effective transaction reporting plan,25 although BBX has not addressed the manner in which transactions will be reported. This would cause the securities to be considered "reported securities," and therefore "covered securities," causing the systems trading these securities to become immediately subject to the order display and execution access requirements of Regulation ATS, if the volume in the securities exceeds the threshold in Rule 301(b)(3).
The transformation of OTCBB securities into "covered securities" could prove beneficial if a realistic neutral forum existed for the trading of these securities. Of course, the NASD's decision to exclude OTCBB securities from the ADF means that no such forum will exist. Any system trading these securities would then be in a troubling position - required by Rule 301(b)(3) to provide quotation information to a "national securities exchange" or "national securities association,"26 but without a mechanism to transmit this information to the NASD, the only registered securities association. The only option for such a system would be to seek access through a national securities exchange, with the attendant technological, financial and other obstacles in addition to the exchange's lack of neutrality.27 WEBIXTRADER has contacted five national securities exchanges regarding our obtaining access to the National Market System, and none have expressed an interest in providing or even discussing access. Whether by design or not, the exclusion of OTCBB securities from the ADF, coupled with the BBX Proposal, would promote a BBX monopoly in OTCBB securities.28
Development of a National Market System is a complex undertaking. The ADF is a logical starting point for this development. However, a model for such a system does not exist and participants who could be helpful in the undertaking are available. In the current environment, however, there is little or no opportunity for commenters to be heard.
A strong market for OTCBB and similar securities is critical to the capital-raising efforts of developing businesses in the United States.29 At the same time, trading in these securities, because of factors such as the lower trading volume and smaller number of shareholders, should not be subject to the same regulations as exist for securities which trade in much greater volume. Congress and the Commission have been resolute in their refusal to mandate the trading of even national market system securities on a particular type of market.30
The exclusion of OTCBB securities from the ADF would serve to defeat one of the basic goals of the national market system, as expressed by Congress in Section 11A of the Exchange Act: "fair competition among . . . exchange markets . . . ."31 Accordingly, we respectfully request that the Commission require, as a condition to approval of the ADF, that the facility include OTCBB securities.
If the Commission staff would like to discuss the issues raised in this letter, please feel free to contact me at the above number.
Very truly yours,
K. Richard B. Niehoff
K. Richard B. Niehoff, Chairman,
President and Chief Executive Officer
cc: The Honorable Harvey L. Pitt, Chairman
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Cynthia A. Glassman, Commissioner
Annette L. Nazareth, Esq., Director, Division of Market Regulation
Robert L.D. Colby, Esq., Deputy Director, Division of Market Regulation
Gordon Fuller, Counsel to the Assistant Director, Division of Market Regulation
John Polise, Senior Special Counsel, Division of Market Regulation
|1||WEBIXTRADER operates an alternative trading system pursuant to Regulation ATS under the Securities Exchange Act of 1934 (the "Exchange Act"). WEBIXTRADER is an Internet-accessible, screen-based system that provides order routing, execution and processing for securities currently traded on the Over-the-Counter Bulletin Board (the "OTCBB"). WEBIXTRADER is operated by X-Change Technologies Corp., a subsidiary of The X-Change Corporation. The X-Change Corporation files periodic reports with the Commission pursuant to Section 15(d) of the Exchange Act.|
|2||See Letter dated February 25, 2002, from Meyer S. Frucher, Chairman and Chief Executive Officer, The Philadelphia Stock Exchange, Inc., to Jonathan G. Katz, Secretary, SEC, in connection with the Proposal ["Frucher Letter"]; Letter dated January 29, 2002, from Sol Reicher, Co-Chairman, Specialists Association, John Hawkey, Chairman, Floor Brokers Association and James Hyde, Chairman, Options Market Maker Association, American Stock Exchange, to Jonathan G. Katz, Secretary, SEC, in connection with the Proposal.|
|3||See Application of the Nasdaq Stock Market, Inc. for Registration as a National Securities Exchange on Form 1, filed with the Commission on March 15, 2001, available at www.sec.gov/rules/other.shtml; Notice of Filing of Application for Registration as a National Securities Exchange Under Section 6 of the Securities Act of 1934, Exchange Act Release No. 44396 (June 7, 2001).|
|4||See Notice of Filing of Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Nasdaq's Proposed Separation from the NASD and the Establishment of the NASD Alternative Display Facility, Exchange Act Release No. 45156 (December 14, 2001). The Commission requested comment on Amendment No. 2 to the Proposal in Exchange Act Release No. 45991 (May 28, 2002) ["ADF Amendment No. 2 Release"].|
|5||See Amendment No. 1 to Proposed Rule Change of The Nasdaq Stock Market, Inc. on Form 19b-4, filed with the Commission on May 10, 2002, available at http://www.bbxchange.com/SEC_Filings/SR-NASD-2002-82_Amendment_1.pdf [the "BBX Proposal"].|
|6||See, e.g., BBX Proposal, supra note 5; ADF Amendment No. 2 Release, supra note 4; Notice of Filing of Proposed Rule Change, Amendment No. 1., and Amendment No. 2 Thereto by the National Association of Securities Dealers, Inc. Relating to Display Requirements When Using Reserve Size in the Nasdaq National Market Execution System, Exchange Act Release No. 45016 (November 5, 2001).|
|7||Moreover, the NASD does not even acknowledge these relationships. In its response to commenters who suggested that the ADF be required to operate for a trial period before either SuperMontage or Nasdaq's exchange application is approved, the NASD states simply that the Nasdaq exchange application and implementation of SuperMontage are "independent issues for the SEC to consider." ADF Amendment No. 2 Release, supra note 4, at section II.A.1.|
|8||15 U.S.C. §78o-3(b)(6).|
|9||Order Approving Proposed Rule Changes by the National Association of Securities Dealers, Inc. and Amendment Nos. 1, 2, 3, 4, 5, 6, 7 and 8 Thereto and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 9 Relating to the Establishment of the Nasdaq Order Display Facility and Order Collector Facility and Modifications of the Nasdaq Trading Platform, Exchange Act Release No. 43863, at section V.I.2. (January 19, 2001) (footnotes omitted) "SuperMontage Release".|
|10||See Definitive Proxy Statement of the Nasdaq Stock Market, Inc., filed with the Commission on May 6, 2002 "Nasdaq Proxy".|
|12||On March 8, 2002, Nasdaq purchased the remainder of the NASD's shares of its common stock. Id. However, as part of the transaction, the NASD received, in addition to cash, 1,338,402 of Nasdaq's Series A Cumulative Preferred Stock and one share of Series B Preferred Stock. Id. The Series B Preferred Stock is designed to ensure that the NASD has control of Nasdaq's voting power until Nasdaq becomes registered as an exchange, and will be redeemed upon exchange registration. See id. The Series A Preferred Stock, while it does not vote, carries a dividend rate of 7.6% for one year beginning in March, 2003 and 10.6% for all succeeding years. Quarterly Report of the Nasdaq Stock Market, Inc. on Form 10-Q, filed with the Commission on May 15, 2002. The NASD, as the holder of the Series A Preferred Stock, would have the right to elect two directors of Nasdaq if dividends have not been paid on the stock for four consecutive quarters. See id. The NASD continues to own warrants to purchase a total of 43,255,976 shares of Nasdaq's common stock. See Nasdaq Proxy, supra note 10. We were unable to determine the exercise price of these warrants. As a result of the ownership of the warrants, the NASD beneficially owns 55.1% of Nasdaq's common stock. Id.|
|13||See Frucher Letter, supra note 2; Letter dated February 7, 2002, from Kevin M. Foley, Bloomberg Tradebook LLC, to Jonathan G. Katz, Secretary, SEC, in connection with the Proposal.|
|14||ADF Amendment No. 2 Release, supra note 4, at section II.A.1.|
|16||Id. The timing of the ADF's launch is unclear; it appears that Nasdaq wants to become an exchange at the same time or even before the ADF becomes operational.|
|17||See SuperMontage Release, supra note 9, at section II.C.2. WEBIXTRADER would be willing to participate in the development of a meaningful, neutral ADF.|
|18||See Frucher letter, supra note 2; Letter dated February 13, 2002 from William O'Brien, Senior Vice President and General Counsel, Brut, LLC, to Jonathan G. Katz, Secretary, SEC, regarding the Proposal.|
|19||17 C.F.R. § 240.11Ac1-1(a)(6). See 17 C.F.R. §242.300(g).|
|20||17 C.F.R. § 240.11Ac1-1(a)(20).|
|21||See Disclosure of Order Routing and Execution Practices, Exchange Act Release No. 43084, at note 33 (Aug. 8. 2000).|
|22||See id. at note 40.|
|23||17 C.F.R. § 242.301(b)(3)(i).|
|24||See BBX Proposal, supra note 5.|
|25||See Rule 11Aa 3-1(b)(1), 17 C.F.R. §240.11Aa3-1(b)(1).|
|26||17 C.F.R. § 242.301(b)(3)(ii).|
|27||Alternatively, an amendment to Rule 300(g) of Regulation ATS would be necessary to exclude OTCBB Securities from the definition of "covered security."|
|28||The manner in which the Proposal and the BBX Proposal combine to promote a monopoly in these securities also illustrates the dangers of considering the NASD's various filings in isolation.|
|29||Kenneth A. Kamen, Congressional Testimony on Market Structure: Effects of Reforms on the Small Issuer Marketplace (May, 11 2000).|
|30||See, e.g., S. Rep. No. 94-75, at 194 (1975) (finding that "within a national market system, securities should trade in the manner most appropriate to their characteristics, consistent with the public interest"); Notice of Filing of Proposed Rule Change by the New York Stock Exchange, Inc. to Rescind Exchange Rule 390; Commission Request for Comment on Issues Relating to Market Fragmentation, Exchange Release No. 42450, at section IV. B. (February 23, 2000) (stating that the Commission has strived to foster "a framework that gives the forces of competition sufficient room to flourish and that allows the markets to develop according to their own genius . . . and remains committed to allowing the forces of competition to shape market structure . . . .").|
|31||15 U.S.C. § 78k-1(a)(1)(C)(ii).|