Instinet Group Incorporated
3 Times Square
New York, NY 10036
Tel +1 212.310.9500
Dir +1 212.310.7728
April 1, 2002
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: Release No. 34-45501; File No. SR-NASD-2002-28
Dear Mr. Katz:
Instinet Corporation ("Instinet")1 welcomes the opportunity to provide the Securities and Exchange Commission (the "Commission") with its comments on the rule changes proposed by the National Association of Securities Dealers, Inc. (the "NASD") to establish transaction and quotation update fees, as well as other charges, for NASD members wishing to use the NASD's Alternative Display Facility (the "NASD Display Facility") for quotation collection, trade comparison and trade reporting for securities traded in the over-the-counter markets.2 The proposed fees correspond roughly to the fees the Nasdaq Stock Market, Inc. ("Nasdaq") currently charges for the same services provided to NASD members.
Unlike Nasdaq's market center fees, however, the NASD Display Facility Fee Proposal is silent on an issue critical to the success of the NASD Display Facility - the sharing of market data revenue with participants. Instinet understands from the NASD staff that there has been a decision by the NASD Board not to do so. In Instinet's view, the lack of a mechanism to share such revenue, together with other aspects of the NASD Display Facility Fee Proposal, make it very unlikely that the NASD Display Facility will be an economically feasible choice for potential participants and a viable over-the-counter alternative to Nasdaq's proprietary order-matching system. Specifically, Instinet is concerned that the following features of the facility's fee structure, as currently proposed, interfere with the facility's viability and success:
These issues must be viewed in combination with those raised by our and others' prior comments on the NASD Display Facility,3 and together they raise significant questions regarding the details of the Facility's operation that should be resolved before the Commission concludes that the Facility adequately provides the mandated alternative to Nasdaq's facilities. Instinet urges the NASD to continue, in close cooperation with the Commission, to work toward finding creative ways to address these serious issues and to assure that the NASD Display Facility will emerge as a neutral and successful quotation display and trade reporting system meeting the needs of the over-the-counter markets, consistent with the letter and spirit of the Exchange Act and the Securities Act Amendments of 1975.4
I. Market Data Revenue Sharing Is A Crucial Feature of a Realistically Competitive Fee Schedule for the NASD Display Facility
The NASD's refusal to share the market data revenue produced from the operation of the NASD Display Facility will seriously impair the Facility's attractiveness to market participants. The fact that Nasdaq itself has recently decided that it is competitively necessary to offer revenue sharing (as have regional exchanges) underscores the importance of including such a mechanism. Furthermore, the costs and revenue sharing arrangements associated with participating in the proposed NASD Display Facility have been a prominent factor in potential participants' analyses of whether to join, as shown by comments already filed with the Commission and available to the NASD at the time of drafting the NASD Display Facility Fee Proposal.5 In Instinet's view, effective competition in today's securities markets by any quotation display and trade reporting facility is untenable without some form of revenue sharing in connection with the operation of the facility.
The NASD's assertion that refusing to share market data revenue "is a reasonable means for the NASD to recover the development costs of the [NASD Display Facility]" is not convincing.6 As other commenters have pointed out, the NASD should already have received ample revenue to recover these costs (which were foreseeable given the Commission's prior orders) as a result of the sale of Nasdaq.7 Indeed, given the more limited scope and functionality of the NASD Display Facility, the NASD should be in a position to (and be striving to) charge participants less than Nasdaq does for the provision of comparable services in order to provide the market with a competitive alternative model. As we have noted in the past, if in fact the NASD is facing revenue shortfalls as a result of the restructuring related to the separation of Nasdaq, that is a powerful indication that the terms of the separation were not in fact at arm's length.8 Market participants should not be forced to make good Nasdaq's underpayment to the NASD.
It is important that the NASD approach the NASD Display Facility with a competitive mindset if the NASD Display Facility is to provide more than a paper alternative to Nasdaq and the regional exchanges. In that context, the NASD should be prepared to share the market data revenues it will collect with participants.
II. The Proposed Quotation Update Fee Will Deter Participation in the NASD Display Facility by ECNs and ATSs
The NASD's proposal to impose on each NASD Display Facility participant a quotation update fee on updates exceeding three times the number of trades reported through the facility will have a disproportionate and anti-competitive effect on ECNs and ATSs.9 Unlike market makers, ECNs and ATSs are required under the Order Handling Rules and Regulation ATS to update the size or price of their quotes in a specific security each time an entry for that security is made in their order books. Setting a relatively low limit on the number of quotation updates possible without paying fees ensures that ECNs and ATSs will incur disproportionate costs merely for meeting their regulatory requirements, thus discriminating against one of the primary business models active in the market, and violates the obligation of the NASD under the Exchange Act to allocate fees equitably10 and in a non-discriminatory manner.11
Instinet recognizes that some limit may be necessary to prevent abuse of the system, but it should be set at a level (for example, ten times reported trades) that will not penalize the ordinary operations of current market participants. Alternatively, a fee could be charged based on the number of quotation updates that are well outside the national best bid and offer. If additional fees are necessary to allocate ordinary costs of operating the facility not arising from "excessive" usage, the NASD should look for an alternative for addressing its concerns that does not arbitrarily exclude one category of potential participants from paying those fees by shifting them entirely to another category.
III. A Fee Structure Appealing to a Broad Range of Market Participants Is Essential If the NASD Display Facility Is to Provide a Competitive Alternative to Nasdaq
A successful NASD Display Facility is crucial to maintaining the competitive balance in the U.S. over-the-counter market, which is currently endangered by Nasdaq's ongoing effort to establish a for-profit order-matching system while retaining the numerous commercial and regulatory advantages built up as an arm of the NASD. The Commission has recognized this fact by conditioning the launch of Nasdaq's SuperMontage proposal12 and the approval of Nasdaq's exchange application13 on the creation of the NASD Display Facility. The Facility is thus an essential element in preserving effective competition and innovation among the nation's brokers, dealers and markets as envisioned by the Exchange Act and the Securities Act Amendments of 1975.14
Participants in the over-the-counter securities markets have made it clear that an equitable and competitive fee structure for the NASD Display Facility is crucial to its ability to provide a practical alternative to Nasdaq's systems.15 Instinet believes that the Commission's goal to preserve and enhance competition is not likely to be achieved, and its efforts could well prove fruitless, unless a more equitable and pro-competitive fee structure for the NASD Display Facility is adopted.
Moreover, the practical difficulties with the NASD Display Facility continue to mount, as other commenters have noted.16 The latest NASD document, the "Technical Overview" published March 20, 2002, gives no indication that critical functional issues have even been considered. The document is devoid of detail regarding matters such as message specifications, a project plan outlining key milestones, an implementation plan including full-scale rehearsals, and phasing in implementation of the system. The NASD has also chosen to use a proprietary communications protocol for the NASD Display Facility that is not compatible with existing protocols in use in the market. The NASD's choice to build an incompatible system - a result Nasdaq itself carefully avoided in implementing SuperMontage - adds another layer of delay, expense, and uncertainty to the already-aggressive schedule for firms' adoption of the NASD Display Facility and underlines the absence of basic commercial considerations from the NASD's planning. It is not reasonable to expect users to commit to a mission-critical system without considerably more sophisticated and detailed planning of the NASD Display Facility and its implementation.
Yet this is precisely what the NASD is asking. Firms were already expected to commit to the NASD Display Facility on March 25, and the NASD is requiring large up-front payments (equal to 50% of expected total third-quarter fees by April 15 and a further 50% by May 15). The substantial questions and concerns raised by potential participants in the NASD Display Facility - which at the very least must be conceded to be reasonable concerns worthy of being addressed before definitive decisions must be made - have had little or no reaction from the NASD and no effect on the timetable. In light of the uncertainty and risk surrounding the NASD Display Facility, the prepayments can only deter participation. We urge the Commission to intervene to ensure that the creation of the NASD Display Facility is a serious, unbiased, and commercially-minded effort rather than a pro-forma exercise in checking off requirements for the launch of SuperMontage and the approval of Nasdaq's exchange application.
Instinet respectfully requests the Commission's careful consideration of the NASD Display Facility Fee Proposal and of the concerns raised by Instinet and others. In our view, the Commission should decline to approve the new NASD rules as proposed and should direct the NASD to modify its filing to provide creative solutions to the important commercial issues facing the NASD Display Facility.
Please do not hesitate to contact the undersigned or Peter Rich of our Washington office (202-789-8550) if you should have any questions regarding this matter.
Douglas M. Atkin
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, Director, Division of Market Regulation
Robert L.D. Colby, Deputy Director, Division of Market Regulation
Belinda Blaine, Associate Director, Division of Market Regulation
Elizabeth K. King, Associate Director, Division of Market Regulation
John Polise, Senior Special Counsel, Division of Market Regulation
|1||Instinet is a registered broker headquartered in New York City. Together with its affiliates, Instinet currently trades in forty global markets and is a member of twenty exchanges around the world. Instinet is a pure agency broker, serving its global client base by consistently reducing transaction costs and thereby increasing investment performance for investors and their proxies. More information about Instinet and its activities is available on Instinet's web site at www.instinet.com.|
|2||Exchange Act Release No. 45501 (Mar. 4, 2002), 67 Fed. Reg. 10,942 (Mar. 11, 2002) (the "NASD Display Facility Fee Proposal").|
|3||Letter from Brut, LLC to Jonathan G. Katz, Secretary of the Commission (Mar. 20, 2002); Letter from Instinet Corporation to Jonathan G. Katz, Secretary of the Commission (Feb. 13, 2002); Letter from Brut, LLC to Jonathan G. Katz, Secretary of the Commission (Feb. 13, 2002); Letter from the Securities Industry Association to Jonathan G. Katz, Secretary of the Commission (Feb. 5, 2002); Letter from The Philadelphia Stock Exchange, Inc. to Jonathan G. Katz, Secretary of the Commission (Jan. 24, 2002); Letter from NexTrade, Inc. to Jonathan G. Katz, Secretary of the Commission (Jan. 18, 2002).|
|4||Securities Acts Amendments of 1975, Pub. L. No. 94-29, 89 Stat. 97 (1975).|
|5||See Letter from NexTrade, Inc. to Jonathan G. Katz, Secretary of the Commission (Jan. 18, 2002); Letter from Instinet Corporation to Jonathan G. Katz, Secretary of the Commission (Feb. 13, 2002).|
|6||NASD Display Facility Fee Proposal, supra note 2, at 10,945.|
|7||Instinet shares the belief of other commenters that the proceeds from the sale of Nasdaq "are directly related to the NASD's spin-off of facilities that made the creation of the [NASD Display Facility] necessary [and] should give the NASD the fiscal flexibility to re-distribute the market-data revenue that its participants generate through quotation and trade reporting." Letter from Brut, LLC to Jonathan G. Katz, Secretary of the Commission (Mar. 20, 2002).|
|8||Letter from Instinet Corporation to Jonathan G. Katz, Secretary of the Commission (Feb. 28, 2002).|
|9||Proposed NASD Rule 7010(b).|
|10||Under Section 15A(b)(5) of the Exchange Act, the NASD is required to provide, through its rules, for "the equitable allocation of reasonable duties, fees, and other charges among members ... using any facility or system which the association operates or controls."|
|11||Section 15(A)(b)(6) of the Exchange Act prohibits NASD rules "designed to permit unfair discrimination between customers, issuers, brokers or dealers."|
|12||See NASD Rulemaking: SuperMontage, Exchange Act Release No. 43,863 (Jan. 19, 2001), 66 Fed. Reg. 8019, 8054 (Jan. 26. 2001).|
|13||The Nasdaq Stock Market, Inc., Notice of Filing of Application for Registration as a National Securities Exchange, Exchange Act Release No. 44,396 (June 7, 2001), 66 Fed. Reg. 31,952, 31,953 (June 13, 2001).|
|14||See Section 11A(a)(1)(C)(ii) of the Exchange Act; S. Rep. No. 94-75, at 14; Subcommittee on Securities of the Senate Committee on Banking, Housing and Urban Affairs, Securities Industry Study, S. Rep. No. 93-13, at 12 (1973).|
|15||See Letter from the Securities Industry Association to Jonathan G. Katz, Secretary of the Commission (Feb. 5, 2002); Letter from Bloomberg Tradebook LLC to Jonathan G. Katz, Secretary of the Commission (Feb. 7, 2002); Letter from Brut, LLC to Jonathan G. Katz, Secretary of the Commission (Feb. 13, 2002).|
|16||See, e.g., Letter from Brut, LLC to Jonathan G. Katz, Secretary of the Commission (Mar. 20, 2002).|