March 20, 2002
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Attention: Mr. Jonathan G. Katz, Secretary
Re: File Nos. SR-NASD-2001-90 and SR-NASD-2002-28
Ladies and Gentlemen:
Brut, LLC ("Brut")1 wishes to provide the Securities and Exchange Commission (the "Commission") with additional comments regarding the plans of the National Association of Securities Dealers, Inc. (the "NASD") to operate the quotation-dissemination and trade-reporting mechanism commonly known as the Alternative Display Facility ("ADF"), as described in Exchange Act Release No. 45156 (the "Rules Release")2 and Exchange Act Release No. 45501 (the "Fee Release").3 The ADF's creation was dictated by the Commission as a condition for the launch of Nasdaq's "SuperMontage" order-execution system.4
Brut is greatly concerned that the NASD is setting parameters for the technological and economic operation of the ADF that all but guarantee that: (i) it will be inaccessible to market participants on a timetable commensurate with Nasdaq's stated intention to deploy SuperMontage in the 3rd quarter of 2002; and (ii) once available, it will not offer a competitive alternative to Nasdaq participation. Constructing the ADF in this manner would be inconsistent with Commission directive to "provide NASD members with the ability to opt-out of the SuperMontage,"5 and undermine the competitive quality of the national market system to the detriment of all market participants. Brut respectfully requests the Commission review the NASD's ADF-related efforts carefully to ensure that its purpose and potential are fulfilled, and provide guidance as to whether Nasdaq's current SuperMontage timetable is still appropriate in light of these developments.
In today's financial markets, a concept is only as good as the technology that supports it, and the ADF is no different. Market participants that are considering use of the ADF to post quotations and report trades are all evaluating the technological requirements for doing so, and whether they represent a cost-effective, sustainable use of precious development resources. The NASD has not made this process easy. To date, the NASD has provided firms with a 330-page document that, incredibly, is materially incomplete regarding the requirements for development of an Application Programming Interface ("API") for ADF usage, the key set of specifications that govern how a market maker or ECN would interact with ADF systems. Vital protocols, message type descriptions, fail-over procedures and requirements for key ADF components, such as the "TRACS" trade-comparison service, remain a mystery to prospective ADF users. This lack of documentation makes any analysis of ADF technology incomplete and more importantly, deters market participants from even considering the ADF as a meaningful alternative.
Unfortunately, what can be gleaned from currently available documentation produces the conclusion that integration into the ADF would require a significant expenditure of time and firm resources. The NASD has chosen to rely on a proprietary technology of the NASD's ADF vendor, OM Group ("OM"), that has limitations that raise serious capacity and operational issues. As currently proposed, the ADF API would not be compatible with the Financial Information Exchange ("FIX") protocol, which is widely-available and an industry standard for financial market communications, and relies instead on the Exchange Transaction Protocol ("XTP"), which is exclusive to OM's own technology. This means that firms wishing to use the ADF must code their API in the language of a protocol with which they are unfamiliar and for which there is no possibility of obtaining assistance from third-party vendors. The lack of FIX compatibility significantly increases the amount of development resources that a market maker or ECN would need to devote in order to use the ADF. Moreover, XTP has considerable operational and capacity limitations that raise questions as to whether it should be the primary protocol to handle the messaging requirements of a major market facility.
Brut has raised these issues with NASD personnel on several occasions, highlighting that it makes NASD-stated June 2002 deadlines for ADF operation untenable and that this technology does not provide a firm foundation for ADF operation. The ADF is not "available" until its potential users have the resources at their disposal to take advantage of its purported functionality. The technological course the NASD has chosen to pursue makes it almost certain that the ADF will not be accessible by market makers and ECN any time in the near future. Given Nasdaq's relentless goal to deploy SuperMontage in the 3rd quarter of 2002, Brut is concerned that Nasdaq will use the inertia of its former parent company as justification for arguing that SuperMontage be allowed to operate despite a competitive landscape without a realistic alternative.
The recently published Fee Release, which sets a rate structure that imitates the fees that Nasdaq currently charge, is silent on the one issue that would make ADF economics sub-standard: market-data revenue redistribution. By failing to share in the substantial revenue produced by its participants' quote and trade information,6 the NASD forces market makers and ECNs to face a Hobbesian choice: further strengthen Nasdaq's competitive position in order to collect market data revenue through their program, or suffer the loss of revenue and participate in the ADF.7
The NASD states that "this fee structure is a reasonable means for the NASD to recover the development costs of the ADF."8 Brut submits that these development costs should be funded from the proceeds of the NASD's sale of their previous quotation and trade-reporting facility operations, namely Nasdaq. The NASD recently entered into a transaction with Nasdaq whereby Nasdaq agreed to re-purchase a portion of the NASD's ownership interest for consideration of roughly $440 million.9 The first stage of this transaction closed on February 21, 2002, with the NASD receiving cash consideration of approximately $175,000,000.10 These proceeds are directly related to the NASD's spin-off of facilities that made the creation of the ADF necessary for the NASD to comply with their obligations as a national securities association under the Exchange Act. Absent a thorough accounting that this money is insufficient to build and operate the ADF, these proceeds should give the NASD the fiscal flexibility to re-distribute the market-data revenue that its participants generate through quotation and trade reporting. This financial situation also raises questions as to whether the NASD's approach of mimicking Nasdaq's fee structure for other charges is appropriate, or whether the NASD is in a position to establish lower rates now that it is operating a more limited-purpose facility and has freed itself of Nasdaq's competitive designs and can truly operate on a not-for-profit basis.11
Brut has previously commented that a competitive fee structure was essential to the ADF's competitive position.12 Brut believes that, as proposed, the Fee Release does not outline an economic framework for ADF participation that gives market participants meaningful choice. At a minimum, the fee structure for the ADF should be revised to incorporate a meaningful market data revenue-sharing program and be thoroughly reviewed to ensure consistency with the NASD's statutory obligations.
Brut is troubled by recent NASD decisions regarding the development and operation of the ADF and believe that this may undermine its value to market participants. Combined with Nasdaq's unyielding efforts towards deployment of SuperMontage, anxiety by market participants over how they will quote, trade and report transactions in Nasdaq securities is increasing. Brut respectfully suggests the Commission thoroughly review the Fee Release and NASD efforts in creating the ADF and provide the market-place with guidance regarding the time-table for ADF and SuperMontage deployment to ensure a transition of market structure that is both stable and sound.
BRUT appreciates this opportunity to offer comments to the Commission. If the Commission or its staff would find further discussions or other assistance helpful, please do not hesitate to contact me at (917) 637-2560.
Senior Vice President & General Counsel
cc: The Hon. Harvey Pitt, Chairman
The Hon. Isaac C. Hunt, Jr., Commissioner
The Hon. Cynthia 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
John Polise, Senior Special Counsel, Division of Market Regulation
Steve Joachim, Senior Vice President, NASD
|1||Brut operates The BRUT ECN System, one of the significant electronic communication networks ("ECNs") in the Nasdaq market. Brut's unique business model strengthens the relationships between broker-dealers and their institutional clients, while its proprietary tools ensure superior functionality and efficient access to market liquidity. BRUT is owned and supported by 26 Wall Street firms. The company is headquartered in New York City.|
|2||December 14, 2001. 67 Fed. Reg. 388 (January 3, 2002). File No. SR-NASD-2001-90.|
|3||March 4, 2002. 67 Fed. Reg. 10942 (March 11, 2002) File No. SR-NASD-2002-28.|
|4||See Exchange Act Release No. 43863 (January 19, 2001). 66 Fed. Reg. 8020 (January 26, 2001) ("SuperMontage Approval Order").|
|5||Id., at 8050.|
|6||Nasdaq earned $240 million in revenue in 2001 from such sources. See Nasdaq Reports Fourth-Quarter/Year-End 2001 Results, available at http://www.nasdaqnews.com.|
|7||This would be further compounded by a predatory pricing scheme recently proposed by Nasdaq, which would charge incrementally higher SuperSOES and SuperMontage fees on firms that did not report an overwhelming majority of their trades to Nasdaq. See Exchange Act Release No. 45506 (March 5, 2002), 67 Fed. Reg. 10949 (March 11, 2002). Brut intends to comment on this release in a future letter.|
|8||Fee Release, supra n. 3, at 10945.|
|11||This approach also reinforces Brut's previously-stated concerns as to the NASD's true independence from Nasdaq. See Letter from William O'Brien, Senior Vice President & General Counsel, BRUT to Jonathan G. Katz, Secretary, Commission, February 13, 2002, at 5.|
|12||See Id., at 3-4.|