DOMESTIC SECURITIES, INC.
160 Summit Avenue
Montvale, New Jersey 07645

August 21, 2002

Jonathan G. Katz
Secretary
U.S. Securities & Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

Re: Nasdaq Super Montage/NASD Alternative Display Facility

Dear Mr. Katz:

Domestic Securities, Inc.("Domestic"), the owner/operator of the ATTAIN® ECN, wishes to comment on whether the Alternative Display Facility (the "ADF") of the National Association of Securities Dealers, Inc. ("NASD") satisfies the preconditions to the Commission's approval of the operation of The Nasdaq Stock Market Inc.'s ("Nasdaq") SuperMontage system ("Super Montage"). Because SuperMontage includes a decrementation feature that would eliminate the ATTAIN® ECN's inside quotes under certain circumstances, Domestic cannot utilize SuperMontage and fulfill the order handling requirements imposed on an ECN. On the other hand, Domestic believes that the ADF is also not a viable alternative and does not satisfy the preconditions in the Commission's approval order for the following reasons:

  1. Failure to Use Standard Interface Protocol
  2. Failure to Develop Interface Converter
  3. Failure to Develop Inter-firm Communications Facilities
  4. Failure to Subject ADF to Market Wide Stress Testing
  5. Failure to Test Direct and Indirect Electronic Access Facilities
  6. Failure to Publicize List of Market Participants to Facilitate Telecommunications Testing
  7. Lack of Economic Incentives to Participate in ADF
  8. Imposition of Unduly Short Turn-around and Reporting Requirements
  9. No Vendor Quote Display Connectivity or Testing
  10. ADF Market Participants Required to Bear Equal Portion of Telecommunications Development Costs of Other Participants

Background

The Commission has determined that SuperMontage may not become operational until the creation of a "quote and trade reporting alternative that satisfies the Order Handling Rules, Regulation ATS and other regulatory requirements for ATSs, ECNs and market makers."1 The Commission also preconditioned the approval of Nasdaq's exchange application on the existence of an operational ADF. By so doing, the Commission sought to ensure that those firms that choose not to become members of Nasdaq would have a viable alternative to Nasdaq.2

Because the ADF is not an order routing system, firms which utilize the ADF to display their quotes ("Market Participants") are required, pursuant to NASD Rule 4300A(a)(1) and (2) of the NASD's Rules of its ADF (the "ADF Rules"), to provide direct electronic access to other NASD Market Participants and to NASD member broker-dealers that wish to (or are required to, due to best execution obligations) access their quotes and to allow NASD members to have indirect electronic access. Each NASD member is also required to have, in close proximity to its Nasdaq Workstation or other quotation and execution computerized facility, an ADF terminal that displays the ADF quotations and execution reports.3 During the Pilot Period, the ADF and Nasdaq will both be operated by the NASD, because Nasdaq's application to become an exchange has not yet been approved.

Numerous commenters on the ADF Rules have noted the NASD's conflict of interest in its investment in the economic success of Nasdaq while positioning itself as the developer and operator of the ADF.4 In response to the Commission's inquiries regarding this conflict of interest, the NASD stated that it "no longer owned any common stock of Nasdaq except the stock that underlies the warrants . . . . By the time the ADF goes live, assuming Nasdaq has been granted approval for its exchange registration, Nasdaq and NASD will have separate boards and will be fully independent in their decision making."5 Additionally the NASD established a Fairness Committee. However, the NASD omitted to mention certain material facts in its response.

There can be no doubt that the NASD has a huge economic stake in the success of Nasdaq and is in a position to exercise control over Nasdaq. In light of its economic stake in Nasdaq's success, why did the NASD volunteer to create a "viable alternative" to Nasdaq? Domestic posits that, given that the creation of an alternative to Nasdaq was required as a precondition to the approval of both Nasdaq's exchange application and SuperMontage proposal, the NASD determined that it was in its best economic interest to create a quotation and reporting system that posed the lowest level of competitive threat to Nasdaq. Some have expressed the belief that the NASD's ADF was "born to fail." Indeed, the NASD has formulated, by the structure of its ADF concept, by its ADF rules and by the ADF's technology, enough reasons to dissuade even the most earnest from becoming a Market Participant in the ADF.

The ADF Is Not a Viable Alternative

Domestic Securities does not believe that the ADF currently constitutes a viable alternative to Nasdaq. While the ADF does exist, one can legitimately question whether it is truly capable of sustaining its own life. Domestic believes that the ADF is nothing more than a Potemkin village, an elaborate facade, and that Domestic, the Commission and the investing public do not suffer from the gullibility of Catherine the Great. The ADF has the appearance but not the substance of a viable alternative. Had the NASD set out to build a system to which few, if any, would be attracted, it could not have succeeded more than the current result indicates.

1. Failure to use Standard Interface Protocol

The ADF is extraordinarily difficult to utilize because it does not use FIX (Financial Information Exchange), which is the industry standard interface in the United States for one broker's automated system to communicate with another broker's automated system. FIX is not difficult to write to and firms with technological ability are experienced in utilizing the FIX protocol. Although the Commission staff believes that the FIX protocol is not widely used, it is via a FIX protocol that each ECN interfaces with each other ECN and, at least in the case of the ATTAIN® ECN, that subscribers are linked to the ECN. Instead of FIX, the NASD's ADF relies on the Exchange Transaction Protocol (XTP), a proprietary technology of the NASD's Swedish vendor, OM Group. We know of no U.S. ECN or market maker which has developed an XTP interface. Furthermore, the technical specifications, published in March of 2002, are at best confusing, yet the NASD stated that any firm which did not sign up for the ADF by the spring of 2002 could experience serious delay in obtaining access later on. The use of the XTP interface, rather than the FIX interface, is a barrier to use of the ADF and therefore impinges on the viability of the ADF.

2. Failure to Develop Interface Converter

In response to numerous comments, the NASD is considering engaging a third party vendor to develop software that would translate from FIX to XTP. No vendor has been engaged nor has that software been developed nor tested; the FIX interface converter is only being considered by the NASD. There can be no assurance that the FIX converter will ever be developed. Its development should be a prerequisite to a finding by the Commission that the conditions precedent contained in the SuperMontage approval order have been met.

3. Failure to Develop Inter-firm Communications Facilities

Each Market Participant is required to establish connectivity with all other Market Participants and to provide direct and indirect electronic access to all NASD and ITS participants. No list of Market Participants has been published by the NASD that would enable potential Market Participants to ensure that they can route orders to other Market Participants. Development and testing of electronic links between NASD member firms and Market Participants is similarly undeveloped and untested. The development of these telecommunications facilities should be a prerequisite to a finding by the Commission that the conditions precedent contained in the SuperMontage approval order have been met.

4. Failure to Subject ADF to Market Wide Stress Testing

The ADF is designed, and the quotation system may have passed initial internal tests, but no market wide access tests have been conducted to ensure that there is adequate access to the quotes directly or through quote vendors and nothing has been published which provides assurance of the capacity of the ADF during periods of heavy quotations. Successful market wide stress testing of the ADF should be a prerequisite to a finding by the Commission that the conditions precedent contained in the SuperMontage approval order have been met.

5. Failure to Test Direct and Indirect Electronic Access Facilities

The direct and indirect electronic access facilities to Market Participants have not been subjected to any market wide testing. Successful market wide stress testing of these facilities should be a prerequisite to a finding by the Commission that the conditions precedent contained in the SuperMontage approval order have been met.

6. Failure to Publicize List of Market Participants to Facilitate Telecommunications Testing

No list of ADF Market Participants has even been published so that market wide testing of inter-firm telecommunication facilities for direct and indirect electronic access may occur.

7. Lack of Economic Incentives to Participate in ADF

The economic benefits of becoming an ADF market participant are not evident and, Domestic believes, are non-existent. The ADF is expensive to utilize, requires some Market Participants to subsidize other Market Participants for communication purposes, and does not offer Market Participants a share of tape revenue either for displaying liquidity or for executions. The NASD's statement that it will review these financial issues at a later date when it is more knowledgeable about the costs of operating the ADF is not consonant with the normal business principle of successfully launching a new business service and seeking to capture market share by offering attractive economic inducements to potential Market Participants. The business model is easy to understand if the business goal is to have a non-competitive display alternative; to have an alternative display facility that market participants will not choose to utilize. However, the less competitive the ADF is, the less viable it is. The addition of reasonably competitive economic advantages to use the ADF should be a prerequisite to a finding by the Commission that the conditions precedent contained in the SuperMontage approval order have been met.

8. Imposition of Unduly Short Turn-Around and Reporting Requirements

Proposed NASD Rule 4300A requires Market Participants to accept or decline an order within two seconds and to report this information to the NASD within 10 seconds or withdraw its markets. While the ATTAIN® ECN has no problem fulfilling this requirement under normal circumstances, if a system problem is being experienced, the withdrawal of markets immediately following the 10 second reporting period may not be possible. The consequences of unintended failure to meet these deadlines are not clear. Furthermore, many major market centers may not currently be able to meet these deadlines and thus may be unable to participate in the ADF. Finally, no market wide testing has occurred to verify whether Market Participants can actually meet these standards.

The technological turn-around and reporting requirements for Market Participants in the ADF far exceed those imposed for Nasdaq participation providing for average turnaround time of five seconds and maximum turnaround time of 30 seconds. Presumably the shortened reporting requirement imposed by the NASD for its ADF facility is due to the fact that since the NASD is not routing orders, it needs access in some other manner to perform its market surveillance activities. However, these requirements should be based on demonstrable need for shortening reporting time from 90 seconds to 10 seconds. No demonstrable need has been evidenced by the NASD. If a Market Participant fails to meet these time requirements, a 20-day suspension from quoting is mandated, regardless of when the problem is repaired.

Much more troublesome, however, is the requirement that a Market Participant is required to have in place a system that can accomplish a "round trip" of an order from another Market Participant in three or fewer seconds. How is the Market Participant supposed to verify the time the order was sent? What is a Market Participant ECN, which is not allowed to refuse service to any member firm other than one that has not paid its ECN bills, to do with respect to a broker/dealer which insists on accessing via the Internet? This rule makes the ECNs, indeed all Market Participants, responsible for the vagaries of both the Internet and the Internet Service Provider utilized by the firm which would access the ECN. In the past Instinet has objected to short turnaround periods and the NASD is fully aware of Instinet's objections to short turnaround periods. Is the NASD seeking to exclude Instinet from participation in the ADF? On the other hand, if the NASD ADF time periods are reasonable and will have a positive effect on the market, rather than being imposed to discourage participation, why weren't they utilized by the NASD's Nasdaq subsidiary for SuperMontage?

Among other things, the ADF timing rules:

The need for these particular timing requirements has not been demonstrated and they may pose a substantial barrier to participation by many market makers, thereby impinging on the viability of the ADF.

Finally, it is the Nasdaq staff and the members of Nasdaq's Market Operations Review Committee who are experienced with such matters who will deal with appeals from Market Participants that fail to meet the standards. Query whether the NASD plans to shift some of these experienced persons to the ADF.

9. No Vendor Quote Display Connectivity or Testing

For the ADF to be truly viable, its data needs to be displayed by the various data vendors. We are not aware of any connectivity that has been established between the major data vendors and the ADF, nor are we aware of any testing of the display of ADF data by these vendors. Establishment and testing of connectivity of ADF quotes to the major data vendors should be a prerequisite to a finding by the Commission that the conditions precedent contained in the SuperMontage approval order have been met.

10. ADF Market Participants Required to Bear Equal Portion of Telecommunications Development Costs of Other Participants

The amended ADF rules inappropriately require that Market Participants share equally in the cost of developing inter-connectivity, penalizing the more efficient Market Participant by requiring it to bear the costs of less technologically adept firms. If each Market Participant is not required to bear its own connectivity development costs, the more technologically adept will find participation in the ADF economically unattractive. Furthermore, since FIX is the industry inter-connectivity standard, each Market Participant will be required to simultaneously develop XTP and FIX protocols prior to joining the ADF.

We submit that the ADF may be "up" but it is not "running." The ADF Pilot Program should not be permitted to proceed until it can be accessed through a FIX protocol, until it has been tested market wide for peak performance, until interconnectivity among its users has been established and tested for peak performance, until the requirement for equal cost sharing for connectivity is amended to provide that each firm will bear its own development, as well as line, costs, and until the NASD provides attractive economic incentives to users, as Nasdaq has done, so that it is economically, as well as technologically, capable of sustaining its life. At the current time, in its current configuration, we cannot consider the NASD's ADF to be a viable, reasonable alternative to Nasdaq's SuperMontage. It is a choice, but not a choice we can make.

Decrementation Under SuperMontage

On the other hand, Nasdaq's SuperMontage presents an almost insurmountable obstacle to its use by ECNs that charge access fees. SuperMontage has admittedly been designed by Nasdaq to favor itself and market makers at the expense of ECNs, and especially those ECNs which charge access fees.7 That conclusion is based on the following:

In the initial period following the Commission's adoption of the Order Handling Rules, which permitted ECNs to charge a commission equivalent labeled an "access fee", there was resistance on the part of certain market makers and order entry firms to paying these fees. The NASD refused to get involved in enforcing the ECNs' right to obtain payment of their fees and instead suggested to ECNs that they could block these firms from access to the ECN and take them to arbitration. The NASD permitted a blocked firm to lock and cross the quote of an ECN that blocked the firm after attempting, in each case, to access that ECN's quote, and, presumably to assist the NASD in this task, asked each ECN to submit to the NASD the names of firms which were on the ECN's blocked list. A substantial amount of locked and crossed markets resulted.

To solve that problem for the SuperMontage environment, rather than enforce its own Rule 2110, which requires members to observe high standards of commercial honor and just and equitable principles of trade (which most would assume precludes theft of services by refusal to pay properly imposed ECN fees), SuperMontage is designed to decrement to zero the entire quotation of an ECN which declines to trade with a blocked market participant, leaving the blocked firm free to attempt to trade around or through the limit order displayed by the ECN or, if a market maker, to display its quotation. We do not believe that such treatment of limit orders is consonant with the requirements of the Order Handling Rules, which were adopted to protect customer limit orders, not to have them decremented into the oblivion to which market makers consigned them prior to the Commission's adoption of its Order Handling Rules. We should not return to the days when market makers ignored customer limit orders, trading around or through them with impunity.

The ATTAIN® ECN charges a per share fee for removing liquidity. The need to impose such a per share fee results from the fact that ECNs are not permitted to collect membership fees, data distribution fees, message traffic fees, or reporting fees as can Nasdaq, and thus must support their existence only through per share fees.

Nothing in Nasdaq's initial SuperMontage rule proposal or any of the nine amendments made it evident that when an ECN rejects an order of a blocked market maker, that rejection will be treated in the same manner as all other declinations. Indeed, in its SuperMontage approval order, the Commission did not even comment on decrementation resulting from the rejection of an order from a blocked market participant nor did the Commission make any reference to any comment regarding decrementation for that reason.8 Domestic did not, in fact, understand that a decline included rejections of blocked market participants until a Nasdaq staff member stated that rejections of blocked market makers would be treated as other declinations at a meeting in Domestic's offices in late May of 2002.

This treatment would destroy the ATTAIN® ECN's ability to operate effectively and therefore renders SuperMontage a non-option for the ATTAIN® ECN. While both the Commission and Nasdaq have suggested that the ATTAIN® ECN could simply cease blocking broker/dealers that refuse to pay their fees and seek fees through arbitration, this is not a realistic business model. Arbitrations typically take at least a year to be heard. Domestic cannot be in the position of waiting for more than a year for its receivables to be paid. The ATTAIN® ECN's fees have been examined by the Commission on several occasions. The ATTAIN® ECN has received no communication from the Commission that its fees are improper for any reason whatsoever. The ATTAIN® ECN's fees should therefore be considered presumptively valid and Nasdaq should be required to enforce its Rule 2110 against broker/dealers that refuse to pay those fees. The requirement of Nasdaq enforcement of Rule 2110 in such a case should be a prerequisite to a finding by the Commission that the conditions precedent have been met.

Furthermore, Domestic submits that this software programming regarding rejections of blocked market participants constitutes a rule change, not a rule interpretation readily ascertainable from a reading of the rules, and therefore notice and a comment period are required. Notice and comment on this aspect of SuperMontage should be a prerequisite to a finding by the Commission that the conditions precedent contained in the SuperMontage approval order have been met.

SuperMontage imposes special fees on decrementation messages from ECNs. The ATTAIN® ECN believes that the Commission should support the competition engendered by the electronic communication networks (who are required to pay Nasdaq the same fees and charges as other members) and reject this attempt by Nasdaq to enhance its competitive position by taxing only the decrementation message traffic the ECNs are required, under the Commission's Order Handling Rules, to transmit and not taxing the decrementation performed by Nasdaq for its market making members. This economic disadvantage ECNs are placed in by SuperMontage is yet another reason SuperMontage is a non-choice for ECNs and thus the NASD ADF must be enhanced to provide a truly viable alternative.

Conclusion

For the foregoing reasons, Domestic believes that the ADF is not a viable alternative to Nasdaq's SuperMontage and therefore the conditions precedent set forth in the Commission's SuperMontage approval order have not been met. Domestic believes that the Commission should not approve SuperMontage to become operational until such time as (i) the SuperMontage decrementation feature has been noticed for comment and comments have been received and analyzed, and (ii) either the SuperMontage decrementation feature has been modified or the many problems inherent in the NASD's ADF have been remedied.

Very truly yours,

DOMESTIC SECURITIES, INC.

By: Mark D. Shefts, President

cc: The Hon. Harvey Pitt, Chairman
The Hon. Cynthia Glassman, Commissioner
The Hon. Harvey Goldschmid, Commissioner
The Hon. Paul Atkins, Commissioner
The Hon. Roel Campos, Commissioner

Annette Nazareth, Esq., Director
Division of Market Regulation

Robert Colby, Esq., Deputy Director
Division of Market Regulation

Katherine England, Esq., Associate Director
Division of Market Regulation

Elizabeth King, Esq., Associate Director
Division of Market Regulation

John S. Polise, Esq., Senior Special Counsel
Division of Market Regulation

Mr. Stephen Williams, Economist
Division of Market Regulation

Mr. Mark Radke, Chief of Staff

Giovanni L. Prezioso, General Counsel

Dr. Lawrence Harris, Chief Economist

The Hon. Paul Sarbanes, Chairman
Senate Committee on Banking, Housing and Urban Affairs

The Hon. Phil Gramm, Ranking Minority Member
Senate Committee on Banking, Housing and Urban Affairs

The Hon. Michael G. Oxley, Chairman,
U.S. House of Representatives Financial Services Committee

The Hon. John LaFalce, Ranking Minority Member
U.S. House of Representatives Financial Services Committee


1 Exchange Act Rel. No. 43863 (Jan. 19, 2001); 66 Fed. Reg. 8020, 8050 (Jan. 26, 2001).

2 The Nasdaq Stock Market, Inc. Notice of Filing of Application for Registration as a National Securities Exchange, Exchange Act Rel. No. 44396 (June 7, 2001), 66 Fed. Reg. 31953 (June 13, 2001).

3 NASD Rule 4613(e).

4 See, e.g., Letter of Instinet Corporation dated July 1, 2002, Letter of Bloomberg Tradebook LLC dated June 28, 2002, Letter of The X-Change Corporation dated June 27, 2002, Letter of Nextrade Holding, Inc. dated June 9, 2002, in each case commenting on SEC File No. SR-NASD-2001-90, Notice of Filing of Amendment No. 2 to a 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 Rel. No. 45991 (May 28, 2002), 67 Fed. Reg. 39476 (June 7, 2002) ("ADF Am. 2").

5 ADF Am. 2, supra, "Self Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change - Other Issues."

6 See Definitive Proxy Statement of Nasdaq filed with the Commission on May 6, 2002.

7 See, for example, press release of TowerGroup dated August 2, 2002, regarding its report "ECNs and SuperMontage: Coexistence or Competition", which concludes, inter alia, that "SuperMontage will regain market share at the expense of competing . . . ECNs." http://www.towergroup.com/public.

8 SEC Exchange Act Rel. No. 43863 (Jan. 19, 2001).