December 22, 1999
Via e-mail and Federal Express
Jonathan G. Katz
The Securities & Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
RE: Release No.34-42165; File No. SR-NASD-99-53
Dear Mr. Katz:
The Security Traders Association of New York ("STANY"), an industry association representing more than 2,300 individual security professionals in the New York metropolitan area, is pleased to have the opportunity to submit its comments concerning the proposal recently submitted by the National Association of Security Dealers, Inc. ("NASD") and Amendments Nos. 1 and 2 Thereto Relating to the Establishment of the Nasdaq Order Display Facility and Modifications of the Nasdaq Trading Platform, Release No. 34-42165; File No. SR-NASD-99-53. We have enclosed six copies of this letter as required.
STANY has been representing the interests of the Wall Street trading community since 1937. Since the inception of the Nasdaq Stock Market, STANY has been supportive of many innovations and changes proposed by the NASD and Nasdaq. Like many of our market making members, STANY has endeavored to work with the NASD and Nasdaq to ensure the viability of the dealer market as a venue for the investing public and as a tool for American business to raise capital. The success of the Nasdaq market has been the direct result of market maker support and commitment of capital in the dealer market.
STANY membership comes from diverse groups within the trading community including, buy and sell side traders, ECN's, wholesalers, and retailers. It is understandably difficult to evaluate any proposed rule change that widely affects the trading community from a perspective that satisfies the individual needs or desires of all of our members. In evaluating any proposal, we look to accomplish the greatest good with the least amount of harm to the various market participants: issuers, investors, market makers and other market participants. We are ever mindful of the best interests of the investing public, upon which we place paramount importance; for without investors, there would be no market.
It has been, and continues to be, STANY's position that competition in the Nasdaq market place is positive and should be encouraged as it leads to increased service and better prices for investors. As such, STANY has voiced its opposition to any Nasdaq system that either implicitly, or by regulatory fiat, effectively eliminates the possibility for systems that compete.
While the current proposal for a Nasdaq Order Display Facility ("NODF") is not as objectionable as previously proposed limit order files, STANY continues to be concerned with any system that sets up a competition between an SRO and the members it regulates. Any system where Nasdaq, "the regulator", competes with its members carries with it the possibility for abuse and must be carefully scrutinized so that no unfair advantage, real or perceived, is gained by the SRO over its market participants. As such, some of our members' firms oppose the creation of a NODF.
If it is in the best interest of all market participants, STANY supports a system that acts as a display facility. STANY has no objection to Nasdaq building a system as proposed in the instant release, with several minor exceptions which will be highlighted herein, however, we feel that Nasdaq should not prevent others from building competing execution systems. In other words, STANY does not endorse this system as the only available system. Other systems should be allowed to develop in the spirit of competition and that there should be no direct or indirect penalty upon those who chose to avail themselves of an alternate system to the Nasdaq system.
Generally speaking and with the exceptions noted above, our members believe this proposal is a good one. However, certain details of the proposal are of concern. We favor the added transparency and the benefits that it will afford to all market participants- market makers and investors alike. We also favor the enhancement of market participants' ability to manage their quotes. The ability of market makers to display multiple orders at multiple price levels is important and will be even more so, as and when the Nasdaq market moves towards decimals.
INTERNALIZATION OF ORDER FLOW
We fully support the NASD's approach to internalization as provided for in the current proposal. It is critical that the system enacted allow market members to internalize order flow. The Nasdaq Order Display Facility as presented in this release, recognizes the significance and importance of retaining the ability of a market maker to cross orders internally. Without this protection, market makers' incentives to make markets and commit capital would be severely diminished, and the system begins to look like a central limit order book, which we are opposed to. As provided for in the release, the market maker will have increased ability to manage order flow and at the same time provide investors with best execution, as internalization of order flow promotes competition among broker/dealers.
5 SECOND DELAY
STANY feels strongly that the five second interval for quote refreshing is inappropriate and would suggest that it would be more appropriate to either have no delays or have a tiered system of delays.
Although certain active stocks may not require that a delay be built into the system and we would, if all stocks were active, lobby for a system without any delays, we are concerned about how inactive stocks would perform with no delay. An inactive stock, with only a few market makers, could send the stock into wildly exaggerated volatile movement by the placement of a large order. For example a 100,000 share order against a 100 share bid could cause multiple executions against the one or two market makers in the stock. Without a delay for refreshing of the quote, a severe decline in the price could result. Taken to an extreme, a low priced stock with two market makers could be driven to zero instantly by a large order.
For top tier, active stocks, for example the Nasdaq 100, a five second delay may be unrealistically long. We suggest that in these stocks little or no delay would be necessary. However, inactively traded stocks may require a longer delay for quote refreshing.
We suggest that Nasdaq conduct a study to determine the most appropriate time delay, if any, for stocks of various trading characteristics and build into the system three to five tiers with different time delay intervals.
To ensure that all market participants have a level playing field, the new montage should be available and applicable to all market participants. The proposal, as presented in the release, prevents both incoming and outgoing UTP Exchange orders from being automatically executed. We recognize the rational behind this prohibition, however, we believe that it would be in the best interests of all market participants for UTP exchanges to have the same responsibilities as market makers. Incoming UTP orders should be subject to automatic execution so that market makers will not have to have there own internal duplicate systems just to service UTP exchanges. Moreover, we could consider it equitable if UTP exchanges offered reciprocal auto-ex capability to market maker orders incoming to the UTP Exchange. We recognize that Nasdaq has no jurisdiction over UTP Exchanges and merely make this comment as a suggestion.
ODD LOT GAMING
We have grave concerns about the manner in which Nasdaq proposes to handle odd lots under the NODF. Distributing odd lot orders to all registered market makers in a "round robin rotation" is both cumbersome and creates the opportunity for gaming. We are concerned that a market participant could take a large order, break it into odd lots and not have the order effect the published quote. We suggest that odd lots be executed against the exposed market maker bids and offers and when totaling a round lot or more, that bid or offer should be decremented. Thus, odd lots will be executed against quoting parties and not dealers without current interest.
The biggest concern that we have about the odd lot "wheel" is the possibility of active trading customers gaming the market. The Nasdaq market has been the victim of gaming schemes in the past. We would be remiss if we did not voice our concern that any system, developed by the NASD and Nasdaq, have protections against gaming in place and that Nasdaq have the capacity to quickly address issues of gaming if they occur.
ISSUE OF INTEGRATION OF SOES AND SELECTNET STILL LEFT OPEN
In Exchange Act Release No. 41298 (April 15, 1999), 64 FR 19844 (April 22, 1999) (Notice for File NO. SR-NASD-99-11) Nasdaq had proposed to functionally integrate SOES and SelectNet. Also included in that release was a proposal for a Nasdaq driven limit order file (LOF) . STANY and its parent organization STA responded to that release and through our comments, as well as, through various meetings and discussion between Nasdaq and our members, we expressed that our members were highly in favor of the integration of the two systems and opposed to the creation of a LOF. More importantly, we expressed our concerns that SOES and SelectNet be immediately integrated to eliminate multiple exposure to market makers and that other systems changes be considered only after that integration.
Nasdaq is aware that large segments of the trading community have long been in favor of one integrated system, rather than two simultaneous Nasdaq systems with competing potential liability. Our endorsement, of Amendments Nos. 1 and 2 in this release, is contingent upon the implementation of the consolidated SOES and SelectNet, prior to the implementation of the changes proposed in the subject release.
PHASE IN OF CHANGES
We are ever mindful of the fact that, no matter how well intentioned change may be, there are often unintended consequences and inherent problems of system changes that cannot always be anticipated, or whose ramifications cannot be properly appreciated until after implementation. STANY is therefore in favor of some sort of roll out or extended pilot period during which the proposed changes can be studied in real market conditions and changes implemented if deemed necessary. With changes as significant as those proposed in the subject release, prudence is advisable.
Along these lines, and on a purely mechanical note, some of our members have expressed a concern the proposed montage is confusing. The center of the montage shows the inside market but reflects only the size of the non- attributable orders. In addition to major concerns of potential unintended problems with the proposed system, a pilot program would afford the NASD an opportunity to address less important concerns, such as the actual look of the montage.
Likewise, our members have grave concerns with the technological capacity of the Nasdaq system, to handle these changes. Capacity issues cannot be taken lightly. Currently, the Nasdaq system, particularly SelectNet, is so over burdened that market makers, and investors have been financially disadvantaged due to delayed executions and delayed reporting. While we have had assurances from the NASD that they will have systems in place to handle the proposed rule changes, we feel it incumbent upon the Commission to consider the NASD's and Nasdaq's preparedness seriously when considering the subject proposal.
We are also concerned with message traffic and the ability of the Nasdaq system to handle increased quotes. With each firm having the opportunity to have multiple quotes entered into the system, there is a concern that message traffic will increase. Currently the SelectNet system is handling more traffic than was thought possible in the past and the resulting delays are a significant concern to us.
The NASD should be required to demonstrate, prior to implementation of the NODF, that it, in fact, will be able to handle the increased traffic that may be caused by the display of multiple orders by market makers at multiple price levels and that it truly has the capacity to handle what it says it can handle.
Our members have also expressed a concern about the fees that NASD will charge for access to the NODF. The market making environment has changed dramatically as a result of various rule changes in the recent past. We anticipate that it will be increasingly difficult to encourage market makers to enter the market and inspire market makers to continue to commit capital when decimalization is implemented in the Nasdaq market. Increased transparency is a positive, but not at the expense of decreased liquidity. Market makers play a vital role in the liquidity in the Nasdaq market and burdensome costs will have the consequence of decline in market participation by market makers and a tremendous negative effect on liquidity and capital formation.
We have not been made privy to the proposed cost structure attendant to the systems changes that are proposed by the NASD and Nasdaq and cannot comment fully on this issue, other than to say that cost is certainly a concern to us and should be addressed up-front.
We appreciate the opportunity to comment on this important proposal and will be happy to assist the commission and the NASD with any questions regarding our comments.