Intermarket Surveillance Group

June 18, 2003

Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549

RE: NASDAQ Petition Relating to the Regulation of NASDAQ-Listed Securities Release No. 34-47849

Dear Mr. Katz:

I am writing on behalf of the Intermarket Surveillance Group ("ISG") in response to the NASDAQ petition dated April 11, 2003 (the "Petition") and attached white paper dated January 24, 2003 (the "White Paper"). In those documents, NASDAQ makes a number of inaccurate statements relating to the ISG as a group and the shared information systems of the ISG.1 ISG believes that NASDAQ's dismissal of ISG's role in providing a framework for cooperation among the ISG participants is shortsighted and ignores the significant advances in coordinated regulation implemented by the ISG participants over the twenty years since its inception.

In light of NASDAQ's assertions, we believe a clear understanding of the ISG model and the role it serves is key to a proper and complete review of the Petition. As a result, we are writing today in order to provide an overview of ISG and the important functions it performs within the regulatory framework for the U.S. securities markets. In doing so, we respond to the Securities and Exchange Commission's (the "Commission's") request for comment on the Petition in regard to ISG's usefulness as a mechanism for coordinating intermarket regulatory efforts and its ability to facilitate comprehensive regulatory coverage.2

At the urging of the Commission, ISG was created in 1983 to, as the name implies, coordinate intermarket surveillance among the self-regulatory organizations ("SROs"). In essence, ISG is an information-sharing cooperative governed by a written agreement (the "ISG Agreement") signed by each of its participant members ("Participants").

Although the ISG Agreement was not established under Section 11A or 17(d) of the Securities Exchange Act of 1934, the Commission has recognized the importance of ISG by requiring new markets to become ISG members as a condition of registration.3 ISG's full members are the American Stock Exchange ("AMEX"), Boston Stock Exchange ("BSE"), Chicago Board Options Exchange ("CBOE"), Chicago Stock Exchange ("CHX"), Cincinnati Stock Exchange ("CSE"), International Securities Exchange ("ISE"), National Association of Securities Dealers ("NASD" - which is the SRO serving as NASDAQ's regulator), New York Stock Exchange ("NYSE"), Pacific Exchange ("PCX") and the Philadelphia Stock Exchange ("PHLX") (collectively "Full Members").4 Each of the Full Members is an SRO for which the Commission has direct oversight. As a result, the regulatory procedures that these SROs have developed, individually and jointly, including those developed for insider trading and certain types of market manipulation, are subject to Commission jurisdiction and are regularly examined for sufficiency.

The goal of ISG is to enhance intermarket surveillance, to assure the integrity of trading and to provide investor protection. As its primary functions, ISG coordinates surveillance and investigations among each of the SROs in and across a diverse population of securities products including equities, options and futures. In this regard, ISG has established information sharing arrangements that provide for the exchange of market data surveillance information among the SROs through various means. In connection with the routine sharing of information, ISG has also defined certain types of violations that can occur across markets and the Full Members have consistently worked together to coordinate regulatory responsibilities.

On a routine basis, ISG Full Members share audit trail information, and on a monthly basis, collect and share short interest data. ISG has developed and implemented investigative practices for coordinated investigations. Further it has established a sub-group on surveillance practices to supplement the existing ISG sub-groups. ISG's general meetings held three times each year, as well as frequent meetings of the Surveillance Practices, Surveillance Investigative Practices, Technology, and Option sub-groups, have resulted in more uniform definitions of intermarket abuses and have provided a forum for coordinating joint surveillance efforts.

The SROs are responsible for their own surveillance systems to monitor for violative activity. However, the ISG has created many surveillance tools, including the ISG Consolidated Equity Audit Trail ("Equity Audit Trail") and the Unusual Activity File ("UAF"), to supplement the individual markets' surveillance systems. ISG also recently completed development of the Consolidated Options Audit Trail System ("COATS"). To the extent there are costs involved with the development and maintenance of these surveillance tools and the operation of ISG generally, the ISG Full Members have mutually agreed on the allocation of these costs.

ISG facilitates the analysis or review of such reports or alerts by, for example, makings its Equity Audit Trail available from SIAC. This Equity Audit Trail was developed by the Full Members to provide a consolidated view across all markets of quotes and trades and clearing information for each of these trades.

NASDAQ, in its White Paper, mischaracterizes the purpose for which the Equity Audit Trail is used. NASDAQ claims that the format and timing of the Equity Audit Trail significantly hinders its ability to investigate unlawful trading activity in real time and that time fields in the data are not generated by clocks subject to uniform synchronization protocols, relative to NASDAQ's Order Audit Trail System ("OATS") data.

ISG does not agree. No other market has raised an issue with respect to the delivery of the Equity Audit Trail or articulated a view that the few days that it takes for the clearing data to be incorporated into the Equity Audit Trail presents an impediment to effective regulation. The Full Members believe that since the Equity Audit Trail is, as previously noted, a supplement to the individual markets' surveillance systems, it continues to provide significant and timely information.

Through coordinated and cooperative efforts, ISG serves to promote comprehensive regulation of the U.S. equities and options markets. To date, NASDAQ has not contacted the ISG, through its designated SRO, the NASD, to request changes to the ISG surveillance tools or discuss ways to improve upon the ISG framework. If NASDAQ genuinely perceives a shortcoming or gap in the current framework, we strongly suggest that these matters be raised for discussion in the ISG forum in order that the group might determine a coordinated and cooperative means for addressing the concerns.

We understand that, prior to submitting its Petition to the Commission, NASDAQ had proposed that issues relating to the intermarket surveillance of NASDAQ listed securities be addressed through the NASDAQ Unlisted Trading Privileges Plan ("UTP" Plan) separate and apart from consideration of the regulation of other exchange listed securities and derivatives products. We also understand that almost all UTP Plan Participants, other than NASDAQ, believed that the UTP Committee was not the appropriate forum for resolving intermarket regulatory issues.

In fact, a number of the UTP Plan participants, who are Full Members of the ISG, suggested that the ISG would be the appropriate forum for discussion of the issues raised in the NASDAQ's White Paper and subsequently in its Petition filed with the Commission. Unfortunately, NASDAQ did not submit a similar proposal to or raise issues related to intermarket surveillance with the ISG either directly, or through its SRO, the NASD.

The Commission's position with respect to the ISG and its role in coordinated regulation has been consistently supportive. The Commission has required that new market entrants become members of the ISG and it has decided that ISG must be involved in coordinated regulation of securities futures products. In light of the Commission's previous positions regarding the ISG's primary role in coordinated regulation, the ISG respectfully suggests that for the Commission not to involve the ISG in high-level policy discussions with NASDAQ and other interested parties relating to NASDAQ's Petition, would be highly inconsistent with past practice and may, in fact, jeopardize the future coordination of cross-market surveillance and investigations.

We welcome the opportunity to further discuss these issues with the Commission, through the ISG forum or elsewhere. If you have any questions related to this letter you may contact me at (617) 235-2158.


Brian F. Colby
Intermarket Surveillance Group

Cc: Chairman William Donaldson
Commissioner Paul Atkins
Commissioner Roel Campos
Commissioner Cynthia Glassman
Commissioner Harvey Goldschmid
ISG Full Members

1 NASD agrees with those portions of this comment letter that clarify the role of ISG and support the inclusion of ISG in high-level policy discussions relating to the Nasdaq Petition. NASD and other members of ISG will communicate their specific policy views on this issue in separate comment letters.
2 Securities Exchange Act Release No. 47849 (May 14, 2003), 68 FR 27722, 27724 (May 29, 2003)(Question 7 of the Commission's concept release asks: "To what extent is ISG a useful mechanism for coordinating intermarket regulatory efforts? Does ISG fully address the regulatory gaps Nasdaq contends exist? Does the fact the Commission does not have direct oversight of ISG limit the sufficiency of the ISG framework in ensuring adequate regulation of volatile conduct in the trading of Nasdaq securities that can occur across markets, such as insider trading or certain market manipulations?").
3 See In the Matter of the Application of The International Securities Exchange LLC for Registration as a National Securities Exchange; Findings and Opinion of the Commission, Exchange Act Release No. 42455 (February 24, 2000), 65 FR 11388 (March 2, 2000). ISG's significance has also been formally recognized by the Commission in respect to security futures trading. See Securities Exchange Act Release No. 45956, 67 FR 36740, 36750-52 (May 24, 2002)(in context of joint final rule by the Commission and Commodities Future Trading Commission (collectively the "Commissions") on cash settlement and regulatory halt requirements for security futures products, the Commissions discussed the statutory requirement for coordinated surveillance and the framework of the ISG).
4 In order to further facilitate information sharing, ISG has also established an affiliate category of membership to all futures exchanges and non-U.S. organizations to join. It should be noted that certain ISG affiliate members (One Chicago LLC, Nasdaq LIFFE Markets LLC, CME Inc. and Island Futures Exchange LLC) by virtue of their status as "notice registered National Securities Exchanges" and as signatories to the Addendum for Securities Futures products, have already submitted themselves to elements of the ISG Agreement, as amended in 1994. As such, they have accepted ISG as the appropriate forum for resolving these issues.