Instinet Group Incorporated
3 Times Square
New York, NY 10036
Tel +1 212.310.9500
Dir +1 212.310.7728
August 28, 2001
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: Release No. 34-44396; File No. 10-131 - Application of the Nasdaq
Stock Market, Inc. for Registration as a National Securities Exchange
Dear Mr. Katz:
Instinet Corporation ("Instinet") appreciates the opportunity to submit its comments in response to the notice, Release No. 34-44396 (the "Notice"), published by the Securities and Exchange Commission (the "Commission") regarding the application of the Nasdaq Stock Market, Inc. ("Nasdaq") for registration as a national securities exchange.1
Nasdaq's exchange application seeks to achieve a fundamental restructuring of the U.S. securities markets - shifting the key facilities of the nation's over-the-counter market to a for-profit exchange market. The application, however, does not resolve basic questions regarding why valuable facilities designed to serve a public purpose - and built over several decades on behalf of the NASD as a national securities association representing all U.S. broker-dealers trading in the over-the-counter market - should be transferred to a private exchange in competition with other exchanges and market centers operated by NASD members. Moreover, the application fails to assure the continued existence of viable, neutral facilities through which over-the-counter trading may occur in National Market System ("NMS") stocks - facilities that Congress has deemed essential to promoting competition and innovation in the U.S. securities markets.
In Instinet's view, Nasdaq must modify its proposal to resolve these crucial policy concerns, as well as to address numerous other issues discussed below, before the Commission may approve its registration as an exchange - and before Nasdaq is permitted to separate from the NASD on terms that would eliminate the over-the-counter facilities so painstakingly created, at the direction of Congress and the Commission, to serve the interests of U.S. investors.
Instinet strongly supports efforts by the Commission to advance the interests of U.S. investors by fostering effective competition and innovation among the nation's brokers, dealers and markets. A key element in achieving this objective, in our view, is a practical mechanism for the registration of for-profit exchanges, including the proposed Nasdaq exchange. At the same time, Instinet considers it crucial that the Commission preserve, as required under the Securities Exchange Act of 1934 (the "Exchange Act"), a viable regulatory framework for effective competition in the U.S. over-the-counter markets - markets not subject to the constraints imposed by the rules of registered exchanges. It is in these markets, as anticipated by Congress in the Securities Act Amendments of 1975 (the "1975 Amendments"), that many of the technological and other innovations most beneficial to investors and issuers have occurred in the past several decades - and in which they can be expected to continue to occur in the future.
Nasdaq's exchange application poses a critical challenge to the Commission in achieving its statutory mandate to advance investors' interests through beneficial innovation in the over-the-counter markets - particularly the obligation under Section 11A(a)(1)(C)(ii) of the Exchange Act to ensure fair competition "between exchange markets and markets other than exchange markets." For several decades, Nasdaq has been the arm of the NASD through which broker-dealers have satisfied their regulatory obligations for over-the-counter transactions in NMS stocks. In that time, Nasdaq has acquired facilities, technology, goodwill and a valuable brand name - all derived from its affiliation with the nation's sole registered national securities association, the NASD, an organization in which membership is compulsory for every broker-dealer trading in the over-the-counter markets.
Yet, upon Nasdaq's registration as an exchange, all of the regulatory facilities, all of the associated technology, and all of the goodwill developed in an effort to enhance the opportunity for effective competition in the over-the-counter markets will be transferred to the facilities of a "listed" market (i.e., the Nasdaq exchange) - a market no longer controlled and regulated under the auspices of the NASD as a registered national securities association. Registration of Nasdaq as an exchange thus constitutes a fundamental reordering of the U.S. securities markets with the potential to eliminate entirely the over-the-counter market for NMS stocks in the United States - and in the process provide Nasdaq with competitive advantages available to no other exchange or market center.
Nasdaq's exchange application does not seek to resolve the basic contradictions posed by transferring the regulatory facilities for the nation's over-the-counter markets to a for-profit exchange. On the contrary, Nasdaq proposes that the exchange application be permitted to go forward even if, by that action, the NASD will be left without the facilities to meet its obligations as a registered securities association. Further, Nasdaq asks the Commission to permit it to register as an exchange - and to proceed as a private company separate from the NASD - even while insisting that its market should be exempted from essentially every significant provision of the Exchange Act that would become applicable to its market as a result of a shift to exchange status.
More generally, Nasdaq's application has not been accompanied by proposed changes to the rules of the NASD and other information essential to analyzing the impact on the securities markets of its proposed registration as an exchange. Without this information (and time to review it), there cannot be a meaningful opportunity for the public to debate before the Commission this fundamental restructuring of the over-the-counter markets - a restructuring that Nasdaq seeks to minimize as nothing more than a mere "technical" change in its status.
Nevertheless, the Commission has an obligation, which we believe it fully recognizes, to continue to fulfill the statutory mandate that historically has engendered technological leadership and rapid innovation in our nation's over-the-counter markets, including the mandate to ensure fair competition between those markets and exchange markets. As discussed in greater detail below, Instinet considers it essential for the Commission, in satisfying this obligation, to examine comprehensively the impact of Nasdaq's exchange registration on trading in over-the-counter markets in the United States - as well as to consider the implications of numerous additional issues left unresolved in Nasdaq's application.
In Instinet's view, Nasdaq has failed to provide a sufficient basis for the Commission to find that its registration as an exchange is consistent with the interests of investors, the maintenance of fair competition between exchange and non-exchange markets or the requirements of the Exchange Act - and thus its application, in the form proposed, should not be approved.
Moreover, in our view the application cannot be reconciled, in any form, with the requirements of the Exchange Act until after the NASD has in place operational facilities to permit over-the-counter trading to continue to flourish in the United States - and until after the Nasdaq has shed all of the regulatory benefits and related competitive advantages that it has acquired as an exclusive securities information processor and an arm of a national securities association. This process, critical to affording U.S. investors the benefits of effective competition in the U.S. stock markets, will require continuing close oversight by the Commission, especially in light of the substantial overlap in management, operations and financial interests of the Nasdaq and its current parent.
II. Nasdaq's Proposed Transfer of the Key Facilities of the Nation's Over-the-Counter Markets to a For-Profit Exchange, Operated Outside the Control and Regulation of the NASD, Cannot Be Approved Consistent with the Interests of Investors, Competition and the Requirements of the Exchange Act
Nasdaq's application fails to come to grips with the central question posed by its proposed registration as an exchange:
Is it consistent with the interests of investors, competition and the requirements of the Exchange Act, to allow the existing facilities of the over-the-counter market to be transferred to a for-profit exchange, operating outside the control and regulatory auspices of the NASD?
Nasdaq's failure to resolve this question reflects the difficulty - if not the impossibility - of squaring its proposed registration with the objective of promoting investors' interests through innovation and competition in the over-the-counter market, as mandated by Congress in the federal securities laws.2
A. Approval of Nasdaq's Exchange Application Would Impermissibly Allow a Private Entity to Profit at the Expense of the Over-the-Counter Markets Built to Meet the Express Mandate of Congress Under the Exchange Act
Registration of Nasdaq as an exchange based on its current application would contravene the fundamental objectives of the Exchange Act, particularly in light of the goals expressly set out in the 1975 Amendments. Nasdaq proposes, without meaningful justification or even discussion, to up-end entirely the balance between exchange markets and over-the-counter markets contemplated by Congress - by transferring into a for-profit exchange market the regulatory and related facilities built to serve broker-dealers engaged in over-the-counter trading. Moreover, it proposes to "privatize" these facilities for the benefit of its new "exchange" even though their value derives principally from having served for years as the only over-the-counter quotation display and trade reporting facilities in the United States.
As the Commission is aware, the creation of the facilities now housed in Nasdaq resulted directly from Commission efforts to assure a viable over-the-counter market in which investors could benefit from competition and innovation, as directed by Congress in the 1975 Amendments.3 Substantial elements of Nasdaq's current activities are performed, in fact, under an express delegation of regulatory responsibilities from the NASD as the sole registered national securities association responsible for the over-the-counter markets.
The NASD has delegated to Nasdaq, among other things, its responsibility "as a registered securities association" (i) to adopt rules for collecting, processing and disseminating quotation and transaction information for over-the-counter trading in Nasdaq and other stocks, (ii) to act as the "securities information processor" for securities traded in Nasdaq-operated markets, (iii) to act as "processor" under the Nasdaq/Unlisted Trading Privileges ("Nasdaq/UTP") plan, and (iv) to administer the NASD's involvement in National Market System Plans related to Nasdaq/UTP trading or trading in the third market for exchange-listed stocks.4
Upon Nasdaq's registration as an exchange, it will no longer be controlled by or operate within the governance and regulatory structure of the NASD - and thus none of these functions will continue to be performed for the over-the-counter market by a registered national securities association. Instead, all of these functions - authorized by the Commission to meet the needs of the over-the-counter market - will become part of the facilities of a "listed" exchange market. In other words, having been entrusted with delegated authority to act as the NASD's agent for the over-the-counter markets, Nasdaq now seeks to use the facilities developed in that role to launch its new exchange - simultaneously stripping the NASD of the capacity to perform regulatory responsibilities critical to its mission as a national securities association.
Nasdaq effectively proposes, in a single stroke, to reverse decades of Congressionally-directed efforts to assure a viable over-the-counter market in the United States by becoming registered as an exchange separate from the NASD. In so doing, its application raises numerous questions critical to the nation's securities markets. Is the NASD in a position to assume all of the regulatory responsibilities for the over-the-counter market that Nasdaq has been performing as its agent (under the delegation plan approved by the Commission)? Does the Exchange Act permit Nasdaq to separate from the NASD on terms that ignore the fact that, until now, Nasdaq has operated facilities performing those regulatory responsibilities on behalf of the NASD, not for Nasdaq's own benefit? Are the over-the-counter regulatory facilities of the nation's only registered securities association actually permitted to be "sold" to an exchange (or to anyone else for that matter)? If so, why not to the New York, American, or Cincinnati stock exchange - indeed, why did Congress and the Commission not ask those exchanges, rather than the NASD, to assume responsibility for building those facilities in the first instance? Nasdaq offers no answers to these questions - apparently taking the view, contradicted by more than a quarter-century of precedent under the Exchange Act, that the distinction between "exchange" and "non-exchange" markets should be viewed as merely "technical" in its case.
The practical impact of the change in Nasdaq's status would be immediate: securities firms will have no option to meet their regulatory obligations through, or to use the facilities of, an NASD-sponsored over-the-counter market operated in the interests of all broker-dealers - but instead will be obligated to use the facilities of an exchange accountable only to its shareholders. Moreover, the technological infrastructure, intellectual property, and goodwill built up over many years based on the compulsory participation of broker-dealers in the NASD will now become part of the shareholders' equity of that exchange, poised to launch a public offering for private benefit. Most importantly, from an investor perspective, this transfer of over-the-counter facilities eliminates any realistic possibility for competition between the nation's over-the-counter markets and exchange markets. Nasdaq will be taking with it all of the assets that have made organized over-the-counter trading practicable in the United States - leaving no facilities behind to permit effective competition from an over-the-counter rival.
The Commission, as discussed below, has an obligation to examine whether this "stripping out" of the NASD's over-the-counter facilities is consistent with the interests of investors and Congress' mandate under the Exchange Act. In Instinet's view, Nasdaq has not provided the Commission with a sufficient basis to approve its exchange application consistent with this obligation, nor can it do so until after the NASD is assured of viable facilities to meet the regulatory needs of the over-the-counter market.
B. The 1975 Amendments Do Not Permit Approval of the Nasdaq Exchange, as Proposed, on Terms That Will Undermine - If Not Eliminate - Competition Between Exchange and Over-the-Counter Markets
The 1975 Amendments cannot be construed to permit Nasdaq's proposed wholesale transfer of the nation's over-the-counter trading facilities from a neutral national securities association to a for-profit exchange market.5 Those amendments, acknowledging the critical need to permit technological advances to enhance securities trading opportunities, expressly seek to preserve the ability of over-the-counter markets to flourish alongside exchange markets. Among other things:
1. The 1975 Amendments Expressly Sought to Promote Innovation and the Interests of Investors by Encouraging Competition Between Exchange and Non-Exchange Markets
In adopting the 1975 Amendments, Congress recognized the significant benefits for investors of maintaining an over-the-counter marketplace that is independent of the national securities exchanges but integrated into the national market system. For instance, in the Senate Report accompanying the 1975 Amendments (the "1975 Senate Report"), the Senate Committee on Banking, Housing and Urban Affairs reaffirmed that "[t]o assure that our markets are able to serve the needs of both individual and institutional investors . . . many types of market makers are necessary and . . . encouragement should be given to all dealers to make simultaneous competing markets within the new national system."10 The purpose of integrating different groups of market-makers "into a single system is not to make all of them do business in the same way, but rather to enable public investors to take fuller advantage of the distinctive contributions that each can make."11 Thus, Congress believed that investors "are entitled to the best combination of the features of the exchange and over-the-counter markets that the trading characteristics of the particular stock can support."12
The Exchange Act incorporates explicitly Congress' objective of assuring fair competition between the exchange and over-the-counter markets. Section 11A of the Exchange Act, as noted above, finds that it is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure, among other things, fair competition "between exchange markets and markets other than exchange markets."13 Similarly, the 1975 Senate Report noted that "the dealers operating in the third market provide valuable competition to the specialists operating on the exchanges and ... this competition enhances the total market making capacity for listed securities."14 The report concluded that "the ability of individual firms as well as the various exchange and over-the-counter markets to compete with one another [would] be a critical element in the successful functioning of the national market system."15
This broad Congressional mandate to protect fair competition is supplemented by an express statutory provision authorizing rules that restrict "third market" over-the-counter trading only where the Commission can satisfy certain specific, narrowly-tailored conditions.16 Before proceeding with any such rule the Commission has the burden of demonstrating that the proposed rule is necessary or appropriate to restore or maintain the fairness and orderliness of the markets for listed securities.17 It must also articulate with particularity why any burden imposed on competition by any such rule was necessary or appropriate in furtherance of the purposes of the Exchange Act.18 These requirements were specifically tailored to ensure "that no exchange rule whatsoever unreasonably restricted competition among dealers generally or between any class of dealers and registered specialists."19
2. The Wholesale Transfer of Existing NASD-Sponsored Facilities for the Over-the-Counter Markets to Nasdaq's For-Profit Exchange Cannot Be Reconciled with the Objectives of the 1975 Amendments
It is difficult to imagine any theory under which approval of Nasdaq's exchange application can be squared with the statutory objectives established by the 1975 Amendments - and Nasdaq has done little in its application to advance one.20 Far from "facilitating trading in non-exchange markets," registration of the Nasdaq exchange as proposed will eliminate the only non-exchange facilities that exist for trading NMS stocks. Instead of assuring "fair competition . . . between exchange markets and non-exchange markets," approval of the application would grant a single exchange - Nasdaq - all of the facilities that have been built over decades to permit over-the-counter trading to flourish. Rather than "removing impediments to, and perfecting the mechanism of, a free and open market and a national market system," the transfer of the nation's over-the-counter markets to an exchange will, especially in the absence of viable over-the-counter facilities operated by the NASD, create an unnecessary and nearly-insuperable "burden on competition" for firms seeking to offer their services in a non-exchange market.
Nasdaq cannot, moreover, seriously dispute the ramifications of this legal framework for its exchange application - since it has relied upon these very statutory provisions for years to build its over-the-counter "franchise" and to support its position in disagreements with the New York Stock Exchange and others. One quotation from Nasdaq's Chairman will suffice to illustrate the point:
"In 1975, recognizing the importance of computer-based communications to facilitate the trading of securities in non-exchange markets, Congress further amended the Exchange Act. The 1975 Amendments directed the Commission to facilitate the development of a free and open market and national market system to preserve the competing exchange and non-exchange markets, to break down all barriers to competition that did not serve a valid regulatory purpose, and to encourage maximum reliance on communication and data processing equipment consistent with justifiable costs.
The 1975 Amendments added Section 11A(a)(1) of the Exchange Act . . . stating . . . that it is in the public interest to assure, among other goals, `the fair competition among brokers and dealers, among markets and between exchange markets and over-the-counter markets. . . . In addition, the 1975 Amendments added specific provisions under Sections 6(b)(5) and 6(b)(8) of the Exchange Act requiring exchanges to design rules to remove impediments to, and perfect the mechanism of, a free and open market and a national market. These same sections also prohibited exchanges from designing rules that are unjustifiably anti-competitive or result in unfair discrimination." 21
Having relied for years upon these unambiguous provisions of the Exchange Act - provisions designed to assure innovation through vibrant and competitive over-the-counter markets - Nasdaq now seeks to turn the statutory mandate on its head. Not only does Nasdaq seek to appropriate for its exchange the existing facilities built to serve the over-the-counter market - it asks the Commission to assure that, for at least some time after the launch of its exchange, there will be no competition from a new over-the-counter facility established by the NASD. Moreover, Nasdaq seeks to strengthen its competitive position even further by funneling into its exchange, for a number of years into the future, the order flow obtained in its capacity as an exclusive securities information processor - again in direct contravention of the Exchange Act.
The 1975 Amendments simply do not permit Nasdaq to become registered as an exchange on this basis - a basis that will undermine, if not wholly eliminate, competition between exchange and non-exchange markets in the United States.22
III. Nasdaq's Proposal Fails to Assure that Over-the-Counter Trading May Occur Through Neutral Regulatory Facilities as Required Under the Exchange Act
Nasdaq's exchange application, as recognized by the Commission in the Notice, also fails to address fully the regulatory obligations established under the Exchange Act to assure the availability of viable, neutral facilities for over-the-counter trading in NMS stocks.23 In particular, Nasdaq seeks registration of its exchange even before the NASD has in place facilities that would allow market makers, electronic communications networks ("ECNs"), alternative trading facilities ("ATSs") and others to meet their order display and trade reporting obligations under existing Commission and related rules.24 In addition, Nasdaq proposes to commence operation as a competitive exchange market, outside the control of the NASD, even before it relinquishes the benefits of its status as an exclusive securities information processor - required by law to remain neutral with respect to all market participants.
Nasdaq's exchange application may not be approved until it has addressed each of these regulatory obligations to provide viable, neutral facilities for trading in the over-the-counter markets. Moreover, in light of the conflicts of interest created by the extensive interrelationships between Nasdaq and the NASD, it is essential that the Commission play an active supervisory role in assuring that the NASD facilities are established through a transparent, arm's-length process and meet the operational standards necessary to achieve the objectives for the over-the-counter market established by Congress in 1975.
A. Nasdaq May Not Be Registered as an Exchange Until Viable, Independent Facilities Exist for Over-the-Counter Trading of NMS Stocks
As a matter of both law and policy, it is essential that the Commission withhold approval of Nasdaq's registration as an exchange until a viable NASD quotation display and trade reporting facility is in place to meet the needs of the over-the-counter markets. Without such a facility, investors and markets will be deprived of the innovation and competitive benefits that Congress expressly sought to achieve in the 1975 Amendments.
Once Nasdaq is registered as an exchange (and no longer acting as an arm of the NASD), the existing "over-the-counter" market for NMS stocks will effectively cease to exist. Under current Commission and self-regulatory organization ("SRO") regulations, broker-dealers will have no choice but to display their best bids and offers, and report their transactions, through the facilities of Nasdaq or another registered exchange. In other words, there will no longer be any "over-the-counter" facility ("NASD OTC Facility") through which to display quotations and report trades in NMS stocks (whether listed on Nasdaq or other exchanges) - and securities firms will be compelled by law to meet their obligations through the facilities of an exchange.
As described above, however, the Exchange Act explicitly requires the Commission to foster competition between exchange and non-exchange markets. Consistent with this objective, the statute specifically directs the NASD, as a registered national securities association, to develop rules and promote orderly procedures for "collecting, distributing and publishing quotations." Section 15A(b)(11) of the Exchange Act provides that a registered national securities association must include provisions in its rules governing "the form and content of quotations relating to securities" sold over-the-counter, which rules "shall be designed to produce fair and informative quotations, to prevent fictitious or misleading quotations, and to promote orderly procedures for collecting, distributing, and publishing quotations."25
Consistent with this framework, the rules of the Commission establishing a national market system have required the NASD to provide for the collection and dissemination of over-the-counter quotations and transactions, both with respect to exchange-listed securities and over-the-counter securities that meet the criteria for the national market system.26 In publishing Nasdaq's exchange application for comment, the Commission explicitly confirmed the statutory requirement that the NASD establish an NASD OTC Facility - a position it has consistently taken in discussions with Congress and in considering Nasdaq's SuperMontage proposal.27
In addition, the Commission's existing framework for integrating ECNs into the national market system effectively is premised upon ECNs meeting requirements under Commission rules through NASD facilities operated by Nasdaq.28 This arrangement raises the issue of whether ECNs could continue to meet these obligations in the absence of a viable NASD OTC Facility without becoming members of a Nasdaq exchange. Moreover, Nasdaq's contention that ECNs could meet these obligations by using the facilities of another exchange only highlights the concerns raised by transferring the NASD's over-the-counter facilities to Nasdaq's exchange.29 In this regard, an ECN that would use the facilities of another exchange would face the same competitive concerns as those that would use a Nasdaq exchange - the ECN would be forced to provide a competitor not only with its best-priced orders, but also would become subject to its regulatory power and technological dictates. More importantly, such an outcome - requiring all ECNs and other market participants to use the facilities of an exchange (whether the Nasdaq exchange or another) - cannot be reconciled with Congress' objective of ensuring fair competition among exchange and over-the-counter markets.
Instinet concurs in the Commission's determination, set out in the Notice, that an NASD-operated over-the-counter facility must be in place before Nasdaq may become registered as an exchange. Moreover, in light of the substantial conflicts of interest created by Nasdaq's current relationship with the NASD discussed in Part III.C below, Instinet considers it crucial that the Commission monitor, from both a procedural and substantive perspective, the manner in which such facility is created.
B. Nasdaq May Not Launch a Competitive, For-Profit Exchange so Long as It Benefits from Order Flow and Related Advantages Obtained in Its Capacity as an Exclusive Securities Information Processor, Obligated to Act as a Neutral Public Utility
Under the Exchange Act, Nasdaq may not be registered as a for-profit exchange while retaining for its marketplace the advantages derived from its role as an exclusive securities information processor. In that role, Nasdaq has a duty of strict neutrality that - as reaffirmed recently in the Commission's SuperMontage approval order - may not be compromised to benefit any market participant or marketplace.30 Upon registration as an exchange, however, Nasdaq will no longer be under the control of, and regulated as, a registered national securities association operated in the public interest - but will instead become a wholly "private firm" free to pursue the competitive interests of its market and its shareholders. Thus, under the clear legislative mandate governing exclusive securities information processors, it must shed the advantages of that status before the Commission may approve its exchange application.
Currently, Nasdaq is the exclusive securities information processor for over-the-counter securities registered with the Commission under Section 11A(b) of the Exchange Act.31 As such Nasdaq performs two closely related functions - it collects information and quotations for the over-the-counter market and acts as the exclusive processor for the Nasdaq/UTP Plan.32 Pursuant to NASD rules, Nasdaq, acting on behalf of the NASD, collects and prepares for distribution information concerning quotations in the over-the-counter market for Nasdaq-listed securities, including Nasdaq NMS securities and Nasdaq Small Cap securities.33 Under the Nasdaq/UTP Plan, information concerning quotations and transactions in participant exchange markets for Nasdaq NMS securities, but not for Nasdaq Small Cap securities, is collected and consolidated by Nasdaq with the information collected by Nasdaq on behalf of NASD.34
Nasdaq's market receives significant competitive benefits in this role as the exclusive securities information processor for Nasdaq stocks. Under existing Commission rules and NMS plans, market makers, ECNs and ATSs, as well as competing exchanges, must submit their most valuable asset - their best bids and offers - to Nasdaq in its role as an exclusive securities information processor for Nasdaq stocks. Nasdaq proposes to integrate these bids and offers, a critical pool of liquidity, into the execution facilities of its new exchange that will compete directly as a market center against the very entities obligated to provide it with their best bids and offers.35 Nasdaq, as an exclusive processor, also dictates the terms of technological interaction with market participants subject to quote display and transaction reporting requirements - granting it a further advantage relative to competing execution venues. These benefits are, in addition, accompanied by market data revenues derived from Nasdaq's favored exclusive processor status.36
Congress has made clear that Nasdaq, as an exclusive securities information processor, must act as a neutral industry utility rather than as an entity under the control or domination of an exchange or other market participant. The legislative history of the 1975 Amendments explicitly mandated that:
"[a]ny exclusive processor is, in effect, a public utility, and thus it must function in a manner which is absolutely neutral with respect to all market centers, all market makers, and all private firms."37
This approach has its roots in a 1973 Securities Industry Study, which noted that in order to preserve the competitive viability of different market centers it would be "extremely important that the processor of market information meet the criterion for neutrality" laid down by the Commission's Advisory Committee on Market Disclosure.38 It reaffirmed that the goals of the pervasive regulatory authority given to the Commission with respect to the processing and distribution of market information are to assure, among other things, that the communications networks are not controlled or dominated by any particular market center and to prevent any competitive restriction on their operation not justified by the purposes of the Exchange Act.39
The registration of Nasdaq as an exchange, far from being a mere "technical" change, will in fact immediately and substantially compromise the neutrality of the exclusive securities information processor for Nasdaq stocks. As noted above, upon becoming a registered national securities exchange, Nasdaq will cease to be under the control of the NASD while retaining its exclusive processor status. At that moment, it will cease to be regulated as part of a national securities association - and the NASD will have no authority to ensure that Nasdaq fulfills its obligations as an exclusive processor in a fair and neutral way for the benefit of all NASD members.
Nasdaq, once outside the regulatory constraints applicable to the NASD, no longer has any arguable claim to neutrality as a for-profit exchange. The legislative history of the Exchange Act clearly demonstrates that Congress did not expect a registered securities exchange to operate the exclusive securities information processor for over-the-counter trading. On the contrary, it envisioned the NASD, as the self-regulatory agency for the over-the-counter markets, as the primary regulator and a "natural source of leadership and initiative" in dealing with matters of securities quotation compilation and processing.40
Moreover, it has become evident over the past few years that, even prior to filing its exchange application, Nasdaq has chosen - notwithstanding its obligations as an exclusive securities information processor controlled by the NASD - to use its status to enter into competition with its members. Nasdaq's SuperSOES facilities, for example, already offer services comparable to those of ECNs and many of its members, even while Nasdaq continues to serve as an exclusive processor.
The Commission expressly recognized Nasdaq's increasing shift into competition with its members earlier this year - and the inconsistency of that shift with the requirements of the Exchange Act. In the approval order for the SuperMontage system, the Commission describes the serious competitive and statutory implications that would result if Nasdaq could launch a competing market center that would profit impermissibly from its status as an exclusive securities information processor.41 Indeed, the Commission expressly conditioned implementation of SuperMontage on the creation of an alternative NASD facility and undertook changes in existing NMS plans to re-establish compliance with the statutory mandate of neutrality.42 Consistent with this approach, the Commission may not permit Nasdaq to advance its efforts to launch a competing market center - through exchange registration that will free it from NASD control - until it has shed its existing regulatory advantages as an exclusive processor.
C. The Extensive Interrelationship Between Nasdaq and the NASD Requires Careful Commission Attention to Assure that Facilities Serving the Over-the-Counter Markets are Established on a Viable, Arm's-Length Basis Consistent with the Requirements of the Exchange Act
The extensive interrelationship between the management, operations and financial interests of Nasdaq and the NASD gives rise to significant potential and actual conflicts of interest. In light of these conflicts, the Commission must closely supervise the NASD's proposal for, and implementation of, the NASD OTC Facility. In addition, it is essential for the Commission to ensure that, in connection with proposed revisions to the NMS plan in which both Nasdaq and the NASD participate, Nasdaq does not delay, modify or otherwise take action that would permit it to obtain advantages by shaping either the choice or functions of the exclusive securities information processor in a manner that would benefit its competing market.
Nasdaq has an exceptionally strong financial incentive to resist efforts to ensure a successful NASD OTC Facility or to require it to abandon the benefits obtained in its role as an exclusive securities information processor. Like any other exchange, Nasdaq will profit to the extent that trading occurs through the facilities of its exchange rather than in a competing over-the-counter market. Most notably, to the extent that market makers, ECNs and ATSs are required by Commission rules to submit their best bids and offers to Nasdaq (because there is no over-the-counter facility in which they can be displayed), Nasdaq will acquire an overwhelming liquidity advantage relative to other markets.43 This liquidity - the most valuable asset of any marketplace - will not only grant Nasdaq a direct competitive advantage, but will also augment the subsidies it obtains through participation in the market data monopoly for NMS stocks (by increasing the number of reported transactions for which it receives credit), with a potential value in the hundreds of millions of dollars. In the context of a company that has announced its intention to launch an initial public offering, moreover, the potential financial implications are magnified - since the price of any offering, and the equity of existing shareholders, will be extremely sensitive to anticipated future profits.
Even while Nasdaq and its management have a strong economic incentive to oppose creation of a viable NASD OTC Facility, there remains a substantial overlap between the management, operation and financial interests of Nasdaq and the NASD. The two organizations currently share a single Chairman, and several members of the Nasdaq Board of Directors serve on the NASD Board.44 Nasdaq leases space in the same buildings as the NASD in both Washington and New York City - an arrangement that is not expected to change upon Nasdaq's registration as an exchange.
From a financial perspective, Instinet understands that Nasdaq stock - if successfully offered to the public - could be worth $400-500 million (or more) to the NASD as its largest shareholder. In addition, the NASD will continue to serve, under contract, as the regulatory authority for members of the Nasdaq exchange - thereby making Nasdaq its biggest "customer" for regulatory services. At the same time, the NASD has "life-and-death" regulatory authority over every broker-dealer that might seek to trade on an over-the-counter basis away from the Nasdaq "exchange." These firms may perceive substantial pressure - whether real or imagined - to support Nasdaq's market to avoid heightened scrutiny from their principal regulator.
These conflicts are not merely a matter of "appearance." Nasdaq's Chairman has actively sought to dissuade the Commission from enforcing the Congressional mandate requiring an NASD OTC Facility - including in correspondence expressly written in his capacity as Chairman of both organizations.45 It is difficult to imagine why Congress, the Commission or the investing public should defer, in determining whether to create such a facility, to the Chairman of Nasdaq - who has the most to lose if the facility succeeds. Moreover, even though the statutory obligations requiring the existence of an NASD facility have been well-known to Nasdaq for many years, efforts to build an "alternative" NASD OTC Facility have taken a back seat to numerous marketing and technology initiatives designed to enhance the value of the Nasdaq "exchange." Further, until very recently, Nasdaq was the only potential vendor that had been consulted regarding the building of an alternative facility.
At a procedural level, Nasdaq should not be permitted to serve as the vendor that builds the NASD OTC facility. The Commission and the public cannot, at this stage, otherwise assure that the choice of vendor is made on a genuinely arm's-length basis - a point confirmed by Nasdaq's continuing efforts (while under common control with the NASD) to seek exemption from the unambiguous legal obligation for the NASD to have such a facility in place before Nasdaq's registration as an exchange.46
At a substantive level, the facility must, in Instinet's view, provide market makers, ECNs and ATSs with industry-standard quote and trade reporting facilities with adequate capacity and scalability to meet initial and future user needs. Among other things, the facility must allow market makers, ECNs and ATSs to comply with applicable Commission rules, including the Order Handling Rules and Regulation ATS, without using the facilities of any exchange.47 Furthermore, consistent with the mandate of the Exchange Act to the NASD as a registered national securities association, the facility must treat all market centers on an arm's-length, non-discriminatory basis, and it must operate on a neutral basis with regard to the business models of its potential users (including terms of access) to ensure that competition and innovation can continue to flourish in the over-the-counter markets.48
Moreover, in connection with the restructuring of the Nasdaq/UTP Plan - the NMS plan governing stocks for which Nasdaq is currently the exclusive securities information processor - the Commission should play an active role in scrutinizing the choice of, and functions offered by, the plan processor. Not only should Nasdaq be prohibited from continuing to serve as the exclusive processor upon its registration as an exchange, it also should not use its current position - acquired solely as a result of its affiliation with the NASD - to bias the playing field once it has ceased to play that role. In particular, the NASD - not Nasdaq - should be the only successor to the NASD's existing membership (and vote) in the Nasdaq/UTP Plan. Moreover, NASD representatives should not be permitted to take direction from, or communicate with, Nasdaq regarding modifications to the plan except on the same basis as they communicate with other markets that are not currently plan members. In addition, Nasdaq should participate in the plan only after purchasing an interest on the same terms as any other new exchange - accompanied by arm's-length negotiations with independent plan participants (i.e. participants other than the NASD).
IV. Nasdaq's Application Fails to Address Essential Issues Prerequisite to Its Approval Under the Requirements of the Exchange Act
In addition to the inconsistencies with the requirements of the Exchange Act described above, it is important to underscore that there are a number of critical questions that have not been addressed in the Notice - questions that must be resolved before the Commission may grant exchange registration. Major open issues include:
The need for additional scrutiny of each of these issues, and the numerous other questions posed by Nasdaq's application, is heightened by the continuing conflict of interest posed by the overlap in management and financial interests of the Nasdaq and the NASD.
A. Nasdaq Has Not Explained How Its Market Will Comply with the Statutory Requirements Applicable to Other Exchange Markets, Nor Why It Should Be Exempted from Those Requirements
Nasdaq fails to address adequately the impact of its proposed registration under a host of statutory and regulatory provisions that govern the trading of securities on an exchange. Instead of seeking to comply with those requirements (which have not applied to Nasdaq solely because it was designed to serve the needs of the over-the-counter market), Nasdaq asks the Commission to grant it exemptions - the terms of which have not been made available for public review - from essentially all of the significant statutory obligations that would apply differently to its market upon acquisition of exchange status.
For example, as the Commission discusses in the Notice, Sections 10(a) and 11(a) of the Exchange Act would become applicable to Nasdaq's market upon its registration as an exchange.50 Yet there is no indication that Nasdaq intends to modify its rules to address the requirements of these provisions of the Exchange Act as made applicable in the context of other exchanges. Rather, Nasdaq is seeking exemptive relief from each of these provisions.51 Without, however, at least some indication of the basis for and the terms of the exemptions that Nasdaq seeks, neither Instinet nor any other commenter can fully address the central issue before the Commission - whether "the requirements of [the Exchange Act] and the rules and regulations thereunder with respect to the applicant are satisfied" (especially since, on the public record, it could not be more clear that the requirements of Sections 10(a) and 11(a) are not satisfied).52
Similarly, Nasdaq does not address the numerous statutory and regulatory implications under Section 12 of the Exchange Act for issuers shifting from over-the-counter trading to exchange listing. Instead, Nasdaq has "requested an exemption from the [Commission] to permit all current Nasdaq-listed companies to maintain the registration of their securities under Section 12(g) of the [Exchange] Act" - essentially contending that there are no meaningful differences between Section 12(b) (which applies to issuers listed on a national securities exchange) and Section 12(g) (applicable to certain public issuers that are not so listed).53
Nasdaq suggests that, rather than require it to restructure its rules and marketplace to meet the requirements applicable to other exchanges, the Commission should effectively ignore the differences between Sections 12(b) and 12(g) for issuers listed on its proposed exchange. These statutory differences, however, are not mere minutiae that can be cast aside as purely "technical" in nature. They were the subject of intensive legislative evaluation and reflect an elaborate set of policy distinctions made by Congress.54 In making these policy decisions, moreover, Congress carefully enumerated the categories of issuers whose securities should be exempted from the registration requirements of Section 12(g) when traded on the over-the-counter market, but not from the comparable registration provisions of Section 12(b) when listed on an exchange. While Instinet recognizes that changes over the past several decades may justify regulatory exemptions that would modify the statutory scheme in various respects, it seems inconceivable that those exemptions should be provided on an across-the-board basis to Nasdaq - and Nasdaq alone - without a compelling justification and a full opportunity for public comment and input.
Indeed, in seeking exemption from the portions of Sections 10, 11 and 12 of the Exchange Act that apply differently in the context of exchanges than in the context of an over-the-counter market, Nasdaq appears to undercut any conceivable rationale that might justify its exchange registration (other than permitting its shareholders to profit by becoming free of the constraints applicable to it as an arm of a registered securities association). After all, what is the point of registering as an exchange if Nasdaq intends to seek exemption from every provision of the Exchange Act that might impose a greater burden on it once it has acquired "exchange" status?
In addition, Nasdaq remains silent on potentially significant legal concerns that its exchange registration may raise for market makers and issuers. For example, Section 16(d) of the Exchange Act currently provides an exemption from the "short swing profit" and related short sale provisions of Sections 16(b) and (c) for dealers in connection with certain market-making activities "otherwise than on a national securities exchange."55 Nasdaq has not highlighted the impact of this change for the many market making dealers that may be effected - and does not, as far as we can determine, propose to address the adverse impact that this may have for those firms.
More generally, the opportunity for issuers and other market participants to analyze fully and comment on the extensive rulemaking package submitted by Nasdaq has been far too truncated to allow companies to assess the impact of the Nasdaq rule changes, especially given the absence of crucial information regarding the continuing operation of the over-the-counter market and the nature of the exemptive relief that Nasdaq is seeking. Further, Nasdaq's failure to provide any section-by-section summary of the changes to its rules (or even promptly to supply a complete blackline when requested by industry trade associations) has needlessly increased the burden of commenters attempting to assess the ramifications of Nasdaq's proposed the rule changes, especially given publication of the Notice in the course of the summer at a time of increased unavailability of key personnel.
B. Nasdaq Has Provided No Information Regarding Changes to the NASD's Rules and Operations and the Impact of Those Changes on the Over-the-Counter Market
As noted by the Securities Industry Association and other commenters, an assessment of the future of operation of the NASD is integral to the ability to review and provide meaningful comments on Nasdaq's Form 1.56 Yet proposed amendments to the NASD's rules have not, even today, been made available to the public.
The opportunity to review the proposed rules governing the future operation of the NASD is not simply a "detail" - it is essential to understanding the policy implications of approving Nasdaq's Form 1. Notably, the public has had no opportunity to review the crucial question of how the NASD will continue to perform its regulatory responsibilities as a registered securities association - responsibilities that have been delegated until now to Nasdaq as its subsidiary. These responsibilities include, as discussed in Part II.A above, numerous key regulatory functions with respect to the over-the-counter market - including the NASD's functions as a securities information processor.
The Commission itself has expressly recognized that "Nasdaq's exchange registration has implications for the NASD which, as a national securities association, will continue to be required to collect bids, offers and quotation sizes for those entities seeking to trade listed securities, including Nasdaq securities, otherwise than on a national securities exchange" and has confirmed that "the NASD's quotation and transaction reporting facility must be operational upon Nasdaq's exchange registration."57 Without information regarding how the NASD will perform its role with regard to collecting bids, offers and quotations, or how this facility will operate more generally, the ability to provide meaningful comment on the impact of the Nasdaq exchange application on the nation's securities markets as a whole - and its consistency with governing provisions of the Exchange Act - has effectively been denied.58
The need for clarification of the continuing role of the NASD is heightened because of the lack of guidance regarding the scope of applicability of Nasdaq's rules. Nasdaq's proposed rules appear to consider activity that occurs in its members' proprietary systems to be conducted "on Nasdaq" and thus subject to its jurisdiction, raising serious competitive concerns as to whether Nasdaq is attempting to regulate its members' off-board trading activity in contravention of Commission regulation and policy.59 Indeed, in some of its proposed rules, Nasdaq appears to view itself as having continuing jurisdiction over transactions in an issuer's securities effected through any "automated inter-dealer quotation system" - a phrase that seemingly suggests that it expects to regulate not merely activities on its new "exchange," but also the over-the-counter market that it is simultaneously seeking to stop operating.60
C. Nasdaq's Application Does Not Adequately Identify or Address the Impact of Exchange Registration on NMS Plans and Other Contractual Arrangements to Which the NASD Is Currently a Party
Nasdaq's application also fails to provide an adequate basis to understand and comment upon its continuing role in existing NMS plans and under other contractual arrangements entered into while it has been acting as an arm of the NASD. From a policy perspective, its role under these plans and other contractual arrangements, acquired on the premise that it would be acting under the auspices of the NASD, must be reassessed in light of the separation that exchange registration will effect between Nasdaq and the NASD.
As noted above, Nasdaq performs a number of functions under existing NMS plans solely under a delegation from the NASD.61 Thus, the NASD - and not Nasdaq - should retain the rights (including the voting rights) granted under the agreements governing those plans. By the same token, Nasdaq - as a new exchange - should be subject to the same expenses, burdens and procedural requirements as any other exchange applicant seeking to participate in those plans. At present, commenters have little or no basis for evaluating the status of Nasdaq under these plans and agreements - a crucial consideration in reviewing Nasdaq's proposed rules and in determining whether its exchange registration can be reconciled with the requirements of the Exchange Act.
In addition, NASD members have entered into a variety of contractual arrangements over the years relating to services provided by Nasdaq, in its role as an arm of a registered national securities association. Many of those agreements contain explicit reference to Nasdaq's status as an "affiliate" of the NASD, a "registered national securities association" - and expressly define the NASD and its affiliates under a singe umbrella term as the "Corporations."62 Nasdaq's application does not provide information regarding how these agreements, entered into under the color of its affiliation with the NASD, will be amended or renegotiated - nor how it will ensure that it does not derive an unfair "leg up" over competing exchanges and markets that have not had the ability to hold themselves out as an "affiliate" of the sole registered national securities association.
D. The Conflict Between the Interests of Nasdaq and the Nation's Over-the-Counter Markets Operated by the NASD Heightens the Need for Additional Scrutiny of Nasdaq's Application
The profound conflict between Nasdaq's interests, as a for-profit exchange, and the interests of the nation's over-the-counter markets only heightens the need for careful Commission scrutiny of the extensive open issues outlined above, as well as numerous related questions. For example, as a threshold matter, why should the NASD be asked to rebuild facilities for the over-the-counter market while Nasdaq transfers the value of existing facilities to its for-profit exchange? As noted above, the existing facilities were developed, funded and acquired their value through the Nasdaq's unique position as an arm of the only U.S. registered national securities association. If anyone should build new facilities, shouldn't it be Nasdaq - since its shareholders will profit? The mere fact that Nasdaq and the NASD may have agreed to these arrangements as a corporate matter is no adequate answer to the question of whether they satisfy the requirements of the federal securities laws - especially in light of the substantial overlap in management, operations and financial interests described above.
Instinet respectfully requests that the Commission withhold approval of Nasdaq's exchange registration until Nasdaq has modified its proposal to ensure fair competition between the exchange and over-the-counter markets, assured the existence of viable, neutral facilities for securities firms to continue to compete and innovate in the over-the-counter markets, and addressed the numerous unresolved procedural and substantive issues posed by the application in its current form.
Nasdaq's application may not, in Instinet's view, proceed under the Exchange Act until Nasdaq has provided the Commission - and the public - with a persuasive justification for its proposed fundamental restructuring of the nation's securities markets - a restructuring that, as discussed in Part II above, Instinet views as radically inconsistent with the interest of investors and the statutory mandate to preserve effective competition among exchange markets, and between exchange and over-the-counter markets in the United States.
Further, Instinet requests that the Commission require publication for comment, before taking action on the application, not only of Nasdaq's rules as a proposed exchange, but also the rules that will continue to apply to the over-the-counter market operated by the NASD. In this connection, Instinet requests a further extension of the comment period to permit adequate review and analysis of the impact of Nasdaq's application and proposed rules on existing markets - especially in light of the magnitude and complexity of the issues raised by Nasdaq's application. This extension should be structured to afford sufficient time for comment after Nasdaq has addressed fully the manner in which over-the-counter trading will occur subsequent to its registration, as well as the numerous additional issues noted above. In the interim, naturally, Instinet will endeavor to supplement this letter with additional comments reflecting continuing review of Nasdaq's extensive rule package and additional information that becomes available to the public.
As a matter of both fairness and substantive compliance with the requirements of the federal securities laws, the public should be afforded an opportunity to be fully informed of, and to comment on, all of the features of Nasdaq's proposed registration that would have a significant impact on the operations of the U.S. securities markets and the objectives established by Congress in the Exchange Act.
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 Laura Simone Unger, Commissioner
The Honorable Isaac C. Hunt, Jr., Commissioner
Annette L. Nazareth, Director, Division of Market Regulation
Robert L.D. Colby, Deputy Director, Division of Market Regulation,
And Senior Advisor to the Chairman
Belinda Blaine, Associate Director, Division of Market Regulation
Elizabeth K. King, Associate Director, Division of Market Regulation
Rebekah Liu, 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.|
|2||As the Commission is aware, Nasdaq's application may not be approved under Section 19(a)(1) of the Exchange Act unless the Commission "finds that the requirements of [the Exchange Act] and the rules and regulations thereunder with respect to the applicant are satisfied." Relevant requirements of the Exchange Act, as discussed in greater detail below, include Section 6(b)(5) (the rules of the exchange must be designed "to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest"); Section 6(b)(8) (the rules of the exchange "do not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the [Exchange Act]"); Section 11A(a)(1)(C)(ii) (finding that it "is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure . . . fair competition . . . among exchange markets, and between exchange markets and markets other than exchange markets"); and Section 15A(b)(11) (requiring that the rules of a registered national securities association be designed "to promote orderly procedures for collecting, distributing, and publishing quotations" relating to securities that may be sold otherwise than on a national securities exchange). In this letter, for ease of exposition, we generally use the term "over-the-counter markets" to refer to "markets other than exchange markets."|
|3||See Part II.B infra, including statutory provisions and legislative history cited therein.|
|4|| The NASD has allocated to Nasdaq, inter alia, the "following responsibilities and functions as a registered securities association":
"a. To operate The Nasdaq Stock Market, automated systems supporting The Nasdaq Stock Market, and other markets or systems for non-Nasdaq securities.
Filing and Order Granting Approval of Allocation and Delegation of Functions by the NASD to Subsidiaries, Exchange Act Release No. 37,107 (April 11, 1996), 61 Fed. Reg. 16,948, 16,952 (April 18, 1996) (emphasis added) (cited in Notice, infra note 23 at 31,953).
|5||Securities Acts Amendments of 1975, Pub. L. No. 94-29, 89 Stat. 97 (1975).|
|6||Section 11A(a)(1)(C)(ii) of the Exchange Act.|
|7||See Section 11A(c)(3) of the Exchange Act; see also S. Rep. No. 94-75, at 21 (1975).|
|8||See Sections 6(b)(5) and 6(b)(8) of the Exchange Act.|
|9||Section 15A(b)(11) of the Exchange Act; Rule 11Ac1-1(b)(1)(ii) of the Exchange Act.|
|10||S. Rep. No. 94-75, at 14 (emphasis added).|
|11||Subcommittee on Securities of the Senate Committee on Banking, Housing and Urban Affairs, Securities Industry Study, S. Rep. No. 93-13, at 12 (1973).|
|12||Id. at 13 (emphasis added).|
|13||Section 11A(a)(1)(C)(ii) of the Exchange Act.|
|14||S. Rep. No. 94-75, at 20.|
|15||Id. at 13 (emphasis added).|
|16||Sections 11A(c)(3) and 23(a)(2) of the Exchange Act; see also S. Rep. No. 94-75, at 21.|
|17||See Section 11A(c)(3)(A) and (B) of the Exchange Act.|
|18||Section 23(a)(2) of the Exchange Act.|
|19||S. Rep. No. 94-75, at 21.|
|20||Nasdaq avers that its application will benefit the investing public by facilitating "improvements to the Nasdaq market" and the "independence of the NASD." See Letter from Frank G. Zarb, Chairman of Nasdaq and the NASD, to Acting Chairman Laura S. Unger, Appendix B (May 8, 2001). Yet there simply is no basis, under the Exchange Act, to presume that "improving" Nasdaq's proprietary market and assuring Nasdaq's "independence" (which will come hand-in-hand with that of the NASD) will benefit investors or "strengthen the U.S. securities markets." Indeed, Congress and the Commission have long operated on the contrary premise - refusing to provide regulatory protection to any exchange that confuses its interest with the public interest, and demanding that competition from over-the-counter venues be permitted to thrive.|
|21||Letter from Frank G. Zarb, Chairman, President and Chief Executive Officer of the National Association of Securities Dealers, Inc., submitted on behalf of the NASD and the Nasdaq Stock Market, to Jonathan G. Katz, Secretary of the Commission regarding SR-NYSE-97-31 4 (January 6, 1998), at http://www.nasdaqnews.com/views/comment.html (citations omitted) (emphasis added).|
|22||The Commission's responsibility to assess the competitive implications of Nasdaq's application is underscored by recent case law preempting antitrust review of exchange rules in light of the extensive authority granted to the Commission to assess the competitive impact of those rules. See In re Stock Exchanges Options Trading Antitrust Litigation, 2001 Fed. Sec. L. Rep. 91,328, 2001 WL 128325 (S.D.N.Y. Feb. 15, 2001).|
|23||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).|
|24||Letter from Frank G. Zarb to Laura S. Unger, supra note 20.|
|25||Section 15A(b)(11) of the Exchange Act.|
|26||See, e.g., Rule 11Ac1-1(b)(1)(ii) under the Exchange Act (requiring every national securities association to collect and process quotation information from over-the-counter market makers); Rule 11Aa3-1(b)(1) of the Exchange Act (requiring every national securities association to file a transaction reporting plan regarding over-the-counter transactions in listed equity and Nasdaq securities).|
|27||NASD Rulemaking: SuperMontage, Exchange Act Release No. 43,863 (Jan. 19, 2001), 66 Fed. Reg. 8019, 8054 (Jan. 26. 2001) (the "SuperMontage Release").|
|28||See Rule 11Ac1-1(c)(5)(ii) under the Exchange Act. To effectuate this provision, Commission staff issue ECNs no-action letters on a periodic basis that are conditioned on the ECN providing the prices and sizes of its best-priced orders to, and access to those orders through, Nasdaq's SelectNet system. See, e.g., Letter from Robert L.D. Colby, Deputy Director, Division of Market Regulation, Commission, to Douglas M. Atkin, Instinet (June 14, 2001).|
|29||SuperMontage Release, 66 Fed. Reg. at 9018.|
|30||Id. at 8053-8054.|
|31||Section 11A(b) of the Exchange Act sets parameters for the registration and activities of securities information processors.|
|32||The Nasdaq/UTP Plan provides for an Operating Committee, comprised of Plan participants. Its responsibilities include oversight of the consolidation and dissemination of quotation information and transaction reports, evaluating the performance of the securities information processor, and determining cost allocation and revenue sharing. See SuperMontage Release, 66 Fed. Reg. at 8053.|
|33||SuperMontage Release, 66 Fed. Reg. at 8053.|
|35||In notable contrast, the Securities Industry Automation Corporation, a joint subsidiary of the New York Stock Exchange and the American Stock Exchange and a securities information processor for exchange-listed securities, collects and disseminates trade and quote information from all U.S. equities and options markets for the NMS, but does not integrate that information into specialists' books on the floor of any exchange. See http://www.siac.com/products_and_services/network_connectivity_intro.html.|
|36||While the creation of an NASD OTC Facility may reduce some of these benefits to the Nasdaq exchange, it will by no means eliminate all of them. Moreover, as discussed below, Congress did not say that an exclusive securities information processor could favor one competitor "just a little bit" - it said that the processor must be "absolutely neutral."|
|37||S. Rep. No. 94-75, at 11 (emphasis added).|
|38||S. Rep. No. 93-13, at 100.|
|39||S. Rep. No. 94-75, at 9.|
|40||Report of Special Study of Securities Markets of the Securities and Exchange Commission, Part 2 (1963), reprinted in H.R. Doc. No. 88-95, at 678 (1963).|
|41||SuperMontage Release, 66 Fed. Reg. at 8052-8054.|
|42||Id. at 8054.|
|43||Although Nasdaq has argued in the past that order display obligations can be met through display on other exchanges, in reality this ability is purely theoretical - since Nasdaq would continue to integrate into the execution facilities of its proposed "exchange" the best prices of competing exchanges obtained in its role as the exclusive securities information processor for the Nasdaq market (anti-competitive conduct that, in our view, is inconsistent with its obligation of neutrality under the Exchange Act). More importantly, this argument simply ignores the central objective of the 1975 Amendments extensively reviewed above: It is no answer to say that market participants may use another exchange when the relevant statutory mandate is to permit trading and innovation to occur in the over-the-counter markets.|
|44||See NASD Board of Governors, at http://www.nasd.com/corpinfo/co_peo_board.html; The Nasdaq Stock Market, Inc. Board of Directors, at http://www.nasd.com/corpinfo/co_peo_00bco.html.|
|45||Letter from Frank G. Zarb to Laura S. Unger 1, supra note 20.|
|46||Notably, no similar conflict exists for firms that are not under common control with the NASD, and that have an interest in the success of the over-the-counter markets.|
|47||See Rules 11Ac1-1(c)(5) of the Exchange Act and 11Ac1-4 of the Exchange Act (the "Order Handling Rules") (advancing fair and equitable marketplace principles by requiring broker-dealers to submit the size, the highest bid and best offer of securities they trade in and of customer limit orders for publication); Rule 301(b)(3) under Regulation ATS (making similar requirements applicable to alternative trading systems).|
|48||S. Rep. No. 94-75, at 12.|
|49||See Letter from Marc E. Lackritz, President of the Securities Industry Association to Jonathan G. Katz, Secretary of the Commission (July 24, 2001).|
|50||See supra note 23 at 31,953.|
|51||See Letter from Edward S. Knight, Executive Vice President and General Counsel of Nasdaq, submitted with Nasdaq's Form 1 Application, to Annette L. Nazareth, Director of the Division of Market Regulation at the Commission (November 9, 2000).|
|52||Section 19(a)(1) of the Exchange Act.|
|53||Press Release, Nasdaq Exchange Registration Q & A, at http://www.nasdaqtrader.com/trader/hottopics/exchange_hottopics.stm.|
|54||See, e.g., S. Rep. No. 88-379, at 9-12 (1963); H.R. Rep. No. 88-1418, at 15-17 (1964).|
|55||Section 16(d) of the Exchange Act provides: "[t]he provisions of [section 16(b)] shall not apply to any purchase and sale, or sale and purchase ... of an equity security ... by a dealer in the ordinary course of his business and incident to the establishment or maintenance by him of a primary or secondary market (otherwise than on a national securities exchange) ..."|
|56||See Letter from Marc E. Lackritz to Jonathan G. Katz, supra note 49. See also Letter from Sol Reicher, John Hawkey and Ross More, submitted on behalf of the Member Associations of the American Stock Exchange, to Jonathan G. Katz, Secretary of the Commission (July 30, 2001); Letter from William O'Brien, submitted on behalf of BRUT ECN, L.L.C. to Jonathan G. Katz, Secretary of the Commission (July 30, 2001).|
|57||See supra note 23 at 31,953.|
|58||See supra note 2.|
|59||See Proposed Nasdaq IM 4630-1. Similarly, the proposed Nasdaq trade reporting rules create a significant ambiguity regarding which trades should be reported on the Nasdaq exchange rather than in the over-the-counter market - an ambiguity exacerbated by the lack of any published revision to the NASD Rulebook. See Proposed Nasdaq Marketplace Rule 4633. This lack of clarity regarding where trades should be reported also raises competitive concerns in light of the NMS plan revenues that would be allocated to Nasdaq as a result of trades reported on its for-profit exchange.|
|60||See, e.g., Proposed Nasdaq Marketplace Rule 4460(j).|
|61||See supra note 4 and the discussion in Part III.C.|
|62||See, e.g., Nasdaq Workstation II Subscriber Agreement Cover Sheet for Market Makers ("THIS AGREEMENT . . . is made by and between Nasdaq, a Delaware Corporation that is an affiliate of the National Association of Securities Dealers, Inc. (NASD) (a registered national securities association . . .) (NASD with its affiliates is collectively referred to herein as the "Corporations")", available at http://www.nasdaqtrader.com/trader/tradingservices/productservices/agreements/agreement.stm#mm. See also Nasdaq ACT Agreement Cover Sheet, available at http://www.nasdaqtrader.com/trader/tradingservices/productservices/agreements/agreement.stm#mm.|