August 30, 2001

Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: The Nasdaq Stock Market, Inc.; Notice of Filing of Application
for Registration as a National Securities Exchange Under Section 6
of the Securities Exchange Act of 1934, Release No. 34-44396;
File No. 10-131 (the "Release")

Dear Mr. Katz:

Charles Schwab & Co., Inc. ("Schwab") appreciates the opportunity to comment on the application by the Nasdaq Stock Market, Inc. ("Nasdaq") to register as a national securities exchange under Section 6 of the Securities Exchange Act of 1934. Schwab has a significant interest in how our customers and our brokerage and market making operations will be affected by this fundamental restructuring of the existing Nasdaq market.

I. Standard of Review

In order to approve Nasdaq's application for registration as a national securities exchange, the Commission must find, among other things, that Nasdaq: (i) is so organized and has the capacity to both carry out the purposes of the Exchange Act and comply with the provisions of the Exchange Act and the rules and regulations promulgated thereunder; (ii) has rules that assure the fair representation of its members in the administration of its affairs; (iii) provides for the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities; (iv) has rules 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; (v) has rules that are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers or to regulate matters not related to the purposes of the Exchange Act; (vi) has fair and appropriate rules and procedures for disciplining its members; and (vii) does not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.1

In addition, the Commission must consider whether approval of the application will assure fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets,2 and will promote efficiency, competition, and capital formation.3

II. General Comments

In principle, Schwab does not oppose Nasdaq's application to register as a national securities exchange or its transition to a for-profit corporation. We have long advocated increased competition and innovation as being beneficial both to the investing public and the capital markets. For this reason, we have welcomed the rise of alternative market centers and execution venues, such as ECNs, as well as the Commission's various market structure initiatives which have opened up the markets to increased competition, efficiency, and transparency. In keeping with this philosophy, we believe Nasdaq should be allowed to take reasonable steps to compete more effectively in this environment.

Those steps, however, must comport with the requirements of the Exchange Act. First and foremost, the Commission cannot free Nasdaq to more fully compete with other market centers, ECNS, and broker-dealers, while at the same time allowing it to continue to enjoy the competitive advantages conferred by its control over industry utilities, such as the mandatory plans for collecting and disseminating market data, and its ability to regulate and discipline its competitors. Over the past several years, as the distinction between for-profit broker-dealers and non-profit self-regulatory organizations has diminished, the inherent conflicts of interest and current and past anti-competitive aspects of the existing market structure have become more and more pronounced. As a result, many market participants have called for reforms of both the current self-regulatory structure and existing market data arrangements. Nasdaq's application to register as a for-profit exchange heightens the need for meaningful restructuring of these areas. Our views as to how this should be accomplished are set forth in more detail below.

In addition, like other commenters, we are concerned by the lack of adequate time to review Nasdaq's application and by the fact that certain important matters remain either unclear or unaddressed. These include (i) the future operation of the OTC Bulletin Board, (ii) the numerous requests for exemptions from various Exchange Act sections and Commission rules which Nasdaq has apparently made or intends to make but which have not be made public, and (iii) the NASD's plans for operating a quotation and transaction reporting facility for its members that continue to trade listed and residual securities, including Nasdaq securities, otherwise than on a national securities exchange. Moreover, it appears that Nasdaq intends to rely heavily on the NASD rulebook in preparing its own rulebook. The industry has not been provided sufficient information to determine what changes may have been made to these rules, nor is it clear whether and to what extent Nasdaq intends to incorporate NASD rule amendments that have occurred since it filed its application or how the NASD's ongoing rule modernization project may impact the Nasdaq rulebook.

Under these circumstances, it is difficult, if not impossible, to adequately assess whether all of the Exchange Act requirements have been met. Should the Commission decide to approve the application, we believe it can only do so contingent on these matters being addressed and subjected to public notice and comment before Nasdaq is allowed to begin operating as an exchange.

III. Self-Regulatory Issues

One of the most fundamental issues raised by the application is the impact that Nasdaq's conversion to a for-profit exchange will have on its ability to carry out its regulatory obligations under the Exchange Act. The conflicts of interest and anti-competitive issues raised by this situation are well-known.4 Becoming a for-profit corporation raises concerns about an exchange's ability to act as an effective and impartial regulator. Even as non-profit enterprises, there is a long history of SROs favoring certain segments of their membership over others, or ignoring potential misconduct that benefited the SRO or its members.5 As a public company, an exchange's highest priority will be to maximize shareholder profits, and its obligation to place its investors' interests first will directly conflict with the objectives of an SRO. As a full-fledged commercial enterprise, an exchange will also directly compete with the broker-dealers and ECNs it regulates, raising concerns about regulatory neutrality. For example, broker-dealers and ECNs may face increased pressure to direct their order flow to an exchange (or exchange-sponsored trading venues) that monitors, inspects and sanctions them. Finally, allowing a for-profit exchange to function as a regulator is fundamentally unfair and antithetical to the concept of free enterprise. Fair competition is precluded when market participants are forced to compete against competitors that can directly use regulatory authority to preserve and enhance their competitive positions.

The Commission has previously indicated that it is considering ways to minimize the heightened conflicts of interest and anti-competitive consequences inherent in Nasdaq's application to become a for-profit exchange.6 However, neither Schwab nor any other commenter knows what measures the Commission is considering and thus cannot evaluate whether they are adequate to meet the requirements of the Exchange Act. In addition, with the sole exception of admission to membership, Nasdaq's application does not address how it intends to carry out its regulatory functions once it becomes an exchange. We understand that NASD Regulation, Inc. ("NASDR") currently performs regulatory functions on behalf of Nasdaq under a Regulatory Services Agreement. In other contexts, senior Nasdaq representatives have stated that Nasdaq will continue to contract with NASDR for its regulatory services once it becomes an exchange.7 The application does not explain, however, what services will be contracted out, how they will be performed, or otherwise provide any details about the arrangement. In addition, we understand that Nasdaq has declined to make some or all of the Regulatory Services Agreement available on confidentiality grounds. Thus, Schwab and other commenters are left with no basis to analyze whether Nasdaq will be able to carry out its self-regulatory functions in a manner consistent with the Exchange Act.

On a more fundamental level, we do not believe that a contractual arrangement between Nasdaq and NASDR for regulatory services will adequately address the conflict of interest and anti-competitive issues arising from Nasdaq's conversion to a for-profit exchange.8 Because of the close association (both historical and continuing) among the NASD, NASDR and Nasdaq, there is simply too great a probability that NASDR's regulatory activities will not be sufficiently insulated from the market-driven interests and actions of Nasdaq.9 Rather, we believe that the optimal solution to these issues is the creation of a single truly neutral SRO to handle all non-market related regulatory functions. This approach, discussed more fully in the SIA White Paper and Ad Hoc Committee Report, would facilitate a more efficient self-regulatory structure, alleviate the conflict of interests associated with demutualization, and promote competition between marketplaces.

The single SRO model would best resolve the conflicts inherent in an exchange's dual roles as regulator and competitor by removing from the exchanges those regulatory functions that pose the most intractable conflicts -- namely, regulation of members and cross-market issues. These would include cross-market trading rules (such as front-running and manipulation), sales practices, industry admission standards, financial responsibility requirements, training and supervision, recordkeeping, and investigation, examination and enforcement. The consolidation of self-regulatory functions in a single entity would have the added benefit of ensuring that investors receive equal protection regardless of the market or broker-dealer involved, and would streamline the oversight of broker-dealers and eliminate the high costs, duplication, and inefficiency inherent in the current multiple-regulator structure. Finally, it would remove the control over market-wide utilities held by the existing SROs, thus eliminating their ability to use their power over this essential market infrastructure in ways that benefit their competitive positions.

IV. Market Data Issues

The second significant issue raised by the Nasdaq application is how Nasdaq, as a for-profit exchange, intends to handle its transaction reporting and market data dissemination obligations. Currently, the collection and dissemination of market data for Nasdaq National Market securities, Nasdaq SmallCap securities and other OTC securities is handled under NASD rules and the Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation, and Dissemination of Quotation and Transaction Information for Nasdaq-Listed Securities Traded on Exchanges on an Unlisted Trading Privilege Basis (the "Nasdaq/UTP Plan"). Nasdaq is the day-to-day administrator of the plan and serves as its exclusive securities information processor ("SIP").

Concerns about Nasdaq's ability to continue as the administrator and central processor for the Nasdaq/UTP Plan were raised by numerous commenters in connection with the NASD's SuperMontage proposal.10 In response, the Commission acknowledged that Nasdaq's plan to become a for-profit exchange, coupled with other market structure developments, required a reevaluation of existing market data arrangements and could necessitate "fundamental structural change."11 In this regard, there are two ongoing efforts. First, the Commission has been overseeing revisions to the current Nasdaq/UTP Plan that are designed to mitigate certain of its more anti-competitive aspects.12 Second, the Commission has been considering broader reform of the existing market data structure, including through its Advisory Committee on Market Data.

We support the Commission's commitment to addressing market data issues, however, we are concerned that neither of these efforts is adequate to address the fundamental problems inherent in the current market data system. In particular, we believe that the Advisory Committee, of which we are a member, has been limited in the issues it has explored and the options it has considered, and that its report will not fully address the more fundamental reforms that we believe are necessary. In our view, the problems inherent in the current system (which will only become more pronounced once Nasdaq begins operating as a for-profit market competitor) can only be resolved through the introduction of meaningful competition - competition that is possible only through elimination of outdated regulations that force broker-dealers to supply market data to the exchanges and then repurchase prescribed data from those same exchanges. We intend to present our views in more detail in conjunction with the Advisory Committee's report, which is expected to be presented to the Commission in the next few weeks.

V. Conclusion

Nasdaq's application to register as an exchange is a watershed event that has significant implications for the securities markets, all market participants, and, most importantly, the investing public. It not only represents a fundamental restructuring of the existing OTC market, but will serve as a precedent for every future exchange application. Indeed, this application presents fundamental questions about structure and regulation of the securities markets that will have ramifications for the entire national market structure created by the 1975 Act Amendments. In order to approve the application, the Commission must satisfactorily address a broad range of issues, the most important of which are those involving the current self-regulatory structure and market data arrangements.

We realize that the Commission must act on the application by September 11, 2001, unless Nasdaq consents to an extension of time. Because it is unlikely the Commission can satisfy the Exchange Act requirements for approval of the application within the required time frame, we recommend that it seek Nasdaq's consent to a further extension of time. If Nasdaq will not consent, the Commission should either deny the application with the understanding that it can be resubmitted or approve it on the condition that it will not become effective until the outstanding issues are satisfactorily resolved.

Very truly yours,

W. Hardy Callcott
Senior Vice President and
General Counsel

cc: Harvey L. Pitt, Chairman
Isaac C. Hunt, Jr., Commissioner
Laura S. Unger, Commissioner
Annette L. Nazareth, Director, Division of Market Regulation


1 See Exchange Act Section 6(b).
2 See Exchange Act Section 11A(a)(1)(C).
3 See Exchange Act Section 3(f).
4 See, e.g., Reinventing Self-Regulation, White Paper for the Securities Industry Association's Ad Hoc Committee on Regulatory Implications of De-Mutualization, January 5, 2000 ("SIA White Paper"), available at
5 See, e.g., Certain Activities of Options Exchanges, Exch. Act Rel. No. 43268 (Sept. 11, 2000); New York Stock Exchange, Inc., Exch. Act Rel. No. 41574 (June 29, 1999); Report Pursuant to Section 21(a) of the Securities Exchange Act of 1934 Regarding the NASD and the Nasdaq Market, Exch. Act Rel. No. 37542 (Aug. 8, 1996).
6 See Exchange Act Release No. 34-43863, NASD Rulemaking: SuperMontage (January 19, 2001) at n. 436 ("SuperMontage Release).
7 See, e.g., Testimony of Richard G. Ketchum, President, The Nasdaq Stock Market, before the House Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, July 26, 2001, at p. 11.
8 The disadvantages of this approach (referred to as the "NASDR Model") are set forth in the SIA White Paper and in the SIA Ad Hoc Committee on the Regulatory Implications of De-Mutualization's paper entitled Recommendations Regarding Self-Regulatory Structure, dated March 23, 2000 ("Ad Hoc Committee Report"), available at
9 The NASDR Model discussed in the SIA White Paper and Ad Hoc Committee Report assumed that the regulatory entity and the for-profit exchange would be affiliated corporations. It is unclear whether the NASD, Nasdaq and NASDR will continue to be formally affiliated after the completion of the Nasdaq private placement. However, even if the NASD divests itself of all ownership interest in Nasdaq, the historical relationship between the entities and the fact that Nasdaq will be a major purchaser of regulatory services from NASDR will create a comparably close ongoing relationship.
10 See discussion at pages 58-61 of the SuperMontage Release (SEC Web site version).
11 Id. at pp. 61-63.
12 The Commission has mandated that the revisions must provide for either a fully viable alternative exclusive SIP for all Nasdaq securities or a fully viable alternative non-exclusive SIP in the event the Nasdaq/UTP Plan does not provide for an exclusive SIP. Further, if the revised plan provides for an exclusive SIP, the presumption should be that a plan participant, in particular Nasdaq, should not operate the exclusive SIP, although the presumption could be overcome if certain specified conditions are met. Finally, if a plan participant does serve as the exclusive SIP, other steps must be taken to ensure neutrality, such as opening the plan to all SROs and giving non-SROs a voice in plan decision-making. See Exchange Act Release No. 34-44694, Joint Industry Plan; Solicitation of Comments and Order Approving Request to Extend Temporary Effectiveness of Reporting Plan for Nasdaq/National Market Securities Traded on an Exchange on an Unlisted or Listed Basis (August 14, 2001).