July 30, 2001
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Attention: Mr. Jonathan G. Katz, Secretary
Re: File No. 10-131
Ladies and Gentlemen:
The BRUT ECN, L.L.C. ("BRUT")1 welcomes the opportunity to provide the Securities and Exchange Commission (the "Commission") with its comments on Exchange Act Release No. 44396 (the "Application"),2 in which the Commission solicits comment on the application of The Nasdaq Stock Market, Inc. ("Nasdaq"), a subsidiary of the National Association of Securities Dealers, Inc. (the "NASD"), to register as a national securities exchange under Section 6 of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
As with other tenets of Nasdaq's business strategy, BRUT believes that the granting of exchange status to Nasdaq at this time is fraught with potential anti-competitive consequences, given Nasdaq's historical role in market structure and its legacy as a facility for broker-dealer compliance with regulatory requirements. In particular, the absence of a meaningful non-Nasdaq alternative for market makers and electronic communication networks ("ECNs") to comply with quotation dissemination and access requirements under the Exchange Act would mandate said firms to subscribe to membership of Nasdaq's exchange, threatening the competitive balance among market centers that Congress dictated be a central component of the national market system. Accordingly, BRUT recommends that the Commission should not approve Nasdaq's exchange application until the implementation of a viable and meaningful market structure framework that allows for Nasdaq to evolve as it wishes while preserving fair and open competition among all market centers.
The Consequences of Exchange Status
The Application is only one in a series of actions by which Nasdaq seeks to complete a transformation from an entity meant to serve as an informational utility for NASD member broker-dealers into a mechanism for order entry and execution in direct competition with said brokers. Exchange status, in combination with the introduction of Nasdaq's "SuperMontage" trading system,3 will bring Nasdaq into direct combination with market makers and ECNs for broker-dealer and institutional order flow. While the over-the-counter ("OTC") market for Nasdaq-traded securities will continue after creation of the Nasdaq exchange, Nasdaq systems such as SelectNet and the revised Small Order Execution System ("SOES") will no longer be means of effecting OTC executions.4
More importantly, market makers and ECNs that are reliant on these Nasdaq systems would be required to seek Nasdaq membership in order to maintain compliance with their regulatory obligations. Market makers provide quotations to Nasdaq to fulfill their obligations under the "Quote Rule" to "promptly communicate to [an] exchange or association... its best bids, best offers, and quotation sizes for any subject security."5 ECNs have provided order information and access through Nasdaq systems in order to satisfy Commission requirements under the ECN Display Alternative.6 The Commission has provided no-action positions to ECN operators regarding compliance with the ECN Display Alternative based on such arrangements.7 No ECN operator has obtained similar relief without using Nasdaq systems in this fashion.
Nasdaq's position that "broker/dealers that currently operate as order entry firms, market makers and ECNs will need to register as Nasdaq members to be able to use Nasdaq trading systems"8 would thus effectively mandate Nasdaq exchange membership for market makers and ECNs. Moreover, it would be unclear whether ECNs would continue to be in compliance with the requirements of the ECN Display Alternative even if they become Nasdaq members, given that non-member non-subscriber broker-dealers would no longer be able to access the ECN orders, raising the question whether ECNs were providing "equivalent access" to its best-priced orders. Nasdaq would thus have unparalleled leverage over market makers and ECNs regarding the "voluntary" decision of whether to obtain membership. Nasdaq's prior suggestions regarding other options for market-maker and ECN compliance9 only highlight the lack of a viable alternative and what Nasdaq's bargaining position would be on the topic of membership.
Without the existence of a vibrant, non-exchange operated alternative for compliance with these and other regulatory requirements, Nasdaq's exchange status would thus threaten the congressional directive that the National Market System promote "fair competition... between exchange markets and markets other than exchange markets."10 Exchange membership cannot be an implicit condition for compliance with Commission rules without undermining the feasibility of market-maker and ECN participation in the OTC market. While national securities exchanges, whether specialist or dealer-based, are currently an invaluable component of securities market structure, the ability to act as a broker or dealer solely in the OTC market is critical to avoiding the oligopoly that concentrating all power in the hands of a few exchanges would ultimately create.
The Commission previously recognized the potential anti-competitive consequences of Nasdaq's transition when requiring that the NASD must implement "a quote and trade reporting alternative that satisfies... regulatory requirements for ATSs, ECNs and market makers" (an "Alternative Display Facility" or "ADF", also known as the "residual market") prior to the operation of Nasdaq's "SuperMontage" trading system.11 BRUT believes a similar condition should be placed on the approval of the Application. Moreover, market participants seeking to build or operate an ADF should be required to publicly report to the Commission regarding the progress towards building an ADF in the six months since the Commission mandated its creation , and an estimated "live" date, so that the Commission can gauge whether efforts towards producing a reliable regulatory alternatives are on pace with Nasdaq's competitive endeavors.
BRUT is also concerned regarding the post-approval relationship between the NASD and Nasdaq and the resultant effect on market participants. Despite the NASD's strategy of gradual divestiture of its ownership interest in Nasdaq, which should be complete before the Application is approved, the risk remains that going forward the NASD-Nasdaq relationship will have some unhealthy characteristics. The NASD will still have a significant, albeit indirect, financial interest in Nasdaq given that it will be a significant customer of the regulatory services of the NASD's subsidiary NASD Regulation, Inc. ("NASDR"). Nasdaq will also share physical facilities with the NASD and NASDR and, in the mind of the public, share an implicit affiliation in their respective names. This raises the specter of whether the NASD can truly act in a market-neutral fashion, which could impact its oversight of non-Nasdaq member broker-dealers as well as its efforts at maintaining the competitive utility of an ADF.
The Commission should accordingly require the NASD, its subsidiaries and Nasdaq to make a thorough public accounting before approving the Application under the purview of an ongoing NASD-Nasdaq relationship. For instance, NASDR and Nasdaq have requested confidential treatment for certain critical provisions of their Regulatory Services Agreement (the "RSA"),12 which would govern the terms under which NASDR would regulate Nasdaq members and market operation.13 BRUT believes that full disclosure of the terms of the RSA is necessary to determine: (i) whether or not the ongoing commercial ties between the NASD and Nasdaq will undermine market structure; and (ii) whether the contract was negotiated at "arms' length" and thus not subsidized by broker-dealers that choose not be Nasdaq exchange members going forward, fulfilling the NASD's statutory requirement that its operations "provide for the equitable allocation of reasonable dues, fees and other charges among members and issuers and other persons using any facility or system which the association operates or controls."14
These and all other material aspects of the contemplated relationship should be made public with maximum disclosure. Only through such a transparent application process can market-at-large provide meaningful comments on the Application and analyze whether Nasdaq's change in status under the Exchange Act would undermine its purposes through unintended consequences.
BRUT believes that the evolutionary aspect of U.S. securities markets, which the Application embodies, is on of its fundamental strengths. It is well within the discretion of Nasdaq to choose to convert itself from a regulatory facility to a for-profit exchange in competition with market makers and ECNs. Nasdaq's legacy, however, requires that such a strategy only be effected when viable alternatives for regulatory compliance are operational, and Nasdaq has rebutted the presumption that its prior affiliations will not provide it with unfair competitive advantages going forward. In taking these and other issues regarding the Application into account, the Commission can preserve the sound fundamentals of market structure and provide a framework for competition and growth for decades to come.
BRUT appreciates this opportunity to offer comments to the Commission. If the Commission or its staff would find further discussions or other assistance helpful, please do not hesitate to contact me at (917) 637-2560.
cc: The Hon. Laura S. Unger, Acting Chairman
|1||The BRUT ECN, L.L.C. is one of the fastest-growing Alternative Trading Systems (ATSs) in the Nasdaq market. BRUT's unique business model strengthens the relationships between broker-dealers and their institutional clients, while its proprietary tools ensure superior functionality and access to all of Nasdaq's liquidity. BRUT is owned and supported by 27 Wall Street firms. The company is headquartered in New York City.|
|2||June 7, 2001. 66 Fed. Reg. 31952 (June 13, 2001). File No. 10-131.|
|3||See Exchange Act Release No. 43863 (January 19, 2001). 66 Fed. Reg. 8020 (January 26, 2001) ("SuperMontage Approval Order").|
|4||Approximately 25-30% of all share volume in Nasdaq securities are executed by means of SelectNet and SOES. See table, "SOES and SelectNet Usage as a Percentage of Nasdaq Share Volume" at http://www.marketdata.nasdaq.com/asp/MaSoesSnet.asp.|
|5||Rule 11Ac1-1(c) under the Exchange Act.|
|6||Rule 11Ac1-1(c)(5)(ii) under the Exchange Act. ECNs have used Nasdaq's quotation display features for providing order-price information and access through the SelectNet system.|
|7||See, e.g., Letter from Robert L.D. Colby, Deputy Director, Division of Market Regulation, Commission, to J. Craig Long, June 14, 2001 (extending the position with respect to BRUT until March 31, 2002).|
|8||Exchange Registration Q&A, The Nasdaq Stock Market, Inc., at 4 (June 2001).|
|9||See, e.g., Exchange Act Release No. 43514 (November 3, 2000), 65 Fed. Reg. 69084 (November 15, 2000), at 69108 (stating the opinion of the NASD and Nasdaq that market makers and ECN could "satisfy [their] obligations... through a number of other means, such as sending its best bid and offer to other market centers, such as the Chicago Stock Exchange or the Cincinnati Stock Exchange," where such means are not widely available to ECNs or non-subscriber broker-dealers seeking to access ECN orders).|
|10||Exchange Act §11A(a)(1)(C)(ii)|
|11||SuperMontage Approval Order, supra note 3, at 8052-8054.|
|12||See Regulatory Services Agreement Between NASD Regulation, Inc. and The Nasdaq Stock Market Inc. (June 28, 2000). The RSA was not included in the|
|13||See Id., §§ 2.03, 4.01-4.02 (describing services to be provided), §§10.01-10.03 (regarding proprietary rights), §11.02 (concerning market data) and §§13.01-13.04 (detailing Nasdaq's payment of fees for services provided by NASDR).|
|14||Exchange Act §15A(b)(5).|