March 19, 2004        

Sent Via Federal Express
Jonathan G. Katz, Esquire
Secretary
United States Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: The United States Capital Market LLC's Comments on "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

Dear Mr. Katz:

Saul Ewing LLP is pleased to submit this comment letter on behalf of our client, The United States Capital Market LLC ("USCM"), an organization of financial market intermediaries which advocates the creation of a 21^st century exchange market facility and structure which focuses upon supporting capital formation and enhanced and expansive secondary market mechanisms for our Nation's small and emerging companies.¹ The USCM is pleased to comment on The NASDAQ Stock Market, Inc.'s ("NASDAQ") Form 1 Application ("NASDAQ's Exchange Application" or "Application") to register as a national securities exchange under Section 6 of the Securities Exchange Act of 1934 ("Exchange Act").

We observe that the Commission published notice of NASDAQ's Exchange Application on June 7, 2001. See Release No. 34-44396 (June 7, 2001). Accordingly, the Application is approaching its third anniversary without Commission approval. We view the lengthy review proceeding as consistent with a proposal that raises significant market structure implications, whereby the overwhelming majority of our Nation's traditional over-the-counter ("OTC") market facilities are to be transformed into a ninth registered national securities exchange. At this point, we encourage the Commission to move forward to approve NASDAQ's Exchange Application expeditiously after addressing one final, major open issue - the decoupling of the OTC Bulletin Board ("OTC-BB") from NASDAQ.

I. Comment Summary

USCM applauds the Commission's instrumental role over the past 30 years as a facilitator of Congress's National Market System ("NMS") mandate and program. The Commission's "Regulation NMS" initiative is the most recent reflection of this conscientious stewardship.

We believe that NASDAQ's Exchange Application is an inevitable outgrowth of the 1975 Amendments, which promulgated Section 11A of the Exchange Act establishing the principles and objectives of the NMS. The blueprint for building the NMS was based on fundamental exchange "auction" principles that would extend to all "qualified" securities suitable for trading in accordance with such principles. The NMS program, based upon auction principles, has had the greatest influence on the OTC marketplace, particularly on the development of the NASD's NASDAQ systems. Such influence has caused NASDAQ to focus on competing for the segment of public companies whose securities are suitable for exchange listing, and producing rules and trading systems that embrace auction-style concepts. This helps explain the anomaly of the Nation's quintessential OTC trading utility's intense desire to become a registered national securities exchange.

What has been lost, however, in the glitz of Times Square and NASDAQ press releases of dual listings of prominent NYSE listed companies is the loss of support and neglect of the trading infrastructure support for America's small and emerging companies. USCM's letter will review the OTC and NASDAQ's historic role in supporting small and emerging companies, including the historic root causes that have lead to an "over supply" of marketplace infrastructure for America's largest companies and a serious erosion of such infrastructure for our small and emerging companies that, despite this neglect, continue to be the heart of our economy.

Our letter also will review NASDAQ's Exchange Application's consistency with Section 6 and 11A of the Exchange Act in view of NASDAQ's current auction-type trading systems for the trading of companies meeting NASDAQ National Market and SmallCap listing standards. Our comment letter will then analyze how NASDAQ's failure to divest its OTC-BB facility has been and will continue to be a major impediment to the Commission's approval of the Application.

We will conclude with an overview of the present capital market for small emerging companies, and USCM's recommendations for the disposition and transformation of the OTC-BB into a platform for building the USCM for small and emerging companies in America.

II. The Historic Role of NASDAQ and the OTC Market in Incubating
     America's Small and Emerging Companies

Historically, the OTC market has been described as a "sponsored," "negotiated" and "dealer" market. The OTC market is also the residual securities market as all transactions that do not take place on a national securities exchange are said to be executed in the "OTC" market. A traditional description of the OTC market structure is as follows:

OTC transactions are usually executed over the telephone by broker-dealers in their offices. If an investor wishes to buy an OTC security, the broker-dealer handling his account may sell him the security as principal out of the broker-dealer's inventory. If the broker-dealer does not own the security (which is the usual case), he will buy the security from a "market maker" in that security and sell the security to his customer, acting either as an agent and charging a commission, or as a principal and charging a markup to the customer. A market maker is a broker-dealer who holds himself out "as being willing to buy and sell [a] security for his own account on a regular and continuous basis. . . . [T]he OTC market. . . is a decentralized market in which transactions are negotiated among broker-dealers and between broker-dealers and their customers. . . [and unlike a single specialist for an assigned stock on an exchange] it is common for there to be several market makers (sometimes as many as thirty) in a particular OTC stock . . . . Norman S. Poser, Restructuring the Stock Markets: A Critical Look at the SEC's National Market System, 56 N.Y.U. L. Rev. 883 (1981) ("Poser Review").

The following excerpt from an article written in the mid 1980's highlights the historic and important role of NASDAQ as the OTC market developer for small and emerging companies:

[t]he path for a maturing company to reach its ultimate trading market after going public [was as follows] [m]ost companies' issues were traded OTC after their initial public offering of stock. However, most OTC companies that chose to list would move directly from the OTC market to one of the primary exchanges in New York. . . . [t]hese companies tended to list initially on the American Stock Exchange, Inc. (AMEX), which had substantially lower initial listing requirements that the NYSE, and in time, as they grew, would move up to the NYSE. Michael J. Simon & Robert L.D. Colby, The National Market System for Over-the Counter Stocks, 55 Geo. Wash. L. Rev. 17, 21-22 (1986) ("Simon and Colby Review").

The Simon and Colby Review noted the important nurturing and seasoning features of the OTC marketplace such as "a crucial reason for remaining in the OTC market was the continued sponsorship provided by the market making activity of the company's underwriter [and other market makers]. . . . These companies feared that if they listed on an exchange their stock would lose the support of a market maker with ties to the company, and activity in the stock would fall from lack of investor interest." Id. at 22.

The Poser Review cites that "[c]ommon stocks traded solely OTC tend to represent smaller and newer companies than those listed on stock exchanges." See Poser Review, supra. In this regard, the advent of NASDAQ on February 8, 1971 was a boon for small company issuers. "[W]ith the inception of NASDAQ, the NASD, under the leadership of a new president, Gordon Macklin, began actively to promote the OTC market. In 1971 the NASD developed a campaign to increase newspaper space allocated to OTC stock tables and began a series of education seminars for OTC companies. To increase the investment market for OTC companies, the NASD pressed for legislation on the state level to eliminate legal list requirements barring insurance companies, banks, and pension funds from investing in OTC stocks, and sought to extend to NASDAQ stocks registration exemptions under state blue sky laws." Simon and Colby Review at 43.

NASDAQ's focus and vision to support and nurture America's small and emerging companies was gradually blurred by a maternal instinct to not let its grown children move on to adult lives and to the exchanges of their choice. Over time, NASDAQ completely lost its historic and important mission in supporting an infrastructure for small and emerging companies. Instead NASDAQ looked to compete directly to keep and woo already developed companies as well as the biggest of America's corporate issuers to NASDAQ.

In some respect, NASDAQ's loss of focus on small and emerging companies stems from the 1975 Amendments and the policy drivers behind the NMS program that encouraged NASDAQ to list and develop securities that are suitable to trade in a market structure based upon exchange auction-style rules.

III. "Qualified Securities" to Trade under Auction-Style Rules in the NMS

On March 29, 1973, the Commission issued the "Policy Statement on the Future Structure of a Central Market System." In this statement, the Commission opined that "[a] central market system [soon to be retitled the National Market System], primarily through its communications network, can maximize the opportunity for public orders to match each other and be executed in classic auction fashion." The Policy Statement further expressed the Commission's "commitment to the preservation of an auction-agency market rather than a purely `dealer market' for listed securities." The Commission policy statement resonated in the legislative history of the 1975 Amendments. In the Senate Committee Report ("S.249"), the Senate observed that "the classic example of a dealer market is the over-the-counter market, in which it is virtually impossible for an investor's order to be executed without the participation of a dealer in the transaction." S.249 compared an exchange auction market with that of an OTC dealer market, with the latter being described as one where:

[t]here is no facility whereby public orders can offset each other, except under the auspices of a market maker, and this rarely occurs. Since the intervention of a dealer involves an additional spread between the prices at which investors can buy and sell, it is likely that in many instances investors obtain less favorable prices on their trades than if they could trade with other investors.

S.249 concluded that the proposed new market structure "would take the best features of the auction-agency market that exchanges now provide and expand them into principles to govern the functioning of the entire central market system."

The 1975 Amendments established the need "to remove impediments to and perfect the mechanisms of a national market system for securities as a purpose of the Exchange Act and directed the Commission to facilitate the establishment of a national market system which may include subsystems for particular types of securities with unique trading characteristics." Section 11A(a)(2) of the Exchange Act. Congress provided that "[t]he linking of all markets for qualified securities . . . will facilitate the offsetting of investors' orders, and contribute to the best execution of such orders." Section 11A(a)(1)(iv). Congress also advocated, among other guiding principals, that an NMS for "qualified securities" would best be served if it assured "investors' orders to be executed without the participation of a dealer." Section 11A(a)(1)(C)(v).

Although alluding strongly to exchange auction-eligible securities, the 1975 Amendments, however, did not specify which securities should be included in an NMS or subsystem thereof. In this regard, Congress provided the Commission with "maximum flexibility" to designate the securities or classes of securities qualified for trading in the NMS from among securities other than exempt securities. The legislative history and prior Commission policy pronouncements indicated that the Commission should evaluate the various characteristics of a security, such as trading volume, price and number of stockholders to determine whether a particular security is appropriate for inclusion in an NMS or subsystem thereof.

The Commission immediately focused on the class of OTC securities that would be suitable for auction trading as qualified securities in an NMS market structure. In 1981, the Commission designated a segment of NASDAQ-traded securities as NMS Securities by establishing Rule 11Aa2-1 under the Exchange Act that established two tiers of relatively high listing standards for this group of OTC securities. Commission designation of these securities required them to be subject to real time last sale reporting and dissemination of quotations that are firm in price and size similar to reporting and quotation mandates already existing for exchange listed securities. See Release No. 34-17549 (February 17, 1981).

A year later, the NASD petitioned the Commission with an amendment to the NMS designation/listing criteria to mirror the listing standards of the AMEX. The NASD stated that "the attraction of NMS designation will help the NASD attract and keep NASDAQ listings." The Commission approved the amendment and overnight NASDAQ National Market securities increased from 650 securities to over 1,450. See Release No. 34-18397 (January 7, 1982).

At this juncture, the NASD, primarily through its NASDAQ Stock Market subsidiary, began to aggressively seek lucrative listings of mid cap and large cap companies in head-to-head competition with the registered national securities exchanges, particularly the NYSE and AMEX. With the creation of further "SmallCap" listing standards that really targeted more mature companies and established companies, NASDAQ became a force to be reckoned with in listing battles with the larger exchanges vis-à-vis the AMEX and NYSE. Most, if not all, of the regional securities exchanges conceded and abandoned their listing programs in order to immediately trade AMEX and NYSE listed securities on an unlisted trading privileges ("UTP") basis. NASDAQ's evolving advertising and marketing campaign targeted ever larger companies, many which have remained on NASDAQ even after they readily can meet AMEX and NYSE listing standards. The zenith or nadir (depending on one's viewpoint) of NASDAQ's focus on big U.S. companies occurred recently with NASDAQ's January 12, 2004 public announcement of its program to dual list prominent NYSE listed companies. The program started with the dual listing of six Big Board companies, with a total market capitalization of approximately $156 billion.

IV. Exchange Auction-Style Rules Require Order Interaction

The hallmark of a registered national securities exchange is its centralized auction where maximum opportunities occur for the highest bid interest to meet the lowest offer interest without the intervention of a dealer. The exchanges have been succinctly described as organizations that "operated auction markets in which the highest bid was routinely matched with the lowest offer; dealer intervention was eliminated except where lack of other orders compelled specialist participation; the auction market was equipped to handle a large flow of small orders." See Werner, National Market System, 75 Colum. L. Rev. 1234, 1243 (1975).

Exchanges, through their systems, rules and procedures zealously promote this order interaction. This simple, but effective, order interaction spawns significant marketplace benefits. In this regard, exchanges' auction markets promote virtually all of the objectives of an NMS:

Section 11A(C).

In regulatory policy practice, the Commission has strictly required registered national securities exchanges to stay true to auction market principles. Whether approving on a permanent basis the Cincinnati Stock Exchange's National Securities Trading System in the early 1980's to justifying the New York Stock Exchange's Rule 390 (off-board trading restrictions), the Commission has vigilantly looked at the exchange's trading systems and rules for absolute consistency with auction principles.

For example, in 1984 when the Pacific Exchange ("PSE") filed a rule change to reduce the order exposure time frame in the Exchange's SCOREX system, the Commission required the following condition to approving the PSE's rule change:

[t]he Commission understands that SCOREX orders on the PSE will continue to be subject to all PSE rules governing the conduct of its auction market. In this regard, the Commission expects that SCOREX orders be executed pursuant to the PSE's rules governing the priority of bids and offers on its floor (e.g., Rule 1, Section 121(e) of the Rules of the PSE's Board of Governors). In addition, while the Commission does not view the current reduction of SCOREX's exposure period as substantially diminishing opportunities for SCOREX orders to interact with interest on the PSE floor, the Commission does recognize that this reduction theoretically could limit such interaction and that meaningful exposure of SCOREX orders possibly could not be achieved if this period was reduced below 15 seconds. In this regard, the Commission will conduct discussions with the PSE during the one year pilot program in an attempt to assess the effect of the 15 second exposure period.

In connection with reviewing the NYSE's Registered Representative Rapid Response Service ("R-4"), a small order execution mechanism in 1983, the Commission's Division of Market Regulation remarked:

[f]undamentally, the Division views exposure of orders on an exchange trading floor as the basic operating premise of an exchange market, making possible interaction of orders between the spread on an exchange floor and hence better executions for customers. It is this opportunity for increased interaction of orders within a market that constitutes the primary justification for centralization of orders on an exchange. Consequently, the Division views the interaction of orders within a market as an essential element of exchange operation; absent this interaction, exchanges lose their distinctive characteristics and begin to look like dealer markets. If exchanges fail to provide opportunities for orders sent there for execution (and merely execute transactions at the bid or offer), the Division believes that this would tend to undermine any basis for continuing to require exchange members to send orders to the exchange (as opposed to executing those orders upstairs as principal at the bid or offer).

Over the years, the NASDAQ has developed a series of automated trading systems that incorporate auction-style order interaction features characteristic of classic exchange systems. SOES, SelectNet, and SuperMontage widely utilized for the execution of NASDAQ National Market and SmallCap securities have characteristics identical to systems operated by the registered national securities exchanges. These NASDAQ automated trading systems all promote vigorous order interaction among competing trading interests of order entry firms and market makers. The latest system, SuperMontage, possesses auction-like priority and parity features.

The development of automated auction-style systems was inevitable once NASDAQ was prompted to trade securities suitable for auction market trading, which are NASDAQ's National Market and SmallCap list. In view of these factors, the Commission should move forward soon in approving NASDAQ's Exchange Application with respect to NASDAQ's facilities and trading structures for NASDAQ National Market and SmallCap issues.

The problem is that NASDAQ has not dealt with divestiture of the OTC-BB.

V. OTC-BB Does Not Meet Exchange Auction Principles

Whether a facility of NASDAQ or not, the OTC-BB operates as a traditional OTC trading mechanism with multiple dealers trading as principal against customer orders that do not interact. Moreover, OTC-BB companies fail to meet NASDAQ National Market or SmallCap listing standards or for that matter any national securities exchange listing standards. OTC-BB securities, therefore, are not qualified nor UTP eligible securities that would be well suited for trading under auction principles.

Based upon the Commission's longstanding and steadfast requirement that all exchange trading rules and mechanisms support auction principles and order interaction, the OTC-BB is utterly unsuited to be a facility of any registered national securities exchange. Therefore, NASDAQ's "simple fix" suggestion that it receive an exemption from Section 12(a) of the Exchange Act does not address the broader underlying policy issue. (Section 12(a) prohibits brokers from trading unregistered or unlisted securities on an exchange; OTC-BB securities are not going to be listed.) Accordingly, NASDAQ must divest the OTC-BB as a facility of NASDAQ before the Commission can finalize its review of NASDAQ's Exchange Application.

VI. The Capital Market for Small Emerging Companies

According to the U.S. Small Business Administration ("SBA"), small companies with fewer than 500 employees represent about 99 percent of the nation's employers, they employ nearly half of the private sector work force, are responsible for approximately two-thirds of all new jobs, and more than half the gross domestic product of the United States. According to the SBA, small businesses "are the stock from which large businesses grow, the first job of many new workers, and the opportunity for their owners to achieve the American Dream."²

Small emerging companies have served as the engine of growth for America's economy. Microsoft, Intel and Genetech started out as simple dreams of visionaries and entrepreneurs, but needed access to capital to fuel the growth that made them into the household names we know them by today. These and thousands of other companies in their early development phase had significant challenges in raising capital. Indeed, small emerging companies generally may not have access to conventional loans through banks and other commercial lending institutions and also may not be taken seriously by any investment banking firms in today's environment. Regarding the latter, many underwriters will pass on a potential primary or secondary offering of a small company's securities if it is not a certain dollar minimum, e.g., $5 - $10 million. In short, a "small" transaction would generate insufficient underwriting fees. Moreover, even if the company could secure an interested underwriter, typically a regional firm, the time, cost and attendant risks involved in a public offering may weigh heavily against using such funding approach.

The increasing scarcity of capital available to small companies correlates with the demise of regional investment banking firms. In bygone days, regional brokerage firms had first hand knowledge of local companies. They knew the principals, understood their business, could tour their offices and factories, and witness directly the acceptance in the marketplace of these companies' products and services. In the past, these regional firms would finance the small companies' operations, bring them public, make markets in their stock, and provide them research coverage. At the right time, the regional firms would partner with larger national brokerage firms to obtain a higher level of funding and exposure as the small companies grew larger.

The macro problem for the small cap marketplace is that the regional firms have become scarcer than an endangered species. The list of bygone regional firms, to name a few, reads like a requiem.

In the East: Alex Brown & Sons in Baltimore, Butcher & Singer, and F.J. Morrisey in Philadelphia.

In the South: J.C. Bradford in Nashville, Howard Weil in New Orleans, and Rotan Mosle in Dallas.

In the Midwest: Burns Pauley in St. Louis, The Chicago Corp in Chicago, John J. Kinnard in Minneapolis, Loewi in Milwaukee, and Prescott Ball & Turben in Cleveland.

In the West: Hambrecht & Quist, Montgomery Securities, and Robertson Stevens in San Francisco.

Sadly and alarmingly, the statistics reveal the negative impact on the capital market for small companies resulting from the losses in the ranks of regional broker-dealers. In 1995, regional brokerages were responsible for about 42 percent of all initial public offerings ("IPOs"). By 2002, that number had dramatically fallen to less than 21 percent. In this regard, using NASDAQ as a barometer for emerging companies, as recently as 20 years ago, 95 percent of IPOs were on NASDAQ, 10 years ago, the number was 85 percent, and today, the number is approximately 60 percent. As for IPO funds raised by small companies, in 1990, the average NASDAQ IPO raised $25 million. In 2003, that average zoomed to $200 million. These statistics identify a cataclysmic change signaling the disappearance of regional broker-dealers, who historically have served as the primary funding source for small and emerging companies seeking capital.

Today, as never before, small emerging companies face formidable capital formation challenges. Access to capital at reasonable cost and timing could likely translate into a strategic turning point for the company. In turn, to raise capital, small companies look to trading markets that can support liquidity, which is critical to induce investors financing commitments.

A renewed commitment of sponsorship and enhanced trading structure commitment must be made for our nation's small companies.

VII. Creation of The United States Capital Market for Small Emerging Companies

Trading markets function to create liquidity, which enables investors to dispose of or purchase securities at a price reasonably related to the preceding price of the security. The success of a company's public distribution of securities requires prospective purchases to have a reasonable assurance of liquidity in the marketplace for the security. Thus, the success of capital formation markets is dependent on the effectiveness of secondary trading markets. Additionally, trading markets are critical price discovery mechanisms, and facilitate the determination of the price at which a company is able to issue additional securities as well as establish a basis for the valuation of securities for loans (business and personal), taxation matters and other purposes.

All companies, whether they are large, small, developed or emerging, do benefit from efficient and fair trading markets if they depend on the public market for capital. Trading market sponsors such as the USCM can also provide many other tangible benefits to the companies served by their markets. In this regard, the NASD and NASDAQ historically assisted small companies in a variety of ways, including:

• Establish special Regional Districts and speak with brokers-dealers and investment banking firms and venture capital firms to support small companies. As we noted the regional broker-dealers were a traditional source for capital raising for the emerging companies.
   
• Work closely with state blue sky administrators to exchange ideas and seek support for efficient capital raising for small companies.
   
• Work with investor groups on issues pertaining to their ideas on enhancing the investment climate for small companies.
   
• Retain analysts and economists to assist the broker-dealer and investment community to receive broader business and performance information about small companies.
   
• Sponsor national and international issuer forums to promote small companies on the electronic dealer market.
   
• Assure enhanced analyst and financial press coverage of small companies trading on the electronic dealer market.
   
• Work closely with law makers and regulators to protect small issuers and the broker-dealers supporting them from "excessive" regulation. Where was the voice for small companies during the debates on the Sarbanes-Oxley Act?
   
• Open regional offices to counsel local small companies that are ready to move up to an exchange listing because their securities are now seasoned to benefit from auction trading mechanisms. Conceivably the next listing could be on NASDAQ, as a registered securities exchange.

The USCM has been established with the sole focus of developing a new and strong trading marketplace and venue for small and emerging companies to assist them in developing into larger, developed companies, at which point they should be listed on NASDAQ or another national securities exchange. The USCM intends to embrace NASDAQ's former sponsorship model for these companies.

Should NASDAQ press forward with its Exchange Application, we foresee that the OTC-BB facility will need to be de-coupled from NASDAQ and thereby will be in need of a new sponsor. The USCM looks forward to exploring with the NASD and NASDAQ the ability of the USCM to be the ideal next sponsor. We seek the Commission and securities industry's support in this endeavor.

VIII. Conclusion

NASDAQ's Exchange Application should be approved for trading NASDAQ National Market and SmallCap securities as soon as NASDAQ divests itself of its OTC-BB facility. The USCM is a highly motivated and extremely interested purchaser and sponsor of the OTC-BB and recommends that the latter be transformed into a platform for building the United States Capital Market for small emerging companies in America.

Our nation's small emerging companies are the engines of economic growth that have created more new jobs than the Fortune 500 and generated products, services and incomes that support millions of American workers and their families. We look forward to corporate America, the securities industry and the Commission supporting the USCM initiatives that can be readily accommodated in a variety of regulatory platforms in accordance with Regulation ATS under the Exchange Act. We believe that current initiatives such as the USCM be fostered to develop new access channels and sources of capital and efficient and transparent trading mechanisms for small companies, which are unquestionably an important segment of our national economy.

We look forward to answering any questions raised in this letter to assist the Commission in considering the efficacy and need for the USCM. Please do not hesitate to call me at (215) 972-1888 if you have any questions or comments on this letter.

¹ The USCM was founded by Arthur J. Pacheco, Senior Managing Director of Bear Stearns & Co. Inc., who is the manager member of the USCM. Mr. Pacheco is a past Chairman of the Security Traders Association ("STA") and a past President of the Security Traders Association of New York. K. Richard B. Niehoff is another founder of the USCM. Mr. Niehoff is President of Mark Securities, Inc., an NASD member firm that operated an alternative trading system for dynamic dealer quotations, order routing, and order execution of OTC-BB securities. Mr. Niehoff was instrumental in launching the National Securities Trading System, the first fully electronic stock exchange facility that was approved by the Commission as an National Market System facility on a permanent basis in 1982. Some of the guiding principles of USCM were announced in a speech delivered by Mr. Pacheco before the Annual Conference of the STA in Scottsdale, AZ on October 18, 2003 ("Pacheco October STA Speech"). In the Pacheco October STA Speech, Mr. Pacheco attributed his remarks as those of his own and not necessarily those of Bear Stearns. Messrs. Pacheco and Niehoff advocate the need today for a new marketplace facility supporting enhanced market structure and sponsorship mechanisms to solely support small and emerging U.S. companies.

² Many of the quotations, statistics and observations cited in this section are based upon remarks made by Arthur J. Pacheco in the Pacheco October STA Speech.