Member Associations of the American Stock Exchange
Floor Brokers Association & Options Market Maker Association & Specialists Association
January 29, 2002
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
|Re:|| File No. SR-NASD-2001-90 |
Notice of Filing of Proposed Rule Change by the National Association of
Securities Dealers, Inc. Relating to Nasdaq's Proposed Separation from the NASD
and the Establishment of the NASD Alternative Display Facility (the "Filing")
Dear Mr. Katz:
The Member Associations of the American Stock Exchange (the "Amex Member Associations") hereby request the Commission to extend the comment period on the above-referenced Filing by 60 days, to March 22, 2002. The Filing, submitted by the National Association of Securities Dealers, Inc. ("NASD"), is a significant component of the NASD's plans to spin off its subsidiary, the Nasdaq Stock Market, Inc. ("Nasdaq"), as a national securities exchange, and can only fairly be evaluated within that broader context. The Filing sets out how the NASD proposes to redefine its role as a registered securities association for the residual over-the-counter ("OTC") markets post-separation, through comprehensive revisions to the existing NASD-Nasdaq Rulebook. Among other important matters, the Filing covers rules for the NASD's planned Alternative Display Facility ("ADF"), reporting of over-the-counter transactions and inter-market access.
The Commission should not act upon the Filing without the benefit of meaningful public comment to help inform its deliberations. The only way to fully understand the implications of the Filing is to evaluate it in conjunction with Nasdaq's pending exchange application and various interim NASD-Nasdaq rule filings that will likely carry forward into the rulebook of at least one of the organizations (although which one is not always clear). The current comment period is far too short and denies interested parties a reasonable opportunity to conduct this type of thorough evaluation.
Complicating matters, Nasdaq's exchange application is in a state of flux. It is our understanding that Nasdaq has submitted three amendments to its initial Form 1 filing since the close of the public comment period on the application.1 The most recent amendment was filed just over two weeks ago, on January 8, 2002, and appears to contain material changes to Nasdaq's proposed exchange rules, notwithstanding Nasdaq's assertion that the changes are non-substantive.2 For example, it appears that Nasdaq is proposing to formalize short-term rules set to expire at the end of February under which executions on the Nasdaq NNMS system are permitted to trade through a UTP exchange's quotes if the exchange is not an auto-execution participant within NNMS.3 In light of these amendments, and the lack of a complete record during the comment period for Nasdaq's exchange filing, we renew our request that the Commission open a new 90-day public comment period on the exchange application once a materially complete and up-to-date record is available to the public.4
Based on our analysis to date, the Amex Member Associations believe that the Filing, like the Nasdaq exchange application, raises significant policy issues that warrant a thorough airing through the public comment process. We are especially troubled by the NASD's proposals to allow OTC market makers for exchange-listed securities to participate in ITS on a voluntary basis and, as an incentive to discourage use of ITS, to provide OTC market makers with relief from inter-market trade through restrictions if they choose not to participate in ITS. We believe these features are contrary to the NASD's obligations under the ITS Plan.
Moreover, allowing OTC market makers to disconnect their ITS order routing linkages with the exchanges - in the absence of a viable alternative order routing mechanism - would represent a decided step backwards from 25 years of progress towards the national market system goals of best execution, market efficiency and inter-market competition. Indeed, the Commission, in 1994, noted the importance of full integration of third market makers into the national market system when it approved the NASD's proposal to require all CQS market makers to register and participate in the NASD's Intermarket Trading System/Computer Assisted Execution System ("ITS/CAES") interface with ITS.5 In its order, the Commission stated that the NASD's proposal would "facilitate the development of the NMS by integrating all registered market makers with intermarket trading in listed securities [and] facilitate the ability of third market makers to interact with orders of other market participants." The Commission noted that not exposing all third market orders to other ITS participants "inhibits a broker's ability to ensure best execution of customer orders and impedes fair competition between and among different types of trading markets and market professionals." NASD's current proposal completely undermines these Commission findings.
We also question the legal justification for the parallel NASD and Nasdaq proposals to adopt trade reporting rules that will permit OTC trades to be reported to Nasdaq as exchange executions. This trade reporting scheme raises troubling concerns as to the reliability and transparency of market data which are hallmarks of the U.S. securities markets, concerns that grow exponentially if Nasdaq is permitted to purchase trade reports from OTC market makers, as contemplated by a separate NASD-Nasdaq rule filing.6 If Nasdaq is permitted to print OTC trade executions as its own, that could well create a false impression that Nasdaq's markets have greater depth and liquidity than is the case, which could in turn improperly influence broker-dealers to direct order flow to Nasdaq over other exchanges.
It should also be noted that Nasdaq has stated in its recent Form 1 amendment that it is proposing to modify its trade reporting rules to mandate that its members must report their internalized trades to Nasdaq if they display quotes in Nasdaq, even though such trades are clearly OTC in character and have no meaningful nexus to Nasdaq exchange execution facilities. This substantive change to Nasdaq's Form 1 was filed only recently, on January 8th, and underscores the challenge of evaluating the Filing when Nasdaq's plans are shifting, and the need to extend the comment period on the Filing and reopen public comment on Nasdaq's exchange application when an appropriate record is available on Nasdaq's plans.
The issues identified above are precisely the type on which input from those directly impacted by the NASD's and Nasdaq's plans would be of value to the Commission. We would like to address these issues more fully, along with other areas of concern, based on our further analysis. These other issues include the adequacy of the NASD's proposed ADF and whether it meets the standards imposed by the Commission in the SuperMontage approval order,7 and the potential anti-competitive implications of various NASD-Nasdaq access and fee-related filings over the past several months.8
We do not believe the Commission can act responsibly on either the Filing or Nasdaq's exchange application without regard to the views of interested parties, especially on such important issues regarding market structure and inter-market competition within the conceptual framework of the national market system embodied in the Exchange Act.
For the reasons explained above, we urge the Commission to extend the comment deadline on the Filing to March 22, 2002 and to reopen public comment on the Nasdaq exchange application when a sufficient public record is available. We are happy to discuss our comments with Commission staff.
|1||The SEC solicited public comment on the Nasdaq exchange filing last June, for a comment period that originally ended on July 30, 2001. SEC Release 34-44396, 66 FR 31952 (June 13, 2001). The comment period was later extended to August 29, 2001.|
|2||See Amendment No. 3, submitted by letter dated January 8, 2002 from Edward S. Knight, Executive Vice President & General Counsel, Nasdaq, to Annette Nazareth, Director, SEC Division of Market Regulation.|
|3||The SEC approved the existing rules permitting the NNMS to automatically trade through a UTP exchange's quotes without any effort to reach the UTP exchange's better price quotes, on a temporary pilot basis scheduled to end on February 28, 2002. The Nasdaq amendment filing is silent on the issue, implying that Nasdaq intends to adopt the rules permanently and not on a pilot basis.|
|4||See our October 2, 2001 letter to Jonathan Katz, Secretary, Securities and Exchange Commission. We note that Nasdaq has waived the statutory 90-day deadline by which the Commission must act upon Nasdaq's exchange application.|
|5||SEC Release No. 34-34280, SR-NASD-93-10 (June 29, 1994).|
|6||See SR-NASD-2001-96, which replaces SR-NASD-2001-71.|
|7||SEC Release 34-43863, 66 FR 8020 (Jan. 26, 2001).|
|8||These include filings regarding inter-market trading and trade reporting linkages with UTP Exchanges (SR-NASD-2001-77, SR-NASD-2001-69 and SR-NASD-2001-81); fees for UTP Exchanges' use of Nasdaq systems (SR-NASD-2001-72, SR-NASD-2001-68 and SR-NASD-2001-64); and fees, rebates and incentive payments for members' use of Nasdaq systems (SR-NASD-2001-63, SR-NASD-2001-67, and SR-NASD-2001-71). The NASD is also seeking comment from members on a proposal to charge transaction fees for trades in Nasdaq securities, wherever they occur, including on UTP exchanges. See Special NASD Notice to Members 02-09.|