VIA ELECTRONIC MAIL and
April 8, 2002
Jonathan G. Katz
U.S. Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0609
Re: File No. SR-NASD-2001-90
Dear Mr. Katz:
NexTrade, Inc. ("NexTrade")1 hereby respectfully submits additional comments to the above-referenced proposed rule changes of the National Association of Securities Dealers, Inc. (NASD). NexTrade is a Securities and Exchange Commission (Commission) registered broker-dealer and operates an electronic communications network (ECN) pursuant to a Commission staff No-Action Letter. As an ECN and NASD member firm, NexTrade appreciates the opportunity to comment on important changes proposed for the operation and regulation of the over-the-counter (OTC) market.
In an earlier letter to the Commission regarding the above-referenced proposal,2 NexTrade enumerated various concerns about the plausibility of the ADF succeeding as a true, alternative OTC market for members of the NASD.3 In a second letter to the Commission regarding the above referenced rule proposal,4 NexTrade articulated specific concerns about the inappropriate burden of a duality of costs being placed on smaller firms as proposed in the ADF rules.
NexTrade believes that concerns it outlined in the second letter have already become stark, but unnecessary, realities due to the manner in which the NASD is proceeding in its race to spin off its own private exchange. Specifically, the NASD's headlong rush toward its goal, through a yet undefined process, is causing the NASD to operate outside of its Congressional mandate while forcing all firms to prepare for multiple contingencies under an unrealistic time-frame.
The NASD Operates Outside its Congressional Mandate
Under Section 11A(a)(1)(C) of the Act, Congress found that it was in the public interest and appropriate to the maintenance of fair and orderly markets to assure, in relevant part, (1) economically efficient execution of securities transactions; (2) fair competition among brokers and dealers and among markets (emphasis added); (3) the availability to brokers, dealers and investors of quotation and transaction information; (4) and the practicability of brokers executing investors' orders in the best market. Additionally, Congress constructed Section 15A(b)(6) of the Act, which requires, in pertinent part, that the NASD "foster cooperation and coordination with persons engaged in...processing information with respect to, and facilitating transactions in securities...and to perfect the mechanism of a free and open market and a national market system." From both the record and the law, it is clear that the Congressional mandate placed on the NASD specifically precludes the creation or imposition of rules that are designed, or result, in discrimination among members of the association.5 Nevertheless, the NASD has imposed deadlines and development burdens upon its membership that, due to the undetermined nature of the ADF and the hasty NASD timelines, heavily discriminate against the smaller members of the NASD, which is expressly forbidden by its Congressional mandate.
With respect to the SuperMontage, the NASD, through its Nasdaq relationship, has established a recklessly short code-to-quality-assurance time frame. In spite of the fact that the final Application Programming Interface ("API") for SuperMontage was not published until April 2, 2002, the NASD expects its membership to complete their internal coding and testing in under a few months. Even to those not well versed in the challenges of software development, certain fundamentals such as final API requirements and sufficient testing time are obviously necessary to prevent total system failures.6 The need to provide the NASD membership with sufficient time to code and test their systems prior to the implementation of SuperMontage is beyond obvious; it is imperative. Unlike larger firms, smaller firms are not in a position to code and re-code as the NASD works out the bugs in its API and testing schedules. For example, the NASD expects its member firms to begin functional testing for SuperMontage on 5/11/02. However, it appears that the NASD does not plan to provide the necessary software update to allow for testing in the member's production environment until 06/02/02.7 Smaller firms without the technical resources available to such firms as NexTrade, including valued customers of NexTrade, have made comments to us indicating their dissatisfaction with the unfair testing process. Specifically, in cases where smaller firms cannot afford replicated testing environments, the NASD is in a position to run roughshod over these smaller members, which will bear a disproportionate burden of cost in vainly attempting to meet the testing and functionality dates that are inherently unfair, unlikely, and inappropriate in the light of the NASD's Congressional mandate regarding discriminatory practices.
Moreover, the difficulty of coding a total system change in a few months is dramatically compounded by the vagaries of business that result from the yet unapproved ADF. According to the order approving SuperMontage, the ADF must be a viable alternative for NASD members. Specifically, the order stated, "The Commission, therefore, is conditioning its approval of the SuperMontage on the following, which must be implemented prior to or at the same time as the SuperMontage...".8 As a consequence of the undetermined nature of the ADF, a large number of firms are unclear as to whether their most viable business opportunities lie in participating in the ADF, the Super Montage, or by participating in both systems simultaneously. From the limited data available, the best business alternative for every firm is to prepare to operate in both systems. Unfortunately, the costs involved in re-developing the entire systems structure in two modalities, which may or may not ever be used, will prove crippling for smaller firms. Connectivity costs will be doubled, market data costs will be doubled, reporting costs will be increased, and development costs will be more than doubled. Many of the systems operated today have been developed over several years, and significant re-development would prove lengthy even in an environment where the rules were understood. In an environment where no one knows the rules, development becomes asymptotic.
Alarmingly, the NASD seems to be leveraging the uncertainties of the ADF to drive business to the SuperMontage. On March 19, 2002, the NASD sent an Executive Representative email to all its member firms that established March 25th as the deadline date for participation in the ADF. In spite of the fact that no one knows HOW the ADF will ultimately operate, the email mandated that firms commit volume forecasts by March 25th or face the possibility of not being able to participate in the launch of the ADF.9 From these volume commitments, the NASD will exact tolls, far in advance of the operation of the actual system, based on the total volume projections received. Interestingly, the NASD will not guarantee a return of these funds if the actual approval of the ADF results in a substantially different operating environment than is projected today. While NexTrade believes that the NASD has inappropriately used its power to set short ADF deadlines and to exact tolls based on faulty projections for a system yet to be conceived, NexTrade believes the greater infraction to be the damage caused to smaller member firms by such abuse of power.
It is not realistic to expect a smaller firm to be in a position to commit volumes, and thereby dollars, to a system that it cannot understand and may never use. In effect, the NASD has already made a choice for the smaller firms by structuring the alternative in a wholly unpredictable manner and then forcing firms that wish to participate to pay for its use in advance or lose the opportunity to do business on the ADF. In so doing, NexTrade believes the NASD to be operating outside its Congressional mandate not to discriminate among member firms and may have already violated the Commission's order that participation in SuperMontage be "voluntary."10
NASD's Competitive Need does not Justify Timeline
NexTrade believes the core of the problem to be NASD's desire to allow the Nasdaq to become a separate, for-profit exchange as quickly as possible. Certainly, NexTrade understands the competitive need for speed and NexTrade intends to be a member of the Nasdaq Exchange, once approved. However, before even the largest firms can successfully prepare for the systems development necessary in the new environment, the new environment must be understood.
Sweeping questions with broad ramifications for all market participants remain unanswered and each of them are relevant, from a business and a regulatory perspective, in guiding every firm's choice of marketplace participation. Without these questions answered, development from a large firm's perspective will prove redundant and costly. Whereas, from a small firm's perspective, the development and business costs could prove life threatening. For example, fundamental questions regarding reporting,11 regulation,12and execution rules13 have been raised in other comment letters all of which remain unaddressed.
Strikingly, even the simple concept of the NBBO has as of yet to be fully resolved, yet firms are being forced to develop by NASD under draconian schedules. As cited by Instinet, the proposed ADF rules reflect the "impermissible presumption that Nasdaq will be the primary market for over-the-counter securities trading,"14 yet this presumption is not fact. NexTrade raises this issue to remind the Commission of the nearly innumerable other regulatory concerns that are derived from primary market data, including, but not limited to, short sale rules, locked/crossed rules, and best execution rules.
Simply, without resolution to these questions, legitimate development from a member perspective to participate in a viable alternative market is not possible. Regardless, the NASD charges forward with its timelines as if the approval of the ADF in its current state is foreordained. Even if the Commission finds the current ADF rule proposal adequate, NexTrade asserts that the timeline laid out by the NASD is at best dangerous and most certainly implausible. If the NASD is allowed to continue on its current timeline, NexTrade believes that it would prove unlikely that any firm would be provided the necessary development time to truly "volunteer" for SuperMontage participation.
NexTrade believes that the development of a viable alternative display facility is in the best interests of the investing public. NexTrade respectfully requests that the Commission carefully consider the substantially greater relative financial impact that smaller firms incur in attempting to prepare for an uncertain environment. NexTrade submits for the consideration of the Commission that the NASD be prevented from enforcing commitments, tolls, or deadlines for either the ADF or the SuperMontage until such time as the rules for both marketplaces are actually written. Finally, NexTrade submits for the consideration of the Commission that it would be in the best interest of the investing public if the alternative display facility had some time in actual production, prior to the release of SuperMontage, to ensure that the Commission's objectives as identified are met.15
If you have any questions regarding this matter, you may contact me at (727) 446-6660 x122.
John M. Schaible
Cc: Katherine A. England, Esq., Division of Market Regulation, SEC
Stephanie M. Dumont, Associate General Counsel, Office of General Counsel, NASD Regulation, Inc.
|1||NexTrade owns and operates the NexTrade ECN, one of the fastest growing ECNs in the Nasdaq Marketplace.|
|2||Letter to Jonathan G. Katz, Secretary, Securities and Exchange Commission, File No. SR-NASD-2001-90 from Mark P. Barracca, Corporate Counsel, NexTrade, Inc., January 18, 2002.|
|3||The Commission directed the NASD to create the ADF as a condition for the approval and operation of Nasdaq's "SuperMontage" order-execution system. Exchange Act Release No. 43863 (January 19, 2001). 66 Fed. Reg. 8020 (January 26, 2001) ("SuperMontage Approval Order").|
|4||Letter to Jonathan G. Katz, Secretary, Securities and Exchange Commission, File No. SR-NASD-2001-90 from Mark P. Barracca, Corporate Counsel, NexTrade, Inc., April 1, 2002.|
|5||See, e.g., H.R. Rep. No. 75-2307, at 8 (1938). ("As safeguards against abuse, and to make clear that activities of associations under this paragraph [Section 15A(b)(6)] are to be consistent with the operation of free and open markets, this paragraph provides that the rules of an association may not be designed to permit unfair discrimination between customers, or issuers, or broker or dealers . . . .").|
|6||Top Ten Reasons why Systems Projects Fail, Dr. Paul Dorsey, Dulican, Inc. URL: http://www.dulcian.com/papers/Top%2010%20Reasons%20Why%20Systems%20Projects%20Fail.htm|
|7||SuperMontage Test and Implementation Calendar. URL: http://www.nasdaqtrader.com/trader//hottopics/SuperMontage/smcalendar.pdf|
|8||See Note 3, supra.|
|9||See Executive Representative Email from Steven Joachim, NASD, March 19, 2002.|
|10||See Note 3, supra.|
|11||See Note 2, supra.|
|12||See Letter from William O'Brien, Senior Vice President and General Counsel of Brut, LLC to Jonathan Katz, Secretary of the Commission, February 13, 2002.|
|13||See Letter from Douglas M. Atkins, President and Chief Executive Officer of Instinet Corporation, to Jonathan Katz, Secretary of the Commission, February 13, 2002|
|14||See Note 13, supra.|
|15||See Note 3, supra.|