August 5, 2002
Annette Nazareth, Director
Division of Market Regulation
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Re: The Alternative Display Facility and Satisfaction of SuperMontage Preconditions
Brut, LLC ("Brut")1 wishes to provide the Securities and Exchange Commission (the "Commission") with its thoughts, in advance of the scheduled Commission open meeting on August 12, regarding the recent approval of the Alternative Display Facility ("ADF")2 and whether the Commission-mandated preconditions currently exist for the operation of Nasdaq's "SuperMontage" trading system with respect to live securities.
In setting the creation of the ADF as a condition for the launch of Nasdaq's SuperMontage,3 the Commission directed the NASD to "provide NASD members with the ability to opt-out of the SuperMontage."4 Brut has provided comments to the Commission on several occasions that the NASD's ADF implementation efforts were not proceeding in a manner that would provide a viable competitive alternative to fulfill that mandate.5 The NASD has stated, with the ADF Approval Order and a purported "launch" on July 29, that the ADF in its current form "fulfills our commitment to provide our members with a viable platform for quotation and trade reporting. The system is ready to go."6 Unfortunately, Brut believes that this simply is not true, and that several steps need to be taken before the ADF truly offers a viable alternative to SuperMontage participation to market makers and ECNs. In particular:
1. Interface Improvements
The NASD's reliance on the Exchange Transaction Protocol ("XTP"), a proprietary technology of the NASD's ADF vendor, OM Group ("OM"), continues to be a bar to meaningful ADF operation in the near term. As discussed in Brut's previous ADF-related comments to the Commission,7 the need to code an XTP-based interface acts as a significant deterrent to ADF usage, given the effort that would be involved and the de-prioritization of other important projects that would result. The marketplace has spoken regarding XTP - to Brut's knowledge no market maker or ECN has developed an XTP interface that would allow for usage of the ADF as currently approved, and thus no market participant has the ability to use the ADF at this time.
To provide a meaningful technological framework for usage, the ADF application programming interface ("API") needs to be compatible with standard industry protocols for financial market communications, such as the Financial Information Exchange ("FIX") protocol. Brut understands that the NASD is considering the engagement of third-party vendors to improve the ADF's compatibility. Until this is done, and the relevant API specifications for both quotation and trade-reporting functionality are created and provided to market makers and ECNs with an adequate period for the necessary development effort to be completed, the ADF can not operate as a meaningful alternative to SuperMontage.
2. Appropriate User Testing
Once a realistic opportunity to use the ADF has been provided, user acceptance testing ("UAT") period will be needed to de-bug the system and foster user and market confidence. While the NASD has claimed successful testing between ADF facilities and the securities information processor responsible for disseminating ADF-collected market data, absent successful testing with a market-maker or ECN this is but a partial step. Nasdaq conducted UAT for over three months prior to the deployment of SuperMontage for test securities. A similar period will be needed so that market-maker and ECN users can be assured that the ADF, and the systems that interact with its facilities, are technologically sound.
3. Period of Un-Interrupted Operation
The ADF should also prove itself in a production environment for a short period of time before a final judgment is made regarding its ability to function as a SuperMontage alternative. To do otherwise runs the risk that early-stage technical and operational issues require restrictions or cessation of ADF operations, leaving no non-Nasdaq alternative for market makers and ECNs in a SuperMontage environment.
Brut suggests that the fulfillment of these conditions would create a truly level playing field, with SuperMontage in competition with market makers and ECNs devoid of any inherent advantages derived from the time when Nasdaq operated as a not-for-profit regulatory utility. Brut respectfully suggests the Commission lay out these steps as the framework for the ADF to fulfill the conditions for SuperMontage's operation with respect to live securities at its August 12 meeting. This should be supplemented by additional guidance that Nasdaq refrain from making statements regarding the timetable for SuperMontage deployment until receiving further guidance from the Commission, as the current Nasdaq practice of continually alluding to an imminent deployment is placing personnel and systems burdens on market participants, many of whom have ceased all other development efforts as a result.
Brut appreciates this opportunity to offer comments to the Commission, and will discuss these issues further with Division of Market Regulation personnel, and/or individual Commissioners and their staff, in whatever forum you would find most helpful. Please do not hesitate to contact me at (917) 637-2560 regarding arranging such follow-up discussions or answering any questions you may have.
Senior Vice President & General Counsel
cc: The Hon. Harvey Pitt, Chairman
The Hon. Cynthia Glassman, Commissioner
The Hon. Paul Atkins, Commissioner
The Hon. Roel Campos, Commissioner
The Hon. Harvey Goldschmid, Commissioner
Giovanni Prezioso, General Counsel
Robert L.D. Colby, Deputy Director, Division of Market Regulation
Alden Adkins, Associate Director, Division of Market Regulation
Katherine A. England, Assistant Director, Division of Market Regulation
John Polise, Senior Special Counsel, Division of Market Regulation
|1||Brut operates The BRUT ECN System, one of the significant electronic communication networks ("ECNs") 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 efficient access to market liquidity. The company is headquartered in New York City.|
|2||Exchange Act Release No. (July 24, 2002). 67 Fed. Reg. 49822 (July 31, 2002); File No. SR-NASD-2002-97 (the "ADF Approval Order").|
|3||See Exchange Act Release No. 43863 (January 19, 2001). 66 Fed. Reg. 8020 (January 26, 2001) ("SuperMontage Approval Order").|
|4||Id., at 8050.|
|5||See Letter from William O'Brien, Senior Vice President & General Counsel, Brut to Jonathan G. Katz, Secretary, Commission, February 13, 2002 ("Brut Letter #1"). See also Letter from William O'Brien, Senior Vice President & General Counsel, Brut to Jonathan G. Katz, Secretary, Commission, March 20, 2002 ("Brut Letter #2").|
|6||Douglas H. Shulman, President of Regulatory Services and Operations, NASD, July 25, 2002 (NASD Press Release).|
|7||See Brut Letter #2, supra n. 5, at 2.|