September 14, 2000
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Attention: Mr. Jonathan G. Katz, Secretary
Re: SEC File No. SR-NASD-99-53
Ladies and Gentlemen:
Philadelphia Stock Exchange, Inc. ("Phlx") appreciates the opportunity to comment on Amendment No. 7 to the SuperMontage proposal of the National Association of Securities Dealers, Inc. (the "NASD"), which the Commission published for comment in Securities Exchange Act Release No. 34-43138 (August 10, 2000).
As a self-regulatory organization ("SRO") and a UTP Exchange,1 Phlx believes that the SuperMontage proposal disadvantages it and other SROs that are now or may later become UTP Exchanges by significantly reducing their ability to compete for order flow. As a result, approval of the SuperMontage proposal would raise precisely the concerns underlying the express congressional direction to the Commission contained in Sections 3(f), 11A and 15A(b)(9) of the Securities Exchange Act of 1934 (the "Exchange Act") to consider burdens on competition in determining the suitability of proposed rule changes.
If the Commission were to approve SuperMontage as proposed by the NASD, the result would be an unacceptable concentration of market power in the NASD at the expense of the regional exchanges. Our participation in SuperMontage would not be voluntary. There is no Intermarket Trading System ("ITS") in Nasdaq securities. Under the SuperMontage proposal, Nasdaq would function as its own ITS. Unlike the ITS, however, in which all participating market centers are represented in the ITS Operating Committee, the SuperMontage would not provide for any representation.
The SuperMontage proposal would impose three competitive burdens on rival exchanges that would not be placed on other market participants. In each case Nasdaq makes no attempt to justify the burden, nor, we believe, could it do so. First, UTP exchanges would not be permitted to submit attributable agency orders to the SuperMontage.2 Second, principal Quote/Orders of UTP Exchanges, in other words the trading interest of the exchange members themselves, would be placed last in the SuperMontage order-execution queue. This apparently would be for no reason other than that the order submitting dealer was a member of a rival exchange. Third, the method by which Nasdaq now proposes to handle non-directed orders of UTP Exchanges electing to receive orders rather than executions raises questions about the NASD's commitment to enforce the market makers' obligation to comply with the Commission's Firm Quote Rule3 when rival exchanges send them orders.
Since UTP exchanges would not be permitted to submit attributable agency orders to the SuperMontage, the liquidity contributed by the UTP exchanges would not be displayed and not acknowledged. Instead, Nasdaq would put its name on Phlx's order flow. As a result, whatever marquee value order attribution has, and it has significant value, would be credited to Nasdaq and denied to Phlx. This would make it extremely difficult for Phlx to compete with Nasdaq for agency order flow in Nasdaq-listed securities.
The fact that principal Quote/Orders of UTP Exchanges would go last in the SuperMontage order-execution queue would appear to speak for itself. Such a rule does not have any place in a market that should be fair and competitive.
With respect to the proposed method of handling non-directed orders submitted by UTP Exchanges, the SuperMontage proposal is silent on the issue of whether the orders submitted to market makers would be liability or non-liability orders. If the orders are to be liability orders, it is left unclear how the resulting obligations are to be communicated to Nasdaq market makers and/or enforced against them. If the orders instead are to be non-liability orders, then the NASD would in effect be telling the Nasdaq market makers that they would not have to comply with their obligations under the Firm Quote Rule in the case of the orders submitted through a rival UTP Exchange. Apparently, this would be the case regardless of whether the orders were proprietary orders of broker-dealers or customer orders.4
The NASD's position in devising the SuperMontage, which in effect would severely curtail the ability of other market centers to trade Nasdaq-listed securities, stands in marked contrast to the policies underlying the Commission's requirement that the New York Stock Exchange rescind its Rule 390. Last September, Chairman Levitt stated:
I can't think of a more propitious time to reconsider other restrictions that distort competition and introduce artificial costs. One, in particular, comes to mind-NYSE Rule 390.
This rule has long prohibited NYSE members from dealing in listed securities off an exchange. For years, proponents have argued that Rule 390 prevents fragmentation. Others contend that the rule is an anticompetitive use of market power by a dominant market. As I see it, Rule 390 may very well be on its ninth life. Now is the time to ask ourselves: is there a valid justification for a rule that appears to be more a barrier than a benefit? And how, under any circumstances, could such an anticompetitive rule be sustained should the NYSE become a for-profit corporation? While rulemaking is certainly an option, one way or another, Rule 390 should not be part of our future.5
The rescission of NYSE Rule 390 in the wake of Chairman Levitt's call for its removal has, of course, given the NASD increased opportunities to compete for order flow to the listed world and that has led to increased competition, as does ECN access to ITS via the NASD's CAES system. In contrast, the NASD's SuperMontage would move in the opposite direction. In economic effect, the SuperMontage as currently formulated would represent a close analogue to NYSE Rule 390 since, in the name of eliminating "fragmentation", it would eliminate competition, deterring NASD members from directing order flow to the UTP Exchanges.
In conclusion, we respectfully suggest that the Commission should not allow the NASD to exploit a conflict of interest between its regulatory powers and responsibilities on the one hand and what it perceives to be its commercial interests on the other. The NASD has asked the Commission to lend its support, and the governmental power it wields, to affect the allocation of valuable market franchises and to prefer the interests of one competitor, at its behest, over those of other SROs. The Commission should decline to approve SuperMontage until the unequal and anti-competitive treatment of UTP Exchanges is corrected and UTP Exchanges are equals under the proposed system with both market makers and ECNs. We appreciate the opportunity to make our views known to the Commission and the Staff.
Very truly yours,
PHILADELPHIA STOCK EXCHANGE, INC.
Meyer S. Frucher
Chairman and Chief Executive Officer
cc: The Hon. Arthur Levitt, Chairman
The Hon. Isaac C. Hunt, Jr., Commissioner
The Hon. Paul R. Carey, Commissioner
The Hon. Laura S. Unger, Commissioner
Annette L. Nazareth, Esq., Director,
Division of Market Regulation
Robert L. D. Colby, Esq., Deputy Director,
Division of Market Regulation
Belinda Blaine, Esq., Associate Director,
Division of Market Regulation
David M. Becker, Esq., General Counsel
1 A "UTP Exchange" is an exchange that is a signatory to the Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation and Dissemination Of Quotation and Transaction Information For Exchange-Listed Nasdaq/National Market System Securities Traded On Exchanges On An Unlisted Trading Privilege Basis.
2 Paragraph (f)(2)(B)(ii) of Rule 4710 would provide:
A UTP Agency Quote/Order shall not be displayed in the Nasdaq Quotation Montage under the MMID for the UTP Exchange.
3 Rule 11Ac1-1 under the Exchange Act.
4 The NASD created that ambiguity in its original filing, in which it stated with respect to non-directed orders submitted by UTP Exchanges:
if a UTP Exchange wishes to access the best Nasdaq market, the UTP Exchange could enter a non-directed Liability Order into the OCF. The OCF would be programmed to send the next Quoting Market Participant an order for delivery, not automatic execution, regardless of whether the receiving Quoting Market Participant participates in automatic execution. Securities Exchange Act Release No. 42166 (November 22, 1999) in text following n.52 [emphasis added].
Thereafter, this language apparently was deleted for, in Amendment No. 7, the NASD noted a comment by the Commission staff objecting to the deletion:
Commission staff has noted that the proposed rules do not address the situation where a UTP Exchange may not wish to participate in automatic execution, but rather may wish to take order delivery against its quotes. In response to comments by Commission staff, Nasdaq has amended the proposed rules to address the situation where a UTP Exchange declines to participate in automatic execution, but rather wishes to take order delivery against its quotes. August 10 Release in text accompanying n.17 [footnote omitted].
The NASD clarified that an order-receiving UTP Exchange could not send executions. August 10 Release in text preceding n.17. It did not clarify, however, whether order-receiving UTP Exchanges could themselves enter orders into the SuperMontage.
5 Chairman Arthur Levitt, "Dynamic Markets, Timeless Principles," Speech at Columbia Law School (September 23, 1999).