June 19, 2000
VIA FEDERAL EXPRESS
Mr. Jonathan G. Katz
Secretary, Office of the Secretary
Mail Stop 0609
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549
Re: Archipelago Comments In Response to File No. SR-NASD-99-53
Dear Mr. Katz:
This letter sets forth the comments of Archipelago, LLC ("Archipelago") in response to a proposed rule change - SR-NASD-99-53 ("the Proposal") - filed with the Securities and Exchange Commission ("SEC" or "Commission") by the National Association of Securities Dealers, Inc. ("NASD") through its wholly-owned subsidiary, The Nasdaq Stock Market, Inc. ("Nasdaq"). Among its many substantial changes, the proposal would allow market participants to display multiple bid and offer quotations, would introduce a Nasdaq-sponsored limit order facility into the marketplace, and would significantly alter Nasdaq-provided order routing systems. 1
Archipelago is an electronic communications network ("ECN"), which was one of the original four ECNs approved in January 1997 by the Commission. As an ECN, Archipelago has been both an innovator and important venue in Nasdaq stocks for investors and traders that access its liquidity, benefit from its contribution to efficient price discovery, and use its routing intelligence to access liquidity in the marketplace. Its average daily volume more than tripled in 1999 and today executes over 3% of Nasdaq's daily volume. In March 2000, Archipelago and the Pacific Exchange ("PCX") announced plans to create a fully electronic national stock exchange to trade securities listed on Nasdaq, the New York Stock Exchange ("NYSE"), and the American Stock Exchange ("Amex").
I. Executive Summary: The Proposal Should Be Rejected
There are three primary components to the Proposal: (1) the Order Collection Facility; (2) a limit order book ("LOB"); and, (3) the Nasdaq Order Display Facility. The Order Collection Facility serves as a single point for orders to enter and leave Nasdaq. The LOB manages all non-marketable quotes and orders directed through the Order Collection Facility. The Nasdaq Order Display Facility displays all non-marketable orders and quotations on the Nasdaq Workstation II ("NWII").
The Order Collection Facility will serve as a single point of entry and delivery of orders and executions. It will accept market orders, marketable limit orders, non-marketable limit orders, and quotations. Non-marketable limit orders and quotations will populate the LOB. Market and marketable orders will execute against orders and quotations residing in the LOB based on "price and then time priority." 2 Market participants are generally permitted to enter orders at multiple price levels. Upon execution, Nasdaq will send reports to all parties involved. ECNs may opt to not have the Order Collection Facility control their executions; and for these ECNs, the Order Collection Facility will direct orders, and the executions will be controlled by the ECN. 3
The Nasdaq Order Display Facility displays individual participant interest as well as aggregate interest by price level on the NWII. As proposed, it will consolidate all orders at each price level and display the top three price levels along with aggregate size for each level. The Order Display Facility will also enable market participants to represent size next to their acronym. Nasdaq market makers and ECNs will be permitted to use a reserve book to conceal trading interest.
From a policy standpoint, Nasdaq's stated purpose for the Proposal is to "encourage the display of greater trading interest," "assist market participants with the management of their back book," "make it easier for ECNs to participate in automatic execution," "assist Nasdaq Quoting Market Participants in complying with the SEC's Order Handling Rules," "reduce the potential for the market to trade through orders that a market maker or ECN is holding in its back book," and reduce "fragmentation of pre-trade information." 4
A. Reject the Order Collection Facility and Limit Order Book
Although at first glance some of the Proposal sounds attractive and appealing, the Commission should reject the Proposal regarding the Order Collection Facility and LOB for three primary reasons:
B. Approve the Nasdaq Order Display Facility Contingent Upon Technological Efficacy
The Commission should approve the Order Display Facility if and only if Nasdaq can prove its technological capability. Archipelago supports the general goals of Nasdaq's Order Display Facility; to wit: greater depth of book enhances the efficiency of price-discovery and increases the likelihood of execution for limit orders.5 It should be noted, however, that the process of receiving and managing this information will almost certainly significantly increase traffic through Nasdaq's system. When this increase is combined with Nasdaq's move to decimals, the Order Display Facility will increase network traffic by orders of magnitude from current levels. 6 The Nasdaq Order Display Facility proposal should only be approved if Nasdaq can adequately assure the Commission, NASD members, and investors as a whole that Nasdaq systems have the capacity to handle such a change. 7
II. Analysis: Proposal Should Be Scrutinized From Three Standpoints
The merits of the Proposal should be explored in light of the current market structure. First, Nasdaq is moving into a new line of business where it will directly compete with brokers-dealers regulated by the NASD and NASDR. For all practical purposes, Nasdaq broker-dealers do not have a choice to go elsewhere if rulemaking and enforcement activities are unreasonable by their regulator. 8 Second, Nasdaq has been experiencing and continues to experience severe, on-going capacity problems; the implementation of the Proposal will only add to these capacity pressures. Third, the competitive market has long provided the functionality described in the Proposal. In fact, Nasdaq itself proposed such a scheme over six years ago. 9
A. Nasdaq's Entry Into the Marketplace for Execution Services Introduces Profound Competitive Issues
1. Congress Imposed Special Heightened Obligations on Nasdaq In Its Capacity As An Exclusive Securities Information Processor
In enacting the 1975 NMS Amendments to the Exchange Act, Congress explicitly observed that SIPs would have inherent conflicts of interest because they were, in effect, public utilities. Accordingly, Congress required SIPs to "function in a manner which is absolutely neutral with respect to all market centers, all market makers, and all private firms." 10 The Congressional Conference Committee responsible for the legislation further stated:
The Committee believes that if economics and sound regulation dictate the establishment of an exclusive central processor for the composite tape or any other element of the national market system, provision must be made to insure that this central processor is not under the control or domination of any particular market center. Any exclusive processor is, in effect, a public utility, and thus it must function in a manner which is absolutely neutral with respect to all market centers, all market makers, and all private firms (emphasis supplied). 11
Nasdaq is a registered SIP under Section 11A of the Securities Exchange Act of 1934 ("Exchange Act"). 12 As the only registered SIP in Nasdaq securities, Nasdaq is an exclusive SIP. As an exclusive SIP, Nasdaq enjoys the monopolistic role of collecting and distributing all quotation and transaction information for all securities that are part of the National Market System. Like Nasdaq, CTA is an exclusive SIP for exchange-listed securities. These two facilities not only receive and send information, but they also provide linkages to enable market centers to interact.
Nasdaq and CTA collect information, while broker-dealers and exchanges compete for and collect orders. Collecting and executing orders and collecting information are significantly different functions. Nasdaq is proposing to retain its historical and monopolistic role of information collector while, at the same time, introducing a new role: order collector and executor.
Approval of the Proposal would allow Nasdaq to serve as order collector and executor, in conjunction with its role as the exclusive SIP. This, Archipelago argues, creates an insurmountable conflict of interest. As an exclusive SIP, Nasdaq is first to have access to the consolidated quotes and transaction data that is critical to any order execution system. If transmission of or access to the consolidated market data were delayed to Nasdaq's competitors, these competitors would be highly disadvantaged because prices displayed to them would be stale. Unfortunately, Nasdaq's proposed role as an order collection and execution facility will mean that it has no economic incentive to distribute market data information efficiently to its competitors.
The Commission, Archipelago respectfully suggests, should preclude Nasdaq from operating as an order collection and execution system while, at the same time, having exclusive right to information. As noted above, Congress recognized the potential harm where SIPs are involved and, thus, imposed special obligations on SIPs so as to avoid these conflicts of interest.
2. Nasdaq Has Rulemaking Authority Over Its Competitors
Nasdaq presently accounts for nearly 98% of trading in Nasdaq securities. 13 Thus, through its authority to adopt rules affecting its membership and operation, Nasdaq maintains and controls a monopoly as a rulemaker and regulator. The fact that there will be competitors to Nasdaq among Nasdaq's own membership raises the real possibility that Nasdaq can use its rulemaking authority to disadvantage other trading systems. Indeed, as a research analyst recently noted, "the easiest way [for Nasdaq] to fight would be to use the collective regulatory weight and central operating position to fight the ECN's progress tooth and nail." 14
In its Proposal, Nasdaq openly admits it "believes that it is critical that Nasdaq be able to compete on the same terms and offer the same services as its competitors." 15 Empirical evidence of Nasdaq's conflict of interest as a competitor can be found in recent actions by Nasdaq to promote its own business relationship with OptiMark. In early 1998, Nasdaq acquired a financial interest in the OptiMark system. Later, in October 1999, the OptiMark system was, by Nasdaq regulatory fiat, accorded special treatment by way of "exemption" from NASD Rule 3380, a SelectNet rule that applies to all other NASD members. 16 As justification for the exemption, a Nasdaq official proclaimed "Nasdaq rules for OptiMark trump [SelectNet Rules]" (emphasis added). 17 As a result of this capricious act by Nasdaq, all ECNs were required to re-code systems to accept special SelectNet messages from OptiMark. To put it simply, Nasdaq circumvented the rule-making process along with the public comment process and, instead, used its raw power over its members to implement OptiMark's entry into Nasdaq at the expense of Nasdaq's ECN competitors.
The proposed Nasdaq LOB, in particular, is designed to compete directly with and against ECNs. The Proposal carefully notes the LOBs compliance with the SEC's Order Handling Rules. 18 In describing the rationale supporting the Nasdaq LOB and the order routing procedures that cover interactions between market participants and the Nasdaq LOB, a senior Nasdaq official stated that "we want first crack [at executing the order]." 19 Whether, in fact, Nasdaq would accord special treatment to companies in which it has an ownership interest, or would engage in actions designed to thwart the potential competition is unclear. Nonetheless, the potential for such would exist. Archipelago fervently believes the creation of a LOB would pose insurmountable conflicts, however, and recent evidence corroborates that Nasdaq's rulemaking is not always impartial. 20
B. The Proposal Will Create A Technology Morass
1. Severe Capacity Problems Continue To Plague Nasdaq
In Nasdaq's recent press release describing its "MarketSite," a video tower at Times Square in New York City, Chairman Zarb declared "[t]he cutting-edge Nasdaq display in Times Square will have visitors stopped in their tracks for years to come." 21
Although this may well prove to be the case, Nasdaq is already successful in "stopping in their tracks" a different constituency on a daily basis; to wit: market participants that rely on its systems. Every morning of the trading day, the SelectNet system is unfailingly slow at order routing and execution, which frustrates market efficiency and the ability of broker-dealers to service investors.
Archipelago and many other Nasdaq participants continue to be gravely concerned with Nasdaq's lack of attention to technical problems that affect the marketplace. 22 Although Nasdaq purports to have "eliminated execution systems processing delays," Archipelago believes such claims are untrue. 23 In fact, an analysis of Nasdaq's system performance based on Archipelago's SelectNet orders submitted between January and April 2000 shows an increase in execution delays.24 Even disinterested industry analysts recognize Nasdaq's technological quagmire. One analyst noted that "Nasdaq is stretching itself in a way that few public companies would be allowed to" and quoted a financial markets consultant who stated "no public company CEO would still be in office if [such failures] were to happen to his or her company." 25
It appears that Nasdaq has spent more energy pursuing business and competitive initiatives than resolving technology problems related to its role as a SIP. SelectNet delays have continued unabated and its quotation system will not be able to support decimals until, the very earliest, first quarter 2001, almost four years after Congress began addressing the decimals issue. 26 Meanwhile, Nasdaq has been consumed by its multiple overseas forays such as Nasdaq-Europe, the Hong Kong Stock Exchange, Nasdaq Canada, Nasdaq Japan, and even a proposed deal in Saudi Arabia. 27 Additionally, at home, Nasdaq is introducing new market structure schemes such as the Agency Quote proposal, OptiMark, Primex, Integrated Order Delivery and Execution System, all above and beyond the Proposal that we speak to today. 28
In light of Nasdaq's sub-par performance and uncertain commitment to improvement, Archipelago asks whether Nasdaq will be able to maintain the traffic its system will encounter as a result of the implementation of the Proposal. In fact, is it not ironic that Nasdaq is requesting approval of the Proposal that will lead to increases in its depth of market at a time when Nasdaq could not even meet its once mandated schedule on July 3, 2000, to move to decimalization. Before allowing Nasdaq to proceed with its competitive initiatives, Archipelago respectfully urges the Commission to require Nasdaq to empirically demonstrate its technological capability on a more conservative scale in a manner that supports its current function as a SIP. For instance, Nasdaq should be compelled to demonstrate its ability to reduce SelectNet delays to sub-second, even in times of market stress.
2. A Single Point of Entry Increases Risk of System Failures
Nasdaq is today a market of markets where broker-dealers execute orders internally and use SelectNet as a tool to facilitate trading with other broker-dealers. Under the Proposal, Nasdaq would manage order books on behalf of broker-dealers and then control the executions against those books. Accordingly, Nasdaq seeks to control all execution points for inter-dealer trading, dealer to customer trading, and investor-to-investor trading. The responsibility for execution would shift from thousands of points to a single point, making trading in Nasdaq stocks dependent on one single system. 29
Irrespective of Nasdaq's recent "underwhelming" technological performance, Nasdaq's attempt to provide a "single point of order entry and single point of delivery" creates a single point of failure and the massive risk associated with it. Above all else, does not the Information Age teach that a single-point anything should be avoided? Accordingly, Archipelago argues that the National Market System should pursue an Internet model where participants are linked with and among themselves to create a robust network and, thus, avoid a single point of failure. If one system were to fail, orders could flow into other trading systems and networks.
C. Proposed Functionality Already Exists in the Marketplace
It is not evident that Nasdaq's Proposal adds a service to the marketplace that either does not already exist today, is not in the process of being developed by the private sector, or is a necessary addition to the market.
1. The first objective of the Proposal is to: "Encourage the display of greater trading interest."
Nasdaq appears to be attempting to achieve this objective through the Order Display Facility, not the Order Collection Facility or LOB. There is an important distinction here between order display and order control: a system can display orders without controlling the execution of those orders. Accordingly, the manner in which greater trading interest will be displayed in Nasdaq causes : (1) firms to cede control of orders to Nasdaq; or, (2) Nasdaq to accept information in addition to or in place of orders.
Under an equal regulatory and competitive framework, Archipelago does not believe Nasdaq will accumulate control of substantial order flow. Nasdaq's Proposal, by Nasdaq's own admission, is nothing more than the creation of an ECN. Accordingly, broker-dealers should have no more incentive to send orders to Nasdaq than they currently have to send orders to an ECN. Thus, Nasdaq will become the tenth ECN approved by the SEC.
Unfortunately, the Proposal envisions that that Nasdaq will only display information about orders it controls; it will not display information about orders controlled by other venues. Thus, Nasdaq will not collect information beyond that contained in its own order flow. The upshot: in order for a competitor to achieve order display, it must give control of that order to Nasdaq.
Finally, on a purely voluntary basis, the private sector has already begun to display greater trading interest. For instance, Archipelago's display not only includes information about all orders controlled by Archipelago, but it also includes information about all orders residing on other ECNs, like the Island ECN and RediBook ECN. Archipelago is working to obtain depth of book from other ECNs and market makers. Further, it is Archipelago's understanding that other ECNs and even non-traditional financial entities are pursuing similar strategies, all of which indicates that the private sector has responded to the Chairman's request that limit order books and depth of markets be publicly disseminated. 30
Thus, the first objective of the Proposal is unsupported by fact.
2. The second objective of the Proposal is to: "Assist market participants with the management of their back book."
Nine ECNs exist today, most of which have offered back books since their inception. Hundreds of order management systems exist today. Thus, Nasdaq's Order Collection Facility and LOB will join the heretofore competitively vibrant and robust order handling market niche.
Thus, the second objective of the Proposal is unsupported by fact.
3. The third objective of the Proposal is to: "Make it easier for ECNs to participate in automatic execution."
To Archipelago's knowledge and contrary to Nasdaq's public representations, no ECNs are interested in participating in an automatic execution system. To participate without risking double executions, ECNs would have to cede control of orders to Nasdaq. This means Nasdaq would manage books and, therefore, be the sole provider of technology for each ECN. Order handling and technology, however, are the very foundation of competition among ECNs. ECNs compete on dimensions such as speed, cost, and functionality. If all ECNs were to give their respective books to Nasdaq, these competitive features would become commoditized and the incentive for competition would evaporate.
Further, ECNs generally respond to SelectNet orders in fractions of a second. Thus, there is no value added to the marketplace for ECNs to receive executions instead of orders. 31
Archipelago believes that were Nasdaq to pursue ECNs' interests in participating in automatic execution, ECNs would have responded with the loud approval. However, this is not the case; to wit: many ECNs have stated such lack of interest in recent comment letters relating to Nasdaq's proposals for the Nasdaq National Market System (SR-NASD-99-11) and Integrated Order Delivery and Execution System (SR-NASD-98-17).
Thus, the third objective of the Proposal is unsupported by fact.
4. The fourth objective of the Proposal is to: "Assist Nasdaq quoting market participants in complying with the SEC's Order Handling Rules."
Since January 1997, ECNs have proliferated in, among other things, assisting broker-dealers and investors with handling of limit orders. In fact, ECNs now account for over 30% of Nasdaq trading and are helping contribute to all-time low spreads.32
The Order Handling Rules have provided substantial and well-documented improvements to Nasdaq market quality. 33 After the vast and unquestioned success of the OHR, and over three years after their implementation, Nasdaq now claims that "the current inability of [its market participants] to submit Nasdaq quotes or orders at multiple price levels has made compliance with [the OHR] difficult." 34
Thus, the fourth objective of the Proposal is unsupported by fact.
5. The fifth objective of the Proposal is to: "Eliminate the `pre-trade information fragmentation' that exists because of the proliferation of ECNs."
In principle, pre-trade fragmentation exists because orders are decentralized in Nasdaq and there is not an effective system to collect information about orders. Specifically, a single broker-dealer is ignorant about orders beyond "top of book" at other broker-dealers, making it more difficult to determine true price and the potential direction of price. Archipelago suggests that there are two methods to solve this "pre-trade information fragmentation" problem. The first is to centralize all orders into one location, and the second is to increase information collection and dissemination.
As stated its first objective to the Proposal, Nasdaq will not increase information beyond what already exists today, absent Nasdaq's monopolistic control of orders. Consequently, in a competitive environment, some degree of "pre-trade fragmentation" will continue to exist.
Thus, the fifth objective of the Proposal is unsupported by fact.
6. The sixth objective of the Proposal is to: "Reduce the potential for the market to trade through orders that a market maker or ECN is holding in its back book."
Similar to the first objective, trade-throughs can be solved through greater information display rather than monopolistic order management. Market participants can control for trade-throughs if they have information about "back book" orders and the ability to access those orders. A number of private sector providers are emerging to achieve this effect, thereby reducing the need for centralized control of orders that, as Chairman Levitt recognizes, "tends towards monopoly" and "becomes more immune to innovation and the benefits of competition." 35
Thus, the sixth objective of the Proposal is unsupported by fact.
To summarize, it appears Nasdaq's primary objectives for the Proposal are either not addressed by the Proposal or are already provided by the private sector. By way of its own admission, Nasdaq is seeking to provide a service that already exists in the marketplace: "Nasdaq believes that it is crucial that Nasdaq be able to compete on the same terms and offer the same services as its competitors." 36 Archipelago respectfully urges the Commission to consider the potential harm that the Proposal would bring; namely, the elimination of competition with and among ECNs, the need to create a new National Market System for Nasdaq securities, and the creation of a single point of failure for the trading of all Nasdaq securities. Such undesirable effects vastly outweigh its nominal-and questionable-benefits.
III. Component Level Analysis of Proposal
Archipelago believes that the LOB and Order Collection Facility not only raise fundamental conflicts of interest, but also contain severe design flaws and should be rejected. The Nasdaq Order Display Facility is, in principle, a move towards greater transparency in the marketplace and should be approved if and only if Nasdaq can resolve its current capacity difficulties. Archipelago's experience with Nasdaq raises issues that cause its technological efficacy to warrant further consideration.
A. Nasdaq Order Display Facility Should Be Approved Only If Technological Efficacy
Archipelago believes the transparency aspect of the Proposal is well conceived and should be approved if Nasdaq can assure the technology associated with its information collection and linkage facilities will not suffer. 37
If Nasdaq were to enable participants to send information, as is the case with SIAC's Consolidated Quotation System ("CQS") today, the Order Display Facility would be an asset to the marketplace. Providing investors with more information is valuable, particularly in a post-decimal world to the extent that size at various price points will be more important. Nasdaq is already in the business of information display with its NWII product and the Nasdaq Order Display Facility proposal could be a substantial improvement upon that product.
Notwithstanding Archipelago's support of this narrow aspect of the Proposal, and because other display products exist, the Nasdaq Order Display Facility should not be the highest priority for Nasdaq. Instead, Archipelago believes that Nasdaq should improve on the areas where it provides a unique service (e.g., as a linkage provider, implementing decimal pricing) before undertaking such an endeavor.
B. The Order Collection Facility Contains Severe Flaws
Archipelago has serious concerns about the proposed Order Collection Facility. Specifically, there are a number of problems that raise serious competitive issues and may have a profound affect, in some instances, on market participants:
1. The priority rules of the Order Collection Facility are a warped deviation of true price-time; they should be branded "Nasdaq priority" instead of "price-time priority." Nasdaq priority contains so many exceptions that the incentives for price discovery created by price-time priority will not be realized:
2. If SelectNet is no longer a liability system (as proposed), there will be a loss of market structure functionality. For example, participants will be prevented from "outsizing" a quote with a liability order (e.g., routing a 1000-share order to a 500-share quote). Archipelago often receives fills in excess of the quoted size. If SelectNet can be used in only a non-liability fashion, market participants may lose significant flexibility. When operable, SelectNet has been a wildly successful Nasdaq product; removing functionality that the market deems useful-as illustrated by excessive use of the system-appears to be unfounded. Archipelago suggests that a better solution is to eliminate SOES, and then to use SelectNet as the single messaging system.
3. The Order Collection Facility proposes to withdraw ECN quotes if the ECNs do not respond to directed orders within five seconds. Archipelago believes this time period is a bit short when considering the fact that SelectNet often takes 5, 10, or even 30 seconds to delivery messages around the opening. 39 Further, given Nasdaq's view of ECNs as competitors, it has no incentive to speed up the delivery time: the longer the time delay, the more participants will object to permitting ECNs to receive orders instead of executions.
The Proposal, which would introduce Nasdaq into the order execution business, is wrought with conflicts of interest that will almost certainly harm investors and our capital markets. Nasdaq's Proposal introduces profound competitive barriers, conflicts of interest and inherent design flaws. These issues have yet to be addressed by Nasdaq. Although Nasdaq clearly recognizes the competitive nature of this Proposal - as stated explicitly on six different occasions in the Proposal - it does not address the potential anti-competitive effects required by Rule 19b-4 under the Exchange Act, save for the perfunctory blanket claim that it "does not impose an unnecessary burden on competition."
Importantly, too, Congress in 1975 called for a National Market System that best serves investors by providing: economically efficient executions; fair competition among broker/dealers, among exchanges, and among exchanges and markets; information transparency; best execution for investors; and the ability to trade without dealer intervention. Here, Nasdaq is attempting to transform its role from an unbiased National Market System and centralized regulator to a combined National Market System, central regulator and exchange. In so doing, Nasdaq would control information created by its competitors, control executions against its competitors, and regulate virtually all of its competitors.
Finally, the Proposal does not promote the values explicitly set forth by Chairman Levitt. In his speech at Columbia University, Chairman Levitt spoke of a virtual marketplace that is both electronically linked and competitive. Archipelago believes in order to support the co-existence of competition and linkage, it is necessary to separate information from control of orders. If market participants are given knowledge of all orders and the ability to access those orders, there is no need centralize control of those orders. In such an environment, innovation, competition, price discovery, and best execution can all flourish simultaneously. Archipelago believes that the Proposal, because it does not separate information from orders, does not further this vision. Instead, it creates an additional competitor that is awarded the luxury of affiliation with the central regulator and information collector. Accordingly, the Proposal may slightly improve price-transparency at the great expense of future innovation and efficient competition.
That being said, the above critique and the conflicts it highlights would fade away if Nasdaq were entirely independent of NASD; to wit: NASD had zero ownership in Nasdaq; Nasdaq withdrew from its standing as an exclusive SIP; and Nasdaq either cedes rulemaking authority or several exchange alternatives were to exist. Note, however, that such changes must occur before Nasdaq is approved to enter the execution business. If these changes were to occur, Archipelago fully supports and welcomes Nasdaq's entry into executions.
Based on the foregoing facts and arguments, Archipelago believes that the Proposal - SR-NASD-99-53 - clearly violates the principles set forth in the Exchange Act and therefore strongly urges the Commission to reject the Proposal.
Gerald D. Putnam
Chief Executive Officer
Cc: Securities and Exchange Commission -
The Honorable Arthur Levitt, Chairman
The Honorable Norman S. Johnson, Commissioner
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Paul R. Carey, Commissioner
The Honorable Laura Simone Unger, Commissioner
Ms. Annette Nazareth
Director of Market Regulation
Mr. Robert Colby
Deputy Director of Market Regulation
Ms. Belinda Blaine
Associate Director of Market Regulation
Ms. Elizabeth King
Associate Director of Market Regulation
Mr. Richard Ketchum
President, National Association of Securities Dealers, Inc.
Mr. Alden Adkins
Senior Vice President and General Counsel, NASD Regulation, Inc.
|1||SEC Release No. 34-42166 (November 22, 1999), 64 FR at 68125.|
|2||There are many exceptions to "price-time" priority in the LOB as described in more detail in Section III.B.|
|3||ECNs that are NASD members are provided with the option of choosing between having Nasdaq control the execution, or having Nasdaq send orders and then controlling the execution internally.|
|4||Proposal at II(A)1.A, II(A)1.C, and II(A)1.E.1, 64 FR at 68126, 68127.|
|5||Archipelago notes that the full potential of this product will likely not be realized because the Order Display Facility includes only information about orders controlled by Nasdaq.|
|6||As Archipelago reflected in its March 22 and May 8, 2000 testimonies before the Senate Banking Committee, Archipelago is extremely disappointed by Nasdaq's delay in decimal implementation. It is Archipelago's and many others' belief that decimalization will immediately heighten quote competition, which will result in savings to investors. Accordingly, converting to decimals should be Nasdaq's top priority and should not take a back seat to competitive initiatives such as the Proposal.|
|7||As assurance to the Commission that its system would be capable of handling the execution delivery component of NNMS, Nasdaq stated its new multi-switch, when implemented, would eliminate execution delays. This new system was implemented on January 26, 2000 and Nasdaq purports that delays have been eliminated. However, an analysis of Archipelago's SelectNet orders reveals that chronic delays still exist. (See Appendix A attached hereto.) Archipelago believes that Nasdaq should be held to an appropriate and higher standard for measuring system performance and capacity.|
|8||There are four other self-regulatory organizations in the Nasdaq UTP Plan that, in principle, could serve as an alternative regulatory venue to Nasdaq. However, three participants do not currently trade Nasdaq securities and the fourth participant accounts for only about 2% of Nasdaq volume. Therefore, as stated above, for all practical purposes viable competitive alternatives do not exist.|
|9||See Nasdaq proposal for N*PROVE (File No. SR-NASD-94-13, Release No. 34-34145, 59 FR at 29649, June 1, 1994).|
|10||U.S. Code Cong. & Ad. News at 189. See also, S. Rep No. 94-75. 1st Session. 11-12 (1975).|
|11||Id. See generally, MCI v. AT&T, 708 F.2d 1081, 1133 (7th Cir.), cert. denied, 464 U.S. 891 (1983)(applying "essential facilities doctrine" in connection with actions taken by a monopolist.)|
|12||"Regulation of Market Information Fees and Revenues," Securities and Exchange Commissions, December 9, 1999 (Release No. 34-42208), Section II.A.3.|
|13||See, http://www.nasdaqtrader.com/static/tdhome.stm, Share Volume Download, Option 1-Detailed Volume Data, May 2000.|
|14||Marks, Jim, "Reinventing NASDAQ: The World's Leading B2B eMarket Plots Competitive Response," Electronic Commerce RE: Marks, Sanford Bernstein, (January 11, 2000). (FIRM???)|
|15||Proposal at II(A)1.E.1, 64 FR at 68127.|
|16||See SEC Release No. 34-42242 (December 16, 1999), 64 FR at 72710.|
|17||Johnson, Laura, "Nasdaq Makes ECNs Take Orders from OptiMark," Wall Street Letter, January 3, 2000 at 12.|
|18||Proposal at II.(A)1.E.2.a, II.(A)1.E.2.b, II.(A)1.E.3.a, II.(A)2, 64 FR at 68128, 68131, 68135.|
|19||Witmer, Rachel, "Archipelago Objects to New Proposals by Both NYSE, Nasdaq as Anti-Competitive," BNA Broker/Dealer Compliance Report, November 10, 1999, at 124.|
|20||Nasdaq references the competitive intent of this Proposal in six different locations, e.g., Proposal at II.(A)1.E.1, II.(A)1.E.3.a, and yet it provides only one perfunctory blanket statement about how the Proposal does not burden competition, i.e., Proposal at II.(B). Definitionally, a self-regulatory organization that is admittedly attempting to compete with its own members will impose burdens on competition.|
|21||"New Nasdaq MarketSite Tower to Light Up Times Square Largest Video Screen in the World; Mayor Guiliani and NASD CEO Zarb to Light at 5 p.m. Today," NASD Press Release, December 28, 1999.|
|22||See, Letter dated December 16, 1999, from Gerald D. Putnam to the Annette Nazareth and Robert Colby regarding "Severe Ongoing Capacity Problems in Nasdaq Marketplace"; and, letter dated June 14, 1999, from Gerald D. Putnam to Jonathan G. Katz regarding SR-NASD-99-11. In addition, on January 6, 2000, Archipelago provided supporting documentation to Mark Denat, Nasdaq Product Development, and Gene Lopez, Nasdaq Trading and Market Services. This documentation clearly reflected no improvements in Nasdaq performance before and after Nasdaq's BUMs release. Archipelago understands that other ECNs also provided Nasdaq with documentation of unsatisfactory and poor SelectNet performance at or about the same time period.|
|23||See, Gregor Bailar, Nasdaq in the New Millennium, www.nasdaqnews.com, May 2000 at 23.|
|24||See, Appendix A.|
|25||See, Chapman, Peter, "Trouble in Trumbull?," Traders, January 2000 at 44.|
|26||See, Ewing, Tezrah, The Wall Street Journal, "Nasdaq is Likely to Have Problems Going to Decimals," March 2, 2000, and "Nasdaq in the New Millennium" March 31, 2000, at 17.|
|27||See, "London Stock Exchange, Deutsche Borse and Nasdaq press conference presentation materials" (May 3, 2000), "Nasdaq and Quebec Agree to Form Nasdaq Canada" (April 26, 2000), "Nasdaq Japan, Inc. and the Osaka Securities Exchange Sign Agreements to Form Nasdaq Japan Market" (April 19, 2000), "Nasdaq-Europe Materials" (November 5, 1999), and "The Coming Global Digital Stock Market" (June 23, 1999), all located at www.nasdaqnews.com.|
|28||It is worth noting that several of these market structure initiatives are still open, making it difficult to understand the interplay between each proposal. Specifically, it is not clear whether open proposals are intended to remain open and, if so, how they would interact under a single market structure.|
|29||Although Nasdaq claims firms will not be compelled to route orders to its Order Collection Facility, Nasdaq's affiliation with the regulator, NASD and NASDR, along with its role as the NMS, will make it difficult for firms to justify not sending orders to Nasdaq. Consequently, where today there are thousands of points of execution, under the Proposal this would be replaced by a single point of execution.|
|30||"Now is the time to embrace a broader and deeper transparency. Now is the time for all market participants to move toward open books across all markets. Now is the time for a voluntary private sector initiative in this important area." "Visible Prices, Accessible Markets, Order Interaction", Chairman Arthur Levitt, Northwestern University School of Law, Kellogg Graduate School of Management, March 16, 2000.|
|31||Unless, of course, the technology of the order routing system is sub-standard and orders are not delivered in a timely manner. Archipelago believes ECNs should not be faulted for deficiencies in the system of which they are required to participate.|
|32||Special Study: Electronic Communication Networks and After-Hours Trading, Division of Market Regulation, Securities and Exchange Commission, June 2000.|
|33||Barclay, Michael J., William G. Christie, Jeffrey H. Harris, Eugene Kandel, and Paul H. Schultz (1997), "The Effect of Nasdaq Market Reform on Trading Costs," Journal of Finance, Volume 54 Number 1, February 1999; "Visible Prices, Accessible Markets, Order Interaction," Chairman Arthur Levitt, Northwestern University School of Law, Kellogg Graduate School of Management, March 16, 2000.|
|34||Note 1, supra, 64 FR at 68127.|
|35||"Dynamic Markets, Timeless Principles", Chairman Arthur Levitt, Columbia Law School, New York, N.Y., September 23, 1999.|
|36||Note 15, supra.|
|37||It is Archipelago's perspective that because Nasdaq will accept only orders, not information, the Order Display Facility will fail to meet its full potential.|
|38|| Nasdaq purports that this "prioritization is consistent with common industry practice today, where a market participant would route its orders first to market makers and ECNs that do not charge a fee and then to ECNs that charge an access fee, to ensure the investor incurs the lowest possible trading costs." (SEC Release No. 34-42573, March 23, 2000, at II.A.1.c.i) Archipelago believes there is no market evidence of this practice today. In fact, Archipelago routes to ECNs before routing to market makers.
Were Nasdaq to claim that market makers will compete access fees to zero, Archipelago would respond that if the intention is to eliminate access fees, Nasdaq should propose to eliminate fees under its Commission-granted authority under Regulation ATS. Nasdaq should not corrupt price-time priority in a manner that reduces efficient price discovery, thereby harming investors and issuers.
|39||See Appendix A.|
|40||Data include all SelectNet orders directed and received by Archipelago in stocks beginning with the letters "A" and "B". Data are not available for the period between January 26 and February 4, 2000.|