|
Via email to www.rule-comments@sec.gov
August 12, 2005
Mr. Jonathan G. Katz
Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: NASD/Nasdaq Trade Reporting Facility
Release No. 34-52049; File No. SR-NASD-2005-087
Dear Mr. Katz:
The National Association of Securities Dealers, Inc. (“NASD”) has filed new rules relating to its proposed separation from The Nasdaq Stock Market, Inc. (“Nasdaq”) and Nasdaq’s application for approval as a national securities exchange. The major substantive aspect of the referenced filing is the establishment of an NASD Trade Reporting Facility (“TRF”), which would funnel trade revenues from certain off-exchange trades from the NASD to Nasdaq. The New York Stock Exchange is submitting this letter to comment on that aspect of the TRF Filing because it seeks to pass through to Nasdaq market data revenue that is derived from off-exchange trades and is required to be allocated to the NASD. That pass-through contravenes the Securities Exchange Act of 1934 (the “Act”), various Commissions rules and the provisions of the CTA Plan and the Plan Governing the Collection, Consolidation and Dissemination of Quotation and Transaction Information for Nasdaq-Listed Securities Traded on Exchanges on an Unlisted Trading Basis (the “OTC/UTP Plan”).
In November 2000, Nasdaq submitted to the Commission an application for registration as a national securities exchange.[1] A year later, in anticipation of the approval of Nasdaq’s exchange application, the NASD submitted a proposed rule change to establish its Alternative Display Facility (“ADF”) for reporting off-exchange trades. The Exchange commented on both filings, stating that it was inappropriate for the NASD and Nasdaq to attempt to define trades executed on Nasdaq to include off-exchange trades such as those executed on ECNs and upstairs trading desks outside of Nasdaq facilities.[2] We explained that Nasdaq’s attempt to take credit (both financially and for disclosure and marketing purposes) for trades that do not take place through its facilities would violate the terms of the CTA Plan and the OTC/UTP Plan and was inconsistent with the Act and the Commission’s rules under the Act. We further explained that, by breaking the nexus between the location of a trade (i.e., the place of the making of a contract for the delivery of stock against payment) and the market claiming credit for the trade report, the NASD and Nasdaq proposed to convert Nasdaq into a “print facility” for off-exchange trades.
Under the guise of a nominal NASD subsidiary, the NASD and Nasdaq are now attempting to do exactly what they cannot do, namely creating a jointly-owned facility of the NASD for the sole purpose of passing through to Nasdaq the revenue pertaining to off-exchange trades that the CTA and OTC/UTP Plans require to be allocated to the NASD. Functionally, the TRF is totally redundant with the NASD’s existing ADF.[3] Net of payments for regulatory services, Nasdaq retains all economic benefit derived from market data revenues paid to the nominal NASD subsidiary. NASD members would ostensibly have the choice of reporting off-exchange trades to the TRF or to the ADF. However, Nasdaq’s practice of rebating tape revenue leaves little doubt where firms will choose to report their trades.
The Commission should not permit two SROs to engage in behavior that mocks the rule of law, contravenes sound public policy, undermines the NASD’s functional independence from Nasdaq, and sanctions the impermissible subsidy of an exchange by the NASD.
- Violations of Law. By attempting to accomplish indirectly that which NASD and Nasdaq cannot do directly, the TRF arrangement violates Section 11A of the Act, Commission Rules under the Act, Regulation NMS, the CTA Plan and the OTC/UTP Plan. Rather than reiterate these arguments in this letter, we refer back to our 2001 and 2002 NYSE Comment Letters, which describe the illegality of this arrangement in detail.
- Against Public Policy. The Filing propagates bad public policy. Trafficking in tape revenues is the reason the SEC went to such lengths in Regulation NMS to lessen the impact of trade reporting on the allocation of market data revenues. The TRF Filing goes in exactly the opposite direction, permitting two SROs to use market data to achieve anticompetitive purposes. The TRF will also promote the increased internalization of orders. The NYSE has long been on record as urging the Commission to ban the internalization of non-block facilitation trades, which removes these orders from the price discovery process.
- Inconsistent with NASD Regulation’s Functional Independence. Prior to this proposal, both Nasdaq and the NYSE were seeking to assure that the economic relationships between them and their former regulatory divisions were at “arm’s length” and confined to assuring adequate funding of their regulatory functions. The NASD’s creation of a subsidiary controlled by Nasdaq that is designed to divert revenue that might otherwise be used to fund the NASD’s regulatory programs or reduce the NASD’s fees charged to its members and member organization impairs the NASD’s independence. Equally troubling is the NASD’s willingness to lend its registration as a national securities association to enable one of several competing exchanges for which it provides regulatory services to attempt indirectly what the law prevents it from doing directly.
- Inconsistent with Nasdaq’s Requested Exchange Status. When Nasdaq made the decision to seek exchange status, it made a decision to leave the OTC market behind with the NASD. The TRF Filing is simply a formalistic attempt by Nasdaq to avoid the ramifications of exchange status and keep the economic benefit of off-exchange trades. Nothing changes in this NASD/Nasdaq operation before separation and after. Moreover, the suggestion in the Filing that TRF trades should be separately identified on the Consolidated Tape and in the media seems designed to permit Nasdaq to publicly claim credit for off-exchange trades and thereby inflate its trading share. The transparency and utility of market data would be compromised if Nasdaq could claim liquidity that in fact did not exist in its market.
- Unfair Competition among Exchanges. Transferring market data revenue from the NASD to Nasdaq amounts to a subsidy by the NASD of one of several competing exchanges. The amount of market data revenues at stake is considerable. The last month Nasdaq separately reported SuperMontage volume, Nasdaq’s reported trading share was 52.5%, of which 37% (or 19.4% of total volume) was attributable to SuperMontage. Nasdaq has never broken out CAES or SuperMontage volume for listed stocks, but we believe it was de minimis in 2004. Based on these numbers, the separation of NASD and Nasdaq, and the appropriate allocation of market data revenue between them, the NASD would have received most of the $16.5 million that NASD received under the CTA Plan and $40.3 million of the $64 million that NASD received under the OTC/UTP Plan. NASD’s giveaway to Nasdaq of more than $55 million for 2004 would have given Nasdaq an unfair economic advantage over other national securities exchanges, even after deducting Nasdaq’s moderate expenses in operating the TRF. The Filing makes no attempt to explain why Nasdaq alone should receive the economic benefit of trades that have no nexus whatsoever with its facilities.
- Appropriateness of Allocating Market Data Revenue to Off-Exchange Trades. The NASD is entitled to this revenue under the existing CTA and OTC/UTP Plans. As discussed above, the NASD could use this revenue stream to expand its regulatory programs or reduce fees charged to its member organizations. In the absence of the NASD doing either, we propose that the Commission should adopt amendments to the national market system plans that would make trades that do not take place through the facilities of an exchange ineligible to participate in the sharing of the markets’ data revenues.
We thank the Commission for granting us this opportunity to comment and are prepared to answer any questions that the Commission may have.
Sincerely yours,
/s/ Mary Yeager
cc: Chairman Christopher Cox
Commissioner Paul S. Atkins
Commissioner Roel C. Campos
Commissioner Cynthia A. Glassman
Commissioner Annette L. Nazareth
ATTACH:
EXHIBIT A: NYSE's August 27, 2001, comment letter (pdf)
EXHIBIT B: NYSE's February 15, 2002, comment letter (pdf)
[1] Release No. 34-44396, File No. 10-131 (June 6, 2001).
[2] See letter dated August 27, 2001, from James E. Buck, Secretary, Exchange, to Jonathan G. Katz, Secretary, Commission (the “2001 NYSE Comment Letter) and letter dated February 15, 2002, from Darla Stuckey, Secretary, Exchange, to Mr. Katz (the “2002 NYSE Comment Letter”). To facilitate your review, we have attached those letters as Exhibits A and B to this letter.
[3] Although the NASD and Nasdaq characterize the TRF as a NASD facility, in reality, it is a Nasdaq facility.
The TRF would be operated by a limited liability company named the “The Trade Reporting Facility, LLC” jointly owned by the NASD and Nasdaq the sole purpose of which is to transfer the revenue resulting from reporting of non-Nasdaq OTC trades from the NASD to Nasdaq.
Nasdaq controls the entity. Nasdaq appoints two of the three members of the Board of Managers, names all officers, controls the company’s day-to-day operations, administers the rules regulating the TRF, regulates the TRF’s activities and budget, provides real-time surveillance, manages the TRF’s business affairs, and provides systems to enable broker-dealers to report trades to the TRF. Although the NASD performs regulatory functions for the TRF, it is paid to do so by Nasdaq.
To download the above Comment Letter as a .pdf, click here.
|
