[Federal Register: September 10, 2004 (Volume 69, Number 175)]
[Notices]
[Page 54818-54821]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr10se04-79]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-50311]
Order Granting Application for a Temporary Conditional Exemption
Pursuant To Section 36(a) of the Exchange Act by the National
Association of Securities Dealers, Inc. Relating to the Acquisition of
an ECN by The Nasdaq Stock Market, Inc.
September 3, 2004.
I. Introduction
The National Association of Securities Dealers, Inc. (``NASD''),
through its subsidiary, The Nasdaq Stock Market, Inc. (``Nasdaq''),
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Rule 0-12 \1\ under the Securities Exchange Act of 1934
(``Exchange Act''), an application for an exemption under Section
36(a)(1) of the Exchange Act \2\ from the rule filing requirements of
Section 19(b) of the Exchange Act \3\ with respect to Nasdaq's
acquisition of Brut, LLC, operator of the Brut ECN (``Brut''), a
registered broker-dealer, and electronic communications network
(``ECN''), as a wholly-owned subsidiary of Nasdaq.\4\ This order
temporarily grants the request for exemptive relief subject to NASD and
Nasdaq satisfying certain conditions, which are outlined below.
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\1\ 17 CFR 240.0-12.
\2\ 15 U.S.C. 78mm(a)(1).
\3\ 15 U.S.C. 78s(b).
\4\ On August 6, 2004, the NASD Board of Governors approved
Nasdaq's proposal to seek the exemption. The obligation to file with
the Commission proposed changes to the NASD rules concerning Nasdaq
systems has been delegated to Nasdaq by the NASD, pursuant to the
Plan of Allocation and Delegation of Functions by NASD to
Subsidiaries (``Delegation Plan''). Nasdaq submitted this request
for exemption pursuant to the Delegation Plan.
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II. Nasdaq's Application for Temporary Conditional Exemption From
Section 19(b) Rule Filing Requirements
On August 25, 2004, Nasdaq requested that the Commission grant
temporary exemptive relief, subject to certain conditions, from the
rule filing procedures of Section 19(b) of the Exchange Act \5\ with
regard to Nasdaq's acquisition and operation of Brut as a wholly-owned
subsidiary of Nasdaq.\6\ According to Nasdaq's Exemption Request,
Nasdaq entered into a definitive agreement to purchase Brut on May 25,
2004. Brut is currently an NASD member and participates in the Nasdaq
Market Center execution system (formerly know as the ``Nasdaq National
Market Execution System'' or ``SuperMontage'') as a Nasdaq Order-
Delivery ECN.\7\ Brut's current relationship with Nasdaq is limited to
participating in the Nasdaq Market Center execution system in the same
manner as other ECNs. Nasdaq currently has no ownership interest in
Brut.\8\
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\5\ Id.
\6\ See letter from Edward S. Knight, Executive Vice President
and General Counsel, Nasdaq, to Jonathan G. Katz, Secretary,
Commission, dated August 25, 2004 (``Exemption Request'').
\7\ See NASD Rule 4701(t).
\8\ See Exemption Request, supra note 6.
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Once acquired by Nasdaq, Brut would become a ``facility'' of a
self-regulatory organization (``SRO'') pursuant to
[[Page 54819]]
Section 3(a)(2) of the Exchange Act \9\ because Brut would be property
of Nasdaq used for the purpose of effecting or reporting securities
transactions.\10\ As a result, NASD and, pursuant to the Delegation
Plan, Nasdaq would be obligated, under Section 19(b) of the Exchange
Act \11\ to file with the Commission proposed rules governing the
operation of Brut's trading system and subscriber fees.
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\9\ See 15 U.S.C. 78c3(a)(2).
\10\ See Exemption Request, supra note 6. See also, supra note
9.
\11\ 15 U.S.C. 78s(b).
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Until transfer of ownership, Nasdaq and Brut remain legally
separate entities, each of which, among other things, are engaged in
and competing for, the business of facilitating securities
transactions. Because Nasdaq and Brut are competitors, Nasdaq
represents that it and Brut are limited in the amount and type of
information that can be exchanged between them prior to the
acquisition's consummation (e.g., information about the technical
specifications of Brut's execution algorithm, order types, and
pricing).\12\ Nasdaq represents that this information from Brut is a
necessary and important component of any rule filing it may submit to
the Commission related to Brut and that this information must be kept
confidential by Brut, and cannot be shared with Nasdaq, prior to the
closing of the transaction. Moreover, Nasdaq stated in its Exemption
Request that without such information, it would be unable to prepare
and submit rule filings regarding Brut's operation and fee structure
prior to close of the transaction and the transfer of ownership of Brut
to Nasdaq. In its Exemption Request, Nasdaq represented that upon
assuming ownership of Brut, Nasdaq and Brut would be relieved of
certain legal constraints in sharing information and would begin to
share the previously restricted information so that, among other
things, Nasdaq could draft rules governing Brut's functionality and
fees (``Brut Filings'').
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\12\ Nasdaq represents that, as legally distinct entities, the
exchange of sensitive information between Nasdaq and Brut pre-
closing would subject them to Section 1 of the Sherman Antitrust
Act, 15 U.S.C. 1, as well as to the ``gun jumping'' provisions of
the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended, 15 U.S.C. 18a. See Section 1 of the Sherman Antitrust Act,
15 U.S.C. 1; Hart-Scott-Rodino Antitrust Improvements Act of 1976,
15 U.S.C. 18a. See Exemption Request, supra note 6.
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In its Exemption Request, Nasdaq asserted that without Commission
approval of rules governing Brut's operation, it would not be able to
operate Brut, thereby causing Brut to cease operations until the Brut
Filings were approved by the Commission. Because Brut presently
accounts for a significant portion of the share volume for Nasdaq-
listed securities, the summary termination of its services could
potentially harm investors and disrupt the functioning of a fair and
orderly market. The requested exemption would allow Brut to continue to
operate, subject to certain conditions, after it is acquired by Nasdaq,
while NASD and Nasdaq undertake to comply with the procedures related
to rule changes under Section 19(b) of the Exchange Act.\13\ In
addition, Nasdaq asserted that the requested exemption would be
consistent with the protection of investors and the public interest,
because it would allow Brut to continue to operate its ECN trading
system during the period immediately after its purchase by Nasdaq.
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\13\ 15 U.S.C. 78s(b).
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The exemption would also provide Nasdaq a reasonable opportunity to
fully analyze Brut's systems, operations, and fee structure to ensure
an orderly integration of Brut and Nasdaq and to make accurate filings
based on such information. In addition, Nasdaq stated that the
exemption would not diminish the Commission's ability to monitor Nasdaq
and Brut. In this regard, Nasdaq noted that to the extent it would
undertake to make changes to its non-Brut systems during the exemption
period, or thereafter, NASD and Nasdaq would remain subject to Section
19(b) and thus obligated to file proposed rule changes with the
Commission. Further, in its Exemption Request, NASD and Nasdaq
committed to satisfying certain conditions, which are outlined below.
For example, as a condition to the exemption, Nasdaq would be required
to submit proposed rule changes with respect to any material changes to
Brut's functions during the exemption period. In this regard, Nasdaq
noted in its Exemption Request that it currently anticipates making no
material changes to Brut's ECN functionality during the exemption
period.\14\
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\14\ If such changes become necessary as the result of continued
competition, however, Nasdaq's commitment above to file proposed
rule changes would provide the Commission the opportunity to review
any such modifications. See Exemption Request, supra note 6.
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III. Order Granting Temporary Conditional Section 36 Exemption
In 1996, Congress gave the Commission greater flexibility to
regulate trading systems, such as Brut, by granting the Commission
broad authority to exempt any person from any of the provisions of the
Exchange Act and to impose appropriate conditions on their
operation.\15\ Specifically, NSMIA added Section 36(a)(1) to the
Exchange Act, which provides that ``the Commission, by rule,
regulation, or order, may conditionally or unconditionally exempt any
person, security, or transaction, or any class or classes of persons,
securities, or transactions, from any provision or provisions of [the
Exchange Act] or of any rule or regulation thereunder, to the extent
that such exemption is necessary or appropriate in the public interest,
and is consistent with the protection of investors.'' \16\ In enacting
Section 36, Congress indicated that it expected that ``the Commission
will use this authority to promote efficiency, competition and capital
formation.'' \17\ It particularly intended to give the Commission
sufficient flexibility to respond to changing market and competitive
conditions:
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\15\ 15 U.S.C. 78mm(a). Section 36 of the Exchange Act was
enacted as part of the National Securities Markets Improvements Act
1996, Pub. L. 104-290 (``NSMIA'').
\16\ 15 U.S.C. 78mm(a).
\17\ H.R. Rep. No. 104-622, 104th Cong., 2d Sess. 38 (1996).
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The Committee recognizes that the rapidly changing marketplace
dictates that effective regulation requires a certain amount of
flexibility. Accordingly, the bill grants the SEC general exemptive
authority under both the Securities Act and the Securities Exchange
Act. This exemptive authority will allow the Commission the
flexibility to explore and adopt new approaches to registration and
disclosure. It will also enable the Commission to address issues
relating to the securities markets more generally. For example, the
SEC could deal with the regulatory concerns raised by the recent
proliferation of electronic trading systems, which do not fit neatly
into the existing regulatory framework.\18\
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\18\ S. Rep. No. 104-293, 104th Cong., 2d Sess. 15 (1996).
In recent years, the Commission has exercised its Section 36
exemptive authority to enhance competition as a means to meet the
objectives of the Exchange Act.\19\
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\19\ 15 U.S.C. 78mm. For example, the Commission issued an order
pursuant to Section 36 of the Exchange Act, granting NASD a
temporary exemption from Section 19(b), relating to the acquisition
and operation by Nasdaq of a software development company. See
Securities Exchange Act Release No. 42713 (April 24, 2000), 65 FR
25401 (May 1, 2000). See also Securities Exchange Act Release No.
49260 (February 17, 2004), 69 FR 8500 (February 24, 2004) (Order
Granting Application for Exemptions Pursuant to Section 36(a) of the
Exchange Act by the American Stock Exchange LLC, the International
Securities Exchange, Inc., the Municipal Securities Rulemaking
Board, the Pacific Exchange, Inc., the Philadelphia Stock Exchange,
Inc., and the Boston Stock Exchange, Inc.).
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Section 19(b)(1) of the Exchange Act requires an SRO, including
NASD, to
[[Page 54820]]
file with the Commission its proposed rule changes accompanied by a
concise general statement of the basis and purpose of the proposed rule
change.\20\ Once a proposed rule change has been filed with the
Commission, the Commission is required to publish notice of it and
provide an opportunity for public comment. The proposed rule change may
not take effect unless approved by the Commission by order, unless the
rule change is within the class of rule changes that are effective upon
filing pursuant to Section 19(b)(3)(A) of the Act.\21\
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\20\ 15 U.S.C. 78s(b)(1). This obligation also applies to
Nasdaq, because Nasdaq has been delegated specific responsibilities
related to rule changes affecting Nasdaq filed with the Commission
pursuant to the Delegation Plan. See also, supra note 4.
\21\ 15 U.S.C. 78s(b)(3)(A).
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Section 19(b)(1) of the Exchange Act \22\ defines the term
``proposed rule change'' to mean ``any proposed rule or rule change in,
addition to, or deletion from the rules of [a] self-regulatory
organization.'' Pursuant to Section 3(a)(27) and 3(a)(28) of the
Exchange Act, the term ``rules of a self-regulatory organization''
means (1) the constitution, articles of incorporation, bylaws and
rules, or instruments corresponding to the foregoing, of an SRO, and
(2) such stated policies, practices and interpretations of an SRO
(other than the MSRB) as the Commission, by rule, may determine to be
necessary or appropriate in the public interest or for the protection
of investors to be deemed to be rules. Rule 19b-4(b) under the Exchange
Act,\23\ defines the term ``stated policy, practice, or
interpretation'' to mean generally ``any material aspect of the
operation of the facilities of the self-regulatory organization \24\ or
any statement made available to the membership, participants, or
specified persons thereof that establishes or changes any standard,
limit, or guideline with respect to rights and obligations of specified
persons or the meaning, administration, or enforcement of an existing
rule.''
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\22\ 15 U.S.C. 78s(b)(1).
\23\ 17 CFR 240.19b-4.
\24\ The term ``facilities of the self-regulatory organization''
is not defined in the Exchange Act. The Commission, however, has
found that Nasdaq generally performs the functions commonly
performed by an exchange. See Securities Exchange Act Release No.
40760 (December 8, 1998), 63 FR 70844 (December 22, 1998) at nn. 58-
61 and accompanying text.
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The term ``facility'' is defined in Section 3(a)(2) of the Exchange
Act, with respect to an exchange, to include ``its premises, tangible
or intangible property whether on the premises or not, any right to use
such premises or property or any service thereof for the purpose of
effecting or reporting a transaction on an exchange (including, among
other things, any system of communication to or from the exchange, by
ticker or otherwise, maintained by or with the consent of the
exchange), and any right of the exchange to the use of any property or
service.''
In its Exemption Request, Nasdaq acknowledges that upon closing of
the purchase transaction, Brut would become a facility of Nasdaq
because the Brut trading system would be property of Nasdaq that is
used for the purpose of effecting or reporting securities transactions.
Section 19(b) of the Exchange Act and Rule 19b-4 thereunder, absent an
exemption, would require NASD to file proposed rules with the
Commission to allow Nasdaq to operate Brut as a facility. Further,
Nasdaq represented in its Exemption Request that, due to legal
constraints regarding information sharing, it would be unable to submit
the Brut filings prior to close of the transaction and the transfer of
ownership of Brut to Nasdaq. In its Exemption Request, Nasdaq
represented that upon assuming ownership of Brut, Nasdaq and Brut would
be permitted to share information so that Nasdaq could undertake to
prepare and submit the Brut Filings in compliance with NASD's
obligations under Section 19(b) of the Exchange Act and Rule 19b-4
thereunder.\25\
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\25\ See Exemption Request, supra note 6.
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The Commission believes that it is appropriate to issue an
exemption, subject to the conditions described below, to allow Nasdaq
to operate Brut as a facility without being subject to the rule filing
requirements of Section 19(b) of the Exchange Act for a temporary
period. Accordingly, the Commission has determined to grant Nasdaq's
request for an exemption, subject to certain conditions, not to exceed
six months from the date Nasdaq acquires ownership of Brut. The
Commission finds that the temporary conditional exemption from the
provisions of Section 19(b) of the Exchange Act \26\ is necessary and
appropriate in the public interest and is consistent with the
protection of investors. In particular, the Commission believes that
this exemption provides a limited amount of time for NASD and Nasdaq to
obtain the necessary information to undertake to comply with NASD's
obligations under Section 19(b) of the Exchange Act relative to
Nasdaq's acquisition of Brut. In addition, the Commission believes that
the exemption should help promote efficiency and competition in the
market by allowing Brut to continue to operate while the Brut filings
are pending before the Commission. In this regard, the Commission
believes that this exemption should help to avoid any potential
negative consequences to investors that could result if Nasdaq was
required to abruptly limit Brut's trading operations immediately upon
consummation of its acquisition of Brut.
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\26\ 26 15 U.S.C. 78s(b).
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To provide the Commission the opportunity to review and act upon
any proposal to change Brut's fees or to make material changes to
Brut's operations as an ECN during the period covered by the exemption,
as well as to ensure that the Commission's ability to monitor Nasdaq
and Brut is not diminished by the exemption, the Commission is imposing
the following conditions while the exemption is in effect.\27\ The
Commission believes such conditions are necessary and appropriate in
the public interest for the protection of investors. Therefore, the
Commission is granting to NASD a temporary exemption, pursuant to
Section 36 of the Exchange Act, from the rule filing requirements
imposed by Section 19(b) of the Exchange Act as set forth above
provided that NASD and Nasdaq comply with the following conditions:
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\27\ See Exemption Request, supra note 6.
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(1) Brut remains a registered broker-dealer under Section 15 of the
Exchange Act and continues to operate as an ECN;
(2) Brut operates in compliance with the obligations set forth
under Regulation ATS;
(3) Brut operates as a separate subsidiary of Nasdaq;
(4) Nasdaq files a proposed rule change under Section 19 of the
Exchange Act if it seeks to make a material change to Brut's
operations. A material change would include any changes to a stated
policy, practice, or interpretation regarding the operation of Brut or
any other event or action relating to Brut that would require the
filing of a proposed rule change by an SRO or an SRO facility; \28\
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\28\ See Section 19(b) of the Exchange Act and Rule 19b-4
thereunder. The Commission notes that a material change would
include, among other things, changes to Brut's operating platform;
the types of securities traded on Brut; Brut's types of subscribers;
or the reporting venue for trading that takes place on Brut. The
Commission also notes that the rule filings must set forth the
operation of the Brut facility and its integration with Nasdaq
sufficiently so that the Commission and the public can evaluate the
proposed change.
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(5) Nasdaq files a proposed rule change under Section 19 of the
Exchange Act \29\ if it seeks to modify Brut's fee schedule;
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\29\ 15 U.S.C. 78s(b).
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(6) Nasdaq treats Brut the same as other ECNs that participate in
the Nasdaq Market Center, and, in particular, Nasdaq does not accord
Brut preferential treatment in how Brut submits orders to the Nasdaq
Market Center execution system or in the way its orders are displayed
or executed; and
(7) Nasdaq submits rule filings under Section 19(b) of the Exchange
Act \30\ fully articulating its operation of Brut and Brut's
integration with Nasdaq within sixty days of the date Nasdaq assumes
ownership of Brut.\31\
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\30\ 15 U.S.C. 78s(b).
\31\ See Exemption Request, supra note 6.
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In addition, the Commission notes that NASD is currently the
Designated Examining Authority (``DEA'') for Brut. On August 6, Nasdaq
applied for membership to the New York Stock Exchange (``NYSE'') on
behalf of Brut. In its Exemption Request, Nasdaq commits to seek the
Commission's approval pursuant to Rule 17d-1 under the Exchange Act
\32\ to have the NYSE appointed as Brut's DEA for financial
responsibility rules upon approval of Brut's membership in the NYSE.
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\32\ 17 CFR 240.17d-1.
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In granting the Commission broad exemptive authority in Section 36
of the Exchange Act,\33\ Congress intended to incorporate flexibility
into the Exchange Act's regulatory scheme to reflect a rapidly changing
marketplace. Congress particularly intended for the Commission to use
this flexibility to promote efficiency and competition. The Commission
believes that the requested temporary conditional exemption will help
achieve these goals, while upholding the regulatory objectives of the
Exchange Act. In granting this relief, the Commission makes no finding
regarding whether Nasdaq's operation of Brut as a facility would be
consistent with the Exchange Act. Proposed rule changes regarding
Nasdsaq's operation of Brut will be evaluated by the Commission in
accordance with the procedures set forth under Section 19(b) of the
Exchange Act.\34\
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\33\ 15 U.S.C. 78mm(a).
\34\ See supra notes 20-23.
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The Commission notes that without its approval of rules governing
the operation of Brut, Nasdaq would be unable to operate Brut, thereby
causing Brut to cease operations until the Brut Filings are approved by
the Commission. Should Brut be required to abruptly cease operations, a
significant source of liquidity would be lost, which could potentially
disrupt the functioning of an orderly market and harm investors. This
exemptive relief should facilitate competition in the market by
allowing Brut to continue to provide liquidity and compete with other
market centers, while also providing NASD and Nasdaq with a reasonable
opportunity to comply with their obligations under Section 19(b) of the
Exchange Act. Therefore, the Commission believes that this exemption
strikes an appropriate balance between the Commission's interest to
encourage competition in the rapidly changing market place and to
uphold the procedural requirements under Section 19(b) of the Exchange
Act, and thus is necessary and appropriate in the public interest and
is consistent with the protection of investors.
For the reasons discussed above, the Commission finds that the
temporary conditional exemptive relief requested by NASD and Nasdaq is
necessary and appropriate in the public interest and is consistent with
the protection of investors.
It is ordered, pursuant to Section 36 of the Exchange Act,\35\ that
the application for a temporary conditional exemption is granted for a
period of six months following Nasdaq's acquisition of Brut.
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\35\ 15 U.S.C. 78mm.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E4-2143 Filed 9-9-04; 8:45 am]
BILLING CODE 8010-01-P