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Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by National Association of Securities Dealers, Inc. Relating to Permanent Approval of the Nasdaq Application of the OptiMark System.

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Start Preamble August 2, 2000.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) [1] and Rule 19b-4 thereunder, [2] notice is hereby given that on June 19, 2000, the National Association of Securities Dealers, Inc. (“NASD” or Start Printed Page 48772“Association”) through its subsidiary The Nasdaq Stock Market, Inc. (“Nasdaq”), filed with the Securities and Exchange Commission (“SEC” or “Commission”) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by Nasdaq. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement Of The Terms Of Substance Of The Proposed Rule Change

Nasdaq is filing this proposed rule change to seek permanent approval of the Nasdaq Application of the OptiMark System (“Nasdaq Application” or “Application”) without any restrictions on the trading activity to be conducted through the facility.

II. Self-Regulatory Organization's Statement Of The Purpose Of, And Statutory Basis For, The Proposed Rule Change

In its filing with the Commission, Nasdaq included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. Nasdaq has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

1. Purpose

a. Summary of Nasdaq's Application of the OptiMark System

Since October 1999, Nasdaq has operated a new Nasdaq facility called the Nasdaq Application of the OptiMark System (“Nasdaq Application” or “Application”). [3] The Application is a screen-based trading service intended for use by NASD members and other non-member users. The Application employs technology developed by OptiMark Technologies, Inc. to provide a computerized mechanism designed to satisfy the trading desires of all market participants, including retail and institutional investors as well as broker-dealers. The Application enables these participants to anonymously represent their trading interest across a full spectrum of prices and sizes, and performs a sophisticated, computer-based, optimal search and match for liquidity in securities listed on Nasdaq. [4]

The Application is available to all Nasdaq market participants and is in addition to existing Nasdaq trading systems. Specifically, the Nasdaq Application is available to any NASD member who chooses to become a User and complies with all applicable rules. A User is a subscriber who has entered into an agreement with Nasdaq and OptiMark Services, Inc. to access the Application. In addition, a non-member may become a User provided it is authorized in advance by one or more NASD members who agree to sponsor the non-member. A non-member User or a member User that is not self-clearing must establish a relationship with a clearing broker that can be deemed a Designated Broker. [5] Orders from sponsored Users are routed, executed, and reported in the Designated Broker's name. To allow a sponsored User to enter a Profile into the Application, Nasdaq must have on file an agreement signed by a Designated Broker stating that the Designated Broker is willing to act in this capacity for a particular User. These agreements include any applicable credit limits imposed by the Designated Broker on the sponsored User. [6] The Designated Broker is responsible for all of its sponsored Users' orders and resulting transactions.

Transactions that result from matches through the Application will be cleared using Nasdaq's post-execution service, the Automated Confirmation Transaction Service (“ACT”). Accordingly, final locked-in trades will be forwarded to The Depository Trust and Clearing Corporation (“DTCC”) in the ordinary course, and will clear and settle the regular way through DTCC, just as any other transaction executed on Nasdaq. [7] All Users will receive a report of any execution resulting from a match of the Profiles submitted by them (including Profiles generated from a quote in the Nasdaq Quote Montage) as soon as possible after the execution takes place. Users that are not self-clearing will have the option of re-allocating for clearing purposes all or a portion of any execution to another broker by the end of the trading day. If the User has designed a trade as set for end-of-day release (i.e., has chosen to re-allocate all or a portion of any trade or trades for clearing purposes), the Designated Broker generally will be notified promptly after the close of the trading day to the extent it has been allocated for clearing purposes any transaction resulting from a Profile submitted by a User sponsored by that Designated Broker.

It is important to note in the comparison, clearance and settlement process, that although the specific identity of the contraparties to a particular trade will be temporarily masked until 4:30 p.m. of the trade day, the Designated Broker that agreed to sponsor a User in the Application is fully responsible for the clearance and settlement of that trade. Nasdaq and the operator of the Application are not responsible for either the User or a Designated Broker failing to pay for or to deliver the securities traded through this facility. Rule 4994(b) clearly states that responsibility for clearance and settlement remains with the Designated Broker. The User and Designated Broker Agreements that each party must sign prior to entering a Profile into the Application likewise make clear that it is the Designated Broker's responsibility to clear and settle the trades, and that the Designated Broker must evaluate the ability of Users to settle trades when it authorizes a User to submit Profiles under its sponsorship.

b. SEC Approval Order

On September 30, 1999, the SEC approved the Nasdaq Application as a pilot program for six months ending on April 3, 2000.[8] Nasdaq commenced operation of the Application in October 1999 for 10 securities and has recently expanded the application to include a total of 205 securities.[9] The Commission recently extended the pilot program for an additional six month period.[10] The order initially approving the Nasdaq Application includes several trading Start Printed Page 48773parameters that limit the operation of the facility until Nasdaq refines the Application's risk management tools. The Commission, along with other market participants, was concerned that some of the ACT risk management tools were not available to monitor transactions executed in the Application. The trading parameters include the following: (1) a limitation on trading to 250 of the most actively traded Nasdaq securities; (2) a limitation on cycle frequency to once every five minutes; (3) a suspension of trading in the Application for 15 minutes if its volume equals or exceeds 12.5% of the average Nasdaq volume in the 250 securities; and (4) suspension of trading in the Application for the remainder of the trading day if its volume equals or exceeds 15% of the average Nasdaq volume in the 250 securities.[11]

c. Proposed Changes

Nasdaq has developed several modifications to the Application's risk management systems to address the SEC's concerns. Accordingly, Nasdaq seeks to rescind Rule 4999, which contains the trading parameters mentioned above, and seeks approval of the Application on a permanent basis without any of the restrictions contained in Rule 4999.

The first modification enables clearing brokers that are Designated Brokers under the Application's rules (“Designated Brokers/Clearing Brokers”) to require correspondent and non-member Users to use the “immediate release” instruction on transactions effected through the Application. This requirement would be specified in the Designated Broker Consent Agreement that each user must execute. The immediate release instruction prevents the User from selecting the end-of-day option discussed earlier. Therefore, this instruction prevents the User from re-allocating a trade from one Designated Broker/Clearing Broker to another at the end of the trading day. In this way, Designated Brokers/Clearing Brokers will be given the ability to know immediately after a trade is done that a sponsored User that the Designated Broker/Clearing Broker allowed to use the Application has completed a trade under the Designated Broker/Clearing Broker's name. To facilitate this flow of information to the Designated Broker/Clearing Broker, the Application has also been modified to permit a one-sided give-up [12] when immediate release instructions have been specified.

The second modification permits Designated Brokers/Clearing Brokers to modify directly through Nasdaq's Act system the Application trading limits that they establish for their Users. As originally constructed, the Application did not permit a Designated Broker/Clearing Broker to adjust a trading limit through ACT's Risk Management system. Instead, Designated Brokers/Clearing Brokers were required to send messages through the electronic data interface or call the Nasdaq/OptiMark desk to change the limits. Nasdaq has developed a new interface between the Application and ACT that permits a Designated Broker/Clearing Broker to directly query and adjust, through the ACT system, the trading limits it establishes in the Application.

2. Statutory Basis

Nasdaq believes that the proposed rule change is consistent with the provisions of section 15A(b)(6)[13] and section 11A [14] of the Act.

Section 15A(b)(6) [15] requires that the rules of a registered national securities association be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principals of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; and not be designed to permit unfair discrimination between customers, issuers, brokers, or dealers.

Section 11A(a)(1) [16] sets forth findings of Congress that new data processing and communications techniques create the opportunity for more efficient and effective market operations. Section 11A(a)(1)(C) [17] states that it is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure (i) economically efficient execution of securities transactions; (ii) fair competition among brokers and dealers; (iii) the availability to brokers, dealers, and investors of information with respect to quotations for and transactions in securities; (iv) the practicability of brokers executing investors' orders in the best market; and (v) an opportunity for investors orders to be executed without the participation of a dealer.

The Commission previously recognized that the Nasdaq Application is consistent with sections 15A [18] and 11A [19] of the Act when it approved the pilot program.[20] The Application was approved as a pilot program with the limitations discussed above because the Commission, along with other market participants, was concerned that the Application did not provide Designated Brokers/Clearing Brokers with the same type of risk management tools that were available to these firms when transactions were executed outside of the Application. Specifically, the commission was concerned that Designated Brokers/Clearing Brokers did not have the ability to monitor their intra-day risk.

The immediate release function provides a Designated Broker/Clearing Broker with immediate notice that a trade has been executed by one of its sponsored Users and prevents Users from re-allocating trades to other Designated Brokers/Clearing Brokers at the end of the day. Consequently, Designated Brokers/Clearing Brokers are able to monitor their Users' positions on an intra-day basis, which provides these brokers with the opportunity to manage and mitigate their risk. Nasdaq believes this function directly addresses the Commission's concern about the Application's risk management tools. In addition, Nasdaq believes the immediate release function coupled with the one-sided, give-up capability strikes the appropriate balance between a Designated Broker/Clearing Broker's need to manage its risk and its sponsored User's desire to trade anonymously. In a one-sided, give-up situation, the identity of the sponsored User is immediately disclosed to the Designated Broker/Clearing Broker, but their identity is not disclosed to the counterparty to the trade until the end of the day.

Furthermore, Designated Brokers/Clearing Brokers will now be able to use the ACT system to query or adjust the credit limits they set for their sponsored Users. Designated Brokers/Clearing brokers previously were required to call the Nasdaq/OptiMark desk or submit instructions through an electronic data interface. The ACT system provides Designated Brokers/Clearing Brokers with a more efficient mechanism to Start Printed Page 48774query or change the credit limits they have set.

Nasdaq expects that the systems change necessary to implement the features described above will be in place in the third quarter of 2000. Because these changes address the issues raised by the commission in its approval order, Nasdaq believes that the trading parameters contained in the approval order and reflected in Application rule 4999 can be eliminated. Further, Nasdaq believes that the Application should be permanently approved because the only concerns that were raised during the approval process have been addressed.

(B) Self-Regulatory Organization's Statement on Burden on Competition

Nasdaq does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others

The Association has neither solicited nor received written comments.

III. Date Of Effectiveness Of The Proposed Rule Change and Timing For Commission Action

Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will:

A. By order approve such proposed rule change, or

B. Institute proceedings to determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposal is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 fifth Street, NW., Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the NASD. All submissions should refer to the file number SR-NASD-00-37 and should be submitted by August 30, 2000.

Start Signature

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.21

Margaret H. McFarland,

Deputy Secretary.

End Signature End Preamble


3.  The OptiMark System was developed by OptiMark, Inc. a computer technology firm located in Jersey City, New Jersey, based on certain patent-pending technology referred to as “The OptiMarkTM. System.”

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4.  For a more complete discussion of the operation of the Nasdaq Application, see Securities Exchange Act Release No. 41967 (September 30, 1999), 64 FR 54704 (October 7, 1999) (“OptiMark Approval Order”).

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5.  A member user that is not self-clearing is referred to as a correspondent User. Correspondent Users and non-member Users are collectively referred to as sponsored Users.

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6.  A User's credit limits, as such limits may be established from time to time by a Designated Broker/Clearing Broker, will be programmed into the OptiMark System. The Designated Broker will be alerted to its potential exposure to its Users, individually or in the aggregate, approaches the established credit limits (“Alarm Threshold”) or reaches the limit at which the Designated Broker will no longer permit a User to submit Profiles (“Trading Limit”).

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7.  DTCC was formed by the recent combination of The Depository Trust Company and the National Securities Clearing Corporation.

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8.  See OptiMark Approval Order, supra note 4.

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9.  See Nasdaq Head Trader Alert 2000-38 (May 23, 2000). Nasdaq Head Trader Alerts are available at​Trader/​News/​headtraderalerts.

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10.  See Securities Exchange Act Release No. 42618 (Apr. 4, 2000); 65 FR 19420 (Apr. 11, 2000).

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11.  See OptiMark Approval Order, supra note 7.

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12.  In a one-sided give-up, the identity of the sponsored User is immediately disclosed to the Designated Broker/Clearing Broker, but their identity is not disclosed to the counterparty to the trade until the end of the day.

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17.  15 U.S.C. 78k-1(a)(1)(C).

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20.  See OptiMark Approval Order, supra note 7.

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[FR Doc. 00-20057 Filed 8-8-00; 8:45 am]