April 6, 2012.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”),
and Rule 19b-4 thereunder,
notice is hereby given that on March 23, 2012, The NASDAQ Stock Market LLC (“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 substantially prepared by NASDAQ. On March 29, 2012, the Exchange submitted Amendment No. 1 to the proposed rule change.
The Commission is publishing this notice to solicit comments on the proposed rule change, as modified by Amendment No. 1 thereto, from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change
NASDAQ (also known as the “Exchange”) is filing with the Commission a proposal to add new Rule 5950 (Market Quality Program) to enable market makers that voluntarily commit to and do in fact enhance the market quality (quoted spread and liquidity) of certain securities listed on the Exchange to qualify for a fee credit pursuant to the Exchange's Market Quality Program, and to exempt the Market Quality Program from Rule 2460 (Payment for Market Making). NASDAQ believes this voluntary program will benefit investors, issuers or companies, and market participants by significantly enhancing the quality of the market and trading in such listed securities.
The Market Quality Program set forth in Rule 5950 will be effective for a one-year pilot period beginning from the date of implementation of the program. During the pilot, NASDAQ will periodically provide information to the Commission about market quality in respect of the Market Quality Program.
The text of the proposed rule change is available from NASDAQ's Web site at http://nasdaq.cchwallstreet.com/Filings/, at NASDAQ's principal office, on the Commission's Web site at www.sec.gov, and at the Commission's Public Reference Room.
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
The purpose of the filing is to propose new Rule 5950 to enable Market Makers 
that enhance the market quality of certain securities listed on the Exchange (known as “targeted securities”) and thereby qualify for a fee credit pursuant to the Market Quality Program (“MQP” or “Program”), and to exempt the Program from Rule 2460.
Rule 5950 will be effective for a one-year pilot period. The pilot period will commence when the Market Quality Program is implemented by the Exchange and an MQP Company 
and one or more related Market Makers are accepted into the MQP in respect of a security listed pursuant to the Program (“MQP Security”).
The pilot program will end one year after implementation.
During the pilot, the Exchange will periodically provide information to the Commission about market quality in respect of the MQP.
MQP Securities may include Exchange Traded Funds (“ETFs”), Linked Securities (“LS”), and Trust Issued Receipts (“TIRs”).
However, the Exchange believes that MQP Securities will predominantly, if not entirely, consist of ETFs as reflected in the proposal.
The proposed Market Quality Program is a voluntary program designed to promote market quality in MQP Securities.
An MQP Company that lists an eligible MQP Security on NASDAQ will pay a listing fee as set forth in proposed Rule 5950 (“MQP Fee”) in addition to the standard (non-MQP) NASDAQ listing fee applicable to such MQP Security as set forth in the Rule 5000 Series (consisting of Rules 5000-5999).
An MQP Fee will be used for the purpose of incentivizing one or more Market Makers in the MQP Security (“MQP Market Maker”) to enhance the market quality of the MQP Security. Subject to the conditions set forth in this rule, this incentive will be credited (“MQP Credit”) to one or more MQP Market Makers that make a quality market in the MQP Security pursuant to the Program.
The Need for the MQP
The Exchange believes that the MQP will be beneficial to the financial markets, to market participants including traders and investors, and to the economy in general. First, the Exchange proposes the MQP to encourage narrow spreads and liquid markets in situations that generally have not been, or may not be, conducive to naturally having such markets. The securities that comprise these markets may include less actively traded or less well known ETF products that are made up of securities of less well known or start-up companies as components.
Second, in rewarding Market Makers that are willing to “go the extra mile” to develop liquid markets for MQP Securities,
the MQP would clearly benefit traders and investors by encouraging more quote competition, narrower spreads, and greater liquidity. Third, the MQP will lower transaction costs and enhance liquidity in both ETFs and their components, making those securities more attractive to a broader range of investors. In so doing, the MQP will help companies access capital to invest and grow. And fourth, the MQP may attract smaller, less developed companies and investment opportunities to a regulated and transparent market and thereby serve the dual function of providing access to on-Exchange listing while expanding investment and trading opportunities to market participants and investors.
There is support for paid for market making (also known as “PFMM”) at the highest governmental levels. Congressman Patrick McHenry, the Chairman of the House Committee on Governmental Reform and Oversight, for example, recently noted that agreements between issuers and market makers to pay for market making activity “* * * would allow small companies to produce an orderly, liquid market for their stocks. Research has shown that these agreements, already permitted overseas, have led to a positive influence on liquidity for small public companies.” 
In a similar vein, Robert Greifeld, Chief Executive Officer of NASDAQ, recently noted that unlike the United States, “[t]he U.K., Canada, and Sweden all have exchange markets that serve as `incubators' for smaller companies.” 
The Exchange believes that the MQP proposal will, by encouraging liquid markets, enable the Exchange to similarly serve as an “incubator,” and to continue being an innovator in expanding markets to benefit market participants, traders, and investors.
The MQP would reward Market Makers for committing capital to securities and meeting rigorous market quality benchmarks established by the Program.
This approach has worked very successfully in overseas markets, including the NASDAQ OMX Nordic First North market (known as “First North”).
The practice of paid for market making to increase the liquidity of less liquid securities was examined by Johannes A. Skjeltorp and Bernt Arne Odegaard in a working paper from June 2011.
Skjeltorp and Odegaard examined paid for market making on the Oslo Stock Exchange, which uses a market making model that is similar to that of NASDAQ's First North market,
and noted that they “* * * find a significant reduction in liquidity risk and cost of capital for firms that hire a market maker. Firms that prior to hiring a market maker * * * [have] a high loading on a liquidity risk factor, experience a significant reduction in liquidity risk to a level similar to that of the larger and more liquid stocks on the exchange.”
About six years prior to the Skjeltorp and Odegaard article, Amber Anand, Carsten Tanggaard, and Daniel G. Weaver studied liquidity provision through paid for market making on the Stockholm Stock Exchange (“SSE”), currently named NASDAQ OMX Stockholm AB.
The researchers examined the success of fifty previously illiquid firms that were listed on the SSE and enjoyed, along with investors, the benefits of paid for market making. The researchers examined the impact of the paid market maker program and found that firms experienced “* * * a decreased cost of capital and significant improvements in market quality and price discovery.” 
The market makers were known as liquidity providers, and the firms could set maximum spread widths for their stocks, as is currently done. Anand, Tanggaard, and Weaver found that following the beginning of paid for market making services, spreads narrowed by a statistically significant amount and depth increased at the inside and in the aggregate for four price levels away from the inside. The researchers found that accompanying the increase in depth was a significant increase in average trade size, suggesting that traders did not find it necessary to break up their orders to accommodate low market depth, and found an increase in trading activity, suggesting that liquidity providers were actively trading with public customers.
More recently, Eric Noll, Executive Vice President, NASDAQ OMX Group, described the positive impact of paid for market making in the First North market, stating that NASDAQ OMX has had “great success” in increasing liquidity in stocks on First North, a European venue for smaller companies that has a program enabling companies to compensate market makers.
Mr. Noll noted that in just five years, First North market has grown to 141 listings with a total capitalization of 2.8 billion Euros, and that 22 of the First North companies have graduated to the main market since 2006.
Paid for Market Making on the First North Market
The Exchange believes that commensurate with the previously-discussed studies regarding paid for market making,
it is instructive to examine the paid for market making experience on the First North market.
By way of background, the First North market is an alternative listing market to the NASDAQ OMX Nordic Main Market (“Main Market”).
Both First North and Main Market are subject to and regulated by European Union (“EU”) directives 
and exchange rules, and are supervised and regulated by one or more Financial Services Authorities (“FSAs”).
While the Main Market is intended for listing companies that are well established, First North is intended for listing small, young or growth companies (not unlike the beneficiaries of the MQP) while providing an infrastructure and trading and settlement systems that are similar to those of the Main Market. First North offers new or small public companies the benefits of listing on a public market and the potential for good markets through a paid for market making system, and is often the first step towards listing on the Main Market.
The First North paid for market making system is based on a standard exchange-supplied contract between a listing firm and a designated market maker (“DMM”) that sets forth market obligations for the market maker. The Exchange sets forth obligations for the MQP Market Makers (as well as MQP Companies) in proposed Rule 5950 in the belief that this provides the greatest amount of transparency and accountability for all that wish to participate in the MQP.
The paid for market making model on NASDAQ's First North has operated since 2002 and has been demonstrably successful to the benefit of issuers and investors, without material regulatory issues. One of the definitive market quality attributes associated with expansion of liquidity through paid for market making is the significant narrowing of bid/ask spreads. This phenomenon is directly and immediately beneficial for all market participants, including investors and listing companies (which may also benefit from accompanying volume increase). As depicted in the chart below, in 2010 and 2011 the Relative Time Weighted Average Spread (“RTWAS”) 
at First North was significantly better for securities with PFMM than for those without the benefit of PFMM.
The substantial positive advantage that market participants receive from PFMM is clearly demonstrated in the chart below, showing that non-PFMM security spreads were: (a) Often more than four times wider than PFMM security spreads; and (b) a majority of the time more than three times wider than PFMM spreads. Moreover, the spreads for stock with PFMM were more stable through time.
A comparison of Relative Time Weighted Average Spread on First North shows the significant, consistent impact of PFMM in narrowing spreads.
This directly benefits investors in PFMM securities by lowering their transaction costs.
In terms of regulation, the First North PFMM experience has not raised concerns. Based on Exchange discussions with the Office of General Counsel at NASDAQ OMX Nordic in respect of the First North market, the Exchange is not aware of regulatory oversight issues (e.g., Swedish FSA or Danish FSA) in respect of paid for market making on First North.
The Exchange believes that the MQP will, like paid for market making on First North, achieve positive results.
The Exchange believes that this proposal would help raise investor and issuer confidence in the fairness of their transactions and the markets in general by enhancing market maker quote competition in securities on the Exchange, narrowing spreads, increasing shares available at the inside, reducing transaction costs, supporting the quality of price discovery, promoting market transparency, and improving investor protection.
As noted, the proposal would enhance the market quality of targeted securities, particularly ETFs. The Exchange believes that ETFs offer great value to retail and institutional investment communities, as reflected in their popularity as investment vehicles both in the U.S. and abroad.
ETFs offer transparency, liquidity, diversification, cost efficiency, and investment flexibility to gain broad market exposure or to express a directional view as a core or satellite component to one's investment portfolio, and do so while offering investment exposure to all asset classes—many of which would otherwise be inaccessible.
Moreover, ETFs, particularly those that are equity based, also benefit listed companies. By being included in a single, diversified security, companies gain access to a greater audience of investors who may not have bought the individual stock.
This means that the markets are deeper and more liquid, benefiting not only investors but the economy as a whole.
This proposal will allow ETFs that may not otherwise see much trading or volume 
to be listed and traded on the Exchange in more liquid markets.
Proposed Rule 2460
Preliminarily, the Exchange is proposing to modify its Rule 2460, which prohibits direct or indirect payment by an issuer to a Market Maker, to indicate that Rule 2460 is not applicable to the MQP.
Specifically, the Exchange is proposing new IM-2460-1 (Market Quality Program) 
to state that Rule 2460 is not applicable to a member that is accepted into the Market Quality Program pursuant to Rule 5950 or to a person that is associated with such member for their conduct in connection with that program. The Exchange believes that this proposed limited clarification is proper in that it allows the MQP to go forward on a pilot basis without denigrating the basic premise of Rule 2460, which was designed to forestall problematic relationships between exchange members (e.g., market makers) and issuers. The Exchange's proposal, on the other hand, assiduously controls the exchange member/issuer relationship by setting forth an extensive rule-based process with clear Program requirements for issuers (MQP Companies) and clear market quality requirements for members (MQP Market Makers) that can only be effected in a lit and highly regulated exchange environment.
In the order approving NASD Rule 2460 (the 1997 order), upon which NASDAQ Rule 2460 is based (as is FINRA Rule 5250), the Commission discussed that NASD Rule 2460 preserved investor confidence, preserved the integrity of the marketplace, and established a clear standard of practice for member firms.
The Exchange designed the MQP to meet the goals of market integrity, investor confidence, and clear member standards as discussed in the 1997 order. In particular, the Exchange designed the MQP to have precise standards for all parties in the Program (e.g., MQP Companies and MQP Market Makers) and to be highly transparent with clear public notification requirements; with clear entry, continuation, and termination requirements; with clear Market Maker accountability standards; and, perhaps most importantly, with clear market quality (liquidity) enhancement standards that benefit investors and market participants. The positive aspects of the MQP are clear and unambiguous.
First, the entire Market Quality Program is clearly and accurately set forth in proposed Rule 5950. This includes the application and withdrawal process, the listing fee and credit structure, the market quality standards that an MQP Market Maker must meet and maintain to secure an MQP Credit, and the Program termination process. Second, the Exchange will provide notification on its public Web site regarding the variable aspects of the Program. Specifically, this notification will include the names of the MQP Companies and the MQP Market Makers that are accepted into the Program; how many MQP Securities an MQP Company may have in the Program; the specific names of the MQP Securities that are listed pursuant to the Program; the identity of the MQP Market Makers in each MQP Security; and the amount of the supplemental MQP Fee, if one is established by an MQP Company, in addition to the basic MQP Fee, as discussed below. Third, MQP Securities will be traded on a highly regulated and transparent exchange, namely NASDAQ, pursuant to the current trading and reporting rules of the Exchange, and pursuant to the established market surveillance and oversight procedures of the Exchange. And fourth, the MQP would encourage narrower spreads and better market quality (more liquid markets) for securities that generally have not been, or may not be, conducive to naturally having such markets. The Exchange believes that these factors, which directly benefit all market participants and investors, are instrumental to developing strong investor confidence in the MQP and the integrity of the market.
Moreover, the Exchange believes that the MQP does not implicate conflicts of interest. That is, unlike the situation that the NASD was trying to address in its Rule 2460 or NASD Notice to Members 75-16, where issuers had the ability to directly pay a market maker to illegally pump up the price of an issuer's stock, the proposed MQP does not encourage MQP Market Makers to improperly pump up prices nor, for that matter, establish any direct financial connection between MQP Market Makers and MQP Companies. First, an MQP Company must go through an MQP application process, and the Exchange must accept the MQP Company into the Program, before an MQP Company can list a product pursuant to the Program.
Second, an MQP Market Maker must go through a separate MQP application process, and the Exchange must accept an MQP Market Maker into the Program, before an MQP Market Maker can make a market in a product listed pursuant to the Program.
Third, in terms of flow of funds, the Exchange stands between an MQP Company and an MQP Market Maker. An MQP Company cannot and does not, under any circumstances, pay any funds to an MQP Market Maker that makes a market in the MQP Company's product pursuant to the Program. This is crucial. The Program is constructed so that the only way that an MQP Market Maker can earn an MQP Credit—the payment of which is administered by the Exchange—is to maintain a quality market in terms of the spread and liquidity of an MQP Security.
The Program does not afford any other way for an MQP Market Maker to earn an MQP Credit. The Exchange firmly believes that the clear, unambiguous, and transparent nature of the Program and its established market quality standards are counter-indicative of any inherent conflict of interest.
Additionally, the Exchange notes that the MQP is proposed initially as a pilot program. This is significant for several reasons. First, NASDAQ is proposing the pilot as an attempt to repair a gap in market structure, namely the challenge of certain small or start-up securities lacking access to quality markets with adequate liquidity.
Second, the Exchange has agreed, as part of the MQP pilot, to submit periodic reports to the Commission about market quality in respect of the MQP. These reports will endeavor to compare, to the extent practicable, securities before and after they are in the MQP. The reports will provide information regarding, for example, volume metrics, number of MQP Market Makers in target securities, and spread size, and will help the Commission and NASDAQ to evaluate the efficacy of the Program and the PFMM concept. And third, if the Exchange desires to expand the pilot program or make the MQP permanent, the Exchange will need to file a new rule change proposal with the Commission.
The Exchange believes that the MQP proposal would help raise investor and issuer confidence in the fairness of their transactions and the markets in general by enhancing market maker quote competition in securities on the Exchange, narrowing spreads, increasing shares available at the inside, reducing transaction costs, supporting the quality of price discovery, promoting market transparency, and improving investor protection.
Proposed Rule 5950—Securities Eligible for the MQP
The MQP is available to Companies that choose to list certain MQP Securities on the Exchange. To be eligible for listing, MQP Securities must meet the requirements to be listed on NASDAQ as an ETF, LS, or TIR pursuant to Rules 5705, 5710, and 5720, respectively.
In addition, the MQP Security must meet all NASDAQ requirements for continued listing during the period of time that the MQP Security is in the MQP.
Proposed Rule 5950—Application and Withdrawal
The first step for an entity wishing to participate in the MQP by listing a security on the Exchange, and for a Market Maker wishing to participate in the MQP as an MQP Market Maker, is to submit an MQP application to the Exchange.
Once the Exchange determines that the MQP Company and the MQP Market Maker are eligible to be in the MQP according to the parameters of the proposed rule, the Exchange will indicate acceptance to the MQP Company and the MQP Market Maker. NASDAQ will provide notification on its Web site regarding acceptance of an MQP Company and an MQP Market Maker into the Program.
NASDAQ may, on a Program-wide basis, limit the number of MQP Securities that any one MQP Company may list in the MQP; any limitation would be uniformly applied to all MQP Companies.
In determining to limit the number of MQP Securities in the MQP, NASDAQ may consider information that it believes will be of assistance to it, such as whether a restriction, if any, is in the best interest of NASDAQ, the MQP Company and the goals of the MQP, and investors.
Moreover, to further enhance the transparency of the Program, proposed Rule 5950(a)(1)(C) indicates that NASDAQ will also provide notification on its Web site regarding the following: the total number of MQP Securities that any one MQP Company may have in the Program; and the names of MQP Securities that are listed on NASDAQ and the MQP Market Maker(s) in each listed MQP Security.
An MQP Company and an MQP Market Maker may choose to withdraw from the Program. After an MQP Company is in the MQP for six consecutive months but less than one year, it may voluntarily withdraw from the MQP on a quarterly basis. The MQP Company must notify NASDAQ in writing not less than one month prior to withdrawing from the MQP. NASDAQ may determine, however, to allow an MQP Company to withdraw from the MQP earlier.
After an MQP Company is in the MQP for one year or more, it may voluntarily withdraw from the MQP on a monthly basis. The MQP Company must notify NASDAQ in writing one month prior to withdrawing.
After an MQP Market Maker is in the MQP for not less than one quarter, he may withdraw from the MQP on a quarterly basis. The MQP Market Maker must, similarly to an MQP Company, notify NASDAQ in writing one month prior to withdrawing.
After an MQP Company is in the MQP for one year, the MQP and all obligations and requirements of the Program will automatically continue on an annual basis unless NAQSAQ [sic] terminates the Program by providing not less than one month prior notice of intent to terminate; the MQP Company withdraws from the Program pursuant to subsection (a)(2) of this rule; or the MQP Company is terminated from the Program pursuant to subsection (d) of this rule.
Proposed Rule 5950—MQP Fees From MQP Companies
An MQP Company seeking to participate in the MQP must pay to NASDAQ an annual basic MQP Fee of $50,000 per MQP Security. The basic MQP Fee must be paid in quarterly installments as billed by NASDAQ. The basic MQP Fee will be allocated as follows: 50% will fund the Quote Share Payment that is based on Qualified Quotes; and 50% will fund the Trade Share Payment that is based on Qualified Trades, as defined and described below.
An MQP Company may also choose to pay an annual supplemental MQP Fee per MQP Security. The basic MQP Fee and supplemental MQP Fee when combined will not exceed $100,000 per year. The supplemental MQP Fee must be paid, together with the basic MQP Fee, in quarterly installments as billed by NASDAQ. The amount of the supplemental MQP Fee, if any, will be determined by the MQP Company on an annual basis. The supplemental MQP Fee must be paid, together with the basic MQP Fee, to NASDAQ in quarterly installments. An MQP Company shall indicate the proportions between 0% and 100% in which the supplemental MQP Fee will be allocated to the Quote Share Payment and/or Trade Share Payment. NASDAQ will provide notification on its Web site regarding the amount, if any, of the supplemental MQP Fee and the Quote Share Payment/Trade Share Payment allocation determined by an MQP Company.
The MQP Fee is in addition to the standard (non-MQP) NASDAQ listing fee applicable to the MQP Security and does not offset such standard listing fee.
The MQP Fee will be paid to the Exchange on a quarterly basis as billed by the Exchange, and will be credited to one or more MQP Market Makers that qualify for such credit for an MQP Security pursuant to proposed Rule 5950. NASDAQ will bill MQP Companies in arrears. NASDAQ will, at the beginning of a quarter, bill each MQP Company for the quarterly portion of an MQP Company's MQP Fee (basic and supplemental) for an MQP Security. Each such quarterly bill will be based on the MQP Credit that one or more MQP Market Makers in an MQP Security qualified for in the immediately preceding quarter pursuant to this rule.
All revenue from MQP Fees (basic and supplemental) will be credited pro rata to the eligible MQP Market Maker(s) in an MQP Security. Any portion of an MQP Fee that is not credited to eligible MQP Market Makers will be refunded to the MQP Company.
Proposed Rule 5950—MQP Credit to Market Makers
When making a market in an MQP Security, an MQP Market Maker must, in addition to fulfilling the market making obligations per Rule 4613,
meet or exceed several market quality requirements on a monthly basis to be eligible for an MQP Credit. First, for at least 25% of the time when quotes can be entered in the Regular Market Session 
as averaged over the course of a month, an MQP Market Maker must maintain: (a) At least 500 shares of attributable, displayed quotes 
or orders at the NBBO or better on the bid side of an MQP Security; and (b) at least 500 shares of attributable, displayed quotes or orders at the NBBO or better on the offer side of an MQP Security. And second, for at least 90% of the time when quotes can be entered in the Regular Market Session as averaged over the course of a month, a MQP Market Maker must maintain: (a) At least 2,500 shares of attributable, displayed posted liquidity on the NASDAQ Market Center that are priced no wider than 2% away from the NBBO on the bid side of an MQP Security; and (b) at least 2,500 shares of attributable, displayed posted liquidity on the NASDAQ Market Center that are priced no wider than 2% away from the NBBO on the offer side of an MQP Security.
MQP Credits for each MQP Security will be calculated monthly and credited quarterly on a pro rata basis to one or more eligible MQP Market Makers. Each MQP Credit will be comprised of a Quote Share Payment that is based on Qualified Quotes, and a Trade Share Payment that is based on Qualified Trades.
Trade Share Payments will, as discussed, be based upon the total aggregate share amount of Qualified Trades in an MQP Security executed on the NASDAQ Market Center, and Quote Share Payments will be based in equal proportions on: (a) Average quoted size at or better than NBBO; and (b) average time spent quoting at or better than NBBO.
An MQP Credit will be credited quarterly to an MQP Market Maker on a pro rata basis for each month during such quarter that an MQP Market Maker is eligible to receive a credit pursuant to the proposed rule. However, the calculation to establish the eligibility of an MQP Market Maker will be done on a monthly basis. Thus, for example, if during a quarter an MQP Market Maker was eligible to receive a credit for two out of three months, he would receive a quarterly pro rata MQP Credit for those two months.
NASDAQ may limit, on a Program-wide basis, how many MQP Market Makers are permitted to register in an MQP Security, and will provide notification on its Web site of any such limitation. As discussed above, if a limit is established, NASDAQ will allocate available MQP Market Maker registrations in a first-come-first-served fashion based on successful completion of an MPQ [sic] Market Maker application.
Finally, to give the Exchange and the Commission an opportunity to evaluate the impact of the MQP on the quality of markets in MQP Securities, the Exchange is proposing that the MQP will be effective for a one-year pilot period. During the pilot period, the Exchange will submit monthly reports to the Commission about market quality in respect of the MQP. The reports will endeavor to compare, to the extent practicable, securities before and after they are in the MQP and will include information regarding the MQP such as: (1) Rule 605 metrics; 
(2) volume metrics; (3) number of MQP Market Makers in target securities; (4) spread size; and (5) availability of shares at the NBBO.
The first report will be submitted within sixty days after the MQP becomes operative.
The Exchange believes that its surveillance procedures are adequate to properly monitor the trading of targeted securities (including ETFs) on the Exchange during all trading sessions, and to detect and deter violations of Exchange rules and applicable federal securities laws. Trading of the targeted MQP Securities through the Exchange will be subject to FINRA's surveillance procedures for derivative products including ETFs.
The Exchange may obtain information via the Intermarket Surveillance Group (“ISG”) from other exchanges that are members or affiliates of the ISG 
and from listed MQP Companies and public and non-public data sources such as, for example, Bloomberg.
2. Statutory Basis
NASDAQ believes that the proposed rule change is consistent with the provisions of Section 6 of the Act,
in general, and with Sections 6(b)(4) and 6(b)(5) of the Act,
in particular, in that it provides for the equitable allocation of reasonable dues, fees, and other charges among members and issuers or Companies and other persons using any facility or system which NASDAQ operates or controls, and it is designed to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market, and, in general, to protect investors and the public interest.
The goal of the MQP—to incentivize members to make high-quality, liquid markets—supports the primary goal of the Act to promote the development of a resilient and efficient national market system. Congress instructed the Commission to pursue this goal by emphasizing multiple policies, including the promotion of price discovery, order interaction, and competition among orders and markets. The MQP promotes all of these policies; it will enhance quote competition, improve NASDAQ liquidity, support the quality of price discovery, promote market transparency and increase competition for listings and trade executions while reducing spreads and transaction costs. Maintaining and increasing liquidity in exchange-listed securities executed on a registered exchange will help raise investors' confidence in the fairness of the market and their transactions. Improving liquidity in this manner is particularly important with respect to ETFs and low-volume securities, as noted by the Joint CFTC/SEC Advisory Commission on Emerging Regulatory Issues.
Each aspect of the MQP adheres to and supports the Act. First, the Program promotes the equitable allocation of fees and dues among issuers. The MQP is completely voluntary in that it will provide an additional means by which issuers may relate to the Exchange without modifying the existing listing options. Issuers can supplement the standard listing fees (which have already been determined to be consistent with the Act) with those of the MQP (which are consistent with the Act as well). While the MQP will result in higher fees for issuers that choose to participate, the issuers receive significant benefits for participating, including committed Market Makers, greater liquidity, and lower transaction costs for their investors. Additionally, issuers will have the ability to withdraw from the Program after an initial commitment in the event they determine that participation is not beneficial. In that case, the withdrawing issuers will automatically revert to the already-approved fee schedule applicable to the market tier in which their shares are listed.
The MQP also represents an equitable allocation of fees and dues among Market Makers. Again, the MQP is completely voluntary with respect to Market Maker participation in that it will provide an additional means by which members may qualify for a credit, without eliminating any of the existing means of qualifying for incentives on the Exchange. Currently, NASDAQ and other exchanges use multiple fee arrangements to incentivize Market Makers to maintain high quality markets or to improve the quality of executions, including various payment for order flow arrangements, liquidity provider credits, and NASDAQ's Investor Support Program (set forth in NASDAQ Rule 7014). Market Makers that choose to undertake increased burdens pursuant to the MQP will be rewarded with increased credits; those that do not undertake such burdens will receive no added benefit. As with issuers, Market Makers that choose to participate in the MQP will be permitted to withdraw from it after an initial commitment if they determine that the burdens imposed by the MQP outweigh the benefits provided.
Additionally, the MQP establishes an equitable allocation of fees among Market Makers that choose to participate and fulfill the obligations imposed by the rule. If one Market Maker fulfills those obligations, the MQP Fee will be distributed to that Market Maker; if multiple Market Makers satisfy the standard, the MQP Fee will be distributed pro rata among them. Any portion of an MQP Fee that is not credited to eligible MQP Market Makers will be refunded to the relevant MQP Company. All fees paid by issuers choosing to participate in the MQP, both initial and supplemental MQP Fees, will be available for distribution to eligible NASDAQ Market Makers. In other words, all of the benefit of the MQP Fees will flow to high-performing Market Makers rather than to NASDAQ, provided that at least one Market Maker fulfills the obligations under the proposed rule.
The MQP is designed to avoid unfair discrimination among Market Makers and issuers. The proposed rule contains objective, measurable (universal) standards that NASDAQ will apply with care. These standards, both for issuers and for Market Makers, will be applied equally to ensure that similarly situated parties are treated similarly. This is equally true for inclusion of issuers and Market Makers, withdrawal of issuers and Market Makers, and termination of eligibility for the MQP. The standards are carefully constructed to protect the rights of all parties wishing to participate in the Program by providing notice of requirements and a description of the selection process. NASDAQ will apply these standards with the same care and experience with which it applies the many similar rules and standards in NASDAQ's rule manuals.
NASDAQ notes that it operates in a highly competitive market in which market participants can readily favor competing venues if they deem fee levels at a particular venue to be excessive, or rebate opportunities available at other venues to be more favorable. In such an environment, NASDAQ must continually adjust its fees and program offerings to remain competitive with other exchanges and with alternative trading systems that have been exempted from compliance with the statutory standards applicable to exchanges. NASDAQ believes that all aspects of the proposed rule change reflect this competitive environment because the MQP is designed to increase the credits provided to members that enhance NASDAQ's market quality.
Finally, NASDAQ notes that the proposed paid for market making system has been used successfully for years on NASDAQ OMX Nordic's First North market. The First North paid for market making system has been quite beneficial to market participants including investors and listing companies (issuers) that have experienced market quality and liquidity with narrowed spreads. The Exchange believes that the proposed MQP will similarly enjoy positive results to the benefit of investors in MQP Securities and Companies related to them and the financial markets as a whole.
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.
C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action
Within 45 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 Exchange consents, the Commission shall:
(a) By order approve or disapprove 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 proposed rule change is consistent with the Act. The Commission requests comment, in particular, on the following aspects of the proposed rule change:
1. Much of the reasoning, empirical data, and academic literature discussed by NASDAQ in its proposal is based on providing market making incentives to enhance the market quality of, and capital formation for, smaller operating companies. However, the MQP proposed by NASDAQ would apply only to certain exchange-traded derivative securities products (defined in the proposal as MQP Securities to include Exchange Traded Funds, Linked Securities, and Trust Issued Receipts), and not to operating companies. Are the same arguments and rationale discussed by NASDAQ for operating companies equally applicable to exchange-traded products? Would the reported effects of other market-making incentive programs designed to enhance the market quality of traded operating companies be similar if applied to exchange-traded products? If so, how so? If not, why not?
2. How, if at all, might a market-making incentive program applied to exchange-traded products impact the operating companies that comprise the index underlying such exchange-traded products? Under what circumstances could an impact on those companies be beneficial or harmful? Could any impact differ depending on whether or not an exchange-traded product uses derivatives to gain exposure to such companies, or uses leverage or inverse leverage?
3. What are commenters' views on NASDAQ's assertion that being included as a “component” of an exchange-traded product (such as an ETF) results in benefits to an individual operating company? Do commenters agree with this assertion? Why or why not? Could such benefits arise independently from a company's inclusion in an underlying index, regardless of whether an exchange-traded product tracking such an index is traded? Is there any data available that analyzes the impact on a company when it becomes a component of an underlying index versus when it becomes a portfolio component of an exchange-traded product that tracks such an index?
4. How does the rationale in support of trading lesser-known or smaller operating companies translate to the need for similar support of an exchange-traded product that tracks these companies? What about an exchange-traded product that tracks and invests in very liquid companies, but itself has low levels of liquidity? Is there an independent rationale for needing to support these types of exchange-traded products when the market does not? Are there unintended consequences of incentivizing such products? If so, what are they?
5. Given the inherent arbitrage link between trading exchange-traded products and their underlying holdings, why would a lack of liquidity in such a product impact the ability of market makers to quote relatively narrow bids and offers? What, if anything, does a lack of liquidity or wide bid-ask spread in an exchange-traded product indicate about the ability of a market maker to make effective use of arbitrage and the creation/redemption mechanisms often associated with exchange-traded products? How, if at all, would a market-making incentive program affect any intraday premium (discount) of the traded price of an exchange-traded product above (below) its intraday indicative value?
6. NASDAQ states that the MQP is designed to promote market quality in MQP Securities by, among other things, encouraging narrow spreads and greater liquidity. Under the proposal, MQP Market Makers would receive MQP Credits for quoting at or near the NBBO, regardless of the actual NBBO spread. The Commission seeks specific commentary on any potential impact of the proposed rules on the market quality of the MQP Securities. Do commenters agree with the Exchange that the MQP would encourage tighter quoted prices and greater quoted size at the NBBO for MQP Securities? If so, please explain. If not, why not?
7. Do commenters believe that the MQP would result in MQP Market Makers quoting at better prices (and larger sizes) than they would otherwise quote without the incentives provided by the Program? Why or why not?
8. If the market qualities of two securities share similar characteristics (quoted spread, size, volume, etc.) but one is supported by MQP incentives and the other is not, what, if anything, does that suggest about the comparative robustness of those market qualities? Are there aspects of this type of incentivized market quality that should concern investors? Are such apparent improvements in market quality consistent with the Act and investor protection? Why or why not?
9. FINRA Rule 5250 prohibits FINRA members from directly or indirectly accepting payment from an issuer of a security for acting as a market maker. NASDAQ notes in its filing that it expects FINRA to file a proposed rule change to amend its Rule 5250 to exempt NASDAQ programs, such as the MQP, that are approved by the Commission. In addition, NASDAQ has its own rule, substantially similar to FINRA Rule 5250, which prohibits direct or indirect payment by an issuer to a market maker. The Exchange stated that it designed the MQP to meet the goals of market integrity, investor confidence, and clear member standards discussed in the Commission's order approving NASD Rule 2460 (which is now FINRA Rule 5250).
Do commenters believe the MQP would or would not raise concerns regarding investor confidence, market integrity, and member standards? For example, NASD Rule 2460 was implemented, in part, to address concerns about issuers paying market makers to improperly influence the price of an issuer's stock.
What are commenters' views on whether, and if so, how, the MQP would be consistent with this basis?
10. Could there be conflicts of interest between an MQP Company (the issuer) and the designated MQP Market Maker(s) for such MQP Securities participating in the Program? If so, what are those conflicts of interest? 
Please explain whether NASDAQ's proposal adequately addresses such potential conflicts.
11. In order to address concerns about potential conflicts of interest between issuers and market makers, NASDAQ stated that it designed the MQP to have clear and precise standards for all parties in the Program (e.g., MQP Companies and MQP Market Makers).
Should such participation standards also be objective to ensure that there is a level playing field in determining who the issuers and market makers are for a particular MQP Security in the Program? Are the proposed criteria for participation by potential MQP Market Makers and/or potential MQP Companies in the MQP sufficiently clear, precise, and objective? Why or why not?
12. Is it appropriate and consistent with the Act to allow MQP Companies to pay the additional Supplemental MQP Fee at their discretion? Why or why not? Is it appropriate and consistent with the Act to allow MQP Companies to be able to decide how to allocate their Supplemental MQP Fee between Quote Share Payments and Trade Share Payments? Why or why not? What would be the impact on market maker incentives of allowing MQP Companies to pay the additional Supplemental MQP Fee and to decide how to allocate its Supplement MQP Fee between Quote Share Payments and Trade Share Payments? Please explain.
13. With respect to a series of MQP Securities, should the MQP Company paying the MQP Fee be the sponsor or the fund? What impact, if any, would it have on fund investors if the fund pays the MQP Fee as opposed to the sponsor? Are the proposed Rules sufficiently clear as to which entity will be paying the MQP Fee?
14. Section 11(d)(1) of the Act generally prohibits a firm that is both a broker and a dealer in securities from extending or maintaining any credit on any new issue security if the broker-dealer participated in the distribution of the new issue security within the preceding 30 days. The Commission has granted relief to authorized participants from these restrictions if, among other things, neither the broker-dealer authorized participant, nor any natural person associated with such broker-dealer authorized participant, directly or indirectly, receives from the fund complex any payment, compensation, or other economic incentive to promote or sell the shares of the fund to persons outside the fund complex, other than non-cash compensation permitted under NASD Rule 2380. Should authorized participants participating in the creation and redemption of shares of MQP Securities that are also MQP Market Makers in those same MQP Securities be eligible to receive MQP Credits derived from Trade Share Payments? Would MQP Credits derived from Trade Share Payments give these authorized participants economic incentives to promote or sell shares of the MQP Security? Should such payments be viewed by the Commission as coming directly or indirectly from the fund complex of the MQP Security? Should MQP Credits derived from Trade Share Payments disqualify broker-dealer authorized participants from relying on the Commission's exemption from Section 11(d)(1) of the Act?
15. Could the MQP have an impact (either positive or negative) on incentives for market making in other exchange-traded products listed and traded on NASDAQ that are not eligible for and/or do not participate in the Program, either because NASDAQ has limited the total number of MQP Securities that any one MQP Company may have in the MQP, the MQP Company does not qualify for the MQP, or the MQP Company's application for participation is otherwise denied? If so, what type of impact, and why? If not, why not? Please explain.
16. Proposed Rule 5950(d)(1)(A) states that the MQP will terminate if an MQP Security sustains an average NASDAQ ATV of two million shares or more for three consecutive months. Is this proposed threshold for discontinuance in the Program reasonable? If so, why? If not, why not? Should there be an alternative threshold or measure to determine termination from the Program? Please explain.
17. Could the MQP have unintended consequences on fair and orderly markets in an MQP Security when such security leaves the program? If so, what could these consequences be? If not, why not? Please explain.
18. NASDAQ has proposed to implement the MQP on a one-year pilot basis. Is one-year a reasonable time period during which to assess the impact of the proposed rules? If not, why not? Please explain.
19. What additional data, if any, should be provided by NASDAQ to help assess during the pilot period whether the MQP is achieving its stated goals? For example, if the Exchange required MQP Securities to be listed and traded outside the MQP for a period of time before being eligible for the MQP, could such a requirement provide useful “before and after” data for MQP Securities to permit the Exchange and the Commission to more accurately assess the market quality of the securities before participating in the Program and the market quality of the same securities while participating in the Program? If so, how? If not, please explain.
20. The MQP proposed rule provides for certain public disclosures relating to the Program (i.e., notifications on NASDAQ's Web site will include names of the MQP Companies and the MQP Market Makers that are accepted into the Program, how many MQP Securities an MQP Company may have in the Program, the specific names of the MQP Securities that are listed pursuant to the Program, the identity of the MQP Market Makers in each MQP Security, the amount of the supplemental MQP Fee, etc.).
Do commenters believe that these disclosures would provide sufficient information to investors? If not, why not? Is there any other information that the Exchange should provide on its Web site regarding the MQP and participating MQP Securities, MQP Companies, and MQP Market Makers? For example, should NASDAQ be required to provide notification on its Web site of any notices from an MQP Company or MQP Market Maker to withdraw from the Program? What advantages or disadvantages would such disclosure provide? Please explain.
21. Would it be helpful to investors to have public notice of an MQP Company's participation in the Program through means other than on the Exchange's Web site, such as in the MQP Company's periodic reports to the Commission, on the MQP Company's Web site, or through a ticker symbol identifier on the consolidated tape? Why or why not?
22. What are commenters' views on whether the proposed disclosures are sufficient to enable all investors, even less sophisticated investors, to understand the potential impact of the proposed MQP on the market quality of an MQP Security, including that an MQP Company's participation in the Program is voluntary and subject to withdrawal, or that the MQP Security may become ineligible for the Program if its trading volume reaches sufficiently high levels?
23. Should the Exchange be required to publicly (and anonymously) disclose statistics on the performance of MQP Market Makers? Would such disclosure provide meaningful information to investors (e.g., would such disclosure provide investors the opportunity to assess how much perceived liquidity is being provided by MQP Market Makers, as opposed to liquidity provided by market makers and other market participants who are not paid an MQP Credit)? If so, what information should be disclosed and why? If not, why not? What advantages or disadvantages would such disclosure provide? Please explain.
Comments may be submitted by any of the following methods:
- Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-NASDAQ-2012-043. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Web site viewing and printing in the Commission's Public Reference Section, 100 F Street NE., Washington, DC 20549-1090, on official business days between 10 a.m. and 3 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-NASDAQ-2012-043 and should be submitted on or before May 3, 2012.
For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.
Kevin M. O'Neill,
[FR Doc. 2012-8789 Filed 4-11-12; 8:45 am]
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