omb approval omb number: 3235-0045 expires:...
TRANSCRIPT
Exhibit 3 Sent As Paper DocumentExhibit 2 Sent As Paper Document
has duly caused this filing to be signed on its behalf by the undersigned thereunto duly authorized officer.
19b-4(f)(6)
19b-4(f)(5)
Provide a brief description of the proposed rule change (limit 250 characters).
(Name)
NOTE: Clicking the button at right will digitally sign and lockthis form. A digital signature is as legally binding as a physicalsignature, and once signed, this form cannot be changed.
Executive Vice President and General Counsel
(Title)
10/19/2009Date
Provide the name, telephone number and e-mail address of the person on the staff of the self-regulatory organizationprepared to respond to questions and comments on the proposed rule change.
Vice President and Deputy General CounselTitle
Contact Information
19b-4(f)(4)
19b-4(f)(2)
19b-4(f)(3)
Extension of Time Periodfor Commission Action
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
Form 19b-4
Withdrawal
Fax (301) 978-8472
Jeffrey Last Name
2
Proposed Rule Change by
Pilot
NASDAQ Stock Market
104-2008
Amendment No.
File No. SR -
Davis
(301) 978-8484Telephone
First Name
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
Section 19(b)(3)(A) Section 19(b)(3)(B)Initial Amendment
Pursuant to Rule 19b-4 under the Securities Exchange Act of 1934
Description
Edward S Knight,
Edward S. KnightBy
Section 19(b)(2)
19b-4(f)(1)
Page 1 of 54
OMB APPROVAL
OMB Number: 3235-0045Expires: August 31, 2011Estimated average burdenhours per response............38
Rule
Date Expires
If the self-regulatory organization is amending only part of the text of a lengthyproposed rule change, it may, with the Commission's permission, file only thoseportions of the text of the proposed rule change in which changes are being made ifthe filing (i.e. partial amendment) is clearly understandable on its face. Such partial amendment shall be clearly identified and marked to show deletions and additions.
Partial Amendment
Add Remove View
The self-regulatory organization may choose to attach as Exhibit 5 proposedchanges to rule text in place of providing it in Item I and which may otherwise bemore easily readable if provided separately from Form 19b-4. Exhibit 5 shall beconsidered part of the proposed rule change.
Exhibit 5 - Proposed Rule Text
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
For complete Form 19b-4 instructions please refer to the EFFS website.
Copies of any form, report, or questionnaire that the self-regulatory organizationproposes to use to help implement or operate the proposed rule change, or that isreferred to by the proposed rule change.
Exhibit Sent As Paper Document
Exhibit 4 - Marked Copies
Add Remove View
Exhibit 3 - Form, Report, or Questionnaire
Add Remove
View
Exhibit 2 - Notices, Written Comments, Transcripts, Other Communications
Add Remove
View
Exhibit 1 - Notice of Proposed Rule Change
Add
Form 19b-4 Information
Remove
Add Remove
The full text shall be marked, in any convenient manner, to indicate additions to anddeletions from the immediately preceding filing. The purpose of Exhibit 4 is to permitthe staff to identify immediately the changes made from the text of the rule with which it has been working.
View
The self-regulatory organization must provide all required information, presented in a clear and comprehensible manner, to enable the public to provide meaningfulcomment on the proposal and for the Commission to determine whether theproposal is consistent with the Act and applicable rules and regulations under the Act.
View
Exhibit Sent As Paper Document
The Notice section of this Form 19b-4 must comply with the guidelines forpublication in the Federal Register as well as any requirements for electronic filingas published by the Commission (if applicable). The Office of the Federal Register(OFR) offers guidance on Federal Register publication requirements in the Federal Register Document Drafting Handbook, October 1998 Revision. For example, allreferences to the federal securities laws must include the corresponding cite to the United States Code in a footnote. All references to SEC rules must include thecorresponding cite to the Code of Federal Regulations in a footnote. All referencesto Securities Exchange Act Releases must include the release number, releasedate, Federal Register cite, Federal Register date, and corresponding file number(e.g., SR-[SRO]-xx-xx). A material failure to comply with these guidelines will result in the proposed rule change being deemed not properly filed. See also Rule 0-3 underthe Act (17 CFR 240.0-3)
Copies of notices, written comments, transcripts, other communications. If suchdocuments cannot be filed electronically in accordance with Instruction F, they shallbe filed in accordance with Instruction G.
Add Remove View
SR-NASDAQ-2008-104 Amendment 2 Page 3 of 54 1. Text of Proposed Rule Change
(a) Pursuant to the provisions of Section 19(b)(1) under the Securities Exchange
Act of 1934 (“Act”),1 and Rule 19b-4 thereunder,2 The Nasdaq Stock Market LLC
(“Nasdaq”), is filing with the Securities and Exchange Commission (“Commission”) a
Response to Comments and Proposed Amendment 2 regarding its proposal (“Proposal”)
to modify NASDAQ Rule 4611 which governs electronic access to NASDAQ’s order
execution systems.3
The text of the proposed rule change is below. Proposed new language is
underlined; proposed deletions are in brackets.
The Proposal is designed to clarify and improve the existing
regulatory framework governing the manner in which NASDAQ members provide
Sponsored Access and Direct Market Access to firms and other NASDAQ members.
Nasdaq is proposing to amend Rule 4611(d) to ensure that member firms are assuming
full responsibility for their customers’ trading activity and have effective financial and
regulatory controls in place to protect market participants from systemic risk and preserve
the integrity of the marketplace. The Proposal will also ensure that NASDAQ has access
to all information necessary to provide effective exchange oversight.
4
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b-4. 3 The Proposal was filed on December 30, 2009, amended on January 8, 2009, and published for
notice and comment in the Federal Register on January 29, 2009. See Exchange Act Release No. 59275 (Jan. 22, 2009), 74 FR 5193 (Jan. 29, 2009).
4 Changes are marked to the rule text that appears in the electronic manual of Nasdaq found at http://nasdaq.complinet.com.
SR-NASDAQ-2008-104 Amendment 2 Page 4 of 54
* * * * *
4611. Nasdaq Market Center Participant Registration
(a) – (c) No change.
(d) [Members may provide “Sponsored Access” to the Nasdaq Market Center in accordance with the provisions below: Sponsored Participants. A Sponsored Participant may obtain authorized access to the Nasdaq Market Center only if such access is authorized in advance by one or more Nasdaq members as follows:]
[(1) Sponsored Participants must enter into and maintain customer agreements with one or more Sponsoring Members establishing proper relationship(s) and account(s) through which the Sponsored Participant may trade on the Nasdaq Market Center. Such customer agreement(s) must incorporate the Sponsorship Provisions set forth in paragraph (2) below.]
[(2) For a Sponsored Participant to obtain and maintain authorized access to the Nasdaq Market Center, a Sponsored Participant and its Sponsoring Member must agree in writing to the following Sponsorship Provisions:
(A) Sponsored Participant and its Sponsoring Member must have entered into and maintained a User Agreement with The NASDAQ Stock Market LLC. The Sponsoring Member must designate the Sponsored Participant by name in its User Agreement as such.
(B) Sponsoring Member acknowledges and agrees that (i) All orders entered by the Sponsored Participants and any person acting on behalf of or in the name of such Sponsored Participant and any executions occurring as a result of such orders are binding in all respects on the Sponsoring Member and
(ii) Sponsoring Member is responsible for any and all actions taken by such Sponsored Participant and any person acting on behalf of or in the name of such Sponsored Participant.
(C) Sponsoring Member shall comply with the Nasdaq Certificate of Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center and Sponsored Participant shall comply with Nasdaq Certificate of Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center, as if Sponsored Participant were a Nasdaq Member.
SR-NASDAQ-2008-104 Amendment 2 Page 5 of 54
(D) Sponsored Participant shall maintain, keep current and provide to the Sponsoring Member a list of individuals authorized to obtain access to the Nasdaq Market Center on behalf of the Sponsored Participant. (E) Sponsored Participant shall familiarize its authorized individuals with all of the Sponsored Participant's obligations under this Rule and will assure that they receive appropriate training prior to any use or access to the Nasdaq Market Center. (F) Sponsored Participant may not permit anyone other than authorized individuals to use or obtain access to the Nasdaq Market Center. (G) Sponsored Participant shall take reasonable security precautions to prevent unauthorized use or access to the Nasdaq Market Center, including unauthorized entry of information into the Nasdaq Market Center, or the information and data made available therein. Sponsored Participant understands and agrees that Sponsored Participant is responsible for any and all orders, trades and other messages and instructions entered, transmitted or received under identifiers, passwords and security codes of authorized individuals, and for the trading and other consequences thereof. (H) Sponsored Participant acknowledges its responsibility to establish adequate procedures and controls that permit it to effectively monitor its employees’, agents’ and customers' use and access to the Nasdaq Market Center for compliance with the terms of this agreement. (I) Sponsored Participant shall pay when due all amounts, if any, payable to Sponsoring Member, Nasdaq, or any other third parties that arise from the Sponsored Participant’s access to and use of the Nasdaq Market Center. Such amounts include, but are not limited to applicable exchange and regulatory fees.]
[(3) The Sponsoring Member must provide Nasdaq with a Notice of Consent acknowledging its responsibility for the orders, executions and actions of its Sponsored Participant at issue.]
Access to a Trading Center. If a member enters into an arrangement with another person (e.g., a customer, another member, or a non-member broker-dealer) to provide that person with access to Nasdaq or otherwise allow such person to route its orders to Nasdaq using the member’s market participant identifier (“MPID”), the member is responsible for all trading conducted pursuant to that arrangement to the same extent as trading directly conducted by the member for customers. Consequently, the member is responsible for implementing policies and
SR-NASDAQ-2008-104 Amendment 2 Page 6 of 54 procedures for supervising and monitoring the trading effected pursuant to the arrangement to ensure that it is in compliance with all applicable federal securities laws and rules and Exchange rules. This obligation applies irrespective of the manner in which orders pursuant to such arrangements reach Nasdaq.
(1) Definition.
(A) Sponsored Access is the practice by a member (“Sponsoring Member”) of providing access to Nasdaq to another person, firm or customer (“Sponsored Participant”) whereby the Sponsored Participant enters orders into Nasdaq using a Sponsored Access System but the orders do not pass through a Member System prior to reaching Nasdaq.
(B). Direct Market Access (“DMA”) is the practice by a member (“Sponsoring Member”) of providing access to Nasdaq to another person, firm or customer (“Sponsored Participant”) whereby the Sponsored Participant makes decisions regarding order routing and order entry but the orders pass through a Member System prior to reaching Nasdaq.
(C). A Member System is any system administered and controlled solely by the Sponsoring Member and that applies the pre- and post-trade financial and regulatory controls set forth in sections (4) and (5) below.
(D) A Sponsored Access System is any system that applies pre- and post-trade financial and regulatory controls set forth in sections (4) and (5) below and that is not administered and controlled solely by the Sponsoring Member.
(2) Compliance. To ensure that Sponsored Access is consistent with high market quality and the protection of investors, Sponsoring Members providing Sponsored Access shall at a minimum comply with the Contractual Provisions, Financial Controls, and Regulatory Controls set forth in sections (3), (4), and (5) below. Sponsoring Members providing Direct Market Access shall at a minimum comply with the Financial Controls and Regulatory Controls set forth in sections (4) and (5) below.
(3) Contractual Provisions.
SR-NASDAQ-2008-104 Amendment 2 Page 7 of 54
(A) A Sponsoring Member that provides Sponsored Access shall execute and maintain agreements with each Sponsored Participant containing the commitments below.
(i ) All trading activity by the Sponsored Participant shall comply with all applicable federal securities laws and rules and Exchange rules, including but not limited to the Nasdaq Certificate of Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center (“Regulatory Requirements”).
(ii) Sponsored Participant shall promptly upon request provide Sponsoring Member with access to such books and records and financial information that is necessary to allow the Sponsoring Member to comply with its regulatory obligations with respect to activity of the Sponsored Participant within the Sponsored Access arrangement, and otherwise cooperate with the Sponsoring Member in furtherance of Sponsoring Member’s compliance with applicable Regulatory Requirements. Information provided by Sponsored Participants to Sponsoring Members pursuant to such requests shall be maintained as confidential by the Sponsoring Member, provided that such information shall be available to Nasdaq upon request for regulatory purposes.
(iii) Sponsored Participant shall maintain its trading activity within the credit, product or other financial limits specified by the Sponsoring Member.
(iv) Sponsored Participant shall maintain all technology permitting sponsored access to Nasdaq in a physically secure manner and may not permit unauthorized individuals to use or obtain access to Nasdaq. Sponsored Participant shall familiarize its authorized individuals with the Regulatory Requirements and will provide appropriate training prior to use or access to Nasdaq.
(v) Sponsored Participant shall agree that the Sponsoring Member or Nasdaq may immediately terminate the Sponsored Access if the Sponsoring Member or Nasdaq determines that continuing such access poses serious risk to the Sponsoring Member or to the integrity of the market.
(B) A Sponsoring Member that provides Sponsored Access shall execute and maintain agreements with each third party (“Third Party Provider”) that provides a Sponsored Access System to Sponsored Participants for accessing Nasdaq, specifying which of the financial and regulatory controls stated in subsections (4) and (5) below are
SR-NASDAQ-2008-104 Amendment 2 Page 8 of 54
satisfied by the technology provided, and containing the commitments below.
(i) Third Party Providers shall promptly upon request provide Sponsoring Member with access to such books and records and financial information that is necessary to allow the Sponsoring Member to comply with its regulatory obligations with respect to activity of the Sponsored Participant within the Sponsored Access arrangement, and otherwise cooperate with the Sponsoring Member in furtherance of Sponsoring Member’s compliance with applicable Regulatory Requirements. Information provided by Sponsored Participants to Sponsoring Members pursuant to such requests shall be maintained as confidential by the Sponsoring Member, provided that such information shall be available to Nasdaq upon request for regulatory purposes.
(ii) Third Party Providers shall maintain all technology permitting Sponsored Access to Nasdaq in a physically secure manner and may not permit unauthorized individuals to use or obtain access to Nasdaq.
(iii) Third Party Providers shall agree that Nasdaq or its agent may audit the Sponsored Access System and that the Sponsoring Member or Nasdaq may immediately terminate the Sponsored Access if the Sponsored Participant or Third Party Provider fails to abide by its commitments.
(4) Financial Controls. Each Sponsoring Member shall establish adequate procedures and controls that permit it to effectively monitor and control the Sponsored Access or Direct Market Access to systemically limit the Sponsoring Member’s financial exposure. At a minimum, the Member System or Sponsored Access System shall be reasonably designed to:
(A) Prevent each Sponsored Participant from entering orders that in aggregate exceed appropriate pre-set credit thresholds. Sponsoring Members may also set finely-tuned credit thresholds by sector, security or otherwise. (B) Prevent Sponsored Participants from trading products that the Sponsoring Member is restricted from trading or that the Sponsored Participant is restricted from trading for reasons specific to the Sponsored Participant. (C) Prevent Sponsored Participants from submitting erroneous orders by providing for the rejection of orders that exceed certain price or size
SR-NASDAQ-2008-104 Amendment 2 Page 9 of 54
parameters, on an order-by-order basis or over a short period of time, or that indicate duplicative orders.
(5) Regulatory Controls. Each Sponsoring Member shall establish
adequate procedures and controls reasonably designed to permit it to effectively monitor and control compliance with Regulatory Requirements,
(A) Each Sponsoring Member shall have systemic controls reasonably designed to ensure compliance by the Sponsored Participant with all applicable Regulatory Requirements. (B) Each Sponsoring Member shall ensure that appropriate supervisory personnel receive and review timely reports of all trading activity by its Sponsored Participants sufficient to permit the Sponsoring Member to comply with applicable Regulatory Requirements, and to monitor for illegal activity such as market manipulation or insider trading. At a minimum, appropriate supervisory personnel should receive immediate post-trade execution reports of trading activity of all Sponsored Participants, including their identities; all required audit trail information by no later than the end of the trading day; and all information necessary to create and maintain the trading records required by applicable Regulatory Requirements by no later than the end of the trading day. Appropriate supervisory personnel shall review execution reports immediately and all other reports promptly.
(b) Not applicable.
(c) Not applicable.
2. Procedures of the Self-Regulatory Organization
The Board of Directors of Nasdaq approved the proposed rule change at its
meeting on March 7, 2006, which authorized the filing of the rule change with the
Commission. No other action is necessary under the Exchange’s governing documents
for the filing of the rule change.
Questions regarding this rule filing may be directed to Jeffrey S. Davis, Vice
President and Deputy General Counsel, The Nasdaq Stock Market LLC at (301) 978-
8484.
SR-NASDAQ-2008-104 Amendment 2 Page 10 of 54 3. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
a. Purpose
Currently, Rule 4611(d) is substantially similar to Sponsored Access rules
adopted by other national securities exchanges, including New York Stock Exchange
Rule 123B and NYSE Arca Exchange Rule 7.29(b). NASDAQ is proposing to amend
Rule 4611(d) to ensure that member firms that are assuming responsibility for their
customers’ trading activity have effective financial and regulatory oversight of the
Sponsored Participant, and that NASDAQ has access to all information necessary to
provide effective exchange oversight.
Seven firms and three industry group representatives submitted comment letters
addressing the original proposal, all of which were thoughtful and all of which merit
specific consideration and response.5
5
Set forth below is a recitation of the suggested
modifications to the Proposal, NASDAQ’s response to the suggested modification, and a
Harvey Cloyd, Chief Executive Officer, Electronic Transaction Clearing, Inc., dated February 5, 2009 (“ETC Letter”); John N. Jacobs, Director of Operations, Lime Brokerage LLC, dated February 17, 2009 (“Lime I Letter”); Manisha Kimmel, Executive Director, Financial Information Forum, dated February 19, 2009 (“FIF Letter”); Ted Myerson, President, FTEN, Inc., dated February 19, 2009 (“FTEN I Letter”); Michael A. Barth, Executive Vice President, OES Market Group, dated February 23, 2009 (“OES Letter”); Jeff Bell, Executive Vice President, Clearing and Technology Group, Wedbush Morgan Securities, dated February 23, 2009 (“Wedbush Letter”); Stuart J. Kaswell, Executive Vice President & General Counsel, Managed Funds Association, dated February 24, 2009 (“MFA Letter”); Ann Vlcek, Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association, dated February 26, 2009 (“SIFMA Letter”), Nicole Harner Williams, Vice President, Associate General Counsel, Penson Financial Services, Inc., dated February 27, 2009 (“Penson Letter”); Gary LaFever, Chief Corporate Development Officer, FTEN, Inc., dated April 29, 2009 (“FTEN II Letter”); Samuel F. Lek, Chief Executive Officer, Lek Securities Corporation, dated June 15, 2009 (“Lek Letter”); John N. Jacobs, Chief Operations Officer, Lime Brokerage LLC, dated June 30, 2009 (“Lime II Letter”).
SR-NASDAQ-2008-104 Amendment 2 Page 11 of 54 description of precise changes to the rule language contained in proposed Amendment 1
to the Proposal.
Uniform Rule, Implementation, and Application
Two commenters stressed that industry regulators should develop a uniform rule
and then apply it consistently across all markets and all market participants.6
NASDAQ agrees with each of these recommendations. The regulation of
electronic access should be uniformly regulated and not create the opportunity for
arbitrage between the rules of competing exchanges. To that end, NASDAQ has been
cooperating with the Commission and the Intermarket Surveillance Group (“ISG”),
which includes all self-regulatory organizations (“SROs”) registered under the auspices
of the Commission, towards the development of a uniform rule governing electronic
access to markets. NASDAQ expects that all SROs will adopt the uniform rule and that
the SROs will coordinate with the industry representatives such as SIFMA to develop a
uniform implementation plan that includes adequate opportunity for programming and
Specifically, SIFMA recommended that all exchanges, the Financial Industry Regulatory
Authority (“FINRA”), and the Commission should cooperate to develop a uniform,
workable rule. SIFMA and Wedbush also suggested that, once developed, the uniform
rule should be consistently interpreted and enforced to ensure a level playing field.
Finally, commenters suggested that all exchanges implement the uniform rule on a
common effective date that allows market participants reasonable notice and preparation
time.
6 See SIFMA Letter, Wedbush Letter.
SR-NASDAQ-2008-104 Amendment 2 Page 12 of 54 testing. NASDAQ expects that consistency in the future application of the uniform rule
will be an on-going topic of discussion at ISG and at the Commission.
Definition of Sponsored Access and Scope of Proposed Rule
Four commenters questioned whether the Proposal properly defines Sponsored
Access.7
Specifically SIFMA and FIF suggest that the proposed definition of Sponsored
Access is overly broad and that the Proposal’s provisions should be limited exclusively to
Sponsored Access arrangements in which Sponsored Participant orders do not flow
through a Sponsoring Member’s trading technology infrastructure prior to reaching
NASDAQ. This would mean that DSA and TPSA would be subject to the proposed
Sponsored Access but that DMA would not and nor would any other electronic order
routing or execution arrangement that involves orders passing through a broker-dealer’s
infrastructure prior to reaching a destination market. The ETC and Penson Letters
recommend that the rule be more narrowly limited to DSA.
The original proposed definition of Sponsored Access included three categories
of access: (1) direct market access, where the Sponsored Participant’s orders pass through
the Sponsoring Member’s systems prior to reaching NASDAQ (“Direct Market Access”
or “DMA”), (b) sponsored access, where the Sponsored Participant enters orders directly
into NASDAQ via a dedicated port provided by the Sponsoring Member (“Direct
Sponsored Access” or “DSA”), and (c) direct access where a service bureau or other third
party provides Sponsored Participants with technology to access NASDAQ under the
auspices of and via an arrangement with the Sponsoring Member (“Third Party
Sponsored Access” or “TPSA”).
7 See ETC Letter, FIF Letter, SIFMA Letter, Penson Letter.
SR-NASDAQ-2008-104 Amendment 2 Page 13 of 54
NASDAQ agrees in part with SIFMA and FIF that the proposed rule should focus
on whether or not orders flow through a Sponsoring Member’s trading technology
infrastructure prior to reaching NASDAQ. Using that rubric, genuine Sponsored Access
would be limited to instances where the Sponsored Participant enters orders directly into
NASDAQ using the Sponsoring Member’s MPID and the orders do not pass through a
Member System before reaching NASDAQ. Sponsored Access is distinguished from
Direct Market Access (“DMA”) whereby a member provides access to NASDAQ to a
person or firm that makes decisions regarding order routing and order entry but the orders
pass through a Member System prior to reaching NASDAQ.
The key to proper regulation of both Sponsored Access and DMA are the
regulatory and financial controls set forth in proposed Rule 4611(d)(4) and (5). In DMA
arrangements, those controls are provided by a “Member System” which is any system
administered and controlled solely by a member that applies the pre- and post-trade
financial and regulatory controls set forth in sections (4) and (5) below. In a Sponsored
Access arrangement, the controls are imposed through contractual provisions set forth in
Rule 4611(d)(3) in combination with the provisions of subsections (d)(4) and (d)(5).
NASDAQ agrees with commenters that DMA arrangements are already
effectively regulated under existing laws and regulations because in such cases, the
broker-dealer that takes responsibility for orders is a member of the exchange with all
attendant compliance obligations and incentives. Orders and executions that flow
through a broker-dealer’s infrastructure are subject to all member compliance obligations
as though generated by the member itself, including capturing details for books and
SR-NASDAQ-2008-104 Amendment 2 Page 14 of 54 record rules and implementing appropriate pre- and post-trade controls.8
The same cannot be uniformly stated with respect to Sponsored Access. It is true
that all orders entering NASDAQ systems must bear a member MPID and all Sponsoring
Members currently assume full responsibility for all orders that enter NASDAQ systems
under their specific MPIDs. It is also true that NASDAQ members are already closely
regulated, and that NASDAQ systems are closely surveilled both in real-time and post
trade. Nonetheless, members may hold different views of what that responsibility
requires. Members may also assess in different ways the risks to the market posed by
Sponsored Access and the likelihood of errors and harm caused by Sponsored
Participants. Therefore, NASDAQ believes it is critical to establish a clear understanding
of the minimum regulatory and financial controls required in Sponsored Access
arrangements where orders pass directly into NASDAQ systems without first passing
through a Member System as defined herein.
In essence,
NASDAQ believes that NASDAQ members already operate Member Systems that
provide the regulatory and financial controls set forth in proposed subsections (d)(4) and
(d)(5). As such, NASDAQ can enhance the clarity of the obligations of members in
DMA arrangements – and bolster market confidence in the integrity and security of the
market -- without imposing additional obligations.
Accordingly, NASDAQ is proposing to amend the Proposal in several ways.
First, NASDAQ is proposing to add prefatory language to Rule 4611(d) that clearly
8 NASDAQ does not believe the same can be said of TPSA arrangements. Although some TPSA
providers may have substantially identical regulatory policies and procedures, this is not necessarily the case and, in any event, it is not mandated by current rules. Therefore, NASDAQ is not proposing to exclude TPSA from coverage under the Sponsored Access rule.
SR-NASDAQ-2008-104 Amendment 2 Page 15 of 54 articulates the responsibility of all members to have policies and procedures reasonably
designed to regulate all orders that it enters into NASDAQ systems under its own
MPID(s) regardless of the order entry and access arrangement. NASDAQ believes that
this new language is superior to similar language, which had been included in Rule
4611(d)(2) that is being deleted. Second, NASDAQ is proposing to amend Rule
4611(d)(1) to distinguish between Sponsored Access and DMA as described above, and
to eliminate the distinction set forth in the original proposal between Direct Sponsored
Access and Third Party Sponsored Access. Third, NASDAQ is proposing to define
Member System and Sponsored Access System to ensure that all DMA and Sponsored
Access arrangements are effectively regulated by a system that provides adequate
regulatory and financial controls.
Contractual Provisions
NASDAQ is not proposing to modify the contractual obligations imposed on
DMA arrangements. Under traditional DMA, where orders pass through the member
firm’s infrastructure, the member firm already maintains adequate regulatory and
financial control and NASDAQ already has adequate access to information necessary to
properly surveil and regulate orders entered into NASDAQ through DMA arrangements.
Again, the same cannot be said with confidence about Sponsored Access relationships
and orders that enter NASDAQ without first passing through a Member System.
Accordingly, NASDAQ is maintaining the requirement, set forth in the original proposal,
that Sponsored Access relationships be memorialized and governed by specific
contractual provisions, while leaving DMA free of that requirement.
SR-NASDAQ-2008-104 Amendment 2 Page 16 of 54
Several commenters object to the contractual provisions that NASDAQ proposed
to apply to Sponsored Access arrangements.9
NASDAQ agrees that the Proposal is needlessly burdensome in requiring Third
Party providers to execute with each Sponsored Participant a contract containing the
detailed provisions proposed in Rule 4611(d)(3). NASDAQ strongly believes, however,
that Sponsoring Members must have individual contractual relationships with all
Sponsored Participants. Such arrangements are particularly important with respect to
non-member Sponsored Participants that are outside NASDAQ’s regulatory jurisdiction
and continuing oversight. NASDAQ also believes that Sponsoring Members must enter
into a contract with any Third Party Providers that operates technology that the member
utilizes to enable, monitor, or control Sponsored Access or to satisfy the financial and
regulatory controls specified in subsections (4) and (5) (a “Sponsored Access System”).
The contract with Third Party Providers must provide that NASDAQ or its agent must be
allowed to audit the Sponsored Access System. Such contractual arrangements are
FIF and ETC object to the requirement that
Sponsoring Members execute contracts with Third Party providers that require Third
Party providers to sign detailed agreements with each Sponsored Participant. FIF argues
that, in the case of TPSA, the burden of compliance and related contractual obligations
should remain with the Sponsoring Member, rather than with the third-party service
bureau as the Proposal suggests. ETC contends that requiring third-party service
providers to execute with Sponsored Participants contracts containing the specified
provisions is overly burdensome, not justified by the benefits, and redundant of the
existing obligations of the Sponsoring Member.
9 See SIFMA Letter, FIF Letter, MFA Letter, and ETC Letter.
SR-NASDAQ-2008-104 Amendment 2 Page 17 of 54 important with respect to NASDAQ members that are Sponsored Participants in that they
require the participants in Sponsored Access relations to assess applicable requirements
and specifically allocate responsibility among the parties.
Accordingly, NASDAQ has proposed to divide proposed Rule 4611(d)(3) into
two subsections: Subsection (A) governing agreements between Sponsoring Members
and Sponsored Participants and Subsection (B) governing agreements between
Sponsoring Members and Third Party Providers. NASDAQ proposes to eliminate the
requirement that Third Party Providers execute agreements with Sponsored Participants
containing detailed contractual provisions identical to those required between Sponsoring
Members and Sponsored Participants. New Subsection (B) requires that the agreement
identify the financial and regulatory controls that are satisfied by the third party
technology, and contain commitments appropriately tailored to the third party
relationship including (1) limited access to books and records, (2) physical security of
technology that accesses NASDAQ, (3) the ability of NASDAQ or its agent to audit the
Sponsored Access System, and (4) the ability for the Sponsoring Member or NASDAQ to
terminate access to NASDAQ.
Additionally, SIFMA objects to aspects of the Proposal that require Sponsored
Participants to make their books and records and corporate and financial information
available to the Sponsoring Member upon request. MFA shares these concerns and notes
that because the proposed contractual provisions implicate sensitive proprietary
information, they must be limited to information relevant to oversight of trading activity
conducted under the particular Sponsored Access arrangement and that information
produced must be maintained as confidential by the Sponsoring Member and regulators.
SR-NASDAQ-2008-104 Amendment 2 Page 18 of 54
NASDAQ agrees that it can achieve effective exchange oversight through more
narrowly tailored contractual provisions between Sponsoring Members and Sponsored
Participants. Accordingly, NASDAQ is proposing to eliminate proposed Rule
4611(d)(3)(A)(E) and to amend Rule 4611(d)(3)(A)(ii) to require Sponsored Participants
to provide Sponsoring Member with access to such books and records and financial
information that is “necessary to allow the Sponsoring Member to comply with its
regulatory obligations with respect to activity of the Sponsored Participant within the
Sponsored Access arrangement.” Additionally, NASDAQ proposes to include
confidentiality provisions to protect sensitive information provided by Sponsored
Participants to Sponsoring Members for regulatory purposes. These provisions, in
combination with the provision requiring full cooperation by Sponsored Participants, will
provide NASDAQ with full access to information needed for proper regulatory oversight.
MFA also objects to proposed Rule 4611(d)(3)(A)(v) which requires sponsorship
agreements to include a provision permitting the Sponsoring Member or NASDAQ
immediately to terminate access in the event that the Sponsored Participant or Third Party
provider fails to abide by its contractual commitments. MFA argues that Sponsoring
Members and Sponsored Participants have established reasonable grace and cure periods
for breaches of sponsorship agreements and that such terms should be left to those
parties.
NASDAQ agrees that the parties should remain free to negotiate commercial
terms. However, those terms are generally designed to protect the parties’ commercial
interests rather than the interests of NASDAQ and other market participants. NASDAQ
has a separate interest in maintaining a fair and orderly market, including the ability to
SR-NASDAQ-2008-104 Amendment 2 Page 19 of 54 limit access by market participants that disrupt the markets or pose systemic risks.
Accordingly, NASDAQ proposes to limit Rule 4611(d)(3)(v) to protecting NASDAQ’s
interest in maintaining a fair and orderly market rather than governing commercial terms
between the parties.
Financial Controls
SIFMA comments extensively on the Financial Controls provisions of proposed
Rule 4611(d)(4), including: (1) the provisions should allow for procedures and controls
“reasonably designed” to prevent certain conduct, rather than impose a strict liability
standard; (2) it is not possible for Sponsoring Members to prevent the entry of orders in a
Direct Sponsored Access arrangement; and (3) by imposing a general obligation on
Sponsoring Members to make a determination of creditworthiness and to impose
financial limits, the proposed rule could cause Sponsoring Members to allow excessive
risk-taking; and (4) the product limitation provision should not impose restrictions on
Sponsored Participants that are unique to the Sponsoring Member.
NASDAQ agrees that in a “procedures-based” regime such as NASDAQ is
proposing to govern Sponsored Access arrangements, such procedures cannot ensure
compliance or prevent errors from occurring. Such procedures must, however, be
reasonably designed to ensure compliance or prevent errors. This is consistent with the
approach that the Commission adopted with respect to enforcement of Regulation NMS
and that SROs have adopted with respect to supervisory systems within member firms.
What constitutes “reasonable” cannot be specified in a one-size-fits-all rule but rather
requires an individual assessment of the facts and circumstances of each Sponsoring
SR-NASDAQ-2008-104 Amendment 2 Page 20 of 54 Member.10
Essentially, NASDAQ’s proposed Financial Controls provisions would require
Sponsoring Members to undertake a creditworthiness determination and to develop
monitoring and controls incorporating that determination.
Accordingly, NASDAQ proposes to modify Rule 4611(d)(4) to require
“reasonably designed” procedures and controls.
11 NASDAQ is not dictating
how that determination is undertaken or implemented but the provision does require at a
minimum that Sponsoring Members have real-time or nearly real-time ability to monitor
and control the conduct of Sponsored Participants.12 The importance of such controls in
limiting systemic risk justifies the burden imposed by the narrowly tailored proposed
provisions.13
The product limitation provision of the contractual requirements set forth in
subsection (d)(4)(B) has two primary goals. First, it requires that Sponsoring Members
be qualified to sponsor market participants to trade specific products. If a Sponsoring
member does not have proper expertise and experience trading a product, it cannot be
expected to effectively monitor the trading of such products. Second, it is another
Indeed, NASDAQ believes that Sponsoring Members should embrace this
requirement as a means of limiting the risk they assume by accepting responsibility for
the trading activity of Sponsored Participants.
10 See Wedbush Letter. 11 It is difficult to see that requiring firms to undertake a creditworthiness determination and to
impose controls would result in more risk-taking behavior than currently exists, as SIFMA appears to claim.
12 NASDAQ is not requiring that Sponsoring Members utilize pre-trade risk management offered by the exchange, or that pre-trade checks occur at the exchange level, as some commenters suggest. See Wedbush Letter. NASDAQ does, recognize that offering additional pre-trade risk management functionality would benefit the marketplace.
13 NASDAQ is skeptical of SIFMA’s claims that such controls cannot be implemented and that requiring such controls would effectively prohibit Direct Sponsored Access. In fact, SIFMA’s claims are directly contradicted by statements contained in the FTEN Letter and the Lime I Letter.
SR-NASDAQ-2008-104 Amendment 2 Page 21 of 54 “know-your-customer” provision that requires Sponsoring Members to assess the market
participants that they sponsor and to limit trading to products for which the Sponsored
Participant is qualified. It is not, as SIFMA implies, designed to transfer to Sponsored
Participants limitations that are specific to the Sponsoring Members, such as restrictions
imposed by SEC Rule 10b-18.
Regulatory Controls
SIFMA also comments extensively on the Regulatory Controls provisions of
proposed Rule 4611(d)(5), including: (1) the provisions should allow for procedures and
controls “reasonably designed” to prevent certain conduct, rather than impose a strict
liability standard; (2) it is not practical for Sponsoring Members to regulate the conduct
of Sponsored Participants on a real-time basis given that much current surveillance
occurs on a post-trade basis; (3) providing a non-exclusive list of regulatory requirements
will create confusion for market participants; and (4) post-trade reports should be
reviewed by “appropriate supervisory personnel” as defined by the Sponsoring Member..
As stated above with respect to Financial Controls, NASDAQ agrees that in a
“procedures-based” regime such as NASDAQ is proposing to govern Sponsored Access
arrangements, such procedures cannot ensure compliance or prevent errors from
occurring. Such procedures must, however, be reasonably designed to ensure compliance
or prevent errors. This is consistent with the approach that the Commission adopted with
respect to enforcement of Regulation NMS and that SROs have adopted with respect to
supervisory systems within member firms. What constitutes “reasonable” cannot be
specified in a one-size-fits-all rule but rather requires an individual assessment of the
facts and circumstances of each Sponsoring Member. Accordingly, NASDAQ proposes
SR-NASDAQ-2008-104 Amendment 2 Page 22 of 54 to modify Rule 4611(d)(5)(A) to require “reasonably designed” procedures and controls.
Nonetheless, NASDAQ continues to believe that the regulatory integrity of its market
requires that all orders entered by Sponsored Participants should be subject to real-time
or nearly real-time regulatory controls.
NASDAQ also proposes to amend Rule 4611(d)(5)(A) to eliminate the non-
exclusive list of regulatory requirements and to replace it with a general reference to
Regulatory Requirements, which is already defined within the proposed rule. NASDAQ
agrees that a non-exclusive list could cause confusion regarding both the regulatory
requirements specifically listed as well as those not listed.
NASDAQ proposes to amend Rule 4611(d)(5)(B) to permit trading activity
reports to be reviewed by “appropriate supervisory personnel” and that execution reports
must be reviewed immediately and other reports must be reviewed “promptly.”
NASDAQ agrees with SIFMA’s contention that Firms should be free to determine which
personnel are best suited to review trading activity reports provided that they have the
requisite supervisory training and responsibility.14
Lastly, several commenters have noted the potential systemic risk posed by
Sponsored Access arrangements and the importance to the marketplace of effective
regulation of such arrangements.
Additionally, the rule as currently
proposed creates ambiguity about when trading reports must be reviewed. It is intended
that firms review execution reports immediately and other reports promptly.
15
14 See SIFMA Letter.
NASDQAQ agrees and, in response to those
commenters, NASDAQ is working to develop a proposal that would require Sponsoring
15 See Lime Letter, Lek Letter, FTEN Letter.
SR-NASDAQ-2008-104 Amendment 2 Page 23 of 54 Members to obtain a unique MPID for each Sponsored Participant. Many but not all
NASDAQ members that sponsor multiple participants already obtain a unique MPID for
each. Separating the trading activity of multiple Sponsored Participants of a single
Sponsoring Member will make automated algorithmic surveillance of the market efficient
and effective without that additional work. Thus, requiring a unique MPID for each
sponsored participant would preserve the ability of Sponsored Participants to maintain
anonymity and achieve the primary goals of sponsorship, while simultaneously ensuring
that NASDAQ has full transparency effectively to regulate conduct on its market.
NASDAQ will work with other markets to develop a uniform rule in the near future.
SR-NASDAQ-2008-104 Amendment 2 Page 24 of 54
b. Statutory Basis
Nasdaq believes that the proposed rule change is consistent with the provisions of
Section 6 of the Act,16 in general and with Section 6(b)(5) of the Act,17
4. Self-Regulatory Organization’s Statement on Burden on Competition
in particular, in
that it is designed to promote just and equitable principles of trade and to protect
investors and the public interest. The proposal is consistent with these obligations
because it updates the standards for providing Sponsored Access, and clearly articulates
the obligations in the NASDAQ’s rules.
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.
5. 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.
6. Extension of Time Period for Commission Action
Nasdaq does not consent to the extension of any time period for Commission
action regarding this proposal.
7. Basis for Summary Effectiveness Pursuant to Section 19(b)(3) or for Accelerated Effectiveness Pursuant to Section 19(b)(2)
Not applicable.
8. Proposed Rule Change Based on rules of Another Self-Regulatory Organization of the Commission
None. 16 15 U.S.C. 78(f). 17 15 U.S.C. 78f-3(6).
SR-NASDAQ-2008-104 Amendment 2 Page 25 of 54 9. Exhibits
1. Completed notice of proposed rule change for publication in the Federal
Register.
4. Comparison of Rule Language proposed in Amendment 2 with that
proposed in Amendment 1.
SR-NASDAQ-2008-104 Amendment 2 Page 26 of 54
EXHIBIT 1 SECURITIES AND EXCHANGE COMMISSION (Release No. 34- ; File No. SR-NASDAQ-2008-104) October __, 2009 Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Notice of Filing and Approval of Proposal to Modify NASDAQ Rule 4611 Governing Sponsored Access 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 October 19, 2009, The NASDAQ
Stock Market LLC (“NASDAQ”) filed with the Securities and Exchange Commission
(“Commission”) the proposed rule change as described in Items I, II, and III below,
which Items have been substantially prepared by Nasdaq. The original proposal was filed
on December 30, 2009, and amended on January 8, 2009.3
I. Self-Regulatory Organization’s Statement of the Terms of the Substance of the
Proposed Rule Change
The Commission is
publishing this notice to solicit comments on the proposed rule change from interested
persons.
NASDAQ hereby submit a Response to Comments and Proposed Amendment 2
regarding its proposal (“Proposal”) to modify NASDAQ Rule 4611 which governs
electronic access to NASDAQ’s order execution systems. The text of the proposed rule
change is available at http://nasdaqomx.cchwallstreet.com/, at NASDAQ’s principal
office, and at the Commission’s Public Reference Room. 1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b-4.
3 See Exchange Act Release No. 59275 (Jan. 22, 2009), 74 FR 5193 (Jan. 29, 2009).
SR-NASDAQ-2008-104 Amendment 2 Page 27 of 54
* * * * *
4611. Nasdaq Market Center Participant Registration
(a) – (c) No change.
[(d) Members may provide “Sponsored Access” to the Nasdaq Market Center in accordance with the provisions below: Sponsored Participants. A Sponsored Participant may obtain authorized access to the Nasdaq Market Center only if such access is authorized in advance by one or more Nasdaq members as follows:]
[(1) Sponsored Participants must enter into and maintain customer agreements with one or more Sponsoring Members establishing proper relationship(s) and account(s) through which the Sponsored Participant may trade on the Nasdaq Market Center. Such customer agreement(s) must incorporate the Sponsorship Provisions set forth in paragraph (2) below.]
[(2) For a Sponsored Participant to obtain and maintain authorized access to the Nasdaq Market Center, a Sponsored Participant and its Sponsoring Member must agree in writing to the following Sponsorship Provisions:
(A) Sponsored Participant and its Sponsoring Member must have entered into and maintained a User Agreement with The NASDAQ Stock Market LLC. The Sponsoring Member must designate the Sponsored Participant by name in its User Agreement as such.
(B) Sponsoring Member acknowledges and agrees that (i) All orders entered by the Sponsored Participants and any person acting on behalf of or in the name of such Sponsored Participant and any executions occurring as a result of such orders are binding in all respects on the Sponsoring Member and
(ii) Sponsoring Member is responsible for any and all actions taken by such Sponsored Participant and any person acting on behalf of or in the name of such Sponsored Participant.
(C) Sponsoring Member shall comply with the Nasdaq Certificate of Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center and Sponsored Participant shall comply with Nasdaq Certificate of Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center, as if Sponsored Participant were a Nasdaq Member.
SR-NASDAQ-2008-104 Amendment 2 Page 28 of 54
(D) Sponsored Participant shall maintain, keep current and provide to the Sponsoring Member a list of individuals authorized to obtain access to the Nasdaq Market Center on behalf of the Sponsored Participant. (E) Sponsored Participant shall familiarize its authorized individuals with all of the Sponsored Participant's obligations under this Rule and will assure that they receive appropriate training prior to any use or access to the Nasdaq Market Center. (F) Sponsored Participant may not permit anyone other than authorized individuals to use or obtain access to the Nasdaq Market Center. (G) Sponsored Participant shall take reasonable security precautions to prevent unauthorized use or access to the Nasdaq Market Center, including unauthorized entry of information into the Nasdaq Market Center, or the information and data made available therein. Sponsored Participant understands and agrees that Sponsored Participant is responsible for any and all orders, trades and other messages and instructions entered, transmitted or received under identifiers, passwords and security codes of authorized individuals, and for the trading and other consequences thereof. (H) Sponsored Participant acknowledges its responsibility to establish adequate procedures and controls that permit it to effectively monitor its employees’, agents’ and customers' use and access to the Nasdaq Market Center for compliance with the terms of this agreement. (I) Sponsored Participant shall pay when due all amounts, if any, payable to Sponsoring Member, Nasdaq, or any other third parties that arise from the Sponsored Participant’s access to and use of the Nasdaq Market Center. Such amounts include, but are not limited to applicable exchange and regulatory fees.]
[(3) The Sponsoring Member must provide Nasdaq with a Notice of Consent acknowledging its responsibility for the orders, executions and actions of its Sponsored Participant at issue.]
(d) Access to a Trading Center. If a member enters into an arrangement with another person (e.g., a customer, another member, or a non-member broker-dealer) to provide that person with access to Nasdaq or otherwise allow such person to route its orders to Nasdaq using the member’s market participant identifier (“MPID”), the member is responsible for all trading conducted pursuant to that arrangement to the same extent as trading directly conducted by the member for customers. Consequently, the member is responsible for implementing policies and procedures for supervising and monitoring the
SR-NASDAQ-2008-104 Amendment 2 Page 29 of 54
trading effected pursuant to the arrangement to ensure that it is in compliance with all applicable federal securities laws and rules and Exchange rules. This obligation applies irrespective of the manner in which orders pursuant to such arrangements reach Nasdaq.
(1) Definition.
(A) Sponsored Access is the practice by a member (“Sponsoring Member”) of providing access to Nasdaq to another person, firm or customer (“Sponsored Participant”) whereby the Sponsored Participant enters orders into Nasdaq using a Sponsored Access System but the orders do not pass through a Member System prior to reaching Nasdaq.
(B). Direct Market Access (“DMA”) is the practice by a member (“Sponsoring Member”) of providing access to Nasdaq to another person, firm or customer (“Sponsored Participant”) whereby the Sponsored Participant makes decisions regarding order routing and order entry but the orders pass through a Member System prior to reaching Nasdaq.
(C). A Member System is any system administered and controlled solely by the Sponsoring Member and that applies the pre- and post-trade financial and regulatory controls set forth in sections (4) and (5) below.
(D) A Sponsored Access System is any system that applies pre- and post-trade financial and regulatory controls set forth in sections (4) and (5) below and that is not administered and controlled solely by the Sponsoring Member.
(2) Compliance. To ensure that Sponsored Access is consistent with high market quality and the protection of investors, Sponsoring Members providing Sponsored Access shall at a minimum comply with the Contractual Provisions, Financial Controls, and Regulatory Controls set forth in sections (3), (4), and (5) below. Sponsoring Members providing Direct Market Access shall at a minimum comply with the Financial Controls and Regulatory Controls set forth in sections (4) and (5) below.
(3) Contractual Provisions.
(A) A Sponsoring Member that provides Sponsored Access shall execute and maintain agreements with each Sponsored Participant containing the commitments below.
(i ) All trading activity by the Sponsored Participant shall comply with all applicable federal securities laws and rules and Exchange rules, including but not limited to the Nasdaq Certificate of Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center (“Regulatory Requirements”).
SR-NASDAQ-2008-104 Amendment 2 Page 30 of 54
(ii) Sponsored Participant shall promptly upon request provide Sponsoring Member with access to such books and records and financial information that is necessary to allow the Sponsoring Member to comply with its regulatory obligations with respect to activity of the Sponsored Participant within the Sponsored Access arrangement, and otherwise cooperate with the Sponsoring Member in furtherance of Sponsoring Member’s compliance with applicable Regulatory Requirements. Information provided by Sponsored Participants to Sponsoring Members pursuant to such requests shall be maintained as confidential by the Sponsoring Member, provided that such information shall be available to Nasdaq upon request for regulatory purposes.
(iii) Sponsored Participant shall maintain its trading activity within the credit, product or other financial limits specified by the Sponsoring Member.
(iv) Sponsored Participant shall maintain all technology permitting sponsored access to Nasdaq in a physically secure manner and may not permit unauthorized individuals to use or obtain access to Nasdaq. Sponsored Participant shall familiarize its authorized individuals with the Regulatory Requirements and will provide appropriate training prior to use or access to Nasdaq.
(v) Sponsored Participant shall agree that the Sponsoring Member or Nasdaq may immediately terminate the Sponsored Access if the Sponsoring Member or Nasdaq determines that continuing such access poses serious risk to the Sponsoring Member or to the integrity of the market.
(B) A Sponsoring Member that provides Sponsored Access shall execute and maintain agreements with each third party (“Third Party Provider”) that provides a Sponsored Access System to Sponsored Participants for accessing Nasdaq, specifying which of the financial and regulatory controls stated in subsections (4) and (5) below are satisfied by the technology provided, and containing the commitments below.
(i) Third Party Providers shall promptly upon request provide Sponsoring Member with access to such books and records and financial information that is necessary to allow the Sponsoring Member to comply with its regulatory obligations with respect to activity of the Sponsored Participant within the Sponsored Access arrangement, and otherwise cooperate with the Sponsoring Member in furtherance of Sponsoring Member’s compliance with
SR-NASDAQ-2008-104 Amendment 2 Page 31 of 54
applicable Regulatory Requirements. Information provided by Sponsored Participants to Sponsoring Members pursuant to such requests shall be maintained as confidential by the Sponsoring Member, provided that such information shall be available to Nasdaq upon request for regulatory purposes.
(ii) Third Party Providers shall maintain all technology permitting Sponsored Access to Nasdaq in a physically secure manner and may not permit unauthorized individuals to use or obtain access to Nasdaq.
(iii) Third Party Providers shall agree that Nasdaq or its agent may audit the Sponsored Access System and that the Sponsoring Member or Nasdaq may immediately terminate the Sponsored Access if the Sponsored Participant or Third Party Provider fails to abide by its commitments.
(4) Financial Controls. Each Sponsoring Member shall establish adequate procedures and controls that permit it to effectively monitor and control the Sponsored Access or Direct Market Access to systemically limit the Sponsoring Member’s financial exposure. At a minimum, the Member System or Sponsored Access System shall be reasonably designed to:
(A) Prevent each Sponsored Participant from entering orders that in aggregate exceed appropriate pre-set credit thresholds. Sponsoring Members may also set finely-tuned credit thresholds by sector, security or otherwise. (B) Prevent Sponsored Participants from trading products that the Sponsoring Member is restricted from trading or that the Sponsored Participant is restricted from trading for reasons specific to the Sponsored Participant. (C) Prevent Sponsored Participants from submitting erroneous orders by providing for the rejection of orders that exceed certain price or size parameters, on an order-by-order basis or over a short period of time, or that indicate duplicative orders.
(5) Regulatory Controls. Each Sponsoring Member shall establish adequate
procedures and controls reasonably designed to permit it to effectively monitor and control compliance with Regulatory Requirements,
(A) Each Sponsoring Member shall have systemic controls reasonably designed to ensure compliance by the Sponsored Participant with all applicable Regulatory Requirements.
SR-NASDAQ-2008-104 Amendment 2 Page 32 of 54
(B) Each Sponsoring Member shall ensure that appropriate supervisory personnel receive and review timely reports of all trading activity by its Sponsored Participants sufficient to permit the Sponsoring Member to comply with applicable Regulatory Requirements, and to monitor for illegal activity such as market manipulation or insider trading. At a minimum, appropriate supervisory personnel should receive immediate post-trade execution reports of trading activity of all Sponsored Participants, including their identities; all required audit trail information by no later than the end of the trading day; and all information necessary to create and maintain the trading records required by applicable Regulatory Requirements by no later than the end of the trading day. Appropriate supervisory personnel shall review execution reports immediately and all other reports promptly.
* * * * *
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
Currently, Rule 4611(d) is substantially similar to Sponsored Access rules
adopted by other national securities exchanges, including New York Stock Exchange
Rule 123B and NYSE Arca Exchange Rule 7.29(b). NASDAQ is proposing to amend
Rule 4611(d) to ensure that member firms that are assuming responsibility for their
customers’ trading activity have effective financial and regulatory oversight of the
SR-NASDAQ-2008-104 Amendment 2 Page 33 of 54
Sponsored Participant, and that NASDAQ has access to all information necessary to
provide effective exchange oversight.
Seven firms and three industry group representatives submitted comment letters
addressing the original proposal, all of which were thoughtful and all of which merit
specific consideration and response.4
Uniform Rule, Implementation, and Application
Set forth below is a recitation of the suggested
modifications to the Proposal, NASDAQ’s response to the suggested modification, and a
description of precise changes to the rule language contained in proposed Amendment 1
to the Proposal.
Two commenters stressed that industry regulators should develop a uniform rule
and then apply it consistently across all markets and all market participants.5
4
Specifically, SIFMA recommended that all exchanges, the Financial Industry Regulatory
Authority (“FINRA”), and the Commission should cooperate to develop a uniform,
workable rule. SIFMA and Wedbush also suggested that, once developed, the uniform
Harvey Cloyd, Chief Executive Officer, Electronic Transaction Clearing, Inc., dated February 5, 2009 (“ETC Letter”); John N. Jacobs, Director of Operations, Lime Brokerage LLC, dated February 17, 2009 (“Lime I Letter”); Manisha Kimmel, Executive Director, Financial Information Forum, dated February 19, 2009 (“FIF Letter”); Ted Myerson, President, FTEN, Inc., dated February 19, 2009 (“FTEN I Letter”); Michael A. Barth, Executive Vice President, OES Market Group, dated February 23, 2009 (“OES Letter”); Jeff Bell, Executive Vice President, Clearing and Technology Group, Wedbush Morgan Securities, dated February 23, 2009 (“Wedbush Letter”); Stuart J. Kaswell, Executive Vice President & General Counsel, Managed Funds Association, dated February 24, 2009 (“MFA Letter”); Ann Vlcek, Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association, dated February 26, 2009 (“SIFMA Letter”), Nicole Harner Williams, Vice President, Associate General Counsel, Penson Financial Services, Inc., dated February 27, 2009 (“Penson Letter”); Gary LaFever, Chief Corporate Development Officer, FTEN, Inc., dated April 29, 2009 (“FTEN II Letter”); Samuel F. Lek, Chief Executive Officer, Lek Securities Corporation, dated June 15, 2009 (“Lek Letter”); John N. Jacobs, Chief Operations Officer, Lime Brokerage LLC, dated June 30, 2009 (“Lime II Letter”).
5 See SIFMA Letter, Wedbush Letter.
SR-NASDAQ-2008-104 Amendment 2 Page 34 of 54
rule should be consistently interpreted and enforced to ensure a level playing field.
Finally, commenters suggested that all exchanges implement the uniform rule on a
common effective date that allows market participants reasonable notice and preparation
time.
NASDAQ agrees with each of these recommendations. The regulation of
electronic access should be uniformly regulated and not create the opportunity for
arbitrage between the rules of competing exchanges. To that end, NASDAQ has been
cooperating with the Commission and the Intermarket Surveillance Group (“ISG”),
which includes all self-regulatory organizations (“SROs”) registered under the auspices
of the Commission, towards the development of a uniform rule governing electronic
access to markets. NASDAQ expects that all SROs will adopt the uniform rule and that
the SROs will coordinate with the industry representatives such as SIFMA to develop a
uniform implementation plan that includes adequate opportunity for programming and
testing. NASDAQ expects that consistency in the future application of the uniform rule
will be an on-going topic of discussion at ISG and at the Commission.
Definition of Sponsored Access and Scope of Proposed Rule
Four commenters questioned whether the Proposal properly defines Sponsored
Access.6
6 See ETC Letter, FIF Letter, SIFMA Letter, Penson Letter.
The original proposed definition of Sponsored Access included three categories
of access: (1) direct market access, where the Sponsored Participant’s orders pass through
the Sponsoring Member’s systems prior to reaching NASDAQ (“Direct Market Access”
or “DMA”), (b) sponsored access, where the Sponsored Participant enters orders directly
into NASDAQ via a dedicated port provided by the Sponsoring Member (“Direct
SR-NASDAQ-2008-104 Amendment 2 Page 35 of 54
Sponsored Access” or “DSA”), and (c) direct access where a service bureau or other third
party provides Sponsored Participants with technology to access NASDAQ under the
auspices of and via an arrangement with the Sponsoring Member (“Third Party
Sponsored Access” or “TPSA”).
Specifically SIFMA and FIF suggest that the proposed definition of Sponsored
Access is overly broad and that the Proposal’s provisions should be limited exclusively to
Sponsored Access arrangements in which Sponsored Participant orders do not flow
through a Sponsoring Member’s trading technology infrastructure prior to reaching
NASDAQ. This would mean that DSA and TPSA would be subject to the proposed
Sponsored Access but that DMA would not and nor would any other electronic order
routing or execution arrangement that involves orders passing through a broker-dealer’s
infrastructure prior to reaching a destination market. The ETC and Penson Letters
recommend that the rule be more narrowly limited to DSA.
NASDAQ agrees in part with SIFMA and FIF that the proposed rule should focus
on whether or not orders flow through a Sponsoring Member’s trading technology
infrastructure prior to reaching NASDAQ. Using that rubric, genuine Sponsored Access
would be limited to instances where the Sponsored Participant enters orders directly into
NASDAQ using the Sponsoring Member’s MPID and the orders do not pass through a
Member System before reaching NASDAQ. Sponsored Access is distinguished from
Direct Market Access (“DMA”) whereby a member provides access to NASDAQ to a
person or firm that makes decisions regarding order routing and order entry but the orders
pass through a Member System prior to reaching NASDAQ.
SR-NASDAQ-2008-104 Amendment 2 Page 36 of 54
The key to proper regulation of both Sponsored Access and DMA are the
regulatory and financial controls set forth in proposed Rule 4611(d)(4) and (5). In DMA
arrangements, those controls are provided by a “Member System” which is any system
administered and controlled solely by a member that applies the pre- and post-trade
financial and regulatory controls set forth in sections (4) and (5) below. In a Sponsored
Access arrangement, the controls are imposed through contractual provisions set forth in
Rule 4611(d)(3) in combination with the provisions of subsections (d)(4) and (d)(5).
NASDAQ agrees with commenters that DMA arrangements are already
effectively regulated under existing laws and regulations because in such cases, the
broker-dealer that takes responsibility for orders is a member of the exchange with all
attendant compliance obligations and incentives. Orders and executions that flow
through a broker-dealer’s infrastructure are subject to all member compliance obligations
as though generated by the member itself, including capturing details for books and
record rules and implementing appropriate pre- and post-trade controls.7
7 NASDAQ does not believe the same can be said of TPSA arrangements.
Although some TPSA providers may have substantially identical regulatory policies and procedures, this is not necessarily the case and, in any event, it is not mandated by current rules. Therefore, NASDAQ is not proposing to exclude TPSA from coverage under the Sponsored Access rule.
In essence,
NASDAQ believes that NASDAQ members already operate Member Systems that
provide the regulatory and financial controls set forth in proposed subsections (d)(4) and
(d)(5). As such, NASDAQ can enhance the clarity of the obligations of members in
DMA arrangements – and bolster market confidence in the integrity and security of the
market -- without imposing additional obligations.
SR-NASDAQ-2008-104 Amendment 2 Page 37 of 54
The same cannot be uniformly stated with respect to Sponsored Access. It is true
that all orders entering NASDAQ systems must bear a member MPID and all Sponsoring
Members currently assume full responsibility for all orders that enter NASDAQ systems
under their specific MPIDs. It is also true that NASDAQ members are already closely
regulated, and that NASDAQ systems are closely surveilled both in real-time and post
trade. Nonetheless, members may hold different views of what that responsibility
requires. Members may also assess in different ways the risks to the market posed by
Sponsored Access and the likelihood of errors and harm caused by Sponsored
Participants. Therefore, NASDAQ believes it is critical to establish a clear understanding
of the minimum regulatory and financial controls required in Sponsored Access
arrangements where orders pass directly into NASDAQ systems without first passing
through a Member System as defined herein.
Accordingly, NASDAQ is proposing to amend the Proposal in several ways.
First, NASDAQ is proposing to add prefatory language to Rule 4611(d) that clearly
articulates the responsibility of all members to have policies and procedures reasonably
designed to regulate all orders that it enters into NASDAQ systems under its own
MPID(s) regardless of the order entry and access arrangement. NASDAQ believes that
this new language is superior to similar language, which had been included in Rule
4611(d)(2) that is being deleted. Second, NASDAQ is proposing to amend Rule
4611(d)(1) to distinguish between Sponsored Access and DMA as described above, and
to eliminate the distinction set forth in the original proposal between Direct Sponsored
Access and Third Party Sponsored Access. Third, NASDAQ is proposing to define
Member System and Sponsored Access System to ensure that all DMA and Sponsored
SR-NASDAQ-2008-104 Amendment 2 Page 38 of 54
Access arrangements are effectively regulated by a system that provides adequate
regulatory and financial controls.
Contractual Provisions
NASDAQ is not proposing to modify the contractual obligations imposed on
DMA arrangements. Under traditional DMA, where orders pass through the member
firm’s infrastructure, the member firm already maintains adequate regulatory and
financial control and NASDAQ already has adequate access to information necessary to
properly surveil and regulate orders entered into NASDAQ through DMA arrangements.
Again, the same cannot be said with confidence about Sponsored Access relationships
and orders that enter NASDAQ without first passing through a Member System.
Accordingly, NASDAQ is maintaining the requirement, set forth in the original proposal,
that Sponsored Access relationships be memorialized and governed by specific
contractual provisions, while leaving DMA free of that requirement.
Several commenters object to the contractual provisions that NASDAQ proposed
to apply to Sponsored Access arrangements.8
8 See SIFMA Letter, FIF Letter, MFA Letter, and ETC Letter.
FIF and ETC object to the requirement that
Sponsoring Members execute contracts with Third Party providers that require Third
Party providers to sign detailed agreements with each Sponsored Participant. FIF argues
that, in the case of TPSA, the burden of compliance and related contractual obligations
should remain with the Sponsoring Member, rather than with the third-party service
bureau as the Proposal suggests. ETC contends that requiring third-party service
providers to execute with Sponsored Participants contracts containing the specified
SR-NASDAQ-2008-104 Amendment 2 Page 39 of 54
provisions is overly burdensome, not justified by the benefits, and redundant of the
existing obligations of the Sponsoring Member.
NASDAQ agrees that the Proposal is needlessly burdensome in requiring Third
Party providers to execute with each Sponsored Participant a contract containing the
detailed provisions proposed in Rule 4611(d)(3). NASDAQ strongly believes, however,
that Sponsoring Members must have individual contractual relationships with all
Sponsored Participants. Such arrangements are particularly important with respect to
non-member Sponsored Participants that are outside NASDAQ’s regulatory jurisdiction
and continuing oversight. NASDAQ also believes that Sponsoring Members must enter
into a contract with any Third Party Providers that operates technology that the member
utilizes to enable, monitor, or control Sponsored Access or to satisfy the financial and
regulatory controls specified in subsections (4) and (5) (a “Sponsored Access System”).
The contract with Third Party Providers must provide that NASDAQ or its agent must be
allowed to audit the Sponsored Access System. Such contractual arrangements are
important with respect to NASDAQ members that are Sponsored Participants in that they
require the participants in Sponsored Access relations to assess applicable requirements
and specifically allocate responsibility among the parties.
Accordingly, NASDAQ has proposed to divide proposed Rule 4611(d)(3) into
two subsections: Subsection (A) governing agreements between Sponsoring Members
and Sponsored Participants and Subsection (B) governing agreements between
Sponsoring Members and Third Party Providers. NASDAQ proposes to eliminate the
requirement that Third Party Providers execute agreements with Sponsored Participants
containing detailed contractual provisions identical to those required between Sponsoring
SR-NASDAQ-2008-104 Amendment 2 Page 40 of 54
Members and Sponsored Participants. New Subsection (B) requires that the agreement
identify the financial and regulatory controls that are satisfied by the third party
technology, and contain commitments appropriately tailored to the third party
relationship including (1) limited access to books and records, (2) physical security of
technology that accesses NASDAQ, (3) the ability of NASDAQ or its agent to audit the
Sponsored Access System, and (4) the ability for the Sponsoring Member or NASDAQ to
terminate access to NASDAQ.
Additionally, SIFMA objects to aspects of the Proposal that require Sponsored
Participants to make their books and records and corporate and financial information
available to the Sponsoring Member upon request. MFA shares these concerns and notes
that because the proposed contractual provisions implicate sensitive proprietary
information, they must be limited to information relevant to oversight of trading activity
conducted under the particular Sponsored Access arrangement and that information
produced must be maintained as confidential by the Sponsoring Member and regulators.
NASDAQ agrees that it can achieve effective exchange oversight through more
narrowly tailored contractual provisions between Sponsoring Members and Sponsored
Participants. Accordingly, NASDAQ is proposing to eliminate proposed Rule
4611(d)(3)(A)(E) and to amend Rule 4611(d)(3)(A)(ii) to require Sponsored Participants
to provide Sponsoring Member with access to such books and records and financial
information that is “necessary to allow the Sponsoring Member to comply with its
regulatory obligations with respect to activity of the Sponsored Participant within the
Sponsored Access arrangement.” Additionally, NASDAQ proposes to include
confidentiality provisions to protect sensitive information provided by Sponsored
SR-NASDAQ-2008-104 Amendment 2 Page 41 of 54
Participants to Sponsoring Members for regulatory purposes. These provisions, in
combination with the provision requiring full cooperation by Sponsored Participants, will
provide NASDAQ with full access to information needed for proper regulatory oversight.
MFA also objects to proposed Rule 4611(d)(3)(A)(v) which requires sponsorship
agreements to include a provision permitting the Sponsoring Member or NASDAQ
immediately to terminate access in the event that the Sponsored Participant or Third Party
provider fails to abide by its contractual commitments. MFA argues that Sponsoring
Members and Sponsored Participants have established reasonable grace and cure periods
for breaches of sponsorship agreements and that such terms should be left to those
parties.
NASDAQ agrees that the parties should remain free to negotiate commercial
terms. However, those terms are generally designed to protect the parties’ commercial
interests rather than the interests of NASDAQ and other market participants. NASDAQ
has a separate interest in maintaining a fair and orderly market, including the ability to
limit access by market participants that disrupt the markets or pose systemic risks.
Accordingly, NASDAQ proposes to limit Rule 4611(d)(3)(v) to protecting NASDAQ’s
interest in maintaining a fair and orderly market rather than governing commercial terms
between the parties.
Financial Controls
SIFMA comments extensively on the Financial Controls provisions of proposed
Rule 4611(d)(4), including: (1) the provisions should allow for procedures and controls
“reasonably designed” to prevent certain conduct, rather than impose a strict liability
standard; (2) it is not possible for Sponsoring Members to prevent the entry of orders in a
SR-NASDAQ-2008-104 Amendment 2 Page 42 of 54
Direct Sponsored Access arrangement; and (3) by imposing a general obligation on
Sponsoring Members to make a determination of creditworthiness and to impose
financial limits, the proposed rule could cause Sponsoring Members to allow excessive
risk-taking; and (4) the product limitation provision should not impose restrictions on
Sponsored Participants that are unique to the Sponsoring Member.
NASDAQ agrees that in a “procedures-based” regime such as NASDAQ is
proposing to govern Sponsored Access arrangements, such procedures cannot ensure
compliance or prevent errors from occurring. Such procedures must, however, be
reasonably designed to ensure compliance or prevent errors. This is consistent with the
approach that the Commission adopted with respect to enforcement of Regulation NMS
and that SROs have adopted with respect to supervisory systems within member firms.
What constitutes “reasonable” cannot be specified in a one-size-fits-all rule but rather
requires an individual assessment of the facts and circumstances of each Sponsoring
Member.9
Essentially, NASDAQ’s proposed Financial Controls provisions would require
Sponsoring Members to undertake a creditworthiness determination and to develop
monitoring and controls incorporating that determination.
Accordingly, NASDAQ proposes to modify Rule 4611(d)(4) to require
“reasonably designed” procedures and controls.
10
9 See Wedbush Letter.
NASDAQ is not dictating
how that determination is undertaken or implemented but the provision does require at a
minimum that Sponsoring Members have real-time or nearly real-time ability to monitor
10 It is difficult to see that requiring firms to undertake a creditworthiness determination and to impose controls would result in more risk-taking behavior than currently exists, as SIFMA appears to claim.
SR-NASDAQ-2008-104 Amendment 2 Page 43 of 54
and control the conduct of Sponsored Participants.11 The importance of such controls in
limiting systemic risk justifies the burden imposed by the narrowly tailored proposed
provisions.12
The product limitation provision of the contractual requirements set forth in
subsection (d)(4)(B) has two primary goals. First, it requires that Sponsoring Members
be qualified to sponsor market participants to trade specific products. If a Sponsoring
member does not have proper expertise and experience trading a product, it cannot be
expected to effectively monitor the trading of such products. Second, it is another
“know-your-customer” provision that requires Sponsoring Members to assess the market
participants that they sponsor and to limit trading to products for which the Sponsored
Participant is qualified. It is not, as SIFMA implies, designed to transfer to Sponsored
Participants limitations that are specific to the Sponsoring Members, such as restrictions
imposed by SEC Rule 10b-18.
Indeed, NASDAQ believes that Sponsoring Members should embrace this
requirement as a means of limiting the risk they assume by accepting responsibility for
the trading activity of Sponsored Participants.
11 NASDAQ is not requiring that Sponsoring Members utilize pre-trade risk
management offered by the exchange, or that pre-trade checks occur at the exchange level, as some commenters suggest. See Wedbush Letter. NASDAQ does, recognize that offering additional pre-trade risk management functionality would benefit the marketplace.
12 NASDAQ is skeptical of SIFMA’s claims that such controls cannot be implemented and that requiring such controls would effectively prohibit Direct Sponsored Access. In fact, SIFMA’s claims are directly contradicted by statements contained in the FTEN Letter and the Lime I Letter.
SR-NASDAQ-2008-104 Amendment 2 Page 44 of 54
Regulatory Controls
SIFMA also comments extensively on the Regulatory Controls provisions of
proposed Rule 4611(d)(5), including: (1) the provisions should allow for procedures and
controls “reasonably designed” to prevent certain conduct, rather than impose a strict
liability standard; (2) it is not practical for Sponsoring Members to regulate the conduct
of Sponsored Participants on a real-time basis given that much current surveillance
occurs on a post-trade basis; (3) providing a non-exclusive list of regulatory requirements
will create confusion for market participants; and (4) post-trade reports should be
reviewed by “appropriate supervisory personnel” as defined by the Sponsoring Member..
As stated above with respect to Financial Controls, NASDAQ agrees that in a
“procedures-based” regime such as NASDAQ is proposing to govern Sponsored Access
arrangements, such procedures cannot ensure compliance or prevent errors from
occurring. Such procedures must, however, be reasonably designed to ensure compliance
or prevent errors. This is consistent with the approach that the Commission adopted with
respect to enforcement of Regulation NMS and that SROs have adopted with respect to
supervisory systems within member firms. What constitutes “reasonable” cannot be
specified in a one-size-fits-all rule but rather requires an individual assessment of the
facts and circumstances of each Sponsoring Member. Accordingly, NASDAQ proposes
to modify Rule 4611(d)(5)(A) to require “reasonably designed” procedures and controls.
Nonetheless, NASDAQ continues to believe that the regulatory integrity of its market
requires that all orders entered by Sponsored Participants should be subject to real-time
or nearly real-time regulatory controls.
SR-NASDAQ-2008-104 Amendment 2 Page 45 of 54
NASDAQ also proposes to amend Rule 4611(d)(5)(A) to eliminate the non-
exclusive list of regulatory requirements and to replace it with a general reference to
Regulatory Requirements, which is already defined within the proposed rule. NASDAQ
agrees that a non-exclusive list could cause confusion regarding both the regulatory
requirements specifically listed as well as those not listed.
NASDAQ proposes to amend Rule 4611(d)(5)(B) to permit trading activity
reports to be reviewed by “appropriate supervisory personnel” and that execution reports
must be reviewed immediately and other reports must be reviewed “promptly.”
NASDAQ agrees with SIFMA’s contention that Firms should be free to determine which
personnel are best suited to review trading activity reports provided that they have the
requisite supervisory training and responsibility.13
Lastly, several commenters have noted the potential systemic risk posed by
sponsored access arrangements and the importance to the marketplace of effective
regulation of such arrangements.
Additionally, the rule as currently
proposed creates ambiguity about when trading reports must be reviewed. It is intended
that firms review execution reports immediately and other reports promptly.
14
13 See SIFMA Letter.
NASDQAQ agrees and, in response to those
commenters, NASDAQ is working to develop a proposal that would require Sponsoring
Members to obtain a unique MPID for each Sponsored Participant. Many but not all
NASDAQ members that sponsor multiple participants already obtain a unique MPID for
each. Separating the trading activity of multiple Sponsored Participants of a single
Sponsoring Member will make automated algorithmic surveillance of the market efficient
14 See Lime Letter, Lek Letter, FTEN Letter.
SR-NASDAQ-2008-104 Amendment 2 Page 46 of 54
and effective without that additional work. Thus, requiring a unique MPID for each
Sponsored Participant would preserve the ability of Sponsored Participants to maintain
anonymity and achieve the primary goals of sponsorship, while simultaneously ensuring
that NASDAQ has full transparency effectively to regulate conduct on its market.
NASDAQ will work with other markets to develop a uniform rule in the near future.
2. Statutory Basis
Nasdaq believes that the proposed rule change is consistent with the provisions of
Section 6 of the Act,15 in general and with Section 6(b)(5) of the Act,16
B. Self-Regulatory Organization’s Statement on Burden on Competition
in particular, in
that it is designed to promote just and equitable principles of trade and to protect
investors and the public interest. The proposal is consistent with these obligations
because it updates the standards for providing Sponsored Access, and clearly articulates
the obligations in the NASDAQ’s rules.
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
Written comments were neither solicited nor received.
15 15 U.S.C. 78(f).
16 15 U.S.C. 78f-3(6).
SR-NASDAQ-2008-104 Amendment 2 Page 47 of 54
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 proposed rule change, as amended, is
consistent with the Act. Comments may be submitted by any of the following methods:
Electronic comments:
• Use the Commission's Internet comment form
(http://www.sec.gov/rules/sro.shtml); or
• Send an e-mail to [email protected]. Please include File Number
SR-NASDAQ-2008-104 on the subject line.
Paper comments:
• 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-2008-104. This file number
should be included on the subject line if e-mail is used.
SR-NASDAQ-2008-104 Amendment 2 Page 48 of 54
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 inspection and copying in the Commission’s Public Reference
Room on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of
such filing also will be available for inspection and copying at the principal offices 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-2008-104, and should
be submitted on or before [insert date 21 days from publication in the Federal Register].
For the Commission, by the Division of Trading and Markets, pursuant to
delegated authority.17
Florence E. Harmon Deputy Secretary
17 17 CFR 200.30-3(a)(12).
SR-NASDAQ-2008-104 Amendment 2 Page 49 of 54
EXHIBIT 4
This document compares the rule language proposed in Amendment 1 with that proposed in Amendment 2. Deletions from Amendment 1 are in strikethrough; additions are in double underline.
4611. Nasdaq Market Center Participant Registration
(a) – (c) No change.
(d) Members may provide “Sponsored Access” to the Nasdaq Market Center in accordance with the provisions below: Sponsored Participants. [A Sponsored Participant may obtain authorized access to the Nasdaq Market Center only if such access is authorized in advance by one or more Nasdaq members as follows:]
[(1) Sponsored Participants must enter into and maintain customer agreements with one or more Sponsoring Members establishing proper relationship(s) and account(s) through which the Sponsored Participant may trade on the Nasdaq Market Center. Such customer agreement(s) must incorporate the Sponsorship Provisions set forth in paragraph (2) below.]
[(2) For a Sponsored Participant to obtain and maintain authorized access to the Nasdaq Market Center, a Sponsored Participant and its Sponsoring Member must agree in writing to the following Sponsorship Provisions:
(A) Sponsored Participant and its Sponsoring Member must have entered into and maintained a User Agreement with The NASDAQ Stock Market LLC. The Sponsoring Member must designate the Sponsored Participant by name in its User Agreement as such.
(B) Sponsoring Member acknowledges and agrees that (i) All orders entered by the Sponsored Participants and any person acting on behalf of or in the name of such Sponsored Participant and any executions occurring as a result of such orders are binding in all respects on the Sponsoring Member and
(ii) Sponsoring Member is responsible for any and all actions taken by such Sponsored Participant and any person acting on behalf of or in the name of such Sponsored Participant.
(C) Sponsoring Member shall comply with the Nasdaq Certificate of Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center and Sponsored Participant shall comply with Nasdaq Certificate of
SR-NASDAQ-2008-104 Amendment 2 Page 50 of 54
Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center, as if Sponsored Participant were a Nasdaq Member. (D) Sponsored Participant shall maintain, keep current and provide to the Sponsoring Member a list of individuals authorized to obtain access to the Nasdaq Market Center on behalf of the Sponsored Participant. (E) Sponsored Participant shall familiarize its authorized individuals with all of the Sponsored Participant's obligations under this Rule and will assure that they receive appropriate training prior to any use or access to the Nasdaq Market Center. (F) Sponsored Participant may not permit anyone other than authorized individuals to use or obtain access to the Nasdaq Market Center. (G) Sponsored Participant shall take reasonable security precautions to prevent unauthorized use or access to the Nasdaq Market Center, including unauthorized entry of information into the Nasdaq Market Center, or the information and data made available therein. Sponsored Participant understands and agrees that Sponsored Participant is responsible for any and all orders, trades and other messages and instructions entered, transmitted or received under identifiers, passwords and security codes of authorized individuals, and for the trading and other consequences thereof. (H) Sponsored Participant acknowledges its responsibility to establish adequate procedures and controls that permit it to effectively monitor its employees’, agents’ and customers' use and access to the Nasdaq Market Center for compliance with the terms of this agreement. (I) Sponsored Participant shall pay when due all amounts, if any, payable to Sponsoring Member, Nasdaq, or any other third parties that arise from the Sponsored Participant’s access to and use of the Nasdaq Market Center. Such amounts include, but are not limited to applicable exchange and regulatory fees.]
[(3) The Sponsoring Member must provide Nasdaq with a Notice of Consent acknowledging its responsibility for the orders, executions and actions of its Sponsored Participant at issue.]
Access to a Trading Center. If a member enters into an arrangement with another person (e.g., a customer, another member, or a non-member broker-dealer) to provide that person with access to Nasdaq or otherwise allow such person to route its orders to Nasdaq using the member’s market participant identifier (“MPID”), the member is responsible for all trading conducted pursuant to that arrangement to the same extent as trading directly conducted by the member for customers. Consequently, the member is responsible for implementing policies and procedures for supervising and monitoring the trading effected pursuant to the arrangement to ensure that it is in compliance with all applicable federal
SR-NASDAQ-2008-104 Amendment 2 Page 51 of 54 securities laws and rules and Exchange rules. This obligation applies irrespective of the manner in which orders pursuant to such arrangements reach Nasdaq.
(1) Definition. Sponsored Access is the practice by a member firm (“Sponsoring Member”) of providing access to Nasdaq to another firm or customer (“Sponsored Participant”). Sponsored Access takes multiple forms, including but not limited to: (a) direct market access, where the Sponsored Participant’s orders pass through the Sponsoring Member’s systems prior to reaching Nasdaq (“Direct Market Access”), (b) sponsored access, where the Sponsored Participant enters orders directly into Nasdaq via a dedicated port provided by the Sponsoring Member (“Direct Sponsored Access”), and (c) direct access where a service bureau or other third party provides Sponsored Participants with technology to access Nasdaq under the auspices of and via an arrangement with the Sponsoring Member (“Third Party Sponsored Access”).
(A) Sponsored Access is the practice by a member (“Sponsoring Member”) of providing access to Nasdaq to another person, firm or customer (“Sponsored Participant”) whereby the Sponsored Participant enters orders into Nasdaq using a Sponsored Access System but the orders do not pass through a Member System prior to reaching Nasdaq.
(B). Direct Market Access (“DMA”) is the practice by a member (“Sponsoring Member”) of providing access to Nasdaq to another person, firm or customer (“Sponsored Participant”) whereby the Sponsored Participant makes decisions regarding order routing and order entry but the orders pass through a Member System prior to reaching Nasdaq.
(C). A Member System is any system administered and controlled solely by the Sponsoring Member and that applies the pre- and post-trade financial and regulatory controls set forth in sections (4) and (5) below.
(D) A Sponsored Access System is any system that applies pre- and post-trade financial and regulatory controls set forth in sections (4) and (5) below and that is not administered and controlled solely by the Sponsoring Member.
(2) Compliance. Irrespective of the form of Sponsored Access provided, Sponsoring Members are responsible for the conduct of their Sponsored Participants as if the conduct were their own. To ensure that Sponsored Access is consistent with high market quality and the protection of investors, Sponsoring Members providing Sponsored Access shall at a minimum comply with the Contractual Provisions, Financial Controls, and Regulatory Controls set forth in sections (3), (4), and (5) below. Sponsoring Members providing Direct Market
SR-NASDAQ-2008-104 Amendment 2 Page 52 of 54
Access shall at a minimum comply with the Financial Controls and Regulatory Controls set forth in sections (4) and (5) below.
(3) Contractual Provisions.
(A) A Sponsoring Member that provides Direct Sponsored Access or Third Party Sponsored Access shall execute and maintain agreements with each Sponsored Participant containing the commitments below. A Sponsoring Member that provides Third Party Sponsored Access must execute and maintain agreements with each service bureau or other entity that facilitates such Third Party Sponsored Access providing that such entity will execute and maintain agreements with each Sponsored Participant containing the commitments below for the benefit of the Sponsoring Member.
(Ai) All trading activity by the Sponsored Participant shall comply with all applicable federal securities laws and rules and Exchange rules, including but not limited to the Nasdaq Certificate of Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center (“Regulatory Requirements”).
(Bii) Sponsored Participant shall promptly upon request provide Sponsoring Member with access to such books and records promptly upon request and financial information that is necessary to allow the Sponsoring Member to comply with its regulatory obligations with respect to activity of the Sponsored Participant within the Sponsored Access arrangement, and otherwise cooperate with the Sponsoring Member in furtherance of Sponsoring Member’s compliance with applicable Regulatory Requirements. Information provided by Sponsored Participants to Sponsoring Members pursuant to such requests shall be maintained as confidential by the Sponsoring Member, provided that such information shall be available to Nasdaq upon request for regulatory purposes.
(Ciii) Sponsored Participant shall maintain its trading activity within the credit, product or other financial limits specified by the Sponsoring Member.
(Div) Sponsored Participant shall maintain all technology permitting sponsored access to Nasdaq in a physically secure manner and may not permit unauthorized individuals to use or obtain access to Nasdaq. Sponsored Participant shall familiarize its authorized individuals with the Regulatory Requirements and will provide appropriate training prior to use or access to Nasdaq.
SR-NASDAQ-2008-104 Amendment 2 Page 53 of 54
(E) Sponsored Participant shall provide the Sponsoring Member complete and current corporate and financial information about the Sponsored Participant.
(Fv) Sponsored Participant shall agree that the Sponsoring Member or Nasdaq may immediately terminate the Sponsored Access if the Sponsored Participant or third party access provider fails to abide by its commitments Sponsoring Member or Nasdaq determines that continuing such access poses serious risk to the Sponsoring Member or to the integrity of the market.
(B) A Sponsoring Member that provides Sponsored Access shall execute and maintain agreements with each third party (“Third Party Provider”) that provides a Sponsored Access System to Sponsored Participants for accessing Nasdaq, specifying which of the financial and regulatory controls stated in subsections (4) and (5) below are satisfied by the technology provided, and containing the commitments below.
(i) Third Party Providers shall promptly upon request provide Sponsoring Member with access to such books and records and financial information that is necessary to allow the Sponsoring Member to comply with its regulatory obligations with respect to activity of the Sponsored Participant within the Sponsored Access arrangement, and otherwise cooperate with the Sponsoring Member in furtherance of Sponsoring Member’s compliance with applicable Regulatory Requirements. Information provided by Sponsored Participants to Sponsoring Members pursuant to such requests shall be maintained as confidential by the Sponsoring Member, provided that such information shall be available to Nasdaq upon request for regulatory purposes.
(ii) Third Party Providers shall maintain all technology permitting Sponsored Access to Nasdaq in a physically secure manner and may not permit unauthorized individuals to use or obtain access to Nasdaq.
(iii) Third Party Providers shall agree that Nasdaq or its agent may audit the Sponsored Access System and that the Sponsoring Member or Nasdaq may immediately terminate the Sponsored Access if the Sponsored Participant or Third Party Provider fails to abide by its commitments.
(4) Financial Controls. Each Sponsoring Member shall establish adequate procedures and controls that permit it to effectively monitor and control the Sponsored Access or Direct Market Access to systemically limit the Sponsoring Member’s financial exposure. At a minimum, the Member System or Sponsored Access System shall be reasonably designed to:
SR-NASDAQ-2008-104 Amendment 2 Page 54 of 54
(A) Prevent each Sponsored Participant from entering orders that in aggregate exceed appropriate pre-set credit thresholds. Sponsoring Members may also set finely-tuned credit thresholds by sector, security or otherwise. (B) Prevent Sponsored Participants from trading products that the Sponsored Participant or Sponsoring Member is restricted from trading or that the Sponsored Participant is restricted from trading for reasons specific to the Sponsored Participant. (C) Prevent Sponsored Participants from submitting erroneous orders by providing for the rejection of orders that exceed certain price or size parameters, on an order-by-order basis or over a short period of time, or that indicate duplicative orders.
(5) Regulatory Controls. Each Sponsoring Member shall establish adequate
procedures and controls reasonably designed to permit it to effectively monitor and control compliance with Regulatory Requirements,
(A) Each Sponsoring Member shall have systemic controls reasonably designed to ensure compliance by the Sponsored Participant with all applicable Regulatory Requirements, including but not limited to compliance with rules relating to short selling; trading halts; proper uses of order types; proper use of Intermarket Sweep Orders; trading ahead of customer limit orders; prohibitions against manipulative trading practices, including wash sales and marking the close; restricted lists of securities for purposes of SEC Rule 10b-18; and applicable margin rules.
(B) Each Sponsoring Member shall ensure that compliance personnel appropriate supervisory personnel receive and review timely reports of all trading activity by its Sponsored Participants sufficient to permit the Sponsoring Member to comply with applicable Regulatory Requirements, and to monitor for illegal activity such as market manipulation or insider trading. At minimum, the member firm’s compliance unit appropriate supervisory personnel should receive immediate post-trade execution reports of trading activity of its all Sponsored Participants, including their identities; all required audit trail information by no later than the end of the trading day; and all information necessary to create and maintain the trading records required by applicable Regulatory Requirements by no later than the end of the trading day. Appropriate supervisory personnel shall review execution reports immediately and other reports promptly.