[Federal Register Volume 66, Number 81 (Thursday, April 26, 2001)]
[Notices]
[Pages 21025-21031]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-10394]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44201; Form Type 34-36 MR; File No. 79-9]


Order Granting Application for a Conditional Exemption by the 
National Association of Securities Dealers, Inc. Relating to the 
Acquisition and Operation of a Software Development Company by the 
Nasdaq Stock Market, Inc.

April 18, 2001.

I. Introduction

    On March 3, 2000, the National Association of Securities Dealers, 
Inc. (``NASD'') and The Nasdaq Stock Market, Inc. (``Nasdaq'') filed 
with the Securities and Exchange Commission (``Commission''), pursuant 
to Rule 0-12 \1\ under the Securities Exchange Act of 1934 (``Exchange 
Act''), an application for a conditional exemption under section 
36(a)(1) of the Exchange Act \2\ relating to the Nasdaq's acquisition 
and operation of a software development company. In addition, the NASD 
requested that, if the commission determined to solicit comment on the

[[Page 21026]]

application for a permanent exemption, the Commission grant a temporary 
conditional exemption for a period of one year.
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    \1\ 17 CFR 240.0-12.
    \2\ 15 U.S.C. 78mm(a)(1).
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    The notice of application was published in the Federal Register on 
May 1, 2000 (``Public Notice''),\3\ along with an order temporarily 
granting the application for a conditional exemption. In this notice, 
the Commission stated that it would make a final determination 
concerning the request for a permanent exemption after reviewing the 
comments submitted in response to the notice and prior to the 
expiration of the temporary exemption.\4\ No comments were received on 
the application. This order approves the NASD's application for a 
conditional exemption under section 36(a)(1) of the Exchange Act \5\ 
relating to Nasdaq's acquisition and operation of a software 
development company.
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    \3\ See Securities Exchange Act Release No. 42713 (April 24, 
2000), 65 FR 25401.
    \4\ Id. at 25401. Nasdaq has submitted a letter reiterating the 
NASD's and Nasdaq's commitment to continue to comply with the terms 
and conditions of the conditional exemption and to continue to 
operate Nasdaq Tools, Inc. (formerly known as Financial Systemware, 
Inc.) in a manner that does not provide the company with an unfair 
competitive advantage. See letter from S. William Broka, Senior Vice 
President, Nasdaq, to Jonathan G. Katz, Secretary, Commission, dated 
February 5, 2001.
    \5\ 15 U.S.C. 78mm(a)(1).
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    The relevant text of the NASD's application is set forth in section 
II below,\6\ followed by the Commission's order granting the NASD's 
request for an exemption in section III.
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    \6\ The full text of the NASD's exemption application was 
published in the Public Notice and is incorporated herein by 
reference.
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II. NASD's Application for Exemption

    On behalf of the NASD an Nasdaq, pursuant to section 36 of the 
Exchange Act and Rule 0-12 thereunder, we are writing to apply for an 
exemption from section 19(b) of the Exchange Act, to (1) permit Nasdaq 
to acquire \7\ and operate a software development company, Financial 
Systemware, Inc. (``FSI''), to market certain financial services 
software, ``OTC Tools'' and related software (``Software''), and to 
expand the products and services offered by FSI to include service 
bureau and back-office functions for NASD broker-dealers, without 
filling proposed rule changes pursuant to Rule 19b-4 under the Exchange 
Act before making or implementing any modifications to the Software, or 
with respect to each new software product or service offered by FSI 
(provided those new software products and services are offered in a 
manner that is not inconsistent with the representations contained in 
this letter), and (2) permit FSI to determine prices for such software 
products and services based on competitive market factors without 
filing proposed rule changes pursuant to Rule 19b-4 under the Exchange 
Act.
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    \7\ The NASD filed its application on March 3, 2000. 
Subsequently, Nasdaq completed its acquisition of the assets of the 
software development company.
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    Subject to receiving the exemptive relief requested herein, Nasdaq 
plans to acquire the assets of FSI, whose primary line of business is 
the development and distribution of a financial services software 
product called ``OTC Tools.'' OTC Tools is designed for and marketed to 
NASD broker-dealers that use Nasdaq Workstation II terminals. OTC Tools 
is a Microsoft Windows-based software product that enhances and 
simplifies a user's interactions with, and use of, the Nasdaq 
Workstation II terminal, but does not change or alter the current 
features of Nasdaq, SelectNet or SOES (i.e., the facilities of the 
NASD). The NASD and Nasdaq proposed that Nasdaq will operate FSI as a 
stand-alone business, capitalized separately and not subsidized by NASD 
members or other revenues of the NASD or Nasdaq.
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    \8\ 
    \8\ The NASD, of course, reserves the right to provide capital 
to FSI adequate for it to compete effectively in the market place 
and to develop and market new products and services.
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    OTC Tools offers a variety of features to assist NASD broker-
dealers in efficiently managing their quotes, monitoring and executing 
incoming orders, continually checking for closed, locked or crossed 
markets, and monitoring the depth of the market. These functions to be 
performed by OTC Tools are not central to the core functionality of 
Nasdaq's marketplace. Rather the functions involved are supplemental 
to, and independent of, the primary functions of Nasdaq.
    Currently, the Software, which is being commercially marketed to 
NASD broker-dealers, offers a variety of features to assist them in 
efficiently managing their quotes, monitoring and executing incoming 
orders, continually checking for closed, locked, or crossed markets, 
and monitoring the depth of the market. There is a high level of 
effective competition in providing these types of software products and 
services to market participants. For example, Automatic Securities 
Clearance, through its BRASS service, provides order-management 
services and software to a large number of NASD member firms that are 
in many respects similar to the Software. Other firms, such as Eagle 
Trading, ADP, TCAM and Royal Blue, offer order handling packages that 
compete with those offered by FSI. Similarly, many NASD member firms 
have developed internal order management and order-routing software 
that provides independent functions comparable to those provided by the 
Software.
    Technology applications for broker-dealers and market makers 
develop and change very rapidly, and FSI needs to be able to move 
quickly to modify existing products and develop new software products. 
If FSI were required to follow the procedures for rule filings and 
approvals each time the Software is modified or enhanced, the delays 
and administrative difficulties associated with the rule filing process 
would put FSI at a significant competitive disadvantage relative to 
other software developers that are not affiliated with an SRO. 
Moreover, the NASD and Nasdaq would not be able to provide NASD broker-
dealers with the type of timely and effective software development that 
users desire and have indicated they need. Thus, in this competitive 
software market, the delays and administrative difficulties associated 
with the rule filing process would, in the NASD's view, put FSI at such 
a competitive disadvantage so as to render the acquisition of FSI or 
the rights to the software impracticable.
    As described in Exchange Act Rule 0-12, in connection with a 
request for exemption from any provision of the Exchange Act, the 
applicant is required to state any conditions or limitations it 
believes would be appropriate for the protection of investors. As a 
general matter, the NASD and Nasdaq believe the request submitted 
herein is appropriate because it deals with nonessential services of 
the NASD and provides the benefit of optional technological innovation 
designed to improve the productivity of NASD member firms. The 
following limitations on the exemptive relief requested are, in the 
view of the NASD and Nasdaq, not objectionable to further this 
objective and to ensure that the operation of FSI is generally 
consistent with the requirements of the Exchange Act applicable to 
SROs.

Continued Presence of Competition

    As indicated above, at the time of this application, there is a 
high level of effective competition in providing software to market 
makers. Automatic Securities Clearance, through its BRASS service, for 
example, provides order-management services and software that are in 
many respects similar to the Software to a large number of NASD member 
firms. Other firms, such as Eagle Trading, ADP, TCAM and Royal Blue, 
offer order handling packages that compete with those offered by FSI. 
Similarly, many NASD member firms have developed internal order 
management and order-routing software

[[Page 21027]]

that provides independent functions comparable to those provided by the 
Software. Moreover, the software industry in general, and the financial 
software industry in particular have low barriers to entry, so that, as 
the markets evolve and technology is increasingly brought to bear on 
securities trading, new entrants can, in our view, emerge. NASD and 
Nasdaq understand that the Commission may reconsider at a later date 
its decision to grant the exemptive relief requested herein in the 
event that effective competition for these software products and 
services no longer exists.

Independent Functionality of Nasdaq and Other NASD-Sponsored Services

    NASD and Nasdaq believe that providing the Software to NASD member 
firms does not, and will not, affect the basic functionality of the 
Nasdaq system. In acquiring FSI and providing the software to NASD 
member firms, the core functions of Nasdaq (currently provided through 
the Nasdaq Workstation II terminal system) will not be changed. Nasdaq 
and other NASD-sponsored systems (such as the Automated Confirmation 
Transaction Service) operate and will continue to operate independently 
of the Software. Use of the Software is not, and will not in the 
future, be necessary to access Nasdaq or any other NASD market-related 
facility, and NASD members that do not use the Software will be able to 
enter and change quotes, route orders, effective transactions and 
perform all market functions in Nasdaq. The NASD and Nasdaq believe 
that requiring full Nasdaq core functionality without use of the 
Software is an appropriate condition to the grant of the exemptive 
relief requested.

Full Public Access to Nasdaq Through the Application Programming 
Interface (``API'') \9\ Will Continue
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    \9\ API provides an electronic interface between a subscriber's 
computer system and the Nasdaq Workstation II system. Through the 
use of the API, a subscriber may build its own workstation 
presentation software to integrate the Nasdaq Workstation II service 
into the subscriber's existing presentation facilities. The API 
allows a subscriber to emulate the Nasdaq Workstation II 
presentation software with equivalent functionality, capacity 
utilization and through-part capability, in addition to providing 
enhanced capability to develop customized internal presentations for 
use in support of a subscriber's activities. API also allows a 
subscriber to operate a quote-update facility to assist solely in 
complying with the Commission's Order Handling Rules. Generally, a 
subscriber establishes an API ``linkage,'' such as a Nasdaq 
Workstation II substitute or quote update facility, which in turn 
connects to a service delivery platform via an API server.
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    As the Commission is aware, the Nasdaq system is an open 
architecture system and Nasdaq has provided an API that enables firms 
to have access to the Nasdaq system through their own software or 
computer system. The NASD and Nasdaq are fully committed to maintaining 
the API to provide for fair and equitable access to the system and to 
encourage the development of software by NASD member firms and 
competing software vendors. Thus, we believe that conditioning the 
exemptive relief on continued free and open access to Nasdaq through 
the API is appropriate in light of the commitment of the NASD and 
Nasdaq to maximum competition in offering services to NASD members.

Fair Access to Information on Nasdaq Developments

    As a fourth condition consistent with the statutory objective and 
our stated objective of maintaining a competitive software market, the 
NASD and Nasdaq agree not to provide FSI an information advantage 
concerning Nasdaq core facilities, particularly changes and 
improvements to the system, that is not available to the industry 
generally or to vendors of financial software for market makers and 
order entry firms, and will prevent FSI from having any advance 
knowledge of proposed changes or modifications to core Nasdaq 
facilities. This is appropriate to avoid giving FSI any informational 
advantage in the development and enhancement of software products for 
the Nasdaq market.
    In this regard, FSI will not share employees with the NASD, Nasdaq 
or any other NASD affiliate, and will be housed in office space 
separate from that of the NASD or Nasdaq. In addition, FSI will be 
notified of any changes or improvements to the Nasdaq system in the 
same manner that other competing vendors are notified of such changes 
or improvements. For example, in addition to mailings and Web site 
disclosure of changes to Nasdaq or to Nasdaq technical specifications, 
Nasdaq currently meets at least quarterly with all vendors to discuss 
proposed modifications to the System and changes that are in the 
pipeline (subject to Commission approval, where needed). FSI will be 
traded, for purposes of these mailings, disclosures and meetings, the 
same as any third party vendor and will not receive any information 
regarding planned or actual changed to Nasdaq in advance of other 
vendors Conversely, FSI will not disclose any system or design 
specifications, or any other information to any employees with the 
NASD, Nasdaq or any other NASD affiliate that would give FSI an unfair 
advantage over its competitors.
    For the reasons set forth above, the NASD hereby requests that the 
Commission grant an exemption from Section 19(b), and the rules and 
regulations thereunder, to (1) permit the Nasdaq to operate FSI and 
offer software to market makers (and other NASD member firms) without 
filing proposed rule changes with respect to making or implementing any 
modifications to the Software, or with respect to each new software 
product or service offered by FSI (provided those new software products 
and services are offered in a manner that is not inconsistent with the 
representations contained in this letter), and (2) permit FSI to 
determine prices for such software products and services based on 
competitive market factors without filing proposed rule changes.

III. Order Granting Conditional Exemption

    The Commission has determined to grant the NASD's application for a 
conditional exemption. The Commission finds that the conditional 
exemption from the provisions of section 19(b) is necessary and 
appropriate in the public interest and is consistent with the 
protection of investors. In particular, the exemption could help 
promote efficiency and competition in the market to provide enhanced 
software services to broker-dealers who interact with the NASD's 
facilities, while upholding the regulatory objectives of the Exchange 
Act.
    As discussed further below, the NASD, as a registered self-
regulatory organization, operates a number of facilities used by 
broker-dealers that effect transactions in securities in the over-the-
counter, particularly securities that are qualified for inclusion in 
Nasdaq. These facilities, which include the automated quotations 
network that is the heart of Nasdaq, order delivery and execution 
systems, and a transaction reporting system, are made available broker-
dealer subscribes primarily through the Nasdaq Workstation II 
(``NWII'') service. The NASD has adopted an open architecture system 
that provides an API between the NWII system and a subscriber's 
computer system. The API allows broker-dealers to employ specialized 
software that supplements the NWII service and enhances their 
interaction with the NASD's facilities, thereby facilitating their 
trading and other proprietary activities. Currently, a number of 
companies independent of the NASD offer this type of software product 
for sale to broker-dealers. Nasdaq has acquired one of these 
companies--FSI.

[[Page 21028]]

    Certain of the functions offered through FSI's products, when 
considered together with the other services offered by the NASD and its 
affiliates,\10\ could cause such products to be considered part of the 
NASD's facilities. Consequently, changes to the products or the fees 
charged for the products could trigger the proposed rule change 
requirements of section 19(b),\11\ which include filings with the 
Commission, public notice and comment on those filings, and Commission 
review and approval of the proposed rule change. These requirements 
could significantly hamper the ability of FSI to compete effectively in 
a rapidly changing technology market to provide specialized software to 
broker-dealers. The requested conditional exemption would allow FSI to 
modify its products, offer new products, and set fees for its products 
without going through the proposed rule change procedures of section 
19(b).\12\
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    \10\ The companies that currently offer the enhanced software 
products for broker-dealers are not owned by an SRO. When considered 
alone, their activities do not fall within the definition of a 
facility of an SRO, and they therefore are not subject to the 
proposed rule change requirements of Section 19(b).
    \11\ 15 U.S.C. 78s(b).
    \12\ 15 U.S.C. 78s(b).
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    In granting the Commission broad exemptive authority in section 
36,\13\ Congress intended to incorporate flexibility into the Exchange 
Act regulatory scheme to reflect a rapidly changing marketplace. 
Congress particularly intended for the Commission to use this 
flexibility to promote efficiency and competition.\14\ The Commission 
believes that the NASD's requested conditional exemption will help 
achieve these goals, while upholding the regulatory objectives of the 
Exchange Act. In particular, the exemption could facilitate vigorous 
competition in the market to provide enhanced software services to 
broker-dealers by allowing FSI to compete on a more equal footing with 
companies that are not subject to the regulatory requirements 
applicable to an SRO. The exemption is subject to four principal 
conditions to help assure that FSI will not obtain an unfair 
competitive advantage because of its ownership by Nasdaq.
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    \13\ 15 U.S.C. 78mm.
    \14\ See discussion at Section III.C., commission's Exemptive 
Authority under Section 36, infra.
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    The Commission believes that granting a conditional exemption is 
warranted because (1) the products of FSI are not required for broker-
dealers to access the NASD's fundamentally important or core services, 
including quotation collection and dissemination, order routing and 
execution, and transaction reporting, and (2) the opportunity for fair 
competition will be preserved in the market to provide enhanced 
software services to broker-dealers who use the NASD's facilities. 
Under these circumstances, the Commission believes that competitive 
forces, rather than the regulatory protections provided by the proposed 
rule change process, can be relied on to uphold the objectives of the 
Exchange Act in an efficient manner. Fair and vigorous competition, by 
creating incentives for companies to provide superior software products 
at fair prices, can serve the interests of broker-dealers, and 
ultimately those of their investor customers.

A. The NASD's Facilities and Its Open Architecture System

    The NASD currently operates a number of facilities for broker-
dealers that effect transactions in securities traded in the OTC 
markets. These facilities include (1) an automated quotations system, 
(2) the SelectNet order delivery system,\15\ (3) the Small order 
Execution System (``SOES``), and (4) the Automated confirmation 
Transaction Service (``ACT'').
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    \15\ The Commission approved a proposed rule change by the NASD 
to establish a revised order delivery and execution system--the 
Nasdaq National Market Execution System. Securities Exchange Act 
Release No. 42344 (Jan. 18, 2000), 65 FR 3987.
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    Currently, Nasdaq is a telecommunications network for the 
centralized collection and dissemination of quotations from market 
makers and electronic communications, networks (``ECNs''). This service 
allows broker-dealers to enter, retrieve, monitor, and adjust 
quotations throughout the trading day. The NASD's SelectNet facility 
offers broker-dealers the ability to automate the negotiation and 
execution of trades and eliminates the need for verbal contact between 
trading desks. It allows Nasdaq subscribers to direct orders for the 
purchase and sale of Nasdaq stocks to specified market makers or ECNs, 
or to broadcast orders for Nasdaq stocks to all market makers and ECNs. 
SelectNet also identifies incoming and outgoing orders and allows 
traders to see subsequent messages and negotiation results. The NASD's 
SOES facility automatically executes small agency orders routed to 
market makers, reports completed trades for public dissemination, and 
sends information with respect to those trades to clearing corporations 
for comparison and settlement. Finally, the NASD's ACT facility is an 
automated service that speeds the post-execution steps of price and 
volume reporting and the comparison and clearing of securities 
transactions.
    Access to the NASD's facilities is made available primarily through 
the NASD's NWII service. In addition, the NASD has adopted an open 
architecture system that provides full public access to its facilities 
through the API. The API provides an electronic interface between a 
subscriber's computer system and the NWII system. Through the use of 
the API, a subscriber may employ its own workstation presentation 
software to integrate the NWII services into its presentation 
capabilities. The API thereby allows a subscriber to develop customized 
internal presentations for use in support of the subscriber's 
activities. In sum, core NASD services are provided through the NWII 
system, while subscribers also are able to develop or purchase 
customized software that enhances the NWII services and responds to 
their individual needs.
    Many broker-dealers have taken advantage of the API and employ 
software to enhance the NASD services provided through the NWII system. 
Some broker-dealers have developed such software internally. In 
addition, a number of companies independent of the NASD have developed 
this type of software and offered it for sale to broker-dealers. For 
example, the promotional materials of one company states that its 
product ``provides full integrated and enhanced Nasdaq Workstation II 
features,'' including automated management of quotations, automated ACT 
reporting, and automated SelectNet order entry and order acceptance. 
Other competing companies make similar assertions concerning the 
ability of their products to enhance the interaction of broker-dealers 
with the NASD's facilities, as well as to facilitate a wide array of 
other broker-dealer proprietary activities.
    The Nasdaq has acquired one of these companies--FSI. FSI is a 
software development company that offers a product called OTC Tools. 
OTC Tools includes a variety of features to assist NASD members in 
conducting their proprietary activities, including efficiently managing 
their quotes, monitoring and executing incoming orders, continually 
checking for closed, locked, or crossed markets, and monitoring the 
depth of the market.\16\

[[Page 21029]]

To enable FSI to modify its products, offer new products, and set fees 
for its products as freely and quickly as its competitors that are not 
owned by an SRO, the NASD has requested a conditional exemption from 
the proposed rule change provisions of section 19(b).
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    \16\ For example, the current version of OTC Tools enables a 
user (1) to maintain a pre-configured maximum market spread in 
specific securities when making spread in specific securities when 
making adjustments in a quotation at one side of the market; (2) to 
capture and execute incoming SelectNet orders in several different 
fashions by combining multiple keystroke or mouse functions; (3) to 
send, with a single point-and-click feature, multiple SelectNet 
preferenced orders to preset market makers or ECNs; and (4) to 
monitor SelectNet broadcast orders for electronic execution based on 
the user's pre-configured order selection file.
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B. Proposed Rule Change Provisions of Section 19(b)

    Section 19(b) \17\ requires that every SRO file with the Commission 
copies of any proposed rule or any proposed change in, addition to, or 
deletion from the rules of such SRO, accompanied by a concise general 
statement of the basis and purpose of such proposed rule change. The 
Commission is required to publish notice of the filing of a proposed 
rule change and to give interested persons an opportunity to submit 
written data, views, and arguments. Section 19(b) \18\ provides that 
the Commission shall approve an SRO's proposed rule change if it is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to the SRO.
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    \17\ 15 U.S.C. 78s
    \18\ 15 U.S.C. 78s(b).
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    The term ``rules of a self-regulatory organization'' is defined in 
section 3(a)(28) of the Exchange Act \19\ to include the rules of an 
association of broker-dealers that is a registered securities 
association, and the term ``rules of an association'' is defined in 
section 3(a)(27) \20\ to include such of the stated policies, 
practices, and interpretations of the association as the Commission 
determines by rule to be necessary or appropriate in the public 
interest or for the protection of investors. In Exchange Act Rule 19b-
4,\21\ the Commission has defined ``stated policy, practice, or 
interpretation'' to include any material aspect of the operation of the 
facilities of a self-regulatory organization. The term ``facility'' 
when used with respect to an exchange \22\ is defined very broadly in 
section 3(a)(2) \23\ to include, among other things, any tangible or 
intangible property of the exchange and any right to the use of such 
property or any service thereof for the purpose of effecting or 
reporting a transaction on an exchange (including any system of 
communication to or from the exchange).
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    \19\ 15 U.S.C. 78c(a)(28).
    \20\ 15 U.S.C. 78c(a)(27).
    \21\ 17 CFR 240.19b-4.
    \22\ The Commissions has found that Nasdaq falls within the 
definition of ``exchange'' under Section 3(a)(1) of the Act. 
Securities Exchange Act Release No. 40760 (Dec. 8, 1998), 63 FR 
70844 (``ATS Release'') at nn. 58-61 and accompany text.
    \23\ 15 U.S.C. 78c(a)(2).
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    Certain aspects of the software products that enhance a broker-
dealer's interaction with the NASD's facilities, when considered 
together with the other services offered by the NASD and its 
affiliates, fall with the Exchange Act definition of a facility and 
therefore require the filing of a proposed rule change for material 
changes in the software and the fees charged for the software. The NASD 
has requested a conditional exemption for this requirement under 
Section 36 of the Exchange Act.\24\
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    \24\ 15 U.S.C. 78mm.
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C. Commission's Exemptive Authority Under Section 36

    Section 36(a)(1) of the Exchange Act \25\ grants the Commission 
broad authority to exempt any person from any provision of the Act to 
the extent that such exemption is necessary or appropriate in the 
public interest and is consistent with the protection of investors. In 
enacting section 36, Congress indicated that it expected that ``the 
Commission will use this authority to promote efficiency, competition 
and capital formation.'' \26\ It particularly intended to give the 
Commission sufficient flexibility to respond to changing market and 
competitive conditions:
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    \25\ 15 U.S.C. 78mm(a)(1).
    \26\ H.R. Rep. No. 104-622, 104th Cong., 2d Sess. 38 (1996).

    The Committee recognizes that the rapidly changing marketplace 
dictates that effective regulation requires a certain amount of 
flexibility. Accordingly, the bill grants the SEC general exemptive 
authority under both the Securities Act and the Securities Exchange 
Act. This exemptive authority will allow the Commission the 
flexibility to explore and adopt new approaches to registration and 
disclosure. It will also enable the Commission to address issues 
relating to the securities markets more generally. For example, the 
SEC could deal with the regulatory concerns raised by the recent 
proliferation of electronic trading systems, which do not fit neatly 
into the existing regulatory framework.\27\
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    \27\ S. Rep. No. 104-293, 104th Cong., 2d Sess. 15 (1996).

    At the same time that it added section 36 to the Exchange Act, 
Congress enacted Section 3(f),\28\ which charges the Commission, when 
it is engaged in rulemaking itself or reviewing an SRO rule and is 
required to consider whether an action is necessary or appropriate in 
the public interest, also to consider whether the action will promote 
efficiency, competition, and capital formation.
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    \28\ 15 U.S.C. 78c(f).
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    Section 36 \29\ and section 3(f) \30\ reaffirm a fundamental and 
long-established principle of the Exchange Act--investor interests are 
best served by a regulatory structure that facilitates fair and 
vigorous competition among market participants. Congress emphasized 
this principle, for example, when it amended the Exchange Act in 1975:
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    \29\ 15 U.S.C. 78mm.
    \30\ 15 U.S.C. 78c(f).

    In 1936, this Committee pointed out that a major responsibility 
of the SEC in the administration of the securities laws is to 
`create a fair field of competition.' This responsibility continues 
today. * * * The objective would be to enhance competition and to 
allow economic forces, interacting within a fair regulatory field, 
to arrive at appropriate variations in practices and services. It 
would obviously be contrary to this purpose to compel elimination of 
differences between types of markets or types of firms that might be 
competition-enhancing.\31\
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    \31\ S. Rep. No. 94-75, 94th Cong., 1st Sess. 8 (1975).

    In recent years, the Commission has exercised its section 36 \32\ 
exemptive authority to enhance competition as a means to meet the 
objectives of the Exchange Act. For example, it exempted alternative 
trading systems from many of the requirements that otherwise would 
apply to an ``exchange,'' including registration and the filing of 
proposed rule changes, when such requirements were not necessary or 
appropriate to further the Exchange Act's objectives. In adopting this 
exemption, the Commission stated that it ``believes that it regulation 
of markets should both accommodate traditional market structures and 
provide sufficient flexibility to ensure that new markets promote 
fairness, efficiency, and transparency.'' \33\
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    \32\ 15 U.S.C. 78mm.
    \33\ ATS Release, note 21 above, section I.
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    In addition, the Commission has used its exemptive authority to 
revise the proposed rule change requirements of section 19(b) to meet 
the changing needs of the SROs in a competitive international 
marketplace. For example, the Commission amended Rule 19b-4 \34\ in 
1998 to streamline the requirements for introduction of new derivative 
securities products.\35\ At the same time,

[[Page 21030]]

the Commission adopted Rule 19b-5 \36\ to help reduce impediments to 
competitive innovation by SROs by exempting them from the requirement 
to file proposed rule changes for pilot trading systems for a two-year 
period. In adopting this exemption, the Commission noted that 
``excessive regulation of traditional exchanges, alternative trading 
systems, or other markets hinders these exchanges' ability to compete 
and survive in the global arena'' and found that the exemption from 
section 19(b) for pilot trading programs ``responds to the SROs' need 
for a more balanced competitive playing field.'' \37\
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    \34\ 17 CFR 240.19b-4.
    \35\ Securities Exchange Act Release No. 40761 (Dec. 8, 1998), 
63 FR 70952.
    \36\ 17 CFR 240.19b-5.
    \37\ ATS Release, note 21 above, section VI.A.
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D. Conditional Exemption for FSI

    The NASD has requested a conditional exemption that would allow FSI 
to modify its products, offer new products, and set fees for its 
products without filing proposed rule changes under section 19(b). The 
exemption would be subject to four principal conditions: (1) The 
continued presence of effective competition in the market to provide 
software products that enhance a broker-dealer's interaction with the 
NASD's facilities; (2) the independent functionality of the NASD's 
facilities; (3) continued full pubic access to the NASD's facilities 
through the API; and (4) fair access to information concerning the 
NASD's facilities and systems.
    The Commission believes that the requested conditional exemption 
will help promote efficiency and competition, while upholding the 
regulatory objectives of the Exchange Act. Nasdaq's ownership of a 
software company whose products facilitate a broker-dealer's 
interaction with the NASD's facilities could promote efficiency and 
competition. Specifically, permitting FSI, with the assistance of 
Nasdaq's knowledge of the securities market, to compete on equal 
footing with other software providers, could result in the development 
of products with features that more closely respond to the needs of a 
wide variety of broker-dealers, both large and small. Such products may 
result in increased efficiency of operations for these broker-dealers. 
Thus, this exemption may enable FSI to offer software products--
enhanced by Nasdaq's insight and experience in the market--that could 
act as spur to competition and thereby help generate better software 
products for broker-dealers.
    Given the pace of change in software technology and market 
conditions, the Commission believes that the procedural requirements of 
section 19(b) \38\ could significantly hamper the ability of FSI to 
compete effectively with companies that are not subject to the same 
regulatory requirements. A software company needs to act rapidly and 
nimbly in developing and pricing its products. If FSI were required to 
comply with the proposed rule change requirements, it necessarily would 
be subject to greater expense, delay, and uncertainty in offering 
products and setting prices than its competitors. Although the 
requirements of section 19(b) \39\ serve vital regulatory functions, 
particularly with respect to the fundamentally important or core 
services of an SRO, the Commission does not believe that they are 
necessary to further the public interest in the context of the limited 
services to be provided by FSI.
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    \38\ 15 U.S.C. 78s(b).
    \39\ 15 U.S.C. 78s(b).
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    In reviewing a proposed rule change under Section 19(b), the 
Commission focuses on the particular section of the Exchange Act that 
sets forth substantive requirements for the SRO's rules. For a national 
securities association such as the NASD, section 15A \40\ of the 
Exchange Act requires, among other things, that its rules (1) provide 
for the equitable allocation of reasonable dues, fees, and other 
charges among members using any facility or system which the 
association operates or controls (subparagraph (b)(5)); (2) be designed 
to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and, in general, to protect investors and the 
public interest, and not be designed to permit unfair discrimination 
between customers, issuers, or broker-dealers (subparagraph (b)(7)); 
and (3) not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Exchange Act 
(subparagraph (b)(9)).
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    \40\ 15 USC 78o-3
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    The four principal conditions of the requested exemption will help 
assure that these regulatory objectives are upheld without requiring 
Commission review and approval of FSI's products and fees.\41\ First, 
the products of FSI will not be necessary for broker-dealers to access 
the NASD's fundamentally important or core services, including 
quotation collection and dissemination, order routing and execution, 
and trade reporting.\42\ The NASD and Nasdaq have agreed to maintain an 
independent functionality for the NASD's market-related facilities--
that is, neither FSI's products nor enhanced software products of any 
kind will be necessary for a broker-dealer to obtain access to the 
NASD's fundamentally important or core services. The basic software 
products necessary to obtain such access (currently provided through 
the NWII service) will be provided separately from FSI.
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    \41\ The Commission reserves the right to modify, by order, the 
terms and scope of the exemption from the proposed rule change 
requirements if it determines such modification is appropriate for 
the protection of investors or in the public interest.
    \42\ This approach is consistent with the Commission's decision 
in an administrative proceeding that included a denial of access 
claim under Section 19(d) of the Exchange Act. In the Matter of the 
Application of Morgan Stanley & Co., Admin. Proc. File No. 3-9289 
(Dec. 17, 1997) (``In those cases in which we have found a denial of 
access, an SRO had denied or limited the applicant's ability to 
utilize one of the fundamentally important services offered by the 
SRO. The services at issue were not merely important to the 
applicant but were central to the function of the SRO.'').
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    In addition, for broker-dealers who wish to employ software 
products that enhance their interaction with the NASD's facilities, the 
exemption is conditioned on the continued existence of effective 
competition in the market to provide such type of products. This 
condition will work to assure that broker-dealers have a variety of 
viable software products from which to choose. To maintain an 
opportunity for fair competition, the NASD and Nasdaq have agreed to 
continue to provide open architecture systems that enable full public 
access to the NASD's facilities through the API. The NASD and Nasdaq 
also have agreed not to provide an unfair information advantages to 
FSI. FSI will not be given information concerning the NASD's facilities 
that is not available to the industry generally or to other companies 
competing to provide enhanced software products to broker-dealers. In 
particular, the NASD and Nasdaq will prevent FSI from having any 
advance private knowledge of proposed changes or modifications to the 
NASD's facilities. To help meet this condition, FSI will not share 
employees with the NASD or any NASD affiliate and will be housed in 
office space separate from that of the NASD or Nasdaq.
    Given these conditions, the Commission does not believe that the 
regulatory protections offered by Commission review and approval of 
proposed rule changes are necessary or appropriate to further the 
Exchange Act's regulatory objectives. Access to the NASD's 
fundamentally important and core services will be independently 
maintained by the NASD and fully subject to the Exchange Act's 
regulatory

[[Page 21031]]

scheme, including the proposed rule change requirements of Section 
19(b).\43\ Fair competition will be maintained in the market to provide 
enhanced software products to broker-dealers. Under these 
circumstances, the Commission believes at this point that competitive 
forces can be relied upon to produce software products at fair prices 
that meet the needs of broker-dealers. In sum, the Commission believes 
that FSI will neither be unnecessarily hampered in its competition to 
provide software services to broker-dealers nor given an unfair 
competitive advantage because of its ownership by Nasdaq.
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    \43\ 15 U.S.C. 78s(b).
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IV. Conclusion

    It Is Therefore Ordered, pursuant to section 36(a)(1) of the 
Exchange Act,\44\ that the NASD's application for a conditional 
exemption (Form Type 34-36 MR; File No. 79-9) is approved.
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    \44\ 15 U.S.C. 78mm(a)(1).

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-10394 Filed 4-25-01; 8:45 am]
BILLING CODE 8010-01-M