Document ID: SEC-2006-0946-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: NASDAQ Stock Market LLC
Posted Date: 2006-07-25T04:00Z

[Federal Register: July 25, 2006 (Volume 71, Number 142)]
[Notices]               
[Page 42149-42151]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr25jy06-119]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54170; File No. SR-NASDAQ-2006-006]

 
Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order 
Granting Approval of Proposed Rule Change as Amended by Amendment No. 1 
Regarding Restrictions on Affiliations Between Nasdaq and Its Members

 July 18, 2006.

I. Introduction

    On April 5, 2006, The NASDAQ Stock Market LLC (``Nasdaq''), filed 
with the Securities and Exchange Commission (``Commission'' or 
``SEC''), pursuant to Section 19(b)(1) of the Securities Exchange Act 
of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule 
change to govern affiliations between Nasdaq and its members and to 
limit in certain respects Nasdaq's regulatory authority with respect to 
members with which it is affiliated On April 12, 2006, Nasdaq filed 
Amendment No. 1 to the proposed rule change. The proposed rule change, 
as amended, was published for comment in the Federal Register on April 
28, 2006.\3\ The Commission received three comment letters on the 
proposal.\4\ On June 20, 2006, Nasdaq filed a response to comments.\5\ 
This order approves the proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 53697 (April 21, 
2006), 71 FR 25265.
    \4\ See e-mail from Richard Gold, Missoula, MT, dated April 28, 
2006 (``Gold E-mail''); and letters to Nancy M. Morris, Secretary, 
Commission from George R. Kramer, Deputy General Counsel, Securities 
Industry Association, dated May 19, 2006 (``SIA Letter''), and Kim 
Bang, Bloomberg L.P., dated May 17, 2006 (``Bloomberg Letter''). One 
commenter expressed general concerns about already approved Nasdaq 
rules requiring members to be broker-dealers, and did not address 
the substance of the proposal. See Gold E-mail.
    \5\ See letter to Nancy M. Morris, Secretary, Commission, from 
Edward S. Knight, Executive Vice President and General Counsel, 
Nasdaq, dated June 20, 2006 (``Nasdaq Response Letter'').
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II. Description of Proposal

    Nasdaq Rule 2140 would prohibit Nasdaq or an entity with which it 
is affiliated from acquiring or maintaining an ownership interest in, 
or engaging in a business venture \6\ with, a Nasdaq member or an 
affiliate of a Nasdaq member in the absence of an effective filing with 
the Commission under Section 19(b) of the Act.\7\ Further, the rule 
would prohibit a Nasdaq member from becoming an affiliate \8\ of Nasdaq 
or an affiliate of an entity affiliated with Nasdaq in the absence of 
an effective filing under Section 19(b) of the Act.\9\ However, 
Nasdaq's rule excludes from this restriction two types of affiliations.
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    \6\ Nasdaq defines a ``business venture'' as an arrangement 
under which (A) Nasdaq or an entity with which it is affiliated and 
(B) a Nasdaq member or an affiliate of a Nasdaq member, engage in 
joint activities with the expectation of shared profit and a risk of 
shared loss from common entrepreneurial efforts.
    \7\ 15 U.S.C. 78s(b).
    \8\ Nasdaq defines the term ``affiliate'' under proposed Rule 
2140 as having the meaning specified in Commission Rule 12b-2 under 
the Act; provided, however, that for purposes of Nasdaq Rule 2140, 
one entity shall not be deemed to be an affiliate of another entity 
solely by reason of having a common director.
    \9\ 15 U.S.C. 78s(b).
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    First, a Nasdaq member or an affiliate of a Nasdaq member could 
acquire or hold an equity interest in The Nasdaq Stock Market, Inc. 
that is permitted pursuant to Nasdaq Rule 2130 without filing such 
acquisition or holding under Section 19(b) of the Act.\10\ Second, 
Nasdaq or an entity affiliated with Nasdaq could acquire or maintain an

[[Page 42150]]

ownership interest in, or engage in a business venture with, an 
affiliate of the Nasdaq member without filing such affiliation under 
Section 19(b) of the Act, if there were information barriers between 
the member and Nasdaq and its facilities. These information barriers 
would have to prevent the member from having an ``informational 
advantage'' concerning the operation of Nasdaq or its facilities or 
``knowledge in advance of other Nasdaq members'' of any proposed 
changes to the operations of Nasdaq or its trading systems. Further, 
Nasdaq may only notify an affiliated member of any proposed changes to 
its operations or trading systems in the same manner as it notifies 
non-affiliated members. Nasdaq and its affiliated member may not share 
employees, office space, or data bases. Finally, the Nasdaq Regulatory 
Oversight Committee must certify, annually, that Nasdaq has taken all 
reasonable steps to implement, and comply with, the rule.
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    \10\ Nasdaq Rule 2130 provides that ``[n]o member or person 
associated with a member shall be the beneficial owner of greater 
than twenty percent (20%) of the then-outstanding voting securities 
of The Nasdaq Stock Market, Inc.''
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    Finally, Nasdaq proposed to amend several of its disciplinary rules 
to provide that Nasdaq will not consider appeals of disciplinary 
actions by affiliated members. Instead, after an initial decision is 
rendered, the affiliated member could appeal directly to the 
Commission.

III. Summary of Comments

    The Commission received three comments on the proposed rule change, 
as amended.\11\ Two commenters believed that the rule was unclear and 
questioned whether it would be consistent with the requirements of 
Section 19(b) of the Act.\12\ Specifically, one commenter believed that 
the rule would curtail the Commission's ability to review Nasdaq rules 
and provide an exemption to a broad category of core Nasdaq facilities 
from Commission review.\13\ The other commenter believed that, by 
carving out many types of business arrangements (licensing agreements, 
provision of transactional services or data etc.) as outside of the 
definition of ``business venture,'' certain provisions of agreements 
``that today rise to the level of `SRO rules' subject to Section 19(b) 
safeguards might potentially be avoided by simply shifting them to a 
new affiliate.'' \14\
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    \11\ See supra note 4.
    \12\ See SIA Letter supra note 4; Bloomberg Letter supra note 4.
    \13\ See Bloomberg Letter supra note 4, at 1-2.
    \14\ See SIA Letter supra note 4, at 3.
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    Both commenters also questioned why Nasdaq's proposed exemptions 
from the general rule requiring a filing with the Commission did not 
include all of the conditions set forth in an earlier Commission order 
(the ``FSI Order''),\15\ which allowed NASD and Nasdaq to develop trade 
analytics through a separate subsidiary without filing proposed rule 
changes on behalf of the subsidiary.\16\ The commenters noted that the 
Commission granted the relief at issue in the FSI Order on several 
conditions ``designed to ensure that (a) the activities of FSI would 
not involve core functions of Nasdaq and (b) FSI would not obtain any 
informational benefit from Nasdaq that would give it a commercial 
advantage over its competitors.'' \17\ By failing to cite the FSI Order 
and adhering to its conditions, one commenter believed that the 
proposal would allow business ventures involving affiliates to be 
executed without a filing with the Commission even where such 
agreements involved ``fundamentally important or core services,'' 
allowing the business venture to ``benefit from Nasdaq's monopoly 
powers'' with respect to such services.\18\
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    \15\ See Securities Exchange Act Release No. 42713 (April 24, 
2000) (2000 SEC LEXIS 807).
    \16\ See Bloomberg Letter supra note 4, at 2; See also SIA 
Letter supra note 4, at 3.
    \17\ See Bloomberg Letter supra note 4, at 2. See also SIA 
Letter supra note 4, at 3.
    \18\ See Bloomberg Letter supra note 4, at 3.
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    Finally, one commenter raised concerns with the broad exception to 
the filing requirement when certain information barriers exist between 
Nasdaq and its member or affiliate, noting that ``[i]t is not clear 
how, absent a filing explaining how such conditions would be met in a 
particular business venture, anyone on the outside could determine in 
any given instance if Nasdaq and its venture partner in fact meet the 
requirements.'' \19\
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    \19\ See SIA Letter supra note 4, at 2.
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IV. Nasdaq's Response to Comments

    On June 20, 2006, Nasdaq responded to the issues raised by the 
commenters.\20\ As a general preface, Nasdaq stated that it believed 
the concerns raised by the commenters reflected a ``fundamental 
misunderstanding of the proposed rule change.'' \21\ Nasdaq explained 
that it designed the proposal to stipulate that Nasdaq would be 
required to file a rule change regarding a proposed affiliation under 
the circumstances described in the rule ``even if the Act does not 
require it to do so'' to address a concern that there may be conditions 
under which the Commission would have a ``strong policy interest in 
reviewing an affiliation between a self-regulatory organization * * * 
and one of its members.'' \22\
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    \20\ See Nasdaq Response Letter supra note 5.
    \21\ See Nasdaq Response Letter supra note 5, at 1.
    \22\ Id.
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    Nasdaq, citing the language of Rule 19b-4 referring to ``facilities 
of the self-regulatory organization'' and the definition of 
``facility'' in Section 3(a)(2) of the Act,\23\ explained that it was 
well-established that the rule filing obligations of Section 19(b) of 
the Act are triggered by changes to an SRO's facilities.\24\ 
Conversely, Nasdaq stated, ``business ventures that do not constitute 
SRO facilities, such as the state-regulated insurance brokerages that 
Nasdaq owns, are not subject to Section 19 of the Act.'' \25\ At the 
same time, contrary to the concerns expressed in the SIA Letter about 
Nasdaq avoiding the application of Section 19 by shifting certain 
operations to an affiliate, to the extent such activities constituted 
the operations of a facility, Section 19 would apply and require a 
filing, regardless of where the operations were located.\26\
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    \23\ 15 U.S.C. 78c(a)(2).
    \24\ See Nasdaq Response Letter supra note 5, at 1-2.
    \25\ Id. at 2.
    \26\ Id. at 2, n.3.
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    Nasdaq makes clear that it was neither the intent nor effect of the 
proposal to alter the Section 19 rule filing obligations applicable to 
Nasdaq. Rather, proposed Rule 2140(a) imposes a rule filing obligation 
where Nasdaq or one of its affiliates seeks to ``acquire or maintain an 
ownership interest in, or engage in a business venture with, a Nasdaq 
member or an affiliate'' and proposed Rule 2140(b) makes clear that 
``[n]othing in this rule shall prohibit, or require a filing'' 
(emphasis added) in the circumstances described in that part of the 
rule.\27\ Nasdaq explains that the rule does not purport to describe 
the circumstances under which Section 19 of the Act would require a 
filing, and that in any event, Nasdaq could not by rule ``place limits 
on the requirements of Section 19 in the absence of an exercise of the 
Commission's exemptive authority under Section 36 of the Act * * *.'' 
\28\ Nasdaq further states that the exceptions in Rule 2140(b) are 
exceptions only to the requirement in Rule 2140(a) and that ``[w]hether 
Section 19 would require a filing in such circumstances would depend on 
the nature of the business venture, as it does today.'' \29\
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    \27\ Id. at 2.
    \28\ Id.
    \29\ Id. at 3.
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    Nasdaq provided a hypothetical example to illustrate its point. 
According to Nasdaq, if the Nasdaq Stock Market Inc. and a diversified

[[Page 42151]]

financial services holding company that also owned a Nasdaq member 
established a joint venture for trading precious metals in the spot 
market or for brokering commercial real estate in lower Manhattan, 
Nasdaq explained, the underlying activity would not be subject to a 
filing requirement under Section 19 because the joint venture would 
engage in activities not subject to Commission jurisdiction and would 
not be operated as a facility of Nasdaq. Although the joint venture 
would arguably result in an indirect affiliation between Nasdaq and one 
of its members, Nasdaq pointed out that its rule would not require a 
filing if the specified conditions of separation between the parties 
were in place. Nasdaq contrasted this scenario with a joint venture in 
which the hypothetical financial services holding company in question 
sold Nasdaq market data, in which case Section 19 of the Act would 
require a filing, regardless of its Rule 2140.

V. Discussion and Commission Findings

    The Commission has carefully reviewed the proposed rule change, as 
amended, the comment letters, and the Nasdaq Response Letter, and finds 
that the proposed rule change, as amended, is consistent with the 
requirements of the Act \30\ and the rules and regulations thereunder 
applicable to a national securities exchange.\31\ In particular, the 
Commission finds that the proposed rule change, as amended, is 
consistent with the requirements of Section 6(b)(5) of the Act,\32\ 
which requires that the an exchange have rules designed, among other 
things, to promote just and equitable principles of trade, to remove 
impediments and to perfect the mechanism of a free and open market and 
a national market system, and in general, to protect investors and the 
public interest.
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    \30\ 15 U.S.C. 78f.
    \31\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See U.S.C. 78c(f).
    \32\ 15 U.S.C. 78f(b)(5).
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    The Commission recently stated that it ``is concerned about [the] 
potential for unfair competition and conflicts of interest between an 
exchange's self-regulatory obligations and its commercial interests 
that could exist if an exchange were to otherwise become affiliated 
with one of its members, as well as the potential for unfair 
competitive advantage that the affiliated member could have by virtue 
of informational or operational advantages, or the ability to receive 
preferential treatment.'' \33\ The Commission believes that Nasdaq's 
proposed rule is designed to mitigate these concerns. Nasdaq's rule 
makes it clear that affiliations between Nasdaq and its members must be 
filed with the Commission unless such affiliation is due to a member's 
interest in The Nasdaq Stock Market, Inc. permitted under Rule 2130 or 
conforms to the specified information barrier requirements.
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    \33\ See Securities Exchange Act Release No. 53382 (February 27, 
2006), 71 FR 11251 (March 6, 2006) (order approving the New York 
Stock Exchange's merger with the Pacific Exchange).
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    In its response letter, Nasdaq correctly noted that its rule does 
not, in any way, limit the Commission's authority under the Act. If 
Nasdaq entered into an affiliation with a member (or any other party) 
that resulted in a change to a Nasdaq rule or the need to establish new 
Nasdaq rules, as defined under the Act, then such affiliation would be 
subject to the rule filing requirements of Section 19(b) of the Act. 
Nasdaq Rule 2140 would have no affect on this statutory rule filing 
requirement.
    Finally, the Commission believes that Nasdaq's revisions to certain 
disciplinary rules are consistent with the Act and are designed to 
protect the integrity of the disciplinary process. These modifications, 
which specify that Nasdaq may not be involved in certain disciplinary 
actions involving members with which it is affiliated, insulate 
Nasdaq's role as an SRO from its commercial interests.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\34\ that the proposed rule change (SR-Nasdaq-2006-006) be, and 
hereby is, approved, as amended.
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    \34\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
[FR Doc. E6-11796 Filed 7-24-06; 8:45 am]

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