Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto by the National Association of Securities Dealers, Inc., To Establish Rules Governing the Operation of Nasdaq's Brut Facility, 4902-4911 [05-1697]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 70, Number 19 (Monday, January 31, 2005)]
[Notices]
[Pages 4902-4911]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-1697]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51078; File No. SR-NASD-2004-173]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the National Association of 
Securities Dealers, Inc., To Establish Rules Governing the Operation of 
Nasdaq's Brut Facility

January 25, 2005.
    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 November 3, 2004, the National Association of Securities Dealers, 
Inc. (``NASD''), through its subsidiary, The Nasdaq Stock Market, Inc. 
(``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 prepared by Nasdaq. On January 24, 
2005, Nasdaq submitted Amendment No. 1 to the proposed rule change.\3\ 
The Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaced and superseded the originally filed 
proposed rule change.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Nasdaq proposes to establish rules governing the operation of its 
Brut trading facility. Nasdaq will implement the proposed rule change, 
as amended, immediately upon approval by the Commission. Below is the 
text of the proposed rule change, as amended. Proposed new language is 
italicized; proposed deletions are in [brackets].

4900. BRUT SYSTEM (System)

4901. Definitions

    Unless stated otherwise, the terms described below shall have the 
following meaning:
    (a) The term ``System securities'' shall mean Nasdaq Market Center 
eligible securities as that term is defined in NASD Rule 4701(s) and 
exchange-listed Intermarket Trading System (ITS) eligible securities as 
defined in NASD Rule 5210(c).
    (b) The term ``Effective Time'' shall mean, for orders so 
designated, the time at which the order shall become eligible for 
display and potential execution with other orders in the System.
    (c) The term ``Immediate or Cancel'' shall mean, for limit orders 
so designated, that if after entry into the System the order (or a 
portion thereof) is not marketable, the order (or unexecuted portion 
thereof) shall be canceled and returned to the entering Participant.
    (d) The term ``limit order'' shall mean an order to buy or sell a 
stock at a specified price or better. This order type is available for 
Nasdaq-listed and Exchange-listed securities.
    (e) The term ``market order'' shall mean an unpriced order to buy 
or sell a stock at the market's current best price. A market order may 
have a limit price beyond which the order shall not be executed. This 
order type is available for Nasdaq-listed and Exchange-listed 
securities.
    (f) The term ``mixed lot'' shall mean an order that is for more 
than a normal unit of trading but not a multiple thereof.
    (g) The term ``Nasdaq Market Center'' shall mean the automated 
system owned and operated by The Nasdaq Stock Market, Inc. pursuant to 
NASD Rule 4700 Series.
    (h) The term ``The BRUT ECN System,'' or ``System,'' shall mean the 
automated system owned and operated by Brut, which is owned and 
operated by The Nasdaq Stock Market, Inc., which enables Participants 
to execute transactions in System securities; to have reports of the 
transactions automatically forwarded to the appropriate National Market 
Trade Reporting System, if required, for dissemination to the public 
and the industry, and to ``lock in'' these trades by sending both sides 
to the applicable clearing corporation(s) designated by the System 
Participant(s) for clearance and settlement; and to provide System 
Participants with sufficient monitoring and updating capability to 
participate in an automated execution environment.
    (i) The term ``Participant'' shall mean an NASD member that 
fulfills the obligations contained in Rule 4902 regarding participation 
in the System.
    (j) The term ``System Book Feed'' shall mean a data feed for System 
eligible securities that Brut will make available to Participants and 
third-party vendors.
    (k) The term ``odd-lot order'' shall mean an order that is for less 
than a normal unit of trading.
    (l) The term ``Reserve Size'' shall mean the functionality that 
permits a Participant to display a portion of an order, with the 
remainder held in reserve on an undisplayed basis.
    (m) The term ``Good-till-Cancelled'' shall mean, for orders so 
designated, that if after entry into the System, the order is not fully 
executed, the order (or unexecuted portion thereof) shall remain 
available for potential display and/or execution only until 4 p.m. 
Eastern Time on the day they are submitted unless cancelled before then 
by the entering party.
    (n) The term ``Good-till-Cancelled-Overnight'' shall mean, for 
orders so designated, that if after entry into the System, the order is 
not fully executed, the order (or unexecuted portion thereof) shall 
remain available for potential display and/or execution until 4 p.m. 
Eastern Time, after which it shall be held by the System in a pending 
state, ineligible for display or execution, until the following trading 
day, when it will become eligible for display and execution from 7:30 
a.m. until 4 p.m. Eastern Time on that and all subsequent trading days, 
until a date provided by the entering party (or if no such date is 
given, indefinitely) until cancelled by the entering party.
    (o) The term ``Good-till-Time,'' shall mean, for orders so 
designated, that if after entry into System, the order is not fully 
executed, the order (or unexecuted portion thereof) shall remain 
available for potential display and/or execution until the time 
designated by the entering party, after which the order will be 
cancelled by the system. This time may

[[Page 4903]]

be relative time (e.g. 30 minutes after entry) or an actual time (e.g. 
2 p.m.).
    (p) The term ``Day'' shall mean, for orders so designated, that if 
after entry into the System, the order is not fully executed, the order 
(or unexecuted portion thereof) shall remain available for potential 
display and/or execution only until 4 p.m. Eastern Time on the day they 
are submitted unless cancelled before then by the entering party.
    (q) The term ``End-of-Day'' shall mean, for orders so designated, 
that if after entry into the System, the order is not fully executed, 
the order (or unexecuted portion thereof) shall remain available for 
potential execution and/or display until 8 p.m. Eastern Time, after 
which it shall be returned to the entering party.
    (r) The term ``Pegged'' shall mean, for priced limit orders so 
designated, that after entry into the System, the price of the order is 
automatically adjusted by the System in response to changes in the 
Nasdaq inside bid or offer (for Nasdaq-listed securities) or the 
national best bid or offer (for ITS securities), as appropriate. The 
Participant entering a Pegged Order can specify that order's price will 
either equal the inside quote or improves the inside quote by an amount 
set by the entering party on the same side of the market (a ``Regular 
Pegged Order'') or offset the inside quote on the contra side of the 
market by an amount (the ``Offset Amount'') set by the Participant 
(e.g., $0.01 less than the inside offer or $0.02 more than the inside 
bid) (a ``Reverse Pegged Order''). The Participant entering a Pegged 
Order may (but is not required to) specify a limit price, to define a 
price at which pegging of the order will stop and the order will be 
permanently converted into an un-pegged limit order at limit price. 
This order type is available for Nasdaq-listed and Exchange-listed 
securities.
    (s) The term ``Discretionary'' shall mean an order that when 
entered into System has both a displayed bid or offer price, as well as 
a non-displayed discretionary price range and size (which shall be 
equal to or less than the Order's Reserve Size) at which the 
Participant is also willing to buy or sell, if necessary. This order 
type is available for Nasdaq-listed and Exchange-listed securities.
    (t) The term ``Post Only'' shall mean, for To Brut limit orders so 
designated, that if an order is marketable against an order then-
displayed in the System upon receipt, it shall be rejected and returned 
to the entering Participant. If the order is marketable against a quote 
displayed outside of Brut, the price of the order is adjusted to a 
price $0.01 inferior to the best bid (or offer, as appropriate) then 
displayed in the Nasdaq Market Center, and then displayed in the 
System. This order type is available for Nasdaq-listed and Exchange-
listed securities.
    (u) The term ``Agency Away'' shall mean an agency order designated 
by the entering Participant as eligible for execution at a price 
inferior to the then-current national best bid/offer. This order type 
is available only for Nasdaq-listed securities.
    (v) The term ``Principal Inside Only'' shall mean a principal order 
designated by the entering Participant as only eligible for execution 
at a price equal or better than the then-current national best bid/
offer. This order type is available for Nasdaq-listed and Exchange-
listed securities.
    (w) The term ``normal unit of trading'' shall mean one hundred 
(100) shares.

4902. System Participant Registration

    (a) Participation in Brut requires current registration with the 
System and is conditioned upon the Participant's initial and continuing 
compliance with the following requirements:
    (1) Execution of a System Subscriber Agreement;
    (2) Satisfaction of the Brut New Accounts Policies & Procedures 
requirements;
    (3) Membership in, or access arrangement with a participant of, a 
clearing agency registered with the Commission that maintains 
facilities through which System compared trades may be settled;
    (4) Acceptance and settlement of each System trade that System 
identifies as having been effected by such Participant, or if 
settlement is to be made through another clearing member, guarantee of 
the acceptance and settlement of such identified System trade by the 
clearing member on the regularly scheduled settlement date;
    (5) Compliance with all applicable rules and operating procedures 
of the Association and the Securities and Exchange Commission.
    (b) Access to the System by non-System participants is available 
through the Nasdaq Market Center as defined in NASD Rule 4701(r) and 
related rules.

4903. Order Entry Parameters

    (a) To Brut Orders--
    (1) General. A To Brut Order is an order that is displayed in the 
System and is executable only against marketable contra-side orders in 
the System. This order type is available for Nasdaq-listed and 
Exchange-listed securities. The following requirements shall apply to 
To Brut Orders entered by Participants:
    (A) A To Brut Order shall be a limit order, and shall indicate 
whether it is a buy, short sale, short-sale exempt, or long sale. A To 
Brut Order can be designated as End-of-Day, Immediate or Cancel, Good-
till-Cancelled, Day, Good-till-Canceled Overnight, Good-till-Time, 
Effective Time, Post Only, Pegged or Discretionary.
    (B) To Brut Orders shall be executed pursuant to the Brut Book 
Process as described in Rule 4905(a).
    (C) A To Brut Order to sell short shall not be executed if the 
execution of such order would violate NASD Rule 3350 or, in the case of 
ITS Securities, SEC Rule 10a-1. In said circumstances, the price of the 
To Brut Order shall be adjusted to $.01 above the Nasdaq inside bid for 
Nasdaq-listed securities or, in the case of exchange-listed securities, 
$.01 above the national best bid or offer, and thereafter be processed 
as if a Reverse Pegged Order.
    (D) The System shall not accept To Brut Orders that are All-or-
None, or have a minimum size of execution.
    (b) Brut Cross Orders--
    (1) General. A Brut Cross Order is an order that is displayed in 
the System, and is executable against marketable contra-side orders in 
the System. The order also is eligible for routing to other market 
centers. If marketable upon receipt against both orders in the System 
as well as other market centers, the order shall execute first against 
System orders. With the exception of Directed Cross Orders, once a Brut 
Cross Order is routed (in whole or in part) to another market center, 
any remaining unexecuted or returned portion of the order shall be 
posted in System and shall no longer be eligible for routing to other 
market centers.
    (A) A Brut Cross Order shall be a limit order, and shall indicate 
whether it is a buy, short sale, short-sale exempt, or long sale. A 
Brut Cross Order can be designated as Immediate or Cancel, End-of-Day, 
Good-till-Cancelled, Day, Good-till-Cancelled Overnight, Good-till-
Time, Effective Time.
    (B) A Brut Cross Order may also be designated as an Aggressive 
Cross Order. An Aggressive Cross Order is an order that is displayed in 
the System during market hours and is executable against marketable 
contra-side orders in the System. The order also is eligible for 
routing to other market centers. If marketable upon receipt against 
both orders in the System as well as other market centers, the order 
shall execute first against System orders. If, after being posted in 
the Brut System, and after it has exhausted available liquidity

[[Page 4904]]

in the Brut System, the Aggressive Cross Order has its price crossed by 
the displayed quote of another market center, the System will be routed 
by Brut to that market center for potential execution. Aggressive Cross 
Orders may comply with paragraph (A) of this rule.
    (C) A Brut Cross Order may also be designated as a Super Aggressive 
Cross Order. A Super Aggressive Cross Order is an order that is 
displayed in the System during market hours and is executable against 
marketable contra-side orders in the System. The order also is eligible 
for routing to other market centers. If marketable upon receipt against 
both orders in the System as well as other market centers, the order 
shall execute first against System orders. If, after being posted in 
the Brut System, and after it has exhausted available liquidity in the 
Brut System, the Aggressive Cross Order has its price locked or crossed 
by the displayed quote of another market center the System will be 
routed by Brut to that market center for potential execution.
    (D) A Brut Cross Order may also be designated as a Directed Cross 
Order. A Directed Cross Order is an order that entered in the System 
during market hours and is executable against marketable contra-side 
orders in the System. The order also is eligible for routing to other 
market centers. If, after being processed in the Brut System and 
exhausting available liquidity in the Brut System, the order is 
automatically routed by Brut to the specific market center selected by 
the entering party for potential execution. Any portion of the Directed 
Cross Order that remains unfilled after being routed to the selected 
market center will be returned to the entering party.
    (E) Brut Cross Orders, including those designated as Aggressive 
Cross Orders, Super Aggressive Cross Orders and Directed Cross Orders, 
shall be executed pursuant to:
    (i) The To Brut Order Process described in Rule 4905(a) to the 
extent marketable against an order resident in the System; and
    (ii) With the exception of Directed Cross Orders, the Brut Order 
Routing Process described in Rule 4905(b) to the extent not marketable 
against an order resident in the System.
    (F) A Brut Cross Order, including those designated as an Aggressive 
Cross Order, Super Aggressive Cross Order and Directed Cross Order, to 
sell short shall not be executed in the System if the execution of such 
order would violate NASD Rule 3350 or, in the case of ITS Securities, 
SEC Rule 10a-1. In said circumstances, the price of the Brut Cross 
Order shall be adjusted to $.01 above the Nasdaq inside bid for Nasdaq-
listed securities or, in the case of exchange-listed securities, $.01 
above the national best bid or offer, and thereafter be processed as if 
a Reverse Pegged Order.
    (c) Thru Brut Orders--
    (1) General. A Thru Brut Order is an order submitted to the System 
that is designated for routing to another market center. This order 
type is available for Nasdaq-listed and Exchange-listed securities. The 
following requirements shall apply to Thru Brut Orders:
    (A) A Thru Brut Order shall be a market order or a limit order, and 
must indicate whether it is a buy, short sale, short-sale exempt, or 
long sale. A Thru Brut Order can be designated as Immediate or Cancel, 
End-of-Day, Good-till-Cancelled, Day, or Good-till-Time, or Effective 
Time.
    (B) Thru Brut Orders do not participate in Brut Routing Process as 
described in Rule 4905(b). Instead such orders are sent directly to the 
market center selected by the entering party. If unexecuted, the order 
(or unexecuted portion thereof) shall be returned to the entering 
party.
    (d) Hunter Orders--
    (1) General. A Hunter Order is a non-displayed order that will 
execute against trading interest in the System or another market 
center. This order type is available only for Nasdaq-listed securities. 
After 6:30 p.m. Eastern Time, Hunter Orders will execute only against 
other orders in the System. The following requirements shall apply to 
Hunter Orders:
    (A) A Hunter Order shall be a limit order, and must indicate 
whether it is a buy, short sale, short-sale exempt, or long sale. A 
Hunter Order can be designated as Immediate or Cancel, End-of-Day, 
Good-till-Cancelled, Day, or Good-till-Time, or Effective Time.
    (B) Hunter Orders shall be executed as follows:
    (i) To the extent marketable upon receipt against orders in the 
System, pursuant to the Brut Book Process as described in Rule 4905(a); 
then/or
    (ii) If not marketable upon receipt against orders in the System 
but marketable against the displayed quotes of other market centers, 
pursuant to the Brut Routing Process as described in Rule 4905(b).
    (iii) If not marketable upon receipt against any quote displayed in 
the System or another market center, the order shall be retained, but 
not be displayed, in the System and shall remain available for 
execution via the Brut Book and/or Brut Routing Processes should the 
order become marketable.
    (e) Entry of Agency and Principal Orders--Participants are 
permitted to submit agency, riskless principal, and principal orders 
for processing in the System. Participants shall correctly note their 
capacity at the time of entry of an order(s) into the System.
    (1) Unless designated as ``Agency Away'', no agency order shall be 
executed at a price inferior to the then current National Best Bid (for 
sell orders) or Best Offer (for buy orders), taking into account prior 
efforts to execute against the bids/offers of other market centers.
    (2) Unless designated as ``Principal Inside Only'', principal and 
riskless principal orders may be executed at a price inferior to the 
then current National Best Bid (for sell orders) or Best Offer (for buy 
orders).
    (f) Order Size--Any order in whole shares up to 1,000,099 shares 
may be entered into the System, subject to a dollar volume limitation 
of $25,000,000.

4904. Entry and Display of Orders

    (a) Entry of Orders--Participants can enter orders into the System, 
subject to the following requirements and conditions:
    (1) Participants shall be permitted to transmit to the System 
multiple orders at a single as well as multiple price levels. Each 
order shall indicate the amount of reserve size (if applicable).
    (2) The System shall time-stamp an order upon receipt, which time-
stamp shall determine the ranking of the order for purposes of 
processing To Brut Orders and Brut Cross Orders.
    (3) Good-till-Cancelled, Day, orders can be entered into the System 
(or previously entered orders cancelled) between the hours 7:30 a.m. to 
4 p.m. Eastern Time. Pegged, Discretionary, Immediate-or-Cancel and 
End-of-Day To Brut Orders, Good-till-Time, Good-till-Canceled Overnight 
and GTX orders can be entered into System (or previously entered orders 
cancelled) between the hours 7:30 a.m. to 8 p.m. Eastern Time. Orders 
entered prior to market open and Good-till-Time orders carried over 
from previous trading days, shall not become available for execution 
until 7:30 a.m. Eastern Time. Good-till-Time orders carried over from 
previous trading days with an Effective Time will not become available 
for execution until the Effective Time on all subsequent trading days 
the order is held by the System.
    (b) Display of Orders--The System will display orders submitted to 
the System as follows:

[[Page 4905]]

    (1) System Book Feed--orders resident in the System will be 
displayed to Participants via the System Book Feed.
    (2) Nasdaq Market Center--For each Nasdaq Market Center eligible 
security, the best priced order to buy and sell resident in the System 
shall be displayed and eligible for execution within the Nasdaq Market 
Center. The System may also provide to the Nasdaq Market Center 
additional orders, up to and including all orders in System, in Nasdaq 
Market Center eligible securities.
    (3) Exceptions--The following exceptions shall apply to the display 
parameters set forth in paragraphs (1) and (2) above:
    (A) Odd-lots, Mixed Lots, and Rounding--The System Book Feed shall 
be capable of displaying trading interest in round lot and mixed-lot 
amounts, and sub-penny increments for quotations priced under $1.00.
    For Nasdaq Market Center display purposes, the System shall 
aggregate all shares, including odd-lot share amounts, entered by 
Participants at a single price level and round the total share amount 
down to the nearest round-lot amount. Any odd-lot portion of an order 
that is not displayed as a result of the rounding process shall remain 
available for execution, in accordance with the time-priority of their 
original entry time. Round-lots that are subsequently reduced by 
executions to a mixed lot amount shall also be rounded for to the 
nearest round-lot amount for purposes of display in the Nasdaq Market 
Center. Any odd-lot number of shares that do not get displayed as a 
result of rounding will remain available for execution, in accordance 
with the time-priority of their original entry time.
    (B) Minimum Increments and Rounding--The minimum trading increment 
for System quotations priced $1.00 and above is $.01. For quotations 
priced below $1.00 the minimum increment is $.0001.
    (i) For System display purposes, quotations in sub-penny increments 
$1.00 and above will be rounded down (for bids) or up (for offers) by 
the System to the nearest $.01 increment. Orders so rounded shall have 
no superior execution priority compared to orders previously submitted 
at the relevant $.01 increment.
    (ii) For Nasdaq Market Center display purposes, any quotations in 
sub-penny increments shall be rounded down (for bids) and up (for 
offers) to the nearest $.01 increment. Sub-penny quotations that are 
rounded for display purposes shall be executed at their actual price, 
rather than the rounded price at which they are displayed.
    (C) Reserve Size--Reserve Size shall not be displayed in the 
System, but shall be accessible as described in Rule 4905.
    (D) Discretionary & Hunter Orders--Hunter Orders, and the 
discretionary portion of Discretionary Orders shall be available for 
execution only upon the appearance of contra-side marketable trading 
interest, and shall be executed pursuant to Rule 4905.

4905. Order Processing

    (a) Brut Book Order Process
    Orders subject to the Brut Book Order Process shall be executed as 
follows:
    (1) Default Execution Algorithm--Price/Time--The System shall 
execute interest within the System in price/time priority in the 
following order:
    (A) Displayed Orders;
    (B) Reserve Size;
    (C) Discretionary Orders within the Discretionary Order's 
discretionary price range; and
    (D) Hunter Orders.
    (2) Decrementation--Upon execution, an order shall be reduced by an 
amount equal to the size of that execution. In the case of orders that 
have both a displayed and reserve share component, share amounts shall 
be reduced starting first with their reserve portions.
    (3) Processing of Locking/Crossing Orders: If during market hours, 
a Participant enters a To Brut order that will lock/cross the market 
(as defined in NASD Rule 4613(e) or in NASD Rule 5263(a) or (b)), the 
System shall adjust the price of the order to $.01 less than the 
current best bid quotation (for buy orders) or $.01 more than the 
current best offer quotation (for sell orders) and thereafter be 
processed as a Reverse Pegged Order.
    (4) Processing of Directed, Aggressive and Super Aggressive Cross 
Orders--The System shall process crossed Directed and Aggressive Cross 
Orders, and locked or crossed Super Aggressive Cross Orders as follows:
    (A) Displayed orders which are designated as ``Directed Cross 
Orders'' by a Participant shall be routed to the market center selected 
by the entering party for potential execution by the System. This order 
type is available Nasdaq-listed and Exchange-listed securities.
    (B) Displayed orders which are designated as ``Aggressive Cross 
Orders'' by a Participant that are subsequently crossed by the 
displayed quotation of another market center shall be executed pursuant 
to the Brut Order Routing Process upon being so crossed. This order 
type is available for Nasdaq-listed and Exchange-listed securities.
    (C) Displayed orders which are designated as ``Super Aggressive 
Cross Orders'' by a Participant that are subsequently locked or crossed 
by the displayed quotation of another market center shall be executed 
pursuant to the Brut Order Routing Process upon being so locked or 
crossed. This order type is available for Nasdaq-listed and Exchange-
listed securities.
    (b) Brut Order Routing Process
    (1) The Brut Order Routing Process shall be available to 
Participants from 7:30 a.m. to 6:30 p.m. Eastern Time, and shall route 
orders in accordance with parameters described in Rule 4903 for a 
particular order type.
    (2) With the exception of Thru Brut and Directed Cross Orders that 
specifically direct which market center an order is to be routed, 
orders routed out of the Brut System to other market centers for 
potential execution are generally delivered to other market centers in 
price/size priority. If the routed order is smaller in size than the 
total combined displayed share amounts of accessible market centers at 
the best price level, the Brut System delivers the routed order to the 
available market centers in price/size priority. If the routed order is 
larger than the total combined displayed share amounts of accessible 
market centers at the best price level, the Brut System delivers over-
sized orders to each displayed market center's quote in proportion to 
the individual market's center share of that total displayed share 
amount.
    (3) In the event an order routed to another market center is not 
executed in its entirety, the remaining portion of the order shall be 
returned to the System and, if upon return the order is marketable 
against a System order then priced at the NBBO, it will be subjected to 
Brut Book Process prior to any further routing.
    (4) An order that has been routed to another market shall have no 
time standing in the System execution queue relative to other orders in 
the System. A request from a Participant to cancel an order while it is 
outside the System shall be processed subject to the applicable rules 
of the market center to which the order has been routed.

4906. Clearance and Settlement

    All transactions executed in, or reported through, System shall be 
cleared and settled by and between the System Participant and Brut, 
through a registered clearing agency using a continuous net settlement 
system.

[[Page 4906]]

4907. Obligation To Honor System Trades

    (a) If a Participant, or clearing member acting on a Participant's 
behalf, is reported by the System, or shown by the activity reports 
generated by the System, as constituting a side of a System trade, such 
Participant, or clearing member acting on its behalf, shall honor such 
trade on the scheduled settlement date.
    (b) Brut and/or Nasdaq shall have no liability if a Participant, or 
a clearing member acting on the Participant's behalf, fails to satisfy 
the obligations in paragraph (a).

4908. Compliance With Rules and Registration Requirements

    (a) Failure by a Participant to comply with any of the rules or 
registration requirements applicable to the System identified herein 
shall subject such Participant to censure, fine, suspension or 
revocation of its registration a Participant or any other fitting 
penalty under the Rules of the Association.
    (b) If a Participant fails to maintain a clearing relationship to 
honor its obligations under Rule 4906, it shall have its access to the 
System restricted until such time as a clearing arrangement is 
reestablished.
    (c) The authority and procedures contained in paragraph (b) do not 
otherwise limit the Association's authority, contained in other 
provisions of the Association's Rules, to enforce its rules or impose 
any fitting sanction.

4909. Adjustment of Open Orders

    Except when a cash dividend or distribution is less than one cent 
($0.01), on the ex-date of a corporate action, the System shall 
automatically adjust the price and/or size of Good-till-Cancelled 
Overnight orders resident in the System in response to issuer corporate 
actions related to a cash dividend as follows:
    (a) Sell Orders--Sell orders shall not be adjusted by the System 
and must be modified, if desired, by the entering party,
    (b) Buy Orders--Buy orders shall be reduced by the dividend amount. 
To the extent that the dividend includes a sub-penny increment, the 
order will be displayed and processed as set forth in Rule 
4904(b)(3)(B). Open buy and sell orders that are adjusted by the System 
pursuant to the above rules, and that thereafter continuously remain in 
the System, shall retain the time priority of their original entry.

4910. Anonymity

    (a) Transactions executed in the System shall be cleared and 
settled with Brut. The transaction reports produced by the System will 
indicate the details of the transactions, and shall not reveal contra 
party identities other than Brut.
    (b) Brut shall reveal a member's identity in the following 
circumstances:
    (1) When the National Securities Clearing Corporation (``NSCC'') 
ceases to act for a member, or the member's clearing firm, and NSCC 
determines not to guarantee the settlement of the member's trades;
    (2) For regulatory purposes or to comply with an order of an 
arbitrator or court;

4911. Clearly Erroneous Transactions

    All matters related to clearly erroneous transactions executed in 
the System shall be initiated and adjudicated pursuant to NASD Rule 
11890.
[4912. Minimum Quotation Increment
    The minimum quotation increment in the BRUT ECN System for 
quotations of $1.00 or above in Nasdaq-listed securities and in 
securities listed on a national securities exchange shall be $0.01. The 
minimum quotation increment in the BRUT ECN System for quotations below 
$1.00 in Nasdaq-listed securities and in securities listed on a 
national securities exchange shall be $0.0001.]

4912. Normal Business Hours

    The Brut System operates from 6:30 a.m. to 8 p.m. Eastern Time on 
each business day.

4913. Limitation of Liability

    The Association and its subsidiaries, as well as Nasdaq and Brut 
and their subsidiaries, shall not be liable for any losses, damages, or 
other claims arising out of the System or its use. Any losses, damages, 
or other claims, related to a failure of the System to deliver, 
display, transmit, execute, compare, submit for clearance and 
settlement, adjust, retain priority for, or otherwise correctly process 
an order, Quote/Order, message, or other data entered into, or created 
by, the System shall be absorbed by the member, or the member 
sponsoring the customer, that entered the order, Quote/Order, message, 
or other data into the System.

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, as 
amended. 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

Background

    On September 7, 2004, Nasdaq completed its purchase of Brut, LLC 
(``Brut''), a registered broker-dealer and member of the NASD, and 
operator of the Brut ECN (the ``Brut System'' or ``System'').\4\ 
According to Nasdaq, as a member of the NASD, Brut remains subject to 
all NASD rules applicable to its activities as a broker-dealer, 
including those requiring its participation in market surveillance and 
audit trail programs conducted by Nasdaq and the NASD. Nasdaq states 
that, as an ECN, Brut participates in the Nasdaq Market Center system 
as an Order-Delivery ECN pursuant to the NASD Rule 4700 Series, and as 
an ITS Market Maker pursuant to the NASD Rule 5200 Series. Brut 
continues to act as a counter-party to all trades taking place in its 
system, for anonymity as well as clearance and settlement purposes. 
Brut also continues to provide outbound order routing services to other 
market centers for its subscribers. According to Nasdaq, to meet its 
limit order display obligations, Brut currently provides the Nasdaq 
Market Center its best single ``top-of-file'' priced orders in 
individual securities Brut has within the System.
---------------------------------------------------------------------------

    \4\ Nasdaq owns Brut via Nasdaq's 100% ownership interest in 
Toll Associates LLC. Toll Associates LLC, in turn, owns 99.78% Brut 
LLC and 100% of Brut Inc., which owns the remaining 0.22% of Brut 
LLC. Both Toll Associates LLC and Brut Inc. conduct no business 
other than serving as holding entities for their respective 
ownership interests in Brut LLC, the entity that operates the Brut 
ECN.
---------------------------------------------------------------------------

    Nasdaq states that, once purchased by Nasdaq, the Brut System 
became a ``facility'' of a national securities association subject to 
the standards set forth in Sections 15A and 19(b)(1) of the Exchange 
Act.\5\ As such, Nasdaq is obligated to file with the Commission rules 
to govern the operation of the Brut System. This filing is intended to 
meet that obligation and includes a description of the Brut System, its

[[Page 4907]]

various features, order processing method, and a proposed set of Brut 
System rules.
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    \5\ Nasdaq currently operates Brut pursuant to a Temporary 
Conditional Exemption from Rule 19(b) of the Exchange Act issued by 
the Commission. See Exchange Act Release No. 50311 (September 3, 
2004), 69 FR 54818 (September 10, 2004).
---------------------------------------------------------------------------

The Brut System

1. Order Display/Matching System

    The Brut System allows subscribers to enter market and priced limit 
orders to buy and sell Nasdaq and Exchange-listed securities. Such 
orders may be in round-lots, mixed-lots, or odd-lots of any size up to 
1,000,099 shares up to a maximum single order dollar cap amount of 
$25,000,000, and may be entered on a principal, riskless principal, or 
agency basis. Nasdaq states that Brut acts only as an agent on behalf 
of its subscribers and engages in no proprietary trading save that 
necessary to correct system errors. Subscribers may enter multiple 
orders at single or multiple price levels. Subscribers have the option 
to have a portion of their order held in reserve and not displayed to 
the marketplace. Brut, in turn, makes available to System subscribers 
and market data vendors a data feed of all displayable orders on both 
the bid and offer side of the market (excluding reserve size share 
amounts) for all price levels at which shares are available within its 
System. According to Nasdaq, to the extent that Brut displays orders in 
the Nasdaq Market Center, those orders are displayed under the same 
terms and conditions generally applicable to Nasdaq Quoting Market 
Participants, including the rounding and aggregation procedures 
contained in NASD Rule 4707. Although Brut currently provides only its 
best top-of-file prices to the Nasdaq Market Center, Nasdaq proposes 
that Brut be given the option to provide the Nasdaq Market Center 
additional orders at other price levels, up to and including Brut's 
full depth-of-book, so that Nasdaq Market Center users may have the 
full benefit of Brut's liquidity.
    Brut also currently accepts sub-penny amounts for orders priced 
under $1.00 a share. Nasdaq states that, for orders priced $1.00 a 
share and above, Brut accept orders only in penny increments.\6\ Sub-
penny order prices are viewable by System subscribers. If a sub-penny 
order is required to be displayed via the Nasdaq Market Center, the 
Brut system rounds such orders down (for bids) or up (for offers) to 
the nearest $.01 increment. Sub-penny orders executed via the Nasdaq 
Market Center, however, will be executed at their actual price, rather 
than the rounded price at which they are displayed.\7\
---------------------------------------------------------------------------

    \6\ See Securities Exchange Act Release No. 50956 (January 3, 
2005), 70 FR 1746 (January 10, 2005) (NASD-2004-190).
    \7\ This filing relocates the standards governing the Brut 
System's acceptance and processing of sub-penny orders from current 
NASD Rule 4912 to proposed NASD Rule 4904(b)(3)(B).
---------------------------------------------------------------------------

2. Access Standards

    According to Nasdaq, to obtain access to the Brut System as a 
system participant, a user must execute a Brut subscriber agreement and 
be a participant in, or have an access arrangement with a participant 
in, a Commission-registered clearing agency. In addition, the Brut 
subscriber must also agree to:
    a. Comply with all applicable rules of the NASD and the Commission; 
and
    b. Accept all Brut System trades identified by the System as being 
effected by the subscriber.
    Broker-dealers may also access System orders through the Nasdaq 
Market Center, regardless of their status as a system participant as 
described above, provided they have met the conditions for access to 
the Nasdaq Market Center.

3. Order Types

    The Brut System makes available to subscribers several order types. 
These order types are described below.
    Limit Order--an order to buy or sell a stock at a specified price 
or better. This order type is available for Nasdaq-listed and Exchange-
listed securities.
    Market Order--an un-priced order to buy or sell a stock at the 
market's current best price. A market order may have a limit price 
beyond which the order shall not be executed. This order type is 
available for Nasdaq-listed and Exchange-listed securities.
    Agency Away Order--an agency order that is designated by the 
entering party as eligible for execution at a price inferior to the 
then-current national best bid/offer. This order type is available for 
Nasdaq-listed securities.
    Principal Inside Only Order--a principal order that is designated 
by the party as only eligible for execution at a price equal or better 
than the then-current national best bid/offer. This order type is 
available for Nasdaq-listed and Exchange-listed securities.
    Brut Cross Order--an order that is displayed in Brut and executable 
against marketable contra-side orders in any market center, including 
the Brut System, at the time of receipt. If equally-priced executable 
orders are available both in Brut and another market center, the order 
will first execute against Brut System orders. Once a Brut Cross Order 
is routed out in whole or in part to another market center, any 
remaining unexecuted or returned portion of the order will be posted in 
the Brut System and will no longer be routed out for potential 
execution, unless the order is designated as an Aggressive Cross Order 
or Super Aggressive Cross Order. This order type is available for 
Nasdaq-listed and Exchange-listed securities.
    Example:
    The market is 10.00 bid--10.01 offer.
    Brut receives a Brut Cross sell order, priced at 10.00.
    Brut will route this order out to any crossing market center for 
potential execution.\8\ If the routed order is only partially executed, 
the outstanding shares remaining will be posted in the Brut book on the 
offer at 10.00. Once posted, the order will no longer be routed out for 
execution.
---------------------------------------------------------------------------

    \8\ For all order type examples, the term ``market center'' 
refers to any trading venue other than Brut, including the Nasdaq 
Market Center.
---------------------------------------------------------------------------

    Directed Cross Order--an order that if, after entry into the Brut 
System and after it has exhausted available liquidity in the Brut 
System is routed by Brut to that specific market center for potential 
execution. This order type is available for Nasdaq-listed and Exchange-
listed securities.
    Example:
    The market is 10.00 bid--10.01 offer.
    Brut receives a Directed Cross sell order, priced at 10.00 and 
directed to Market Center A.
    After checking the Brut system for available liquidity, the system 
will route this order to Market Center A for potential execution. If 
the routed order is only partially executed, the outstanding shares are 
returned to the entering party.
    Aggressive Cross Order--a Brut Cross Order that if, after being 
posted in the Brut System and after it has exhausted available 
liquidity in the Brut System, has its price crossed by the displayed 
quote of another market center is routed by Brut to that market center 
for potential execution. This order type is available for Nasdaq-listed 
and Exchange-listed securities.
    Example:
    The market is 10.00 bid--10.01 offer.
    Brut receives an Aggressive Cross sell order, priced at 10.01.
    Brut will first post this order on the offer at 10.01. Soon 
thereafter, another market center posts a bid price at 10.02. Since 
this 10.02 price is marketable against the Aggressive Cross Order's 
limit price of 10.01, the order will be routed out by Brut to the other 
market center for execution. If the liquidity priced at 10.02 is 
depleted, and the Aggressive Cross Order still has outstanding shares 
remaining, the order

[[Page 4908]]

will be re-posted in the Brut book at its price of 10.01. If the price 
of returned shares is again crossed, the shares will again be routed 
for potential execution.
    Super Aggressive Cross Order--a Brut Cross Order that, if after 
being posted in the Brut System, has its price locked or crossed by the 
displayed quote of another market center, is routed by Brut for 
potential execution. This order type is available for Nasdaq-listed and 
Exchange-listed securities.
    Example:
    The market is 10.00 bid--10.01 offer
    Brut receives a Super Aggressive Cross sell order, priced at 10.01.
    Brut will first post this order on the offer at 10.01. Soon 
thereafter, another market center posts a bid price at 10.01. Since 
this 10.01 price is equal to the Super Aggressive Cross Order's limit 
price of 10.01, the order will be routed out by Brut to the other 
market center for execution. If the liquidity priced at 10.01 is 
depleted, and the Super Aggressive Cross Order still has shares 
remaining, the order will be re-posted in the Brut book at its price of 
10.01. This same process would be followed if the other market center 
had posted a price that crossed the Super Aggressive Cross Order. If 
the price of returned shares is again locked or crossed, the shares 
will again be routed for potential execution.
    Thru Brut Order--an order that is directed to a market center other 
than Brut for execution. This order type is available for Nasdaq-listed 
and Exchange-listed securities.
    To Brut Order--an order eligible for execution upon receipt solely 
against Brut System orders, and displayed in the System to the extent 
the order cannot be executed upon receipt. This order type is available 
for Nasdaq-listed and Exchange-listed securities.
    Hunter Order--an order that is not displayed in the System, but 
will execute against available trading interest residing in the Brut 
System or another market center. This order type is available for 
Nasdaq-listed and Exchange-listed securities.
    Example:
    The market is 10.00 bid--10.02 offer.
    Brut receives a Hunter Order to buy, priced at 10.01.
    Since there is no liquidity at the 10.01 price, Brut will hold the 
order undisplayed until marketable trading interest is available. If 
thereafter an offer is posted at 10.01 either in Brut or in another 
market center Brut will execute or route the Hunter Order to access 
that liquidity. Any unexecuted shares will remain/return to the book 
and wait undisplayed until another order is marketable against the 
Hunter Order or the Hunter Order times out. If the returned shares of 
the Hunter Order again become marketable, the shares will again be 
routed for potential execution.
    Pegged Order--a To Brut limit order that, after entry, has its 
price automatically adjusted by the System in response to changes in 
the Nasdaq Market Center (for Nasdaq-listed securities) or national 
best bid or offer (for Exchange-listed securities), as appropriate. 
Pegged Orders can specify that its price will either equal the inside 
quote on the same side of the market or improves the inside quote by an 
amount set by the entering party (a ``Regular Pegged Order''), or a 
price that is offset from the inside quote on the contra side of the 
market by an amount (the ``Offset Amount'') set by the entering party 
(e.g., $0.01 less than the inside offer or $0.02 more than the inside 
bid) (a ``Reverse Pegged Order''). The Pegged Order only moves towards, 
or up to, the best price as appropriate. The entering party may 
voluntarily specify a limit price at which pegging price changes of the 
order will stop and the order will be permanently converted into an un-
pegged limit order at the limit price. This order type is available for 
Nasdaq-listed and Exchange-listed securities. Pegged orders may not be 
combined with other order processing designations.
    Example:
    The market is 10.00 bid--10.01 offer.
    Brut receives a Regular Pegged buy order, with a peg limit of 
10.05.
    Brut will post the order at 10.00. If the inside bid moves to 
10.01, Brut will move the Pegged Order also to the 10.01 bid price. 
This process will continue until the order is executed or its price 
reaches the peg limit of 10.05.
    Discretionary Order--an order that has both a displayed price, as 
well as a non-displayed discretionary price range and size (which shall 
be equal to or less than the order's reserve size) in which the 
entering party, if necessary, is also willing to buy or sell. This 
order type is available for Nasdaq-listed and Exchange-listed 
securities.
    Example:
    The market is 10.00 bid--10.50 offer.
    Brut receives a Discretionary buy order, with a limit price of 
10.00 and a display quantity of 200 shares, a discretion price of 10.25 
and a discretion quantity of 1,000 shares.
    Brut posts the order at 10.00. Thereafter, another market 
participant posts an offer for 1,000 shares at 10.20. Since this is 
within the Discretionary Order's price range, Brut will route the full 
discretion quantity (i.e., 1,000 shares) for potential execution while 
the displayed portion remains in the Brut book.
    Post Only Order--a To Brut Limit Order that, if marketable upon 
receipt against an order then-displayed in the System, is rejected and 
returned to the entering party. If the order is marketable against a 
quote displayed outside of Brut, the price of the order is adjusted to 
a price $0.01 inferior to the best bid (or offer, as appropriate) then 
displayed in the Nasdaq Market Center, and then displayed in Brut. This 
order type is available for Nasdaq-listed and Exchange-listed 
securities.
    Example:
    The market is at 10.00 bid--10.01 offer. Brut is at the 10.00 bid.
    Brut receives Post-Only sell order, priced at 10.00.
    Normally, this order would execute against the Brut 10.00 bid, but 
since the order is post-only, the order is rejected back to the 
entering party. Had the 10.00 bid not been in Brut but another venue, 
Brut would not reject the order but instead adjust the order's price 
and post it in the Brut System.

4. Time in Force Designations

    Orders entered into the Brut System may be designated by the 
entering party to remain in force and available for display and/or 
potential execution for varying periods of time. Unless cancelled 
earlier, once these time periods expire, the order (or the unexecuted 
portion thereof) is returned to the entering party. These ``time in 
force'' designations are described below:
    Immediate or Cancel (IOC)--limit orders with this designation are 
returned to the sender if not immediately executed. If partially 
executed, un-executed remainders of these orders are returned 
immediately to the entering party.
    Good-till-Canceled (GTC)--orders with this designation (or the 
unexecuted portions of such orders) are held by the Brut System and 
remain available for potential display/execution until 4 p.m. Eastern 
Time on the day they are submitted unless cancelled before then by the 
entering party.\9\
---------------------------------------------------------------------------

    \9\ Currently, the Brut System processes orders designated as 
GTC and Day in the exact same manner. In the near future, Nasdaq 
states that Brut will modify the names of its order types to 
eliminate this duplication.
---------------------------------------------------------------------------

    Day (DAY)--orders with this designation (or the unexecuted portions 
of such orders) are held by the Brut System and remain available for 
potential display/execution until 4 p.m. Eastern Time on the day they 
are submitted unless cancelled before then by the entering party. This 
is the default

[[Page 4909]]

time in force where none is provided by the entering party.
    Good-till-Canceled-Overnight (GTCO)--orders with this designation 
(or the unexecuted portions of such orders) are treated like GTC 
orders, but are held by the Brut System overnight and remain available 
for potential display/execution until 4 p.m. of a date provided by the 
entering party, or indefinitely, unless and until cancelled by the 
entering party. GTCO orders are not eligible for execution between 4 
p.m. and 8 p.m. Eastern Time.
    End-of-Day (GTX)--orders with this designation (or the unexecuted 
portions of such orders) are held by the Brut System and remain 
available for potential display/execution until 8 p.m. Eastern Time on 
the day they are submitted unless cancelled before then by the entering 
party.
    Good-till-Time (GTT)--orders with this designation (or the 
unexecuted portions of such orders) are held by the Brut System and 
remain available for potential display/execution until the time 
designated by the entering party. This time may be a relative time 
(e.g., 30 minutes after receipt) or an actual time (e.g., 2 p.m.).
    Effective Time (EFT)--orders with this designation (or the 
unexecuted portions of such orders) are held by the Brut System and 
only become available for potential display/execution at an actual time 
during the trading day selected by entering party (e.g., 3 p.m.).
    Nasdaq states that the Brut System normally operates between the 
hours of 6:30 a.m. and 8 p.m. Eastern Time. Orders with the above time 
in force designations may be entered into the Brut System, or 
previously entered orders cancelled, starting at 6:30 a.m. Eastern 
Time. With the exception of the GTC and DAY designations, which may 
only be entered until 4 p.m. Eastern Time, all time in force 
designations may be entered into Brut until 8 p.m. Eastern Time. Though 
the entry of various time in force designations is permitted throughout 
the System's hours of operation, the Brut System will not execute an 
order in contravention of the time in force period selected by the 
entering party, and instead will hold all such entries until they can 
be processed in conformity with the time in force parameters selected 
upon entry.

5. Routing

    The Brut System provides the capability to route orders to other 
available market centers between the hours of 7:30 a.m. and 6:30 p.m. 
Eastern Time.\10\ The entering party designates, through the order type 
it selects (e.g., Thru Brut, Brut Cross, Aggressive Cross, Super 
Aggressive Cross, Directed Cross, or Hunter), whether the System should 
first seek to execute the order against contra-side marketable orders 
in the System prior to routing. Nasdaq states that in no event, 
however, does the router give an order to a market center displaying an 
inferior-priced order until the router has attempted to access better-
priced displayed orders in that or other market centers.\11\
---------------------------------------------------------------------------

    \10\ Nasdaq states that Brut routes to other market centers 
trading Nasdaq securities as well as to National Securities 
Exchanges, including the American and New York stock exchanges and 
other regional stock exchanges using the Intermarket Trading System 
(``ITS''). Access to the New York Stock Exchange's DOT system is 
currently provided to Brut through an agreement with NYSE-member 
SunGuard Global Execution Services. As part of this access 
arrangement, Brut allows subscribers to send orders for immediate 
pass-through to SunGuard and then to DOT, including market on open/
close and limit on open/close orders and orders with the fill-or-
kill and all-or-none share amount designations.
    \11\ According to Nasdaq, use of the Brut router is voluntary. 
Users can select, by the type of order entered, if they want the 
Brut System to route their order to another market center for 
potential execution.
---------------------------------------------------------------------------

    According to Nasdaq, with the exception of Thru Brut and Directed 
Cross Orders that specifically direct which market center an order is 
to be routed, orders routed out of the Brut System to other market 
centers for potential execution are generally delivered to other market 
centers in price/size priority. If the Nasdaq Market Center has 
displayed shares at the best price level, the System will first deliver 
to the displayed Nasdaq Market Center quote/order before routing to 
other market centers. If the routed order is smaller in size than the 
total combined displayed share amounts of accessible market centers at 
the best price level, the Brut System delivers the routed order to the 
available market centers in price/size priority. If the routed order is 
larger than the total combined displayed share amounts of accessible 
market centers at the best price level, the Brut System delivers over-
sized orders to each displayed market center's quote in proportion to 
the individual market's center share of that total displayed share 
amount. For example, if Market Center A is showing 60% of the total 
amount of displayed shares across all markets at the best price level, 
and Brut has a routable order greater in size than the total displayed 
share amount across all markets, Brut will send an oversized order to 
Market Center A representing 60% of the total amount of shares Brut is 
attempting to execute via the routed order. The other market centers at 
that price will likewise receive oversized orders in proportion to 
their displayed amounts.
    Nasdaq states that orders routed by Brut to another market do not 
retain time priority with respect to other orders in Brut's System and 
Brut continues to execute other orders while the routed order is away 
at another market. Once routed by Brut, an order becomes subject to the 
rules and procedures of the destination market including, but not 
limited to, short-sale regulation and order cancellation.

6. Execution Algorithm

    Nasdaq states that the Brut System has an execution algorithm of 
price/time priority. For each order, among equally-priced trading 
interest, the System executes against available contra-side displayed 
share amounts in full, in price/time priority, before then moving to 
reserve shares which are likewise executed in price/time priority. 
After display and reserve size are exhausted at a particular price 
level, the Brut System will then access, if available, share amounts of 
Discretionary Orders within the Discretionary Order's discretionary 
price range at that same price level, followed by executable Hunter 
Orders before moving on to the next price level.
    For example, assume the following orders in particular security at 
the best price level in System:

2 p.m.--Order 1 BUY 100 at 20.00 (100 displayed, 0 reserved).
2:02 p.m.--Order 2 BUY 2,500 at 20.00 (1,500 displayed, 1,000 
reserved).
2:03 p.m.--Order 3 BUY 1,000 at 20.00 (discretion to 20.07) 
(500 displayed, 500 reserved).
2:04 p.m.--Order 4 BUY 400 at 20.00 (Hunter Order) (0 
displayed, 400 reserved).
2:05 p.m.--Order 5 BUY 500 at 20.00 (200 displayed, 300 
reserved).

    Thereafter, the system receives a 10,000 share To Brut limit order 
to sell at 19.99.

Matching

    In the above situation, the System will match Order 1 for 
100 shares, then match the 1,500 share displayed portion of Order 
2, followed by the 500 share displayed portion of Order 
3, and finally the 200 share displayed portion of Order 
5 for a total of 2,300 shares. Since 7,700 shares are still 
needed to fill the market sell order in full, the system will then 
match the 1,000 share reserve amount of Order 2, and then 500 
share displayed portion of Order 3, followed next by the 300 
share reserve amount of Order 5.

[[Page 4910]]

Decrementation

    Having determined which orders are eligible for execution via the 
matching process, the Brut System then proceeds to decrement (reduce) 
share amounts from those orders. These share amounts are decremented 
from the matched orders starting with reserve size of the orders, if 
any.\12\ (Order 1--no reserve, 100 shares display portion 
decremented in full; Order 2--1,000 shares reserve decremented 
followed by 500 shares of displayed 1,500 shares, leaving 1,000 shares 
displayed; Order  3--500 shares (discretionary amount treated 
as reserve = 500 executed, 500 share displayed portion remains); Order 
5--300 shares reserve decremented by 200 shares, leaving 300 
shares). Finally, the System will execute the 400 share Hunter Order 
4. Having exhausted all trading interest at the best price 
level in the system, the order would then move on to seek additional 
shares at the next price level in the System.
---------------------------------------------------------------------------

    \12\ This decrementation process differs from that of the Nasdaq 
Market Center, which decrements shares directly from the matched 
portion of quotes/orders and then refreshes those matched portions 
from any remaining reserve share amounts. See NASD Rule 4710.
---------------------------------------------------------------------------

7. Clearly Erroneous Trade Procedures

    According to Nasdaq, Brut adjudicates clearly erroneous trade 
disputes for executions taking place exclusively within its System. 
While generally reviewing clearly erroneous trade claims in response to 
subscriber requests, Brut reserves the right to take action on its own 
initiative if it determines that a trade is clearly erroneous and needs 
to be modified or cancelled. Nasdaq states that, in the normal course, 
Brut limits its clearly erroneous review to only those Brut System 
trades that execute at prices that are a certain percentage or raw 
dollar price away from the National Best Bid/Offer at the time of 
execution. These parameters, which vary based on the execution price of 
the asserted clearly erroneous trade, are summarized below:

------------------------------------------------------------------------
            Execution price                  Range away from the NBBO
------------------------------------------------------------------------
$.01-$.99..............................  10%.
$1-$19.99..............................  5%.
$20 and above..........................  1 Point.
------------------------------------------------------------------------

    According to Nasdaq, if a Brut-only trade satisfies the above, Brut 
considers the trade potentially erroneous and conducts a facts and 
circumstances analysis to determine what, if any, action should be 
taken. In addition to the individual facts and circumstances of the 
trade, Brut also considers other factors in evaluating clearly 
erroneous trade claims including: If the trade created a new high or 
low in the stock; if the trade consisted of an excessive number of 
shares; if the trade took place in close proximity to news released on 
the security; if the trade took place during a locked or crossed market 
or during a period of extreme volatility; if the trade took place 
before or after normal market hours; if the trade took place in close 
proximity to halt and subsequent resumed trading in the security; how 
soon after the trade the subscriber notified Brut of the potentially 
erroneous trade; and if the trade or trades at issue involves a 
security whose issuer was recently reorganized.
    Nasdaq states that, while Brut follows the above procedures today, 
when Brut operates pursuant to rules approved by the Commission, Brut 
will automatically cease operating an independent clearly erroneous 
review process and instead trades taking place in its System will 
immediately become subject to NASD Rule 11890 that already governs 
trades in the Nasdaq Market Center and grants authority to designated 
Nasdaq officers ``to review any transaction arising out of the use or 
operation of any execution or communication System owned or operated by 
Nasdaq and approved by the Commission, * * *'' \13\
---------------------------------------------------------------------------

    \13\ See NASD Rule 11890(a)-(b) and proposed NASD Rule 4911. 
Telephone conversation between Thomas Moran, Associate General 
Counsel, Nasdaq, and David Liu, Attorney, Division of Market 
Regulation, Commission, on January 25, 2005.
---------------------------------------------------------------------------

8. Other System Features and Standards

    As part of the proposed set of rules governing its Brut Facility, 
Nasdaq is also proposing to codify current Brut system functions and, 
where appropriate, establish similar standards regarding operational 
issues between the Nasdaq Market Center and Brut. For example, Nasdaq 
is proposing that the Brut System have a limitation of liability rule 
substantially similar to that already in place for the Nasdaq Market 
Center.\14\ Nasdaq is also proposing that the Brut system adjust open 
orders in its system in a manner substantially similar to the way they 
are adjusted in the Nasdaq Market Center,\15\ as well codifying 
standards regarding the obligation of users to honor system trades,\16\ 
and the removal of users for fail