Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order Disapproving Proposed Rule Change To Establish “Benchmark Orders” Under NASDAQ Rule 4751(f), 3928-3931 [2013-00871]

Download as PDF 3928 Federal Register / Vol. 78, No. 12 / Thursday, January 17, 2013 / Notices For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.7 Kevin M. O’Neill, Deputy Secretary. disapprove the proposed rule change.7 On December 17, 2012, NASDAQ submitted a response letter to the comments on the proposal.8 This order disapproves the proposed rule change. [FR Doc. 2013–00874 Filed 1–16–13; 8:45 am] II. Description of the Proposal As set forth in more detail in the Notice, the Exchange has proposed to offer Benchmark Orders that would seek to achieve the performance of a specified benchmark—Volume Weighted Average Price (‘‘VWAP’’), Time Weighted Average Price (‘‘TWAP’’), or Percent of Volume (‘‘POV’’)—over a specified period of time for a specified security.9 The entering party would specify the benchmark, period of time, and security, as well as the other order information common to all order types, such as buy/ sell side, shares and price.10 Benchmark Orders would be received by NASDAQ but by their terms would not be executable by the NASDAQ matching engine upon entry.11 Rather, NASDAQ would direct them to a system application (‘‘Application’’) that is licensed from a third-party provider and dedicated to processing Benchmark Orders.12 The Application would process Benchmark Orders by generating ‘‘Child Orders’’ in a manner designed to achieve the desired benchmark performance, i.e., VWAP, TWAP or POV, in accordance with the member’s instructions.13 Child Orders would be executed within the NASDAQ system under NASDAQ’s existing rules, or made available for routing under NASDAQ’s current routing rules.14 The Application would not be capable of executing Child Orders, but instead would send Child Orders, using the proper system protocol, to the NASDAQ matching engine or to the NASDAQ router as needed to complete the Benchmark Order.15 Child Orders would be processed in an identical manner to orders generated BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–68629; File No. SR– NASDAQ–2012–059] Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order Disapproving Proposed Rule Change To Establish ‘‘Benchmark Orders’’ Under NASDAQ Rule 4751(f) January 11, 2013. I. Introduction On May 1, 2012, The NASDAQ Stock Market LLC (‘‘NASDAQ’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘Commission’’), 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 establish various ‘‘Benchmark Orders’’ under NASDAQ Rule 4751(f). The proposed rule change was published for comment in the Federal Register on May 17, 2012.3 On June 26, 2012, the Commission extended to August 15, 2012, the time period in which to approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to disapprove the proposed rule change.4 On August 14, 2012, the Commission instituted proceedings to determine whether to approve or disapprove the proposed rule change.5 The Commission thereafter received two comment letters on the proposal.6 On November 9, 2012, the Commission issued a notice of designation of a longer period for Commission action on proceedings to determine whether to approve or pmangrum on DSK3VPTVN1PROD with 7 17 CFR 200.30–3(a)(12). 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 See Securities Exchange Act Release No. 66972 (May 11, 2012), 77 FR 29435 (May 17, 2012) (‘‘Notice’’). 4 See Securities Exchange Act Release No. 67258 (June 26, 2012), 77 FR 39314 (July 2, 2012). 5 See Securities Exchange Act Release No. 67655 (August 14, 2012), 77 FR 50191 (August 20, 2012) (‘‘Order Instituting Proceedings’’). 6 See Letters to the Commission from Theodore R. Lazo, Managing Director and Associate General Counsel, SIFMA, dated October 5, 2012 (‘‘SIFMA Letter’’); and James J. Angel, dated August 16, 2012 (‘‘Angel Letter’’). VerDate Mar<15>2010 14:19 Jan 16, 2013 Jkt 229001 7 See Securities Exchange Act Release No. 68199 (November 9, 2012), 77 FR 68873 (November 16, 2012). 8 See Letter to the Commission from Jeffrey S. Davis, Vice President and Deputy General Counsel, NASDAQ, dated December 17, 2012 (‘‘NASDAQ Letter’’). 9 See proposed NASDAQ Rule 4751(f)(15). 10 Id.; see also Notice, 77 FR at 29436. 11 See proposed NASDAQ Rule 4751(f)(15); see also Notice, 77 FR at 29435–36. 12 See Notice, 77 FR at 29436. 13 See proposed NASDAQ Rule 4751(f)(15); see also Notice, 77 FR at 29435–36. 14 See Notice, 77 FR at 29435. Child Orders that require routing would be routed by NASDAQ Execution Services, NASDAQ’s wholly-owned routing broker-dealer. Id. at 29436 n.8. In addition, fees applicable to existing orders and trades would apply to Child Orders. Id. at 29436. 15 Id. at 29435–36. PO 00000 Frm 00051 Fmt 4703 Sfmt 4703 independently of a Benchmark Order.16 NASDAQ states that the third-party provider of the Application would have no actionable advantage over NASDAQ members with respect to the NASDAQ system.17 NASDAQ represents that it would test the Application rigorously and regularly, monitor the Application performance on a real-time and continuous basis, and have access to the technology, employees, books and records of the third-party provider that are related to the Application and its interaction with NASDAQ.18 NASDAQ states that it considers the Application to be a functional offering of the NASDAQ Stock Market, and that it would be integrated closely with the NASDAQ system and provided to members subject to NASDAQ’s obligations and responsibilities as a selfregulatory organization.19 In addition, NASDAQ represents that it would maintain control of and responsibility for the Application.20 III. Discussion Under Section 19(b)(2)(C) of the Act, the Commission shall approve a proposed rule change of a selfregulatory organization if it finds that such proposed rule change is consistent with the requirements of the Act, and the rules and regulations thereunder that are applicable to such organization.21 The Commission shall disapprove a proposed rule change if it does not make such a finding.22 The Commission’s Rules of Practice, under Rule 700(b)(3), state that the ‘‘burden to demonstrate that a proposed rule change is consistent with the Exchange Act and the rules and regulations issued thereunder * * * is on the selfregulatory organization that proposed the rule change’’ and that a ‘‘mere assertion that the proposed rule change is consistent with those requirements * * * is not sufficient.’’ 23 16 Id. at 29436. 17 Id. 18 Id. 19 Id. 20 Id. at 29437. 15 U.S.C. 78s(b)(2)(C)(i). 22 See 15 U.S.C. 78s(b)(2)(C)(ii). 23 See 17 CFR 201.700. The description of a proposed rule change, its purpose and operation, its effect, and a legal analysis of its consistency with applicable requirements must all be sufficiently detailed and specific to support an affirmative Commission finding. See id. Any failure of a selfregulatory organization to provide the information elicited by Form 19b–4 may result in the Commission not having a sufficient basis to make an affirmative finding that a proposed rule change is consistent with the Act and the rules and regulations issued thereunder that are applicable to the self-regulatory organization. Id. 21 See E:\FR\FM\17JAN1.SGM 17JAN1 Federal Register / Vol. 78, No. 12 / Thursday, January 17, 2013 / Notices After careful consideration, the Commission does not find that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.24 In particular, the Commission does not find that the proposed rule change is consistent with: (i) Section 6(b)(5) of the Act,25 which requires, among other things, that the rules of a national securities exchange 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, to protect investors and the public interest, and not to permit unfair discrimination between customers, issuers, brokers, or dealers; and (ii) Section 6(b)(8) of the Act,26 which requires that the rules of a national securities exchange not impose any burden on competition not necessary or appropriate in furtherance of the Act. In the Order Instituting Proceedings, the Commission stressed, among other things, that the application of appropriate risk controls under the Market Access Rule, Rule 15c3–5 under the Act,27 is critically important to maintaining a robust market infrastructure.28 The Commission expressed concern as to whether Child Orders, which would be generated solely by the Application and presumably outside the control and supervision of the broker-dealer firm that entered the initial Benchmark Order, would be subject to adequate pretrade risk checks, and noted that NASDAQ’s proposal did not indicate how or whether pre-trade controls would be applied to Child Orders generated by the Application.29 The Commission received two comment letters on the proposed rule change and a response from NASDAQ.30 In its comment letter, SIFMA objects to, and urges the Commission to pmangrum on DSK3VPTVN1PROD with 24 In disapproving the proposed rule change, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 25 15 U.S.C. 78f(b)(5). 26 15 U.S.C. 78f(b)(8). 27 17 CFR 240.15c3–5. Rule 15c3–5 is designed to ensure that broker-dealers appropriately control the risks associated with market access, so as not to jeopardize their own financial condition, that of other market participants, the integrity of trading on the securities markets, or the stability of the financial system. See Securities Exchange Act Release No. 63241 (November 3, 2010), 75 FR 69792 at 69794 (November 15, 2010). 28 See Order Instituting Proceedings, 77 FR at 50192. 29 Id. 30 See SIFMA Letter and Angel Letter, supra note 6; NASDAQ Letter, supra note 8. VerDate Mar<15>2010 14:19 Jan 16, 2013 Jkt 229001 disapprove, the proposed rule change.31 SIFMA expresses the belief that NASDAQ’s proposed rule change would create a regulatory disparity giving NASDAQ an inappropriate advantage with respect to the Market Access Rule over broker-dealers that provide the same services that NASDAQ proposes.32 SIFMA notes that NASDAQ is not subject to the Market Access Rule, and its affiliated routing broker-dealer benefits from significant exceptions to the Market Access Rule, whereas brokerdealers unaffiliated with NASDAQ are subject to all of the requirements of the Market Access Rule when they offer similar algorithmic trading services to those NASDAQ proposes to offer, and such requirements are reinforced through regulatory examination and oversight.33 Accordingly, SIFMA ‘‘urge[s] the Commission to assure that the same regulatory requirements and obligations would apply to Benchmark Orders and Child Orders effected by Nasdaq that would apply to those orders if they were effected by a brokerdealer.’’ 34 SIFMA further states that it shares the concern raised by the Commission in the Order Instituting Proceedings that Child Orders would not be subject to appropriate controls to manage risk, and that NASDAQ has not adequately addressed how or whether the Child Orders would be subject to adequate pre-trade risk controls.35 SIFMA states that, given that Child Orders would be generated by a third-party Application and outside of the control and supervision of the broker-dealer that submitted the Benchmark Order, Child Orders would not be subject to the risk controls that the entering firm is required to have in place pursuant to the Market Access Rule.36 SIFMA notes that, while NASDAQ has stated in the proposal that Child Orders will comport with existing NASDAQ rules, including those intended to enforce the Market Access Rule, NASDAQ has provided no details regarding how Child Orders will meet these requirements.37 According to SIFMA, this lack of detail raises concerns about the potential for market disruptions that NASDAQ’s proposed algorithmic functionality could cause.38 According to the other commenter, Angel, NASDAQ’s assurances in the 31 See SIFMA Letter, supra note 6. at 2. 33 Id. at 5. 34 Id. at 2. 35 Id. at 4. 36 Id. at 4–5. 37 Id. at 5. 38 Id. 32 Id. PO 00000 Frm 00052 Fmt 4703 Sfmt 4703 3929 proposal that it will have adequate risk controls are credible.39 NASDAQ responds by, among other things, committing to provide additional risk management safeguards for Benchmark Orders.40 Specifically, NASDAQ states that, unlike existing order types, which are subjected only once to NASDAQ’s suite of standardized, system-enforced riskmanagement checks, including but not limited to duplicative and erroneous order and credit threshold checks, Benchmark Orders will trigger such checks twice—once with respect to the Benchmark Order itself at the time of entry and a second time with respect to each Child Order attributable to the Benchmark Order.41 In addition, NASDAQ states that it will provide new safeguards, specifically designed for Benchmark Orders, that compare each Child Order to its parent Benchmark Order to ensure that the system cannot mistakenly create excess Child Orders or otherwise ‘‘spray’’ orders to the detriment of market participants.42 According to NASDAQ, if any of these checks fail at any stage in the process, the entire order will be cancelled.43 As the Commission noted in the Order Instituting Proceedings, the application of appropriate risk controls under Rule 15c3–5 is critically important to maintaining a robust market infrastructure supporting the protection of investors, investor confidence, and fair, orderly, and efficient markets for all participants.44 Under the proposal, the risk controls required by Rule 15c3–5 would not be applicable to Child Orders generated by the proposed Application—a facility of NASDAQ—but NASDAQ represents that it would nevertheless impose substantial risk controls to govern its proposed Benchmark Orders, and in particular with respect to the Child Orders to which Rule 15c3–5 would not directly apply. The representations 39 See 40 See Angel Letter, supra note 6, at 2. NASDAQ Letter, supra note 8, at 3. 41 Id. 42 Id. According to NASDAQ, there are four such ‘‘comparison’’ checks: (i) Child Order limit price cannot violate the Parent Order limit price; (ii) Child Order quantity cannot exceed the original Parent Order quantity; (iii) Child Order quantity cannot exceed the ‘‘leaves’’ balance of the Parent Order; and (iv) Child Order quantity cannot be greater than the eligible routing quantity. Id. at 3– 4. NASDAQ represents that it will conduct these checks at four stages of the Benchmark Order process: (i) at the point of entry; (ii) during the processing of any Child Orders; (iii) after the processing of Child Orders; and (iv) when Child Orders are sent to be booked on NASDAQ or routed to an away destination. Id. at 4. 43 Id. 44 See Order Instituting Proceedings, 77 FR at 50192. E:\FR\FM\17JAN1.SGM 17JAN1 3930 Federal Register / Vol. 78, No. 12 / Thursday, January 17, 2013 / Notices made in NASDAQ’s response letter, if appropriately developed and reflected in NASDAQ’s proposed rule change, could potentially address the concerns regarding the risk controls surrounding Benchmark Orders, and whether in this regard the proposal imposes an undue burden on competition under the Act or whether it is designed to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market and a national market system, to protect investors and the public interest, and not to permit unfair discrimination between customers, issuers, brokers, or dealers. NASDAQ, however, has not amended its proposed rule change to address this issue or detail its proposed commitments with respect to the risk controls it proposes to implement with respect to Benchmark Orders. Accordingly, the Commission does not believe that it can make the finding that NASDAQ’s proposal is consistent with the requirements of Sections 6(b)(5) and 6(b)(8) of the Act.45 In the Order Instituting Proceedings, the Commission also expressed concern that NASDAQ’s proposed Benchmark Order functionality could permit unfair discrimination or impose an unnecessary burden on competition.46 In this regard, SIFMA notes, among other things, that the proposed Benchmark Order functionality would compete with algorithms that brokerdealers and other market participants currently use and offer, and questions whether it is appropriate for NASDAQ, as a national securities exchange, to offer that functionality.47 SIFMA states that NASDAQ’s proposal could create regulatory disparities that would give NASDAQ an inappropriate advantage over broker-dealers providing the same services, both in terms of the Market 45 15 U.S.C. 78f(b)(5) and (b)(8). Order Instituting Proceedings, 77 FR at pmangrum on DSK3VPTVN1PROD with 46 See 50192. 47 See SIFMA Letter, supra note 6, at 2. In addition, SIFMA notes that it shares an additional concern raised by the Commission in the Order Instituting Proceedings regarding whether Benchmark Orders and Child Orders could receive preferential treatment as compared to orders generated by broker-dealers that choose to use a competing algorithm. See SIFMA Letter, supra note 6, at 3. The other commenter, Angel, opines that there could be a small time advantage from the proximity of the Benchmark Order application to the order entry gateway of NASDAQ’s matching engine, but the amount of time gained by such proximity would not likely result in a major advantage. See Angel Letter, supra note 6, at 3. In response to SIFMA, NASDAQ states that, as a selfregulatory organization, it is not permitted to give and would not give Benchmark Orders any preferential treatment vis a vis other orders entered into NASDAQ systems. See NASDAQ Letter, supra note 8, at 4. VerDate Mar<15>2010 14:19 Jan 16, 2013 Jkt 229001 Access Rule 48 and other regulatory requirements that apply to brokerdealers.49 Specifically, SIFMA observes that NASDAQ has characterized the Benchmark Order as part of its function as a self-regulatory organization, and states that this characterization is cause for concern that NASDAQ would use the doctrine of regulatory immunity to shield the Exchange from any liability that could arise out of the use of the Benchmark Order functionality.50 SIFMA suggests that the proposed functionality is not part of NASDAQ’s role as a market regulator, but rather is a commercial offering of the Exchange that should not enjoy immunity from liability that is not available to brokerdealers providing identical services.51 SIFMA further opines that ‘‘it would be an incongruous result if NASDAQ were permitted to use regulatory immunity as a shield against liability, while competing algorithm providers offering the same services may assume unlimited liability [without an] armslength agreement.’’ 52 SIFMA believes that exchanges should not enjoy regulatory immunity that is not available to broker-dealers in providing the same services.53 NASDAQ’s response letter takes the position that, as a self-regulatory organization, the doctrine of regulatory immunity would apply to the services that it proposes to offer.54 NASDAQ believes that the proposal would not give NASDAQ an inappropriate advantage over broker-dealers, and that the Application would be a functional offering of the NASDAQ Stock Market similar to other functions, including order types, that process member trading interest.55 NASDAQ states that it has taken steps to ensure that the Application performs to the standards that the Commission sets for all selfregulatory organizations and complies with applicable SEC regulations and NASDAQ rules.56 According to NASDAQ, it is beyond dispute that NASDAQ is subject to regulation by the Commission in providing access to a facility of the Exchange such as Benchmark Orders and that NASDAQ must regulate its members’ use of such facilities.57 NASDAQ states that, as a national securities exchange under the Act, it is, by definition, a self-regulatory 48 17 CFR 240.15c3–5. SIFMA Letter, supra note 6, at 2. 50 Id. at 3. 51 Id. at 4. 52 Id. at 3. 53 Id. at 4. 54 See NASDAQ Letter, supra note 8, at 8. 55 Id. at 2, 4, 7–8. 56 Id. at 8. 57 Id. 49 See PO 00000 Frm 00053 Fmt 4703 Sfmt 4703 organization, and that SIFMA’s contention that NASDAQ, in making the proposal, is not acting as a selfregulatory organization is illogical and inconsistent with the plain language of the Act.58 Further, according to NASDAQ, common law immunity is not at issue in connection with the Commission’s review of the proposal and there is no need for the Commission to discuss such immunity in analyzing the consistency of the proposal with the Act.59 NASDAQ also contends that the proposed Benchmark Orders will operate much like NASDAQ’s alreadyapproved order types, and that SIFMA has identified no salient feature of Benchmark Orders that distinguish them from NASDAQ’s already-approved order types, nor has SIFMA explained how Benchmark Orders would compete with broker systems any differently than certain features of NASDAQ’s system that already compete with broker systems, such as routing and order execution.60 NASDAQ further argues that Benchmark Orders possess no characteristics that the Commission has described as belonging to broker-dealer functions, and that Benchmark Orders bear little or no resemblance to traditional brokerage functions as defined and applied by the Commission.61 NASDAQ has acknowledged, however, that Benchmark Orders are designed to compete with services currently offered by broker-dealers, noting that ‘‘the establishment of Benchmark Orders on NASDAQ will enhance NASDAQ’s ability to compete with similar functionality that already is widely dispersed in the industry both among members and trading venues.’’ 62 In addition, NASDAQ has stated that ‘‘[t]he Benchmark Order will not itself be available for execution, but instead will be used by a sub-system of the trading system to generate a series of ‘Child Orders’ of the types that already exist in the current NASDAQ rules.’’ 63 NASDAQ has further articulated that ‘‘Benchmark Orders will not be executed by the NASDAQ matching engine, but will upon entry be directed 58 Id. 59 Id. at 7. at 2, 4. 61 Id. at 7. 62 See Notice, 77 FR at 29437. In addition, Angel notes that brokerage firms typically offer their clients the ability to place orders designed to match the VWAP, TWAP or POV, and that NASDAQ’s proposal represents another example of the blurring borders between exchanges and broker-dealers, and states that there is nothing inherently wrong with competition between the two. See Angel Letter, supra note 6, at 2. 63 See Notice, 77 FR at 29435. 60 Id. E:\FR\FM\17JAN1.SGM 17JAN1 Federal Register / Vol. 78, No. 12 / Thursday, January 17, 2013 / Notices to [the Application] dedicated to processing Benchmark Orders.’’ 64 The Commission believes that one significant difference between Benchmark Orders and existing NASDAQ or other exchange orders is that the Benchmark Order is not initially directed to the NASDAQ matching engine for potential execution, but instead is directed to the Application for further processing and the generation of Child Orders, to be routed to the NASDAQ matching engine or another trading center. Thus, NASDAQ’s proposed Benchmark Order is not an exchange order in the traditional sense, in that it would not immediately enter the Exchange’s order book (i.e., NASDAQ Market Center) 65 for potential execution. Instead, it essentially is an instruction that would reside outside of the matching engine and be processed by an Application, which would then route orders to NASDAQ, or another trading venue, using a selected algorithm, over a particular period of time, to achieve a particular objective. Because NASDAQ is proposing to offer a novel order type designed to compete with services offered by brokerdealers, the Commission must consider, among other things, whether the proposed rule change would impose an unnecessary or inappropriate burden on competition under Section 6(b)(8) of the Act.66 As noted above, SIFMA is concerned that NASDAQ’s proposal could create regulatory disparities that would give NASDAQ an inappropriate advantage over broker-dealers providing the same services, and that NASDAQ ‘‘would use the doctrine of regulatory immunity to protect itself from any liability that arises out of the Benchmark Order functionality, through systems issues or otherwise.’’ 67 In addition, the Commission notes that NASDAQ Rule 4626 generally provides that ‘‘Nasdaq and its affiliates shall not be liable for any losses, damages, or other claims arising out of the Nasdaq Market Center or its use.’’ 68 NASDAQ does not respond to concerns raised by SIFMA with any substantive analysis of whether pmangrum on DSK3VPTVN1PROD with 64 Id. at 29436. 65 The term ‘‘NASDAQ Market Center’’ is defined in pertinent part as the ‘‘automated system for order execution and trade reporting owned and operated by The NASDAQ Stock Market LLC * * * [comprising] an order execution service that enables Participants to automatically execute transactions in System Securities; and provides Participants with sufficient monitoring and updating capability to participate in an automated execution environment.’’ See NASDAQ Rule 4751(a)(1). 66 15 U.S.C. 78f(b)(8). 67 See SIFMA Letter, supra note 6, at 3. 68 See NASDAQ Rule 4626. VerDate Mar<15>2010 14:19 Jan 16, 2013 Jkt 229001 regulatory immunity, or exchange rules limiting liability, in the context of NASDAQ’s proposal to offer a service traditionally provided by broker-dealers, would impose an undue burden on competition under the Act. NASDAQ simply responds that this ‘‘judicially recognized doctrine is not at issue in connection with the Commission’s review of NASDAQ’s Benchmark Order Proposal’’ and that ‘‘[t]here is no need for the Commission to discuss immunity in analyzing the consistency of NASDAQ’s Proposal with the Exchange Act.’’ 69 Accordingly, the Commission does not believe that it can make the finding that NASDAQ’s proposal is consistent with the requirements of Section 6(b)(8) of the Act.70 As noted above, Rule 700(b)(3) of the Commission’s Rules of Practice states that ‘‘[t]he burden to demonstrate that a proposed rule change is consistent with the Exchange Act and the rules and regulations thereunder * * * is on the self-regulatory organization that proposed the rule change’’ and that a ‘‘mere assertion that the proposed rule change is consistent with those requirements * * * is not sufficient.’’ 71 For the reasons set forth above, the Commission does not believe that NASDAQ has met its burden to demonstrate that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder. IV. Conclusion For the foregoing reasons, the Commission does not find that the proposed rule change is consistent with the Act and the rules and regulations thereunder applicable to a national securities exchange, and, in particular, with Sections 6(b)(5) and 6(b)(8) of the Act.72 It is therefore ordered, pursuant to Section 19(b)(2) of the Act,73 that the proposed rule change (SR–NASDAQ– 2012–059) be, and hereby is, disapproved. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.74 Kevin M. O’Neill, Deputy Secretary. [FR Doc. 2013–00871 Filed 1–16–13; 8:45 am] BILLING CODE 8011–01–P 69 See NASDAQ Letter, supra note 8, at 7. U.S.C. 78f(b)(8). 71 17 CFR 201.700(b)(3). 72 15 U.S.C. 78f(b)(5) and (b)(8). 73 15 U.S.C. 78s(b)(2). 74 17 CFR 200.30–3(a)(12). 70 15 PO 00000 Frm 00054 Fmt 4703 Sfmt 4703 3931 SECURITIES AND EXCHANGE COMMISSION [Release No. 34–68626; File No. SR– NASDAQ–2012–149] Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change To Modify NASDAQ’s Order Execution Rebates and Investor Support Program January 11, 2013. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’),1, and Rule 19b–4 2 thereunder, notice is hereby given that on December 31, 2012, The NASDAQ Stock Market LLC (‘‘NASDAQ’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) the proposed rule change as described in Items I, II and III, below, which Items have been prepared by NASDAQ. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change NASDAQ is proposing (i) to amend its schedule of execution rebates under Rule 7018(a), and (ii) to modify the Investor Support Program (the ‘‘ISP’’) under Rule 7014. While changes pursuant to this proposal are effective upon filing, the Exchange will implement the proposed rule on January 2, 2013. The text of the proposed rule change is available on the Exchange’s Web site at http:// www.nasdaq.cchwallstreet.com, at the principal office of the Exchange, and at the Commission’s Public Reference Room. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. 1 15 2 17 E:\FR\FM\17JAN1.SGM U.S.C. 78s(b)(1). CFR 240.19b–4. 17JAN1

Agencies

[Federal Register Volume 78, Number 12 (Thursday, January 17, 2013)]
[Notices]
[Pages 3928-3931]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-00871]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68629; File No. SR-NASDAQ-2012-059]


Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order 
Disapproving Proposed Rule Change To Establish ``Benchmark Orders'' 
Under NASDAQ Rule 4751(f)

January 11, 2013.

I. Introduction

    On May 1, 2012, The NASDAQ Stock Market LLC (``NASDAQ'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), 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 establish various ``Benchmark Orders'' under 
NASDAQ Rule 4751(f). The proposed rule change was published for comment 
in the Federal Register on May 17, 2012.\3\ On June 26, 2012, the 
Commission extended to August 15, 2012, the time period in which to 
approve the proposed rule change, disapprove the proposed rule change, 
or institute proceedings to determine whether to disapprove the 
proposed rule change.\4\
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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. 66972 (May 11, 
2012), 77 FR 29435 (May 17, 2012) (``Notice'').
    \4\ See Securities Exchange Act Release No. 67258 (June 26, 
2012), 77 FR 39314 (July 2, 2012).
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    On August 14, 2012, the Commission instituted proceedings to 
determine whether to approve or disapprove the proposed rule change.\5\ 
The Commission thereafter received two comment letters on the 
proposal.\6\ On November 9, 2012, the Commission issued a notice of 
designation of a longer period for Commission action on proceedings to 
determine whether to approve or disapprove the proposed rule change.\7\ 
On December 17, 2012, NASDAQ submitted a response letter to the 
comments on the proposal.\8\ This order disapproves the proposed rule 
change.
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    \5\ See Securities Exchange Act Release No. 67655 (August 14, 
2012), 77 FR 50191 (August 20, 2012) (``Order Instituting 
Proceedings'').
    \6\ See Letters to the Commission from Theodore R. Lazo, 
Managing Director and Associate General Counsel, SIFMA, dated 
October 5, 2012 (``SIFMA Letter''); and James J. Angel, dated August 
16, 2012 (``Angel Letter'').
    \7\ See Securities Exchange Act Release No. 68199 (November 9, 
2012), 77 FR 68873 (November 16, 2012).
    \8\ See Letter to the Commission from Jeffrey S. Davis, Vice 
President and Deputy General Counsel, NASDAQ, dated December 17, 
2012 (``NASDAQ Letter'').
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II. Description of the Proposal

    As set forth in more detail in the Notice, the Exchange has 
proposed to offer Benchmark Orders that would seek to achieve the 
performance of a specified benchmark--Volume Weighted Average Price 
(``VWAP''), Time Weighted Average Price (``TWAP''), or Percent of 
Volume (``POV'')--over a specified period of time for a specified 
security.\9\ The entering party would specify the benchmark, period of 
time, and security, as well as the other order information common to 
all order types, such as buy/sell side, shares and price.\10\
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    \9\ See proposed NASDAQ Rule 4751(f)(15).
    \10\ Id.; see also Notice, 77 FR at 29436.
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    Benchmark Orders would be received by NASDAQ but by their terms 
would not be executable by the NASDAQ matching engine upon entry.\11\ 
Rather, NASDAQ would direct them to a system application 
(``Application'') that is licensed from a third-party provider and 
dedicated to processing Benchmark Orders.\12\ The Application would 
process Benchmark Orders by generating ``Child Orders'' in a manner 
designed to achieve the desired benchmark performance, i.e., VWAP, TWAP 
or POV, in accordance with the member's instructions.\13\ Child Orders 
would be executed within the NASDAQ system under NASDAQ's existing 
rules, or made available for routing under NASDAQ's current routing 
rules.\14\ The Application would not be capable of executing Child 
Orders, but instead would send Child Orders, using the proper system 
protocol, to the NASDAQ matching engine or to the NASDAQ router as 
needed to complete the Benchmark Order.\15\ Child Orders would be 
processed in an identical manner to orders generated independently of a 
Benchmark Order.\16\ NASDAQ states that the third-party provider of the 
Application would have no actionable advantage over NASDAQ members with 
respect to the NASDAQ system.\17\
---------------------------------------------------------------------------

    \11\ See proposed NASDAQ Rule 4751(f)(15); see also Notice, 77 
FR at 29435-36.
    \12\ See Notice, 77 FR at 29436.
    \13\ See proposed NASDAQ Rule 4751(f)(15); see also Notice, 77 
FR at 29435-36.
    \14\ See Notice, 77 FR at 29435. Child Orders that require 
routing would be routed by NASDAQ Execution Services, NASDAQ's 
wholly-owned routing broker-dealer. Id. at 29436 n.8. In addition, 
fees applicable to existing orders and trades would apply to Child 
Orders. Id. at 29436.
    \15\ Id. at 29435-36.
    \16\ Id. at 29436.
    \17\ Id.
---------------------------------------------------------------------------

    NASDAQ represents that it would test the Application rigorously and 
regularly, monitor the Application performance on a real-time and 
continuous basis, and have access to the technology, employees, books 
and records of the third-party provider that are related to the 
Application and its interaction with NASDAQ.\18\ NASDAQ states that it 
considers the Application to be a functional offering of the NASDAQ 
Stock Market, and that it would be integrated closely with the NASDAQ 
system and provided to members subject to NASDAQ's obligations and 
responsibilities as a self-regulatory organization.\19\ In addition, 
NASDAQ represents that it would maintain control of and responsibility 
for the Application.\20\
---------------------------------------------------------------------------

    \18\ Id.
    \19\ Id.
    \20\ Id. at 29437.
---------------------------------------------------------------------------

III. Discussion

    Under Section 19(b)(2)(C) of the Act, the Commission shall approve 
a proposed rule change of a self-regulatory organization if it finds 
that such proposed rule change is consistent with the requirements of 
the Act, and the rules and regulations thereunder that are applicable 
to such organization.\21\ The Commission shall disapprove a proposed 
rule change if it does not make such a finding.\22\ The Commission's 
Rules of Practice, under Rule 700(b)(3), state that the ``burden to 
demonstrate that a proposed rule change is consistent with the Exchange 
Act and the rules and regulations issued thereunder * * * is on the 
self-regulatory organization that proposed the rule change'' and that a 
``mere assertion that the proposed rule change is consistent with those 
requirements * * * is not sufficient.'' \23\
---------------------------------------------------------------------------

    \21\ See 15 U.S.C. 78s(b)(2)(C)(i).
    \22\ See 15 U.S.C. 78s(b)(2)(C)(ii).
    \23\ See 17 CFR 201.700. The description of a proposed rule 
change, its purpose and operation, its effect, and a legal analysis 
of its consistency with applicable requirements must all be 
sufficiently detailed and specific to support an affirmative 
Commission finding. See id. Any failure of a self-regulatory 
organization to provide the information elicited by Form 19b-4 may 
result in the Commission not having a sufficient basis to make an 
affirmative finding that a proposed rule change is consistent with 
the Act and the rules and regulations issued thereunder that are 
applicable to the self-regulatory organization. Id.

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[[Page 3929]]

    After careful consideration, the Commission does not find that the 
proposed rule change is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\24\ In particular, the Commission does not find 
that the proposed rule change is consistent with: (i) Section 6(b)(5) 
of the Act,\25\ which requires, among other things, that the rules of a 
national securities exchange 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, to protect 
investors and the public interest, and not to permit unfair 
discrimination between customers, issuers, brokers, or dealers; and 
(ii) Section 6(b)(8) of the Act,\26\ which requires that the rules of a 
national securities exchange not impose any burden on competition not 
necessary or appropriate in furtherance of the Act.
---------------------------------------------------------------------------

    \24\ In disapproving the proposed rule change, the Commission 
has considered the proposed rule's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f).
    \25\ 15 U.S.C. 78f(b)(5).
    \26\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

    In the Order Instituting Proceedings, the Commission stressed, 
among other things, that the application of appropriate risk controls 
under the Market Access Rule, Rule 15c3-5 under the Act,\27\ is 
critically important to maintaining a robust market infrastructure.\28\ 
The Commission expressed concern as to whether Child Orders, which 
would be generated solely by the Application and presumably outside the 
control and supervision of the broker-dealer firm that entered the 
initial Benchmark Order, would be subject to adequate pre-trade risk 
checks, and noted that NASDAQ's proposal did not indicate how or 
whether pre-trade controls would be applied to Child Orders generated 
by the Application.\29\
---------------------------------------------------------------------------

    \27\ 17 CFR 240.15c3-5. Rule 15c3-5 is designed to ensure that 
broker-dealers appropriately control the risks associated with 
market access, so as not to jeopardize their own financial 
condition, that of other market participants, the integrity of 
trading on the securities markets, or the stability of the financial 
system. See Securities Exchange Act Release No. 63241 (November 3, 
2010), 75 FR 69792 at 69794 (November 15, 2010).
    \28\ See Order Instituting Proceedings, 77 FR at 50192.
    \29\ Id.
---------------------------------------------------------------------------

    The Commission received two comment letters on the proposed rule 
change and a response from NASDAQ.\30\ In its comment letter, SIFMA 
objects to, and urges the Commission to disapprove, the proposed rule 
change.\31\ SIFMA expresses the belief that NASDAQ's proposed rule 
change would create a regulatory disparity giving NASDAQ an 
inappropriate advantage with respect to the Market Access Rule over 
broker-dealers that provide the same services that NASDAQ proposes.\32\ 
SIFMA notes that NASDAQ is not subject to the Market Access Rule, and 
its affiliated routing broker-dealer benefits from significant 
exceptions to the Market Access Rule, whereas broker-dealers 
unaffiliated with NASDAQ are subject to all of the requirements of the 
Market Access Rule when they offer similar algorithmic trading services 
to those NASDAQ proposes to offer, and such requirements are reinforced 
through regulatory examination and oversight.\33\ Accordingly, SIFMA 
``urge[s] the Commission to assure that the same regulatory 
requirements and obligations would apply to Benchmark Orders and Child 
Orders effected by Nasdaq that would apply to those orders if they were 
effected by a broker-dealer.'' \34\
---------------------------------------------------------------------------

    \30\ See SIFMA Letter and Angel Letter, supra note 6; NASDAQ 
Letter, supra note 8.
    \31\ See SIFMA Letter, supra note 6.
    \32\ Id. at 2.
    \33\ Id. at 5.
    \34\ Id. at 2.
---------------------------------------------------------------------------

    SIFMA further states that it shares the concern raised by the 
Commission in the Order Instituting Proceedings that Child Orders would 
not be subject to appropriate controls to manage risk, and that NASDAQ 
has not adequately addressed how or whether the Child Orders would be 
subject to adequate pre-trade risk controls.\35\ SIFMA states that, 
given that Child Orders would be generated by a third-party Application 
and outside of the control and supervision of the broker-dealer that 
submitted the Benchmark Order, Child Orders would not be subject to the 
risk controls that the entering firm is required to have in place 
pursuant to the Market Access Rule.\36\ SIFMA notes that, while NASDAQ 
has stated in the proposal that Child Orders will comport with existing 
NASDAQ rules, including those intended to enforce the Market Access 
Rule, NASDAQ has provided no details regarding how Child Orders will 
meet these requirements.\37\ According to SIFMA, this lack of detail 
raises concerns about the potential for market disruptions that 
NASDAQ's proposed algorithmic functionality could cause.\38\ According 
to the other commenter, Angel, NASDAQ's assurances in the proposal that 
it will have adequate risk controls are credible.\39\
---------------------------------------------------------------------------

    \35\ Id. at 4.
    \36\ Id. at 4-5.
    \37\ Id. at 5.
    \38\ Id.
    \39\ See Angel Letter, supra note 6, at 2.
---------------------------------------------------------------------------

    NASDAQ responds by, among other things, committing to provide 
additional risk management safeguards for Benchmark Orders.\40\ 
Specifically, NASDAQ states that, unlike existing order types, which 
are subjected only once to NASDAQ's suite of standardized, system-
enforced risk-management checks, including but not limited to 
duplicative and erroneous order and credit threshold checks, Benchmark 
Orders will trigger such checks twice--once with respect to the 
Benchmark Order itself at the time of entry and a second time with 
respect to each Child Order attributable to the Benchmark Order.\41\ In 
addition, NASDAQ states that it will provide new safeguards, 
specifically designed for Benchmark Orders, that compare each Child 
Order to its parent Benchmark Order to ensure that the system cannot 
mistakenly create excess Child Orders or otherwise ``spray'' orders to 
the detriment of market participants.\42\ According to NASDAQ, if any 
of these checks fail at any stage in the process, the entire order will 
be cancelled.\43\
---------------------------------------------------------------------------

    \40\ See NASDAQ Letter, supra note 8, at 3.
    \41\ Id.
    \42\ Id. According to NASDAQ, there are four such ``comparison'' 
checks: (i) Child Order limit price cannot violate the Parent Order 
limit price; (ii) Child Order quantity cannot exceed the original 
Parent Order quantity; (iii) Child Order quantity cannot exceed the 
``leaves'' balance of the Parent Order; and (iv) Child Order 
quantity cannot be greater than the eligible routing quantity. Id. 
at 3-4. NASDAQ represents that it will conduct these checks at four 
stages of the Benchmark Order process: (i) at the point of entry; 
(ii) during the processing of any Child Orders; (iii) after the 
processing of Child Orders; and (iv) when Child Orders are sent to 
be booked on NASDAQ or routed to an away destination. Id. at 4.
    \43\ Id.
---------------------------------------------------------------------------

    As the Commission noted in the Order Instituting Proceedings, the 
application of appropriate risk controls under Rule 15c3-5 is 
critically important to maintaining a robust market infrastructure 
supporting the protection of investors, investor confidence, and fair, 
orderly, and efficient markets for all participants.\44\ Under the 
proposal, the risk controls required by Rule 15c3-5 would not be 
applicable to Child Orders generated by the proposed Application--a 
facility of NASDAQ--but NASDAQ represents that it would nevertheless 
impose substantial risk controls to govern its proposed Benchmark 
Orders, and in particular with respect to the Child Orders to which 
Rule 15c3-5 would not directly apply. The representations

[[Page 3930]]

made in NASDAQ's response letter, if appropriately developed and 
reflected in NASDAQ's proposed rule change, could potentially address 
the concerns regarding the risk controls surrounding Benchmark Orders, 
and whether in this regard the proposal imposes an undue burden on 
competition under the Act or whether it is designed to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, to 
protect investors and the public interest, and not to permit unfair 
discrimination between customers, issuers, brokers, or dealers. NASDAQ, 
however, has not amended its proposed rule change to address this issue 
or detail its proposed commitments with respect to the risk controls it 
proposes to implement with respect to Benchmark Orders. Accordingly, 
the Commission does not believe that it can make the finding that 
NASDAQ's proposal is consistent with the requirements of Sections 
6(b)(5) and 6(b)(8) of the Act.\45\
---------------------------------------------------------------------------

    \44\ See Order Instituting Proceedings, 77 FR at 50192.
    \45\ 15 U.S.C. 78f(b)(5) and (b)(8).
---------------------------------------------------------------------------

    In the Order Instituting Proceedings, the Commission also expressed 
concern that NASDAQ's proposed Benchmark Order functionality could 
permit unfair discrimination or impose an unnecessary burden on 
competition.\46\ In this regard, SIFMA notes, among other things, that 
the proposed Benchmark Order functionality would compete with 
algorithms that broker-dealers and other market participants currently 
use and offer, and questions whether it is appropriate for NASDAQ, as a 
national securities exchange, to offer that functionality.\47\ SIFMA 
states that NASDAQ's proposal could create regulatory disparities that 
would give NASDAQ an inappropriate advantage over broker-dealers 
providing the same services, both in terms of the Market Access Rule 
\48\ and other regulatory requirements that apply to broker-
dealers.\49\ Specifically, SIFMA observes that NASDAQ has characterized 
the Benchmark Order as part of its function as a self-regulatory 
organization, and states that this characterization is cause for 
concern that NASDAQ would use the doctrine of regulatory immunity to 
shield the Exchange from any liability that could arise out of the use 
of the Benchmark Order functionality.\50\ SIFMA suggests that the 
proposed functionality is not part of NASDAQ's role as a market 
regulator, but rather is a commercial offering of the Exchange that 
should not enjoy immunity from liability that is not available to 
broker-dealers providing identical services.\51\ SIFMA further opines 
that ``it would be an incongruous result if NASDAQ were permitted to 
use regulatory immunity as a shield against liability, while competing 
algorithm providers offering the same services may assume unlimited 
liability [without an] arms-length agreement.'' \52\ SIFMA believes 
that exchanges should not enjoy regulatory immunity that is not 
available to broker-dealers in providing the same services.\53\
---------------------------------------------------------------------------

    \46\ See Order Instituting Proceedings, 77 FR at 50192.
    \47\ See SIFMA Letter, supra note 6, at 2. In addition, SIFMA 
notes that it shares an additional concern raised by the Commission 
in the Order Instituting Proceedings regarding whether Benchmark 
Orders and Child Orders could receive preferential treatment as 
compared to orders generated by broker-dealers that choose to use a 
competing algorithm. See SIFMA Letter, supra note 6, at 3. The other 
commenter, Angel, opines that there could be a small time advantage 
from the proximity of the Benchmark Order application to the order 
entry gateway of NASDAQ's matching engine, but the amount of time 
gained by such proximity would not likely result in a major 
advantage. See Angel Letter, supra note 6, at 3. In response to 
SIFMA, NASDAQ states that, as a self-regulatory organization, it is 
not permitted to give and would not give Benchmark Orders any 
preferential treatment vis a vis other orders entered into NASDAQ 
systems. See NASDAQ Letter, supra note 8, at 4.
    \48\ 17 CFR 240.15c3-5.
    \49\ See SIFMA Letter, supra note 6, at 2.
    \50\ Id. at 3.
    \51\ Id. at 4.
    \52\ Id. at 3.
    \53\ Id. at 4.
---------------------------------------------------------------------------

    NASDAQ's response letter takes the position that, as a self-
regulatory organization, the doctrine of regulatory immunity would 
apply to the services that it proposes to offer.\54\ NASDAQ believes 
that the proposal would not give NASDAQ an inappropriate advantage over 
broker-dealers, and that the Application would be a functional offering 
of the NASDAQ Stock Market similar to other functions, including order 
types, that process member trading interest.\55\ NASDAQ states that it 
has taken steps to ensure that the Application performs to the 
standards that the Commission sets for all self-regulatory 
organizations and complies with applicable SEC regulations and NASDAQ 
rules.\56\ According to NASDAQ, it is beyond dispute that NASDAQ is 
subject to regulation by the Commission in providing access to a 
facility of the Exchange such as Benchmark Orders and that NASDAQ must 
regulate its members' use of such facilities.\57\ NASDAQ states that, 
as a national securities exchange under the Act, it is, by definition, 
a self-regulatory organization, and that SIFMA's contention that 
NASDAQ, in making the proposal, is not acting as a self-regulatory 
organization is illogical and inconsistent with the plain language of 
the Act.\58\ Further, according to NASDAQ, common law immunity is not 
at issue in connection with the Commission's review of the proposal and 
there is no need for the Commission to discuss such immunity in 
analyzing the consistency of the proposal with the Act.\59\
---------------------------------------------------------------------------

    \54\ See NASDAQ Letter, supra note 8, at 8.
    \55\ Id. at 2, 4, 7-8.
    \56\ Id. at 8.
    \57\ Id.
    \58\ Id.
    \59\ Id. at 7.
---------------------------------------------------------------------------

    NASDAQ also contends that the proposed Benchmark Orders will 
operate much like NASDAQ's already-approved order types, and that SIFMA 
has identified no salient feature of Benchmark Orders that distinguish 
them from NASDAQ's already-approved order types, nor has SIFMA 
explained how Benchmark Orders would compete with broker systems any 
differently than certain features of NASDAQ's system that already 
compete with broker systems, such as routing and order execution.\60\ 
NASDAQ further argues that Benchmark Orders possess no characteristics 
that the Commission has described as belonging to broker-dealer 
functions, and that Benchmark Orders bear little or no resemblance to 
traditional brokerage functions as defined and applied by the 
Commission.\61\
---------------------------------------------------------------------------

    \60\ Id. at 2, 4.
    \61\ Id. at 7.
---------------------------------------------------------------------------

    NASDAQ has acknowledged, however, that Benchmark Orders are 
designed to compete with services currently offered by broker-dealers, 
noting that ``the establishment of Benchmark Orders on NASDAQ will 
enhance NASDAQ's ability to compete with similar functionality that 
already is widely dispersed in the industry both among members and 
trading venues.'' \62\ In addition, NASDAQ has stated that ``[t]he 
Benchmark Order will not itself be available for execution, but instead 
will be used by a sub-system of the trading system to generate a series 
of `Child Orders' of the types that already exist in the current NASDAQ 
rules.'' \63\ NASDAQ has further articulated that ``Benchmark Orders 
will not be executed by the NASDAQ matching engine, but will upon entry 
be directed

[[Page 3931]]

to [the Application] dedicated to processing Benchmark Orders.'' \64\
---------------------------------------------------------------------------

    \62\ See Notice, 77 FR at 29437. In addition, Angel notes that 
brokerage firms typically offer their clients the ability to place 
orders designed to match the VWAP, TWAP or POV, and that NASDAQ's 
proposal represents another example of the blurring borders between 
exchanges and broker-dealers, and states that there is nothing 
inherently wrong with competition between the two. See Angel Letter, 
supra note 6, at 2.
    \63\ See Notice, 77 FR at 29435.
    \64\ Id. at 29436.
---------------------------------------------------------------------------

    The Commission believes that one significant difference between 
Benchmark Orders and existing NASDAQ or other exchange orders is that 
the Benchmark Order is not initially directed to the NASDAQ matching 
engine for potential execution, but instead is directed to the 
Application for further processing and the generation of Child Orders, 
to be routed to the NASDAQ matching engine or another trading center. 
Thus, NASDAQ's proposed Benchmark Order is not an exchange order in the 
traditional sense, in that it would not immediately enter the 
Exchange's order book (i.e., NASDAQ Market Center) \65\ for potential 
execution. Instead, it essentially is an instruction that would reside 
outside of the matching engine and be processed by an Application, 
which would then route orders to NASDAQ, or another trading venue, 
using a selected algorithm, over a particular period of time, to 
achieve a particular objective.
---------------------------------------------------------------------------

    \65\ The term ``NASDAQ Market Center'' is defined in pertinent 
part as the ``automated system for order execution and trade 
reporting owned and operated by The NASDAQ Stock Market LLC * * * 
[comprising] an order execution service that enables Participants to 
automatically execute transactions in System Securities; and 
provides Participants with sufficient monitoring and updating 
capability to participate in an automated execution environment.'' 
See NASDAQ Rule 4751(a)(1).
---------------------------------------------------------------------------

    Because NASDAQ is proposing to offer a novel order type designed to 
compete with services offered by broker-dealers, the Commission must 
consider, among other things, whether the proposed rule change would 
impose an unnecessary or inappropriate burden on competition under 
Section 6(b)(8) of the Act.\66\ As noted above, SIFMA is concerned that 
NASDAQ's proposal could create regulatory disparities that would give 
NASDAQ an inappropriate advantage over broker-dealers providing the 
same services, and that NASDAQ ``would use the doctrine of regulatory 
immunity to protect itself from any liability that arises out of the 
Benchmark Order functionality, through systems issues or otherwise.'' 
\67\ In addition, the Commission notes that NASDAQ Rule 4626 generally 
provides that ``Nasdaq and its affiliates shall not be liable for any 
losses, damages, or other claims arising out of the Nasdaq Market 
Center or its use.'' \68\
---------------------------------------------------------------------------

    \66\ 15 U.S.C. 78f(b)(8).
    \67\ See SIFMA Letter, supra note 6, at 3.
    \68\ See NASDAQ Rule 4626.
---------------------------------------------------------------------------

    NASDAQ does not respond to concerns raised by SIFMA with any 
substantive analysis of whether regulatory immunity, or exchange rules 
limiting liability, in the context of NASDAQ's proposal to offer a 
service traditionally provided by broker-dealers, would impose an undue 
burden on competition under the Act. NASDAQ simply responds that this 
``judicially recognized doctrine is not at issue in connection with the 
Commission's review of NASDAQ's Benchmark Order Proposal'' and that 
``[t]here is no need for the Commission to discuss immunity in 
analyzing the consistency of NASDAQ's Proposal with the Exchange Act.'' 
\69\ Accordingly, the Commission does not believe that it can make the 
finding that NASDAQ's proposal is consistent with the requirements of 
Section 6(b)(8) of the Act.\70\
---------------------------------------------------------------------------

    \69\ See NASDAQ Letter, supra note 8, at 7.
    \70\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

    As noted above, Rule 700(b)(3) of the Commission's Rules of 
Practice states that ``[t]he burden to demonstrate that a proposed rule 
change is consistent with the Exchange Act and the rules and 
regulations thereunder * * * is on the self-regulatory organization 
that proposed the rule change'' and that a ``mere assertion that the 
proposed rule change is consistent with those requirements * * * is not 
sufficient.'' \71\ For the reasons set forth above, the Commission does 
not believe that NASDAQ has met its burden to demonstrate that the 
proposed rule change is consistent with the requirements of the Act and 
the rules and regulations thereunder.
---------------------------------------------------------------------------

    \71\ 17 CFR 201.700(b)(3).
---------------------------------------------------------------------------

IV. Conclusion

    For the foregoing reasons, the Commission does not find that the 
proposed rule change is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, with Sections 6(b)(5) and 6(b)(8) of the Act.\72\
---------------------------------------------------------------------------

    \72\ 15 U.S.C. 78f(b)(5) and (b)(8).
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\73\ that the proposed rule change (SR-NASDAQ-2012-059) be, and 
hereby is, disapproved.
---------------------------------------------------------------------------

    \73\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\74\
---------------------------------------------------------------------------

    \74\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-00871 Filed 1-16-13; 8:45 am]
BILLING CODE 8011-01-P