[Federal Register Volume 78, Number 159 (Friday, August 16, 2013)]
[Notices]
[Pages 50123-50126]
[FR Doc No: 2013-19907]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70159; File No. SR-NASDAQ-2013-102]

Self-Regulatory Organizations; The NASDAQ Stock Market LLC;
Notice of Filing of a Proposed Rule Change to Assume Operational
Responsibility for Certain Surveillance Activity Currently Performed by
FINRA Under the Exchange's Authority and Supervision

August 12, 2013.
    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 July 31, 2013, The NASDAQ Stock Market LLC (``NASDAQ'' or the
``Exchange'') filed with the Securities and Exchange Commission
(``Commission'') a proposed rule change as described in Items I, II and
III below, which Items have been prepared by the Exchange. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    NASDAQ is proposing to assume operational responsibility for
certain surveillance activity currently performed by the Financial
Industry Regulatory Authority (``FINRA'') under the Exchange's
authority and supervision.

II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASDAQ included statements
concerning the purpose of, and basis for, the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of those 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 parts of such
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Section 6 of the Act requires that national securities exchanges
enforce their members' compliance with federal securities laws and
rules as well as the exchanges' own rules.\3\ As a self-regulatory
organization (``SRO''), NASDAQ must conduct surveillance of trading on
the Exchange as part of a comprehensive regulatory program that also
includes member examinations and investigation and prosecution of
suspicious activity. Since it became a national securities exchange,
NASDAQ has contracted with FINRA through various regulatory services
agreements to perform certain surveillance and other regulatory
functions on its behalf. However, as the Commission has made clear,
``the Nasdaq Exchange bears the responsibility for self-regulatory
conduct and primary liability for self-regulatory failures, not the SRO
retained to perform regulatory functions on the Exchange's behalf.''
\4\
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    \3\ 15 U.S.C. 78f.
    \4\ Securities Exchange Act Release No. 53128 at 28 (January 13,
2006), 71 FR 3550, 3556 (January 23, 2006).
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    Notwithstanding its use of FINRA, the Exchange has also retained
operational responsibility for a number of surveillance and other
regulatory functions including real-time surveillance, qualification of
companies listed on NASDAQ and most surveillance related to its
affiliated options markets. Historically NASDAQ retained operational
responsibility in areas where NASDAQ's expertise regarding its own
markets, technology and listed companies enhanced regulation. For the
reasons outlined

below, NASDAQ now proposes to reallocate operational responsibility
from FINRA to NASDAQ Regulation for a limited number of equities
surveillance patterns and related review functions focused on:
     Manipulation patterns that monitor solely NASDAQ activity,
including patterns that monitor the Exchange's opening and closing
crosses and compliance with minimum bid listing requirements, and
     monitoring of compliance by member firms with elements of
Regulation M and NASDAQ Rule 4619 compliance.
    FINRA operates a full suite of equities surveillance patterns on
behalf of NASDAQ that covers many types of potential misconduct. In
recent years FINRA, with NASDAQ's oversight and approval, modified a
number of these NASDAQ patterns to incorporate data from markets
operated by NYSE Euronext. NASDAQ plans to continue to participate in
this cross-market surveillance performed by FINRA, some of which
focuses on identifying similar violative activity, which will not be
impacted by this proposal. However, a limited number of FINRA's
patterns only review NASDAQ market data and detect conduct occurring
only on the Exchange. These patterns incorporate unique elements of
NASDAQ's market structure and focus on trading activity in the NASDAQ
opening and closing cross process, as well as NASDAQ minimum bid
listing standards, an area already regulated by NASDAQ. An additional
pattern monitors attempts to manipulate NASDAQ using small orders to
advantage larger orders placed on the opposite side of the NASDAQ
market at an improved price (often referred to as ``odd lot
manipulation'' or ``mini-manipulation'').
    NASDAQ believes that its expertise in its own market structure
coupled with its continued monitoring of these activities in real-time
will enable it to enhance existing patterns to better detect improper
activity on its market. In addition, these patterns, the underlying
rules, and analytical requirements are similar to patterns NASDAQ
regulatory personnel already operate for affiliated options markets.
For example, NASDAQ regulatory personnel routinely monitor affiliated
options markets for market closing activity and other patterns designed
to detect various types of price influence.
    NASDAQ also proposes to assume operational responsibility for real-
time monitoring of compliance by market makers that are members of an
underwriting syndicate with the quoting and trading restrictions in
Rules 101 and 103 under the Act \5\ and NASDAQ Rule 4619. Lead
underwriters affected by the rules file a Regulation M Commencement
Notification at the beginning of a secondary offering and subsequent
Underwriter Activity Report for the offering. The surveillance pattern
monitors quoting and trading of firms that are designated as
participants in the secondary offering and alerts regulatory staff if a
firm that has requested passive market making exceeds its trading
thresholds or an excused withdrawal has traded in a way that could lead
to violations of the rules. The activity is monitored in real-time and
firms are called upon receipt of regulatory alerts to prevent potential
or further violations. This is the only real-time surveillance function
performed by FINRA and NASDAQ believes that this responsibility is more
properly handled by NASDAQ's MarketWatch group that handles all other
real-time surveillance of the NASDAQ market. MarketWatch already has
responsibility for monitoring similar activity on NASDAQ OMX BX by
market makers participating in secondary offerings, although this
surveillance is not currently active as BX does not have any registered
market makers.
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    \5\ 17 CFR 242.101 and 17 CFR 242.103.
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    NASDAQ plans to operate the surveillance patterns referenced above
in the SMARTS surveillance system. SMARTS is a state-of-the-art
surveillance platform used in 26 markets and by 9 government regulators
around the world. NASDAQ plans to use SMARTS for both real-time
monitoring and the limited non-real time surveillance covered by this
proposal. Running the patterns in real-time will permit an expedited
review of critical alerts that previously would not have been completed
the same day. It will now be easier to quickly compare unusual activity
noted as part of NASDAQ's operations monitoring of market activity with
surveillance alerts. NASDAQ anticipates being able to refer a broader
cross section of problematic activity to FINRA for expedited review
than was previously the case.
    NASDAQ Regulation intends to leverage its existing staff of
experienced analysts, lawyers, programmers and market structure experts
to perform the new functions covered by this proposal. This group is
working with NASDAQ's regulatory technology group to develop and test
the surveillance patterns that will run in the SMARTS system. This
distribution of responsibilities was the result of detailed discussions
between NASDAQ and FINRA that focused on reallocating responsibilities
based on the core competencies of each organization. NASDAQ Regulation
and FINRA have developed comprehensive plans covering the transition
and the groups have met regularly over more than nine months to ensure
a smooth transition of the work and prevent any gaps in surveillance
coverage. NASDAQ and FINRA anticipate a phased transition of patterns,
with NASDAQ formally relieving FINRA of operational responsibility for
each pattern once testing, training, procedures and other preparations
are completed. FINRA will retire each pattern once relieved of
responsibility. After the transition, NASDAQ Regulation will review
surveillance alerts and refer potentially violative conduct to FINRA
using existing processes and systems. FINRA will continue to have
operational responsibility for the vast majority of surveillances
involving NASDAQ's equity market as well as examination and enforcement
matters, subject to NASDAQ's supervision and ultimate responsibility.
    The provisions of NASDAQ Rule 0150 require that NASDAQ obtain
Commission approval if regulatory functions subject to the regulatory
services agreement in effect at the time NASDAQ became a national
securities exchange are no longer performed by FINRA or another
independent self-regulatory organization. For the reasons stated above,
NASDAQ believes that the reassignment of operational responsibility for
a limited number of equities surveillance patterns will further its
regulatory program and benefit investors and the markets. Commission
approval of the proposal would allow NASDAQ OMX to better leverage data
and systems across its three equities exchanges, including NASDAQ OMX
PHLX, an affiliate of NASDAQ, that does not have an equivalent to Rule
0150 requiring Commission approval for this reallocation.
    In addition, NASDAQ notes that its proposal is consistent with, but
more limited than, surveillance work performed by other national
securities exchanges. The SEC has previously approved several
applications for registration as national securities exchanges in which
the SRO proposed to perform its own surveillance function. For example,
the SEC approved BATS Exchange's application where BATS performed most
surveillance for its markets, finding in its approval order that it was
consistent with the Act for BATS Exchange to contract with FINRA to
perform regulatory functions limited to ``examination, enforcement, and

disciplinary functions.'' \6\ Similarly, NASDAQ understands that Miami
International Securities Exchange (``MIAX'') performs the majority of
its surveillance operations in-house. This is consistent with MIAX's
Form 1, which states that the new exchange entered into a regulatory
services agreement with CBOE that is limited to ``conducting certain
market surveillances'' in addition to other regulatory work.\7\
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    \6\ Securities Exchange Act Release No. 34-58375 (August 18,
2008), 73 FR 49498 (August 21, 2008).
    \7\ Securities Exchange Act Release No. 34-68341 (December 3,
2012), 77 FR 73065 (December 7, 2012) (emphasis added).
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2. Statutory Basis
    NASDAQ believes that the proposed rule change is consistent with
the provisions of Section 6 of the Act,\8\ in general and with Sections
6(b)(5) of the Act,\9\ in particular in that it is designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general, to
protect investors and the public interest. The Exchange believes that
this proposal is in keeping with those principles by leveraging the
SMARTS technology system that has the ability to operate in real-time
and, as a consequence, will permit NASDAQ to react more quickly to
potential manipulation in the applicable regulatory areas covered by
this proposal. The surveillance patterns to be reallocated to NASDAQ
involve solely activity on NASDAQ's own market. NASDAQ believes that
its expertise in its own market structure, coupled with its existing
monitoring of these activities in real-time, will enable it to enhance
current patterns to better detect improper activity on its market. In
addition, NASDAQ will be able to leverage the knowledge and the
regulatory staff that already perform similar work for affiliated
options markets.
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    \8\ 15 U.S.C. 78f.
    \9\ 15 U.S.C. 78f(b)(5).
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    NASDAQ will continue to refer potentially violative conduct to
FINRA for further review. Moreover, FINRA will continue to perform the
vast majority of surveillance activity for NASDAQ's equities markets,
in many cases using patterns that incorporate data from other market
centers. FINRA will also perform examination and enforcement work,
subject to NASDAQ's supervision and ultimate responsibility.
    NASDAQ also believes the proposal is consistent with the Act
because, as the Commission has made clear on many occasions, an SRO
cannot delegate its ultimate responsibility for surveillance in the
absence of an SEC-approved agreement under Section 17(d)(2) of the Act,
and therefore must remain involved and responsible for its regulatory
program. In addition, NASDAQ notes that its proposal is consistent
with, but more limited than, surveillance work performed by other
national securities exchanges. As noted above, the SEC has previously
approved several applications for registration as national securities
exchanges in which the SRO proposed to perform its own surveillance
function.\10\ NASDAQ believes it would therefore be consistent with the
Act for NASDAQ to perform a much more limited surveillance function
than has been approved for other exchanges and, in fact, more limited
than surveillance functions NASDAQ already performs for non-cash
equities markets.
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    \10\ See supra notes 6 and 7, and accompanying text discussing
the surveillance work by BATS and MIAX.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will
result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act, as amended.

C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action

    Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the Exchange consents, the Commission shall: (a) By order approve
or disapprove such proposed rule change, or (b) institute proceedings
to determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to<EMAIL_ADDRESS>Please include
File Number SR-NASDAQ-2013-102 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number SR-NASDAQ-2013-102. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549 on official business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of such filing also will be available
for inspection and copying at the principal office of the Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly. All
submissions should refer to File Number SR-NASDAQ-2013-102, and should
be submitted on or before September 6, 2013.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-19907 Filed 8-15-13; 8:45 am]
BILLING CODE 8011-01-P