[Federal Register: January 20, 2010 (Volume 75, Number 12)]
[Notices]
[Page 3263-3270]
[DOCID:fr20ja10-110]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61345; File No. SR-NASDAQ-2008-104]

Self-Regulatory Organizations; The NASDAQ Stock Market LLC;
Notice of Filing of Amendment Nos. 2 and 3 and Order Granting
Accelerated Approval to Proposed Rule Change, as Modified by Amendment
Nos. 1, 2, and 3 Thereto, To Adopt a Modified Sponsored Access Rule

January 13, 2010.

I. Introduction

    On December 30, 2008, 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 modify its rule governing electronic access to
the Exchange's order execution systems. On January 28, 2009, Nasdaq
filed Amendment No. 1 to the proposed rule change. The proposed rule
change, as modified by Amendment No. 1, was published for comment in
the Federal Register on January 29, 2009.\3\ The Commission received
thirteen comment letters on the proposal.\4\ On October 19,

2009, Nasdaq filed Amendment No. 2 to the proposed rule change and
responded to the comment letters. On October 23, 2009, Nasdaq filed
Amendment No. 3 to the proposed rule change. This notice and order
provides notice of filing of Amendment Nos. 2 and 3, and grants
accelerated approval to the proposed rule change, as modified by
Amendment Nos. 1, 2, and 3.
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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. 59275 (January 22,
2009), 74 FR 5193.
    \4\ Letters to Elizabeth M. Murphy, Secretary, Commission, from
Harvey Cloyd, Chief Executive Officer, Electronic Transaction
Clearing, Inc., dated February 5, 2009 (``ETC Letter''); John
Jacobs, Director of Operations, Lime Brokerage LLC, dated February
17, 2009 (``Lime I Letter''); Manisha Kimmel, Executive Director,
Financial Information Forum, dated February 19, 2009 (``FIF
Letter''); Ted Myerson, President, FTEN, Inc., dated February 19,
2009 (``FTEN I Letter''); Michael A. Barth, Executive Vice
President, OES Market Group, dated February 23, 2009 (``OES
Letter''); Jeff Bell, Executive Vice President, Clearing and
Technology Group, Wedbush Morgan Securities, dated February 23, 2009
(``Wedbush Letter''); Stuart J. Kaswell, Executive Vice President &
General Counsel, Managed Funds Association, dated February 24, 2009
(``MFA Letter''); Ann Vlcek, Managing Director and Associate General
Counsel, Securities Industry and Financial Markets Association
(``SIFMA''), dated February 26, 2009 (``SIFMA I Letter''), Nicole
Harner Williams, Vice President, Associate General Counsel, Penson
Financial Services, Inc., dated February 27, 2009 (``Penson
Letter''); Samuel F. Lek, Chief Executive Officer, Lek Securities
Corporation, dated June 15, 2009 (``Lek Letter''); letter to David
S. Shillman, Associate Director, Division of Trading and Markets
(``Division''), James A. Brigagliano, Associate Director, Division,
and A. Duer, Meehan, Associate Director, Office of Compliance
Inspections and Examinations, Commission, from Gary LaFever, Chief
Corporate Development Officer, FTEN, Inc., dated April 29, 2009
(``FTEN II Letter''); letter to James Brigagliano, Co-Acting
Director, David Shillman, Associate Director, John Roeser, Assistant
Director, Marc McKayle, Special Counsel, Division, Commission, from
John Jacobs, Chief Operations Officer, Lime Brokerage LLC, dated
June 30, 2009 (``Lime II Letter''); and letter to David S. Shillman,
Associate Director, Division, from Ann Vlcek, Managing Director and
Associate General Counsel, SIFMA, dated November 23, 2009 (``SIFMA
II Letter'').
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II. Description of the Proposed Rule Change, as Modified by Amendment
Nos. 1, 2, and 3 Thereto

    The Exchange proposes to modify Nasdaq Rule 4611 to improve its
existing regulatory framework governing the manner in which a Nasdaq
member provides access to other entities to Nasdaq order execution
systems through the use of the member firm's market participant
identifier (``MPID'').\5\ Nasdaq notes that the proposal is designed to
ensure a member firm is assuming full responsibility for its customers'
trading activity and has effective financial and regulatory controls in
place to protect market participants from systemic risk and preserve
the integrity of the marketplace.
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    \5\ The following description incorporates changes proposed by
Nasdaq in Amendment Nos. 1, 2, and 3. See Section IV, infra, for a
discussion of the changes proposed in Amendment Nos. 2 and 3.
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    Under the proposal, a Nasdaq member that enters into an arrangement
with another person or entity (e.g., a customer, another member, or a
non-member broker-dealer) to provide that person with access to Nasdaq
or otherwise allow such person to route its orders to Nasdaq using the
member's MPID shall do so through either a Sponsored Access System or a
Member System, as defined in the rule.\6\ A Sponsored Access System is
defined as any system that applies pre- and post-trade financial and
regulatory controls set forth in proposed sections (d)(4) and (d)(5) of
Rule 4611 and that is not administered and controlled solely by the
Sponsoring Member.\7\ A Member System is defined as any system
administered and controlled solely by the Sponsoring Member and that
applies the pre- and post-trade financial and regulatory controls set
forth in proposed sections (d)(4) and (d)(5) of Rule 4611.\8\
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    \6\ See Amendment Nos. 2 and 3.
    \7\ See Amendment No. 2.
    \8\ Id.
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    Members that provide such access are responsible for all trading
conducted pursuant to that arrangement to the same extent as trading
directly conducted by the member for customers. The member is
responsible for implementing policies and procedures for supervising
and monitoring the trading effected pursuant to the arrangement to
ensure that it is in compliance with all applicable federal securities
laws and rules and Nasdaq rules. This obligation applies irrespective
of the manner in which orders pursuant to such arrangements reach
Nasdaq.
    The proposal defines the two types of access a member provides to
another person or entity to access Nasdaq, Sponsored Access and Direct
Market Access.\9\ Sponsored Access is defined as the practice by a
member (``Sponsoring Member'') of providing access to Nasdaq to another
person, firm, or customer (``Sponsored Participant'') whereby the
Sponsored Participant enters orders into Nasdaq using a Sponsored
Access System but the orders do not pass through a Member System prior
to reaching Nasdaq. Direct Market Access is defined as the practice by
a Sponsoring Member of providing access to Nasdaq to another person,
firm, or customer (``Sponsored Participant'') whereby the Sponsored
Participant makes decisions regarding order routing and order entry but
the orders pass through a Member System prior to reaching Nasdaq.
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    \9\ Id.
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    The proposal requires Sponsoring Members that provide Direct Market
Access to, at a minimum, comply with the financial controls and
regulatory controls set forth in proposed sections (d)(4) and (d)(5) of
Rule 4611. In addition, the proposal requires Sponsoring Members that
provide Sponsored Access to, at a minimum, comply with the contractual
provisions, financial controls, and regulatory controls set forth in
proposed sections (d)(3), (d)(4), and (d)(5) of Rule 4611.

A. Contractual Provisions

    Pursuant to proposed section (d)(3) of Rule 4611, a Sponsoring
Member that provides Sponsored Access shall execute and maintain
agreements with each Sponsored Participant containing the following
commitments:
     All trading activity by the Sponsored Participant shall
comply with all applicable federal securities laws and rules and
Exchange rules, including but not limited to the Nasdaq Certificate of
Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq
Market Center (``Regulatory Requirements'').
     The Sponsored Participant shall promptly upon request
provide the Sponsoring Member with access to such books and records and
financial information that is necessary to allow the Sponsoring Member
to comply with its regulatory obligations with respect to activity of
the Sponsored Participant within the Sponsored Access arrangement, and
otherwise cooperate with the Sponsoring Member in furtherance of the
Sponsoring Member's compliance with applicable Regulatory Requirements.
Information provided by Sponsored Participants to Sponsoring Members
pursuant to such requests shall be maintained as confidential by the
Sponsoring Member, provided that such information shall be available to
Nasdaq upon request for regulatory purposes.\10\
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    \10\ Id.
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     The Sponsored Participant shall maintain its trading
activity within the credit, product or other financial limits specified
by the Sponsoring Member.
     The Sponsored Participant shall maintain all technology
permitting sponsored access to Nasdaq in a physically secure manner and
may not permit unauthorized individuals to use or obtain access to
Nasdaq. Sponsored Participant shall familiarize its authorized
individuals with the Regulatory Requirements and will provide
appropriate training prior to use or access to Nasdaq.
     The Sponsored Participant shall agree that the Sponsoring
Member or Nasdaq may immediately terminate the Sponsored Access if the
Sponsoring Member or Nasdaq determines that continuing such access
poses serious risk to the Sponsoring Member or to the integrity of the
market.
    In addition, a Sponsoring Member that provides Sponsored Access
shall execute and maintain agreements with each third party (``Third
Party Provider'') that provides a Sponsored Access System to Sponsored
Participants for accessing Nasdaq.\11\ The agreements shall specify
which of the financial and regulatory controls stated in proposed
sections (d)(4) and (d)(5) are satisfied by the technology provided,
and contain the following commitments:
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    \11\ Id.
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     Third Party Providers shall promptly upon request provide
the Sponsoring Member with access to such books and records and
financial information that is necessary to allow the Sponsoring Member
to comply with its regulatory obligations with respect to activity of
the Sponsored Participant

within the Sponsored Access arrangement, and otherwise cooperate with
the Sponsoring Member in furtherance of Sponsoring Member's compliance
with applicable Regulatory Requirements. Information provided by
Sponsored Participants to Sponsoring Members pursuant to such requests
shall be maintained as confidential by the Sponsoring Member, provided
that such information shall be available to Nasdaq upon request for
regulatory purposes.
     Third Party Providers shall maintain all technology
permitting Sponsored Access to Nasdaq in a physically secure manner and
may not permit unauthorized individuals to use or obtain access to
Nasdaq.
     Third Party Providers shall agree that Nasdaq or its agent
may audit the Sponsored Access System and that the Sponsoring Member or
Nasdaq may immediately terminate the Sponsored Access if the Sponsored
Participant or Third Party Provider fails to abide by its commitments.

B. Financial Controls

    Under proposed section (d)(4) of Rule 4611, each Sponsoring Member
shall establish adequate procedures and controls that permit it to
effectively monitor and control the Sponsored Access or Direct Market
Access to systemically limit the Sponsoring Member's financial
exposure. At a minimum, the Member System or Sponsored Access System
shall be reasonably designed to: \12\
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    \12\ Id.
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     Prevent each Sponsored Participant from entering orders
that in aggregate exceed appropriate pre-set credit thresholds.
Sponsoring Members may also set finely-tuned credit thresholds by
sector, security or otherwise.
     Prevent Sponsored Participants from trading products that
the Sponsoring Member is restricted from trading or that the Sponsored
Participant is restricted from trading for reasons specific to the
Sponsored Participant.
     Prevent Sponsored Participants from submitting erroneous
orders by providing for the rejection of orders that exceed certain
price or size parameters, on an order-by-order basis or over a short
period of time, or that indicate duplicative orders.

C. Regulatory Controls

    Under proposed section (d)(5), each Sponsoring Member shall
establish adequate procedures and controls reasonably designed to
permit it to effectively monitor and control compliance with Regulatory
Requirements.\13\ Specifically, each Sponsoring Member shall have
systemic controls reasonably designed to ensure compliance by the
Sponsored Participant with all applicable Regulatory Requirements.
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    \13\ Id.
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    In addition, each Sponsoring Member shall ensure that appropriate
supervisory personnel receive and review timely reports of all trading
activity by its Sponsored Participants sufficient to permit the
Sponsoring Member to comply with applicable Regulatory Requirements,
and to monitor for illegal activity such as market manipulation or
insider trading. At a minimum, appropriate supervisory personnel should
receive immediate post-trade execution reports of trading activity of
all Sponsored Participants, including their identities, all required
audit trail information by no later than the end of the trading day,
and all information necessary to create and maintain the trading
records required by applicable Regulatory Requirements by no later than
the end of the trading day. Appropriate supervisory personnel shall
review execution reports immediately and all other reports
promptly.\14\
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    \14\ Id.
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III. Discussion and Commission's Findings

    After careful review of the proposed rule change, as amended, the
comment letters, and Nasdaq's response to the comment letters, the
Commission finds 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.\15\ In particular, the
proposal is consistent with Section 6(b)(5) of the Act,\16\ 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 and, in general, to protect
investors and the public interest, and not be designed to permit unfair
discrimination between customers, issuers, brokers, or dealers.
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    \15\ In approving this 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).
    \16\ 15 U.S.C. 78f(b)(5).
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    Specifically, the Commission believes that Nasdaq's proposed rule
change should clarify and strengthen a Sponsoring Member's obligations
to control risks when it provides customers access to Nasdaq's
execution facilities, whether through Direct Market Access or Sponsored
Access. The Nasdaq proposed rule change would require a Sponsoring
Member that offers Direct Market Access or Sponsored Access to
establish effective procedures and controls to systemically limit its
financial exposure and comply with applicable Regulatory Requirements,
in the manner set forth therein. Sponsoring Members providing Sponsored
Access would also be required to comply with certain contractual
provisions.
    Generally, Nasdaq's proposed rule change amends Nasdaq Rule 4611(d)
to: (1) Define categories of electronic access and explicitly include
Direct Market Access and Sponsored Access; (2) require certain specific
systemic financial and regulatory controls; (3) require certain
contractual commitments for Sponsored Access; and (4) require the real-
time receipt and timely review of relevant trade activity reports. The
Commission believes that the proposal should help reduce the risks that
arise when a Sponsoring Member provides a Sponsored Participant with
access to Nasdaq.
    Currently, Nasdaq Rule 4611(d), which governs sponsored access to
Nasdaq's order execution systems, is substantially similar to sponsored
access rules adopted by the other national securities exchanges.\17\
However, Nasdaq proposes to modify Rule 4611(d) to clarify and
strengthen the risk controls required by Sponsoring Members providing
electronic access to Nasdaq's order execution systems.
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    \17\ See, e.g., New York Stock Exchange LLC Rule 123B.30 and
NYSE Arca, Inc. Rule 7.29(b).
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    The Commission received thirteen comment letters on Nasdaq's
proposal, as modified by Amendment No. 1 (``Original Proposal'').\18\
Most commenters offered general support for Nasdaq's proposal, but
raise various issues regarding specific aspects of the proposal.\19\
Three commenters believe that Nasdaq's proposal is either unnecessary
because Nasdaq's current access rule is adequate or that the proposal
should be limited to apply only to Sponsored Access.\20\ One commenter
noted concerns about Sponsored Access and suggested that Nasdaq's
proposal does not go far enough to address Sponsored Access.\21\
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    \18\ See supra note 4.
    \19\ See FIF Letter, FTEN I Letter, Wedbush Letter, MFA Letter,
SIFMA I Letter, and Lek Letter.
    \20\ See ETC Letter, OES Letter, and Penson Letter.
    \21\ See Lime I Letter.

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A. Definition of Sponsored Access and Scope of the Proposal

    In the Original Proposal, the definition of Sponsored Access
included three categories of access: (1) Direct Market Access, where
the Sponsored Participant's orders pass through the Sponsoring Member's
systems prior to reaching Nasdaq; (2) Sponsored access, where the
Sponsored Participant enters orders directly into Nasdaq via a
dedicated port provided by the Sponsoring Member (``Direct Sponsored
Access'' or ``DSA''); and (3) direct access where a service bureau or
other third party provides Sponsored Participants with technology to
access Nasdaq under the auspices of and via an arrangement with the
Sponsoring Member (``Third Party Sponsored Access'' or ``TPSA'').
    Four commenters question whether the proposal properly defines
Sponsored Access and whether the rule is overly broad.\22\ Two
commenters suggest that the definition of Sponsored Access should be
limited to DSA and TPSA.\23\ These commenters believe that Direct
Market Access is already effectively regulated under existing laws and
regulations. One commenter expresses concern that the proposal would
modify the contractual obligations imposed on Direct Market Access
arrangements.\24\ The two other commenters recommend that the rule be
limited to DSA.\25\
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    \22\ See ETC Letter, FIF Letter, SIFMA I Letter, and Penson
Letter.
    \23\ See FIF Letter and SIFMA I Letter.
    \24\ See FIF Letter.
    \25\ See ETC Letter and Penson Letter.
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    Nasdaq agrees, in part, that the proposed rule should focus on
Sponsored Access arrangements and amends the proposal in three ways.
First, Nasdaq adds prefatory language to Rule 4611(d) to clearly
articulate the responsibility of all members to have policies and
procedures reasonably designed to regulate all orders that it enters
into Nasdaq systems under its own MPID(s) regardless of the order entry
and access arrangement. Second, Nasdaq amends Rule 4611(d)(1) to
distinguish between Sponsored Access and Direct Market Access to
eliminate the distinction set forth in the original proposal between
Direct Sponsored Access and Third Party Sponsored Access. Third, Nasdaq
defines Member System and Sponsored Access System to ensure that all
DMA and Sponsored Access arrangements are effectively regulated by a
system that provides adequate regulatory and financial controls.
    While Nasdaq concedes that regulatory obligations for Direct Market
Access are generally understood in uniform manner, it acknowledges that
the same could not be stated with respect to Sponsored Access as
Sponsoring Members could hold differing views of what that
responsibility requires. Because it is critical to establish a clear
understanding of the regulatory and financial controls required in all
access arrangements, Nasdaq determined that both Direct Market Access
and Sponsored Access should be addressed by the rule. Nasdaq stated
that the key to proper regulation of both Sponsored Access and Direct
Market Access are the regulatory and financial controls set forth in
proposed Rule 4611(d)(4) and (5). Nasdaq believes that Nasdaq members
providing Direct Market Access may already operate Member Systems that
provide the regulatory and financial controls set forth in proposed
subsections (d)(4) and (d)(5), but the proposal could serve to clarify
the obligations of members in Direct Market Access arrangements--and
bolster market confidence in the integrity and security of the market--
without imposing additional obligations.
    Some commenters express concern regarding the apparent scope of the
proposal, and two commenters believe that the rule should take into
account differences between a Sponsored Participant that is a non-
broker-dealer, non-exchange member, or an exchange member.\26\
Specifically, one commenter believes that Sponsored Participants that
are non-broker-dealers should be subject to the highest level of due
diligence and oversight because they are unregulated entities. This
commenter noted that Sponsored Participants that are non-member broker-
dealers should be subject to policies and procedures to ensure that
their trading is consistent with the exchange rules without requiring
the Sponsoring Member to be responsible for non-exchange regulatory
requirements. The commenter further noted that regulation of Sponsored
Participants that are member broker-dealers was duplicative and
unnecessary.\27\ Another commenter expressed that the proposal could
impose duplicative regulatory requirements on the Sponsoring Member and
Sponsored Participant, if the Sponsored Participant is a broker-
dealer.\28\ Nasdaq responded that it believes that it is the
responsibility of each Sponsoring Member to have policies and
procedures reasonably designed to control the risks of all orders that
it enters into Nasdaq systems under its own MPID(s) regardless of the
order entry and access arrangement. Accordingly, Nasdaq's proposal
would apply to Sponsoring Members regardless of whether the Sponsored
Participant is a broker-dealer, non-broker-dealer, or non-member
broker-dealer.
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    \26\ See Wedbush Letter and Penson Letter.
    \27\ See Wedbush Letter.
    \28\ See Penson Letter.
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    Nasdaq's proposal, as modified by Amendment Nos. 1, 2, and 3
(``Final Proposal''), requires that members that provide electronic
access to Nasdaq to another person or entity using the member's MPID
must do so through either a Sponsored Access System or a Member System.
A Sponsored Access System is defined as any system that applies pre-
and post-trade financial and regulatory controls set forth in the rule
and that is not administered and controlled solely by the Sponsoring
Member.\29\ A Member System is defined as any system administered and
controlled solely by the Sponsoring Member and that applies the pre-
and post-trade financial and regulatory controls set forth in the rule.
In addition, the proposal makes clear that members that provide such
access are responsible for all trading conducted pursuant to that
arrangement to the same extent as trading directly conducted by the
member for customers.
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    \29\ See Amendment No. 2.
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    The Final Proposal defines the two types of electronic access a
member provides to another person or entity to access Nasdaq: (1)
Sponsored Access, whereby the Sponsored Participant enters orders into
Nasdaq using a Sponsored Access System but the orders do not pass
through a Member System prior to reaching Nasdaq; and (2) Direct Market
Access, whereby the Sponsored Participant makes decisions regarding
order routing and order entry but the orders pass through a Member
System prior to reaching Nasdaq. A member that provides Sponsored
Access must, at a minimum, comply with the contractual provisions,
financial controls, and regulatory controls set forth in the rule. A
member that provides Direct Market Access must, at a minimum, comply
with the financial controls and regulatory controls set forth in the
rule.
    The Commission shares Nasdaq's concern that unfettered access by
customers of member firms to trading systems presents serious risks to
the market and its participants.\30\ The Commission believes that it is

consistent with the Act for Nasdaq to require that access to its market
occur through systems that apply appropriate financial and regulatory
controls to address the risks of the activity. In addition, the
Commission agrees that these requirements should exist whether the
Sponsored Participant is a non-broker-dealer, a non-member broker-
dealer, or a member broker-dealer. The Commission believes this is
appropriate because in all instances, the Sponsoring Member assumes, at
a minimum, the intra-day financial risks incurred as a result of
trading under its MPID. Further, the Sponsoring Member is uniquely
positioned to prevent erroneous trades and comply with Exchange rules
and other applicable Regulatory Requirements.
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    \30\ See SIFMA I Letter, Lime I Letter, FTEN I Letter, and Lek
Letter.
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B. Contractual Provisions

    Several commenters object to the contractual provisions that Nasdaq
proposed to apply to Sponsored Access arrangements.\31\ Two commenters
object to the requirement that Sponsoring Members execute contracts
with Third Party Providers that require Third Party Providers to sign
detailed agreements with each Sponsored Participant.\32\ One commenter
argues that, in the case of TPSA, the burden of compliance and related
contractual obligations should remain with the Sponsoring Member,
rather than with the third-party service bureau as the Original
Proposal suggests.\33\ Another commenter contends that requiring Third
Party Providers to execute contracts with Sponsored Participants
containing the specified provisions is unduly burdensome, not justified
by the benefits, and redundant of the existing obligations of the
Sponsoring Member.\34\
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    \31\ See SIFMA I Letter, FIF Letter, MFA Letter, and ETC Letter.
    \32\ See FIF Letter and ETC Letter.
    \33\ See FIF Letter.
    \34\ See ETC Letter.
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    Nasdaq agrees that the Original Proposal was needlessly burdensome
in requiring Third Party Providers to execute with each Sponsored
Participant a contract containing the detailed provisions proposed in
Rule 4611(d)(3). Accordingly, in the Final Proposal Nasdaq eliminates
the requirement that Third Party Providers execute agreements with
Sponsored Participants containing detailed contractual provisions
identical to those required between Sponsoring Members and Sponsored
Participants. Instead, the Final Proposal requires that the agreement
identify the financial and regulatory controls that are satisfied by
the technology provided by the third party, and contain commitments
appropriately tailored to the relationship with the third party
including: (1) Limited access to books and records; (2) physical
security of technology that accesses Nasdaq; (3) the ability of Nasdaq
or its agent to audit the Sponsored Access System; and (4) the ability
for the Sponsoring Member or Nasdaq to terminate access to Nasdaq.
Nasdaq believes that Sponsoring Members should have individual
contractual relationships with all Sponsored Participants and contracts
with any Third Party Providers that operate technology that the member
utilizes to enable, monitor, or control Sponsored Access or to satisfy
the required financial and regulatory controls that should allow Nasdaq
or its agent to audit the Sponsored Access System.
    Two commenters object to aspects of the Original Proposal that
would require Sponsored Participants to make their books and records
and corporate and financial information available to the Sponsoring
Member upon request.\35\ One commenter notes that because the proposed
contractual provisions implicate sensitive proprietary information,
they should be limited to information relevant to oversight of trading
activity conducted under the particular Sponsored Access arrangement
and that information produced should be maintained as confidential by
the Sponsoring Member and regulators.\36\ In response, Nasdaq agrees
that it can achieve effective exchange oversight through more narrowly-
tailored contractual provisions between Sponsoring Members and
Sponsored Participants. Accordingly, the Final Proposal limits access
to the books and records of a Sponsored Participant that are necessary
to allow the Sponsoring Member to comply with its regulatory
obligations with respect to activity of the Sponsoring Participant
within the Sponsored Access arrangement. In addition, the Final
Proposal requires that such information received by the Sponsoring
Member be maintained as confidential, but available to Nasdaq upon
request for regulatory purposes.
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    \35\ See SIFMA I Letter and MFA Letter.
    \36\ See MFA Letter.
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    The commenter also objects to the requirement that the contract
include a provision permitting the Sponsoring Member or Nasdaq to
immediately terminate access in the event that the Sponsored
Participant or Third Party Provider fails to abide by its contractual
commitments.\37\ The commenter argues that Sponsoring Members and
Sponsored Participants have established reasonable grace and cure
periods for breaches of sponsorship agreements, and that such terms
should be left to those parties.\38\ Nasdaq agrees that the parties
should remain free to negotiate commercial terms but is also aware that
these terms are generally designed to protect the parties' commercial
interests rather than the interests of Nasdaq and other market
participants. Because Nasdaq has a separate interest in maintaining a
fair and orderly market, including the ability to limit access by
market participants that disrupt the markets or pose systemic risks,
Nasdaq amends and limits proposed Rule 4611(d)(3)(v) to protecting
Nasdaq's interest in maintaining a fair and orderly market rather than
governing commercial terms between the parties. Specifically, the Final
Proposal limits the required provision allowing termination of the
Sponsored Access arrangement to situations where Nasdaq or the
Sponsoring Member determines that a continuation of the arrangement
poses serious risk to the Sponsoring Member or to the integrity of the
market.
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    \37\ Id.
    \38\ Id.
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    The Commission believes that the proposed contractual provisions
required for Sponsored Access, as set forth in the Final Proposal, are
consistent with the Act. The Commission notes that the required
contractual provisions should facilitate effective oversight of
Sponsored Access arrangements by the Sponsoring Member and Nasdaq by
assuring Sponsored Participants have contractually committed to provide
important information, conduct trading in an appropriate manner and
otherwise cooperate with the Sponsoring Member and Nasdaq.

C. Financial Controls

    Commenters express several concerns with the financial controls
provisions of the Original Proposal, including the view that: (1) The
provisions should allow for procedures and controls ``reasonably
designed'' to prevent certain conduct, rather than impose a strict
liability standard; \39\ (2) it is not possible for Sponsoring Members
to prevent the entry of orders in a Direct Sponsored Access
arrangement; \40\ (3) the financial controls provisions designed to
prevent systemic risk are too general; \41\ and (4) the product
limitation provision should not impose restrictions on Sponsored

Participants that are unique to the Sponsoring Member.\42\ Nasdaq
agrees that in a ``procedures-based'' regime, as Nasdaq proposes to
govern Sponsored Access arrangements, such procedures cannot ensure
compliance or prevent errors from occurring but should instead be
reasonably designed to ensure compliance or prevent errors.
Accordingly, Nasdaq amends Rule 4611(d)(4) to require ``reasonably
designed'' procedures and controls.
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    \39\ See ETC Letter, Lime I Letter, and SIFMA I Letter.
    \40\ See SIFMA I Letter.
    \41\ Id.
    \42\ Id.
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    Nasdaq's proposed financial controls provisions would require
Sponsoring Members to undertake a creditworthiness determination and to
develop monitoring and controls incorporating that determination.
Nasdaq notes that it is not dictating how that determination is
undertaken or implemented but the provision does require at a minimum
that Sponsoring Members have real-time or nearly real-time ability to
monitor and control the conduct of Sponsored Participants. Nasdaq adds
that it is skeptical of the commenter's claims that such controls
cannot be implemented and that requiring such controls would
effectively prohibit Direct Sponsored Access. In fact, Nasdaq asserts
that the commenter's claims are contradicted \43\ by other comment
letters.\44\
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    \43\ See Amendment No. 2.
    \44\ See FTEN I Letter (``Sponsored Access systems that do not
provide pre-trade risk management should no longer be authorized * *
* systems offered by Exchanges [or] developed in-house by Sponsoring
Members and by third parties that provide pre-trade risk management
* * * [could] be used to provide Sponsored Access). Also see Lime I
Letter (``[I]t is critical that the [Sponsoring Member] concurrently
monitor, on a real-time basis, the Sponsored Participant's order
placement and trading activity * * *'').
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    Nasdaq states that the product limitation provision is not designed
to transfer to Sponsored Participants limitations that are specific to
the Sponsoring Members, such as restrictions imposed by Exchange Act
Rule 10b-18. The provision requires that Sponsoring Members be
qualified to assess Sponsored Participants and limit trading to
products for which the Sponsored Participant is qualified.
    The Final Proposal requires each Sponsoring Member that provides
either Sponsored Access or Direct Market Access to establish adequate
procedures and controls that permit it to effectively monitor and
control access to systemically limit the Sponsoring Member's financial
exposure. At a minimum, the Member System or Sponsored Access System
shall be reasonably designed to prevent each Sponsored Participant from
entering orders that in aggregate exceed appropriate pre-set credit
thresholds; prevent Sponsored Participants from trading products that
the Sponsoring Member is restricted from trading or that the Sponsored
Participant is restricted from trading for reasons specific to the
Sponsored Participant; and prevent Sponsored Participants from
submitting erroneous orders by providing for the rejection of orders
that exceed certain price or size parameters, on an order-by-order
basis or over a short period of time, or that indicate duplicative
orders.
    The Commission believes that the proposed financial controls
required for Sponsored Access and Direct Market Access, as set forth in
the Final Proposal, are consistent with the Act. The Commission
believes that a requirement that each Sponsoring Member establish
adequate procedures and controls that permit it to effectively monitor
and control the Sponsored Access or Direct Market Access offered by it,
to systemically limit the Sponsoring Member's financial exposure,
should help reduce the risks associated with such access for the
Sponsoring Members as well as other market participants.

D. Regulatory Controls

    Commenters express concern regarding the regulatory controls
provisions of the Original Proposal, including the view that: (1) The
provisions should allow for procedures and controls ``reasonably
designed'' to prevent certain conduct, rather than impose a strict
liability standard; \45\ (2) it is not practical for Sponsoring Members
to regulate the conduct of Sponsored Participants on a real-time basis
given that much current surveillance occurs on a post-trade basis; \46\
(3) use of Sponsored Access Systems that cannot comply with pre-trade
oversight and compliance obligations should not be permitted; \47\ (4)
providing a non-exclusive list of regulatory requirements will create
confusion for market participants; \48\ and (5) post-trade reports
should be reviewed by ``appropriate supervisory personnel'' as defined
by the Sponsoring Member.\49\
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    \45\ See ETC Letter, Lime I Letter, and SIFMA I Letter.
    \46\ See FIF Letter, SIFMA I Letter, and MFA Letter.
    \47\ See Lime I Letter and FTEN I Letter.
    \48\ See SIFMA I Letter.
    \49\ Id.
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    As with the proposed financial controls, Nasdaq agrees that in a
``procedures-based'' regime, as Nasdaq proposes to govern Sponsored
Access arrangements, such procedures cannot ensure compliance or
prevent errors from occurring, and should instead be reasonably
designed to ensure compliance or prevent errors. Accordingly, Nasdaq
proposes to modify Rule 4611(d)(5)(A) to require ``reasonably
designed'' procedures and controls. However, Nasdaq continues to
believe that the regulatory integrity of its market requires that all
orders entered by Sponsored Participants be subject to real-time or
nearly real-time regulatory controls.\50\ In addition, because Nasdaq
agrees that a non-exclusive list of regulatory requirements could cause
confusion regarding both the regulatory requirements specifically
listed as well as those not listed, a conforming change eliminating the
non-exclusive list of regulatory requirements is contained in the Final
Proposal.
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    \50\ Two commenters opined that the use of Sponsored Access
Systems that cannot comply with the pre-trade oversight and
compliance obligations should not be permitted. See Lime I Letter
and FTEN I Letter.
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    The Final Proposal requires each Sponsoring Member to establish
adequate procedures and controls reasonably designed to permit it to
effectively monitor and control compliance with Regulatory
Requirements. Specifically, each Sponsoring Member shall have systemic
controls reasonably designed to ensure compliance by the Sponsored
Participant with all applicable Regulatory Requirements.
    Nasdaq also agrees with a commenter that firms should be free to
designate personnel to review trading activity reports that have the
requisite supervisory training and responsibility.\51\ Nasdaq believes
that ``appropriate supervisory personnel'' should review trading
activity and that execution reports must be reviewed immediately and
other reports must reviewed promptly. Accordingly, the proposal
requires that each Sponsoring Member shall ensure that appropriate
supervisory personnel receive and review timely reports of all trading
activity by its Sponsored Participants sufficient to permit the
Sponsoring Member to comply with applicable Regulatory Requirements,
and to monitor for illegal activity such as market manipulation or
insider trading. At a minimum, appropriate supervisory personnel should
receive immediate post-trade execution reports of trading activity of
all Sponsored Participants, including their identities, all required
audit trail information by no later than the end of the trading day,
and all information necessary to create and maintain the trading
records required by

applicable Regulatory Requirements by no later than the end of the
trading day. Appropriate supervisory personnel shall review execution
reports immediately and all other reports promptly.
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    \51\ See SIFMA I Letter.
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    The Commission believes that the proposed regulatory controls
required for Sponsored Access and Direct Market Access, as set forth in
the Final Proposal, are consistent with the Act. The Sponsoring Member
ultimately is responsible for complying with all Regulatory
Requirements to which it is subject in connection with trading activity
conducted through use of its MPID. Requiring each Sponsoring Member to
establish adequate procedures and controls reasonably designed to
permit it to effectively monitor and control order flow sent to Nasdaq
for compliance with Regulatory Requirements should help assure that
such orders enter Nasdaq's systems in compliance with Regulatory
Requirements. The Commission also notes that in today's highly
automated trading environment, systemic controls are essential to
reasonably ensure that orders sent to an exchange comply with
Regulatory Requirements. The Commission also believes that requiring
receipt and review of post-trade reports by the Sponsoring Member
should provide surveillance personnel with important information about
potential regulatory violations, and better enable them to investigate,
report or halt suspicious or manipulative trading activity. The post-
trade execution reports should provide a valuable supplement to the
pre-trade risk controls contained in the Final Proposal.
    Several commenters note the potential systemic risk posed by
Sponsored Access arrangements and the importance to the marketplace of
effective regulation of such arrangements.\52\ In response to those
commenters, Nasdaq notes that it is working to develop a proposal that
would require Sponsoring Members to obtain a unique MPID for each
Sponsored Participant. In addition, two commenters stressed that
industry regulators should develop a uniform rule and then apply it
consistently across all markets and all market participants.\53\ Nasdaq
agrees that the regulation of electronic access should be uniformly
regulated as to not create the opportunity for arbitrage between the
rules of competing exchanges.
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    \52\ See Lime I Letter, Lek Letter, and FTEN I Letter.
    \53\ See SIFMA I Letter and Wedbush Letter.
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E. Commission Findings

    The Commission believes that Nasdaq's proposal is a productive step
toward assuring that broker-dealers providing access to the markets,
including through Sponsored Access and Direct Market Access
arrangements, implement risk management controls and supervisory
procedures reasonably designed to manage the financial, regulatory, and
other risks of that activity. In particular, Nasdaq's proposal requires
Sponsoring Members to implement controls and procedures to address
certain key risks, such as the potential breach of a credit limit, the
submission of erroneous orders, and the failure to comply with
Regulatory Requirements. The Commission also believes the requirement
that a Sponsoring Member receive immediate post-trade execution reports
should provide a valuable supplement to the pre-trade risk controls and
represents an improvement over the rules and guidance issued by other
self-regulatory organizations in this area. The Commission notes,
however, that a Nasdaq rule would, of course, apply only to broker-
dealers offering Sponsored Access or Direct Market Access to Nasdaq.
    In addition, Nasdaq's proposal permits a fair amount of flexibility
in the extent to which a Sponsoring Member can delegate the
administration and control of its risk management controls to others,
and rigor with which the financial controls are applied on a pre-trade
basis. Nevertheless, the Commission believes that Nasdaq's proposal
would strengthen the risk management requirements applicable to Nasdaq
members that offer Sponsored Access or Direct Market Access, and
thereby help address concerns about the risks posed by this activity to
the Sponsoring Member and the markets. Accordingly, the Commission
believes Nasdaq's proposal is consistent with the Act.

IV. Accelerated Approval of the Proposed Rule Change, as Modified By
Amendment Nos. 1, 2, and 3 Thereto

    The Commission finds good cause, pursuant to Section 19(b)(2) of
the Act,\54\ for approving the proposed rule change, as modified by
Amendment Nos. 1, 2, and 3 thereto, prior to the thirtieth day after
the date of publication of notice of filing of Amendment Nos. 2 and 3
in the Federal Register.
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    \54\ 15 U.S.C. 78s(b)(2). Pursuant to Section 19(b)(2) of the
Act, the Commission may not approve any proposed rule change, or
amendment thereto, prior to the thirtieth day after the date of
publication of the notice thereof, unless the Commission finds good
cause for so doing.
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    In Amendment No. 2, Nasdaq responds to comments on the Original
Proposal. Several commenters argue that Nasdaq's proposed definition
for Sponsored Access is overly broad and expands the scope of what the
industry typically defines as Sponsored Access.\55\ In response, Nasdaq
limits the definition of Sponsored Access to instances where the
Sponsored Participant enters orders directly into Nasdaq using the
Sponsoring Member's MPID and the orders do not pass through a Member
System before reaching Nasdaq. Nasdaq distinguishes Sponsored Access
from Direct Market Access, where an Exchange member provides access to
a firm or person that makes decisions on order routing and order entry,
but the orders pass through a Member system before reaching Nasdaq.
Nasdaq also eliminates the distinction in the Original Proposal between
Direct Sponsored Access and Third Party Sponsored Access. Moreover,
Nasdaq also defines two different types of systems, Member Systems and
Sponsored Access Systems, to ensure that all Direct Market Access and
Sponsored Access arrangements are effectively regulated with adequate
financial and regulatory controls.
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    \55\ See supra notes 22-25.
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    Several commenters also object to a requirement in the Original
Proposal that Sponsoring Members execute contracts with Third Party
Providers that would require Third Party Providers to in turn sign
agreements with each Sponsored Participant.\56\ The commenters believe
that this requirement was needlessly burdensome and that the compliance
burden should remain only with the Sponsoring Member.\57\ Nasdaq
responds by eliminating the requirement that Third Party Providers and
Sponsored Participants must sign agreements between them. Nasdaq also
modifies the proposal to clearly differentiate between two different
types of agreements: those between Sponsoring Members and Sponsored
Participants, and those between Sponsoring Members and Third Party
Providers. Agreements between Sponsoring Members and Third Party
Providers must identify financial and regulatory controls that are
satisfied by the Third Party's technology, and must also contain
commitments regarding limited access to books and records, physical
security of technology, Nasdaq's ability to audit

the Sponsored Access system, and the ability for either the Sponsoring
Member or Nasdaq to terminate Participant access.
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    \56\ See supra note 32.
    \57\ Id.
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    Nasdaq also responds to comments regarding the financial and
regulatory controls provisions of the Original Proposal. Commenters
argue that the procedures and controls meant to prevent certain conduct
should be ``reasonably designed,'' rather than impose a strict
liability standard; \58\ and that the regulatory controls provision
should not include a non-exclusive list of regulatory requirements that
would potentially confuse market participants.\59\ In Amendment No. 2,
Nasdaq agrees with both points, and modifies the proposed rule change
to require ``reasonably designed'' procedures and controls, and to
eliminate the non-exclusive list of regulatory requirements. Nasdaq
also clarifies that trading activity reports would be reviewed by
``appropriate supervisory personnel.'' The Commission finds that
Nasdaq's proposed changes in response to commenter concerns in
Amendment No. 2 are consistent with the Act.
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    \58\ See supra notes 39-41 and 45.
    \59\ See supra note 48.
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    In Amendment No. 3, Nasdaq modifies language in the proposed rule
change to clarify the requirement that when a Sponsoring Member
provides another person or entity with access to Nasdaq, it must do so
either through a Sponsored Access System or a Member System. By
providing such access through either of these two types of systems,
Sponsoring Members are responsible for all trading conducted pursuant
to that arrangement to the same extent as trading directly conducted by
the Member for its customers.\60\ The Commission believes that this
proposed change sufficiently clarifies the significant responsibilities
that the Sponsoring Members must assume for any Sponsored Access
arrangements. The Commission believes that Nasdaq's proposed changes in
response to commenter concerns in Amendment No. 3 are consistent with
the Act.
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    \60\ See proposed Nasdaq Rule 4611(d).
---------------------------------------------------------------------------

    The changes proposed in Amendment Nos. 2 and 3, discussed above,
seek to clarify the operation of the proposal and address commenters
concerns regarding the proposal as noticed in the Federal Register on
January 29, 2009. The Commission notes that one commenter requests that
the proposal, as modified by Amendment Nos. 2 and 3, be published for
notice and comment before Commission approval of the proposal.\61\ The
Commission believes that the changes proposed in Amendment Nos. 2 and
3, discussed above, are designed to address commenters' concerns as
raised through the notice and comment process under Section 19(b).\62\
Accordingly, the Commission finds that good cause exists to approve the
proposed rule change, as modified by Amendment Nos. 1, 2, and 3 on an
accelerated basis.
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    \61\ See SIFMA II Letter.
    \62\ See 15 U.S.C. 78s(b).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning Amendment Nos. 2 and 3, including whether
Amendment Nos. 2 and 3 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 e-mail to<EMAIL_ADDRESS>Please include
File No. SR-NASDAQ-2008-104 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-2008-104. This
file number should be included on the subject line if e-mail 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 inspection
and copying in the Commission's Public Reference Room, 100 F Street,
NE., Washington, DC 20549, on official business days between the hours
of 10 am and 3 pm. 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-2008-104 and should
be submitted on or before February 10, 2010.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\63\ that the proposed rule change (SR-NASDAQ-2008-104), as
modified by Amendment Nos. 1, 2, and 3, be, and it hereby is, approved
on an accelerated basis.
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    \63\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\64\
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    \64\ 17 CFR 200.30-3(a)(12).

Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-940 Filed 1-19-10; 8:45 am]
BILLING CODE 8011-01-P