[Federal Register: August 1, 2007 (Volume 72, Number 147)]
[Notices]
[Page 42169-42190]
[DOCID:fr01au07-130]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56145; File No. SR-NASD-2007-023]

Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Approving Proposed Rule Change To Amend the By-
Laws of NASD To Implement Governance and Related Changes To Accommodate
the Consolidation of the Member Firm Regulatory Functions of NASD and
NYSE Regulation, Inc.

July 26, 2007.

I. Introduction

    On March 19, 2007, the National Association of Securities Dealers,
Inc. (``NASD'') filed with the Securities and Exchange Commission
(``Commission'' or ``SEC'') pursuant to section 19(b)(1) of the
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend the By-Laws of NASD
(``NASD By-Laws'') to implement governance and related changes to
accommodate the consolidation of the member firm regulatory functions
of NASD and NYSE Regulation, Inc. (``NYSE Regulation''), a wholly-owned
subsidiary of New York Stock Exchange LLC (``NYSE LLC''). The proposed
rule change was published for comment in the Federal Register on March
26, 2007.\3\ The Commission received 80 comment letters from 72
commenters on the proposed rule change.\4\ The NASD filed a response to
comments on May 29, 2007 and a supplemental response to comments on
July 16, 2007.\5\ This order approves the proposed rule change.
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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. 55495 (March 20,
2007), 72 FR 14149 (``Notice'').
    \4\ A list of commenters on the rule proposal, whose comments
were received as of July 16, 2007, is attached as Exhibit A to this
Order. The public file for the proposal, which includes comment
letters received on the proposal, is located at the Commission's
Public Reference Room located at 100 F Street, NE., Washington, DC
20549. The comment letters are also available on the Commission's
Internet Web site (http://www.sec.gov/rules/sro.shtml).

    \5\ See Letter from Patrice M. Gliniecki, Senior Vice President
and Deputy General Counsel, NASD, to Nancy M. Morris, Secretary,
Commission, dated May 29, 2007 (``NASD Response Letter'') and Letter
from T. Grant Callery, Executive Vice President and General Counsel,
NASD, to Nancy M. Morris, Secretary, Commission, dated July 16, 2007
(``NASD Supplemental Response Letter''). NASD Dispute Resolution
also filed two letters in response to comments. See Letter from
Linda D. Fienberg, President, NASD Dispute Resolution, to the Public
Members of SICA, dated January 26, 2007 (``NASD Dispute Resolution
Letter I'') and Letter from Linda D. Fienberg, President, NASD
Dispute Resolution, to Nancy M. Morris, Secretary, Commission, dated
May 29, 2007 (``NASD Dispute Resolution Letter II''). NASD submitted
an opinion of counsel regarding the approval by NASD members of
proposed amendments to the NASD By-Laws and the amount of the
payment to NASD members under Delaware Law. See Letter from William
J. Haubert, Richards, Layton & Finger, to Nancy M. Morris,
Secretary, Commission, dated July 16, 2007 (``RLF Letter''). NASD
also submitted an opinion of counsel describing generally the case
law, statutory provisions, and guidance published by the Internal
Revenue Service (``IRS'') relevant to the disclosure in the NASD's
proxy statement to members. See Letter from Mario J. Verdolini,
Davis Polk & Wardwell, to Nancy M. Morris, Secretary, Commission,
dated July 16, 2007 (``DPW Letter'').

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II. Description of the Proposed Rule Change

    In November 2006, NASD and NYSE Group, Inc. (``NYSE Group'') \6\
announced their plan to consolidate their member regulation operations
into a single self-regulatory organization (``SRO'') that would provide
member firm regulation for securities firms that do business with the
public in the United States (``Transaction''). Pursuant to the
Transaction, the member firm regulation and enforcement functions and
employees from NYSE Regulation would be transferred to NASD, and NASD
would adopt a new corporate name. In the proposed rule change, the NASD
proposes to amend the NASD By-Laws to implement governance changes that
are integral to the Transaction. The proposed rule change and this
Order refer to the NASD, whose name would be changed to the Financial
Industry Regulatory Authority, as the ``New SRO'' and the amended NASD
By-Laws as the ``New SRO By-Laws.''
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    \6\ NYSE Group recently combined with Euronext N.V.
(``Euronext'') to form a single, publicly traded holding company
named ``NYSE Euronext.'' NYSE Group and Euronext became separate
subsidiaries of NYSE Euronext. The corporate structure for the
businesses of NYSE Group (including the businesses of the NYSE LLC
and NYSE Arca, Inc., a registered national securities exchange)
remained unchanged following the combination. Specifically, NYSE LLC
remains a wholly-owned subsidiary of NYSE Group. NYSE Market remains
a wholly-owned subsidiary of the NYSE LLC and conducts NYSE LLC's
business. NYSE Regulation remains a wholly-owned subsidiary of NYSE
LLC and performs the regulatory responsibilities for NYSE LLC
pursuant to a delegation agreement with NYSE LLC and many of the
regulatory functions of NYSE Arca pursuant to a regulatory services
agreement with NYSE Arca. See Securities Exchange Act Release No.
55293 (February 14, 2007), 72 FR 8033 (February 22, 2007).
    Commenters on the proposed rule change generally referred to
NYSE Group as ``NYSE.''
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    The New SRO would be responsible for regulatory oversight of all
securities firms that do business with the public; professional
training, testing and licensing of registered persons; arbitration and
mediation; market regulation by contract for The NASDAQ Stock Market,
Inc., the American Stock Exchange LLC, and the International Securities
Exchange, LLC; and industry utilities, such as Trade Reporting
Facilities and other over-the-counter operations. NASD represents that
none of NASD's current functions and activities would be eliminated as
a result of the Transaction.
    The closing of the Transaction (``Closing'') and the consolidation
of the member firm regulatory functions of the NASD and NYSE Regulation
are subject to the execution of definitive agreements between NASD and
NYSE Group, the Commission's approval of the proposed rule change, and
certain additional regulatory approvals.\7\ The effective date of the
proposed rule change would be the date of the Closing. There would be a
transitional period commencing on the date of the Closing and ending on
the third anniversary of the date of the Closing (``Transitional
Period'').
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    \7\ On March 7, 2007, NASD and NYSE Group filed notification
reports with the Department of Justice and the Federal Trade
Commission under the Hart-Scott-Rodino Antitrust Improvements Act of
1976. NASD represented that the waiting period for such a filing
expired on April 6, 2007. NASD also represented that it received a
favorable ruling by the IRS that the Transaction would not affect
the tax-exempt status of NASD or NASD Regulation. See NASD
Supplemental Response Letter, supra note 5, at 3.
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    A description of the most significant changes to the NASD By-Laws
follows.

A. Composition of the New SRO Board

    The proposed rule change would implement a governance structure
that includes both public and industry representation, and designates
certain Governor \8\ positions on the New SRO Board of Governors (``New
SRO Board'') to represent member firms. Members would not have the
ability to elect all Governors of the New SRO Board, but would have the
ability to elect Governors that are from member firms that are similar
in size to their own firms. All other Governors would be appointed, as
described below. All members would continue to have the ability to vote
on any future amendments to the New SRO By-Laws,\9\ to petition to
propose amendments to the New SRO By-Laws,\10\ to vote in district
elections,\11\ and to petition to nominate a candidate for the Governor
position(s) they are entitled to elect.\12\
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    \8\ A ``Governor'' is a member of the Board of Governors of the
New SRO. See New SRO By-Laws, Article I(q).
    \9\ See New SRO By-Laws, Article XVI, Section 1.
    \10\ Id.
    \11\ See Article VIII of the NASD Regulation, Inc. By-Laws
(``NASD Regulation By-Laws'').
    \12\ See New SRO By-Laws, Article VII, Section 10.
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1. Composition of New SRO Board During the Transitional Period
    During the Transitional Period, the New SRO Board would consist of
23 Governors as follows: (a) Eleven Governors would be ``Public
Governors;'' \13\ (b) ten Governors would be ``Industry Governors'';
\14\ and (c) two Governors initially would be Richard G. Ketchum,
currently Chief Executive Officer (``CEO'') of NYSE Regulation and Mary
L. Schapiro, currently CEO of NASD. Mr. Ketchum would serve as Chair of
the New SRO Board (``Chair'') \15\ for a term of three years.\16\ Ms.
Schapiro would serve as CEO of the New SRO.
    Initially, five Public Governors would be appointed by the Board of
Directors of NYSE Group (``NYSE Group Board''); five Public Governors
would be appointed by the NASD Board of Governors in office prior to
the Closing (``NASD Board''); and one Public Governor would be
appointed jointly by the NYSE Group Board and the NASD Board (the
``Joint Public Governor''). A Public Governor must not have any
material business relationship with a broker or dealer or an SRO
registered under the Exchange Act (other than serving as a public
director of such an SRO).\17\
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    \13\ A ``Public Governor'' means any Governor who is not the
Chief Executive Officer of the New SRO or, during the Transitional
Period, the CEO of NYSE Regulation, who is not an Industry Governor
(as defined below) and who otherwise has no material business
relationship with a broker or dealer or an SRO registered under the
Exchange Act, other than as a public director of such an SRO. See
New SRO By-Laws, Article I(tt).
    \14\ An ``Industry Governor'' is the Floor Member Governor (as
defined below), the Independent Dealer/Insurance Affiliate Governor
(as defined below), the Investment Company Affiliate Governor (as
defined below) or any other Governor (excluding the CEO of the New
SRO and, during the Transitional Period, the CEO of NYSE Regulation)
who: (a) Is or has served in the prior year as an officer, director
(other than as an independent director), employee or controlling
person of a broker or dealer, or (b) has a consulting or employment
relationship with or provides professional services to an SRO
registered under the Exchange Act, or has had any such relationship
or provided any such services at any time within the prior year. See
New SRO By-Laws, Article I(t).
    \15\ See infra text accompanying notes 63 to 65 for a more
detailed description of the Chair.
    \16\ During the Transitional Period, Mr. Ketchum, the current
CEO of NYSE Regulation, would serve as the Chair so long as he
remains a Governor. See New SRO By-Laws, Article XXII, Section 2(b).
    \17\ See supra note 13.
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    The ten Industry Governors would consist of: (a) Three Governors
who are

registered with members that employ 500 or more registered persons
(``Large Firm Governors''); (b) one Governor who is registered with a
member that employs at least 151 and no more than 499 registered
persons (``Mid-Size Firm Governor''); (c) three Governors who are
registered with members that employ at least one and no more than 150
registered persons (``Small Firm Governors'' and, together with the
Large Firm Governors and the Mid-Size Firm Governors, ``Firm
Governors''); (d) one Governor who is associated with a floor member
(or a firm in the process of becoming a floor member) of the New York
Stock Exchange (``Floor Member Governor''); \18\ (e) one Governor who
is associated with an independent contractor financial planning member
firm or an affiliate of an insurance company (``Independent Dealer/
Insurance Affiliate Governor''); \19\ and (f) one Governor who is
associated with an affiliate of an Investment Company (``Investment
Company Affiliate Governor'').\20\ During the Transitional Period, the
three Small Firm Governors would be nominated by the NASD Board and
elected by members that have at least one and no more than 150
registered persons, although members of that size also would have the
right to nominate opposing candidates for the Small Firm Governor
position. The one Mid-Size Firm Governor would be nominated jointly by
the NYSE Group Board and the NASD Board and elected by members that
have at least 151 and no more than 499 registered persons, although
members of that size also can nominate opposing candidates for the Mid-
Size Firm Governor position. The three Large Firm Governors would be
nominated by the NYSE Group Board and elected by members that have 500
or more registered persons, although members of that size also can
nominate opposing candidates for the Large Firm Governor position. In
addition, the one Floor Member Governor would be appointed by the NYSE
Group Board; the one Independent Dealer/Insurance Affiliate Governor
would be appointed by the NASD Board; and the one Investment Company
Affiliate Governor would be appointed jointly by the NYSE Group Board
and the NASD Board.\21\
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    \18\ See New SRO By-Laws, Article I(n).
    \19\ See New SRO By-Laws, Article I(r). See infra text
accompanying note 213 for additional discussion regarding the
definition of Independent Dealer/Insurance Affiliate Governor.
    \20\ See New SRO By-Laws, Article I(w). See infra text
accompanying note 213 for additional discussion regarding the
definition of Investment Company Affiliate Governor.
    \21\ See New SRO By-Laws, Article XXII, Sections 3 and 4.
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    To implement the New SRO Board structure described above, the NYSE
Group Board and the NASD Board would appoint the Public Governors and
Industry Governors that they, either individually or jointly, have the
power to appoint, effective as of the Closing. The Public Governors,
the Floor Member Governor, the Investment Company Affiliate Governor,
and the Independent Dealer/Insurance Affiliate Governor would hold
office for the three-year Transitional Period. The three Small Firm
Governors, three Large Firm Governors, and one Mid-Size Firm Governor
would be elected as Governors at the first annual meeting of members of
the New SRO following the Closing, which is expected to be held within
ninety days after the Closing, and would hold office until the first
annual meeting of members of the New SRO following the Transitional
Period.\22\ During the interim period from the Closing until the first
annual meeting of members, the Small Firm Governor, Large Firm
Governor, and Mid-Size Firm Governor seats would be filled by three
interim Industry Governors appointed by the NASD Board from industry
governors currently on the NASD Board, three interim Industry Governors
appointed by the NYSE Group Board, and one interim Industry Governor
jointly appointed by the NYSE Group Board and the NASD Board, in each
case prior to the Closing.\23\
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    \22\ Id.
    \23\ See New SRO By-Laws, Article XXII, Section 2(a).
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2. Composition of the New SRO Board after the Transitional Period
    The composition of the New SRO Board would remain the same after
the Transitional Period, except that the term of office of the CEO of
NYSE Regulation as a member of the New SRO Board would automatically
terminate at the end of the Transitional Period. Thus, the authorized
number of members of the New SRO Board would be reduced by one.\24\
Other changes after the Transitional Period are described below.
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    \24\ Under New SRO By-Laws, Article VII, Section 4 (Composition
and Qualification of the Board), the total number of Governors is
determined by the Board of Governors, with such number being no
fewer than 16 nor more than 25 Governors. The number of Public
Governors must exceed the number of Industry Governors. As a
practical matter, the New SRO Board cannot have fewer than 22
Governors due to the number of designated Industry Governor
positions and the requirement that the number of Public Governors
must exceed the number of Industry Governors. Thus, absent the
filing of a proposed rule change under Section 19(b) of the Exchange
Act, there would be a minimum number of ten Industry Governors,
eleven Public Governors, plus the CEO of the New SRO. See NASD
Response Letter, supra note 5, at 3.
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    As of the first annual meeting of members following the
Transitional Period, the Large Firm Governors, the Mid-Size Firm
Governor, and the Small Firm Governors would be divided into three
classes.\25\ The composition of the classes would be arranged as
follows: \26\
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    \25\ See New SRO By-Laws, Article VII, Section 5.
    \26\ Id.
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     First class: Consisting of one Large Firm Governor and one
Small Firm Governor, who would be elected for a term of office expiring
at the first succeeding annual meeting of members;
     Second class: Consisting of one Large Firm Governor, one
Mid-Size Firm Governor, and one Small Firm Governor, who would be
elected for a term of office expiring at the second succeeding annual
meeting of members; and
     Third class: Consisting of one Large Firm Governor and one
Small Firm Governor, who would be elected for a term of office expiring
at the third succeeding annual meeting of members.
    While these classes are designed to ensure staggered board seats,
at no time would there be less than ten Industry Governor positions on
the New SRO Board. At each annual election following the first annual
meeting of members after the Transitional Period, Large Firm Governors,
Small Firm Governors, and Mid-Size Firm Governors would be elected for
a term of three years to replace those Governors whose terms have
expired.\27\ These Governors would serve until a successor is duly
appointed and qualified, or until death, resignation, disqualification
or removal. A Governor elected by the members may not serve more than
two consecutive terms.
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    \27\ Governors would be elected by a plurality of the votes of
the members of the New SRO present in person or represented by proxy
at the annual meeting of the New SRO and entitled to vote for such
category of Governors. See New SRO By-Laws, Article VII, Section 13.
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    As of the first annual meeting of members following the
Transitional Period, the Public Governors, the Floor Member Governor,
the Independent Dealer/Insurance Affiliate Governor, and the Investment
Company Affiliate Governor (``Appointed Governors'') would be divided
by the New SRO Board into three classes, as equal in number as
possible, with the first class holding office until the first
succeeding annual meeting of members, the second class holding office
until the second succeeding annual meeting of members, and the third
class holding office until the third succeeding annual meeting of
members. Each class would initially contain as equivalent a number as
possible of Appointed Governors who

were members of the New SRO Board appointed or nominated by the NYSE
Group Board or are successors to such Governor positions, on the one
hand, and Appointed Governors who were members of the New SRO Board
appointed or nominated by the NASD Board or are successors to such
Governor positions, on the other hand, to the extent the New SRO Board
determines such persons are to remain Governors after the Transitional
Period. At each annual election following the first annual meeting of
members following the Transitional Period, Appointed Governors would be
appointed by the New SRO Board for a term of three years to replace
those whose terms expire. These Governors would serve until a successor
is duly appointed and qualified, or until death, resignation,
disqualification or removal. No Appointed Governor may serve more than
two consecutive terms.\28\
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    \28\ See New SRO By-Laws, Article VII, Section 5.
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B. Governor Vacancies

1. During the Transitional Period
    As noted above, the CEO of NYSE Regulation would be a Governor and
the Chair during the Transitional Period. In the event of a vacancy in
the Governor position held by Mr. Ketchum (or his successor) during the
Transitional Period, the new CEO of NYSE Regulation would serve as a
Governor for the remainder of the Transitional Period. If Mr. Ketchum
ceases to occupy the office of Chair for any reason during the
Transitional Period, then his successor as Chair would be selected by
the NYSE Group Committee,\29\ from among its members, with the
exception that those Governors who also serve as NYSE Group directors
may not become Chair nor may Mr. Ketchum's successor as CEO of NYSE
Regulation become Chair.\30\
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    \29\ ``NYSE Group Committee'' means a committee of the New SRO
Board composed of the five Public Governors and the Floor Member
Governor appointed as such by the Board of NYSE Group, and the Large
Firm Governors which were nominated for election as such by the
Board of NYSE Group, and in each case their successors. See New SRO
By-Laws, Article I(pp).
    \30\ See New SRO By-Laws, Article XXII, Section 2(b).
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    In the event of any vacancy among the Large Firm Governors, the
Mid-Size Firm Governor, or the Small Firm Governors during the
Transitional Period, (a) Such vacancy would be filled, and nominations
for persons to fill such vacancy would be made, by the NYSE Group
Committee in the case of a Large Firm Governor vacancy; (b) such
vacancy would be filled by the Board, and nominations for persons to
fill such vacancy would be made by the New SRO's Nominating Committee
in the case of a Mid-Size Firm Governor vacancy; and (c) such vacancy
would be filled, and nominations for persons to fill such vacancy would
be made by the NASD Group Committee \31\ in the case of a Small Firm
Governor vacancy.\32\ In the event the remaining term of office of any
such Governor is more than twelve months, nominations would be made as
set forth above, but such vacancy would be filled by the New SRO
members entitled to vote on such Governor position at a meeting of
members called to fill the vacancy.\33\
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    \31\ ``NASD Group Committee'' means a committee of the New SRO
Board composed of the five Public Governors and the Independent
Dealer/Insurance Affiliate Governor appointed as such by the NASD
Board in office prior to the Closing, and the Small Firm Governors
which were nominated for election as such by the NASD Board in
office prior to the Closing, and in each case their successors. See
New SRO By-Laws, Article I(jj).
    \32\ See New SRO By-Laws, Article XXII, Section 3.
    \33\ Id.
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    In the event of any vacancy among the Floor Member Governor, the
Investment Company Affiliate Governor, or the Independent Dealer/
Insurance Affiliate Governor during the Transitional Period, (a) Such
vacancy would be filled by, and nominations for persons to fill such
vacancy would be made by the NYSE Group Committee in the case of a
Floor Member Governor vacancy; (b) such vacancy would be filled by the
New SRO Board, and nominations for persons to fill such vacancy would
be made by the New SRO's Nominating Committee in the case of an
Investment Company Affiliate Governor vacancy; or (c) such vacancy
would be filled by, and nominations for persons to fill such vacancy
would be made by, the NASD Group Committee in the case of an
Independent Dealer/Insurance Affiliate Governor vacancy.\34\
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    \34\ Id.
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    In the event of any vacancy among those Public Governors appointed
by the NYSE Group Board (or their successors), such vacancy would be
filled by, and nominations for persons to fill such vacancy would be
made by, the NYSE Group Committee. In the event of any vacancy among
those Public Governors appointed by the NASD Board (or their
successors), such vacancy would be filled by, and nominations for
persons to fill such vacancy would be made by, the NASD Group
Committee. In the event of any vacancy of the Public Governor position
jointly appointed by the NYSE Group Board and the NASD Board (or their
successors), such vacancy would be filled by the New SRO Board, and
nominations for persons to fill such vacancy would be made by the New
SRO's Nominating Committee.\35\
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    \35\ Id.
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2. After the Transitional Period
    In the event of any vacancy among the Large Firm Governors, the
Mid-Size Firm Governor, or the Small Firm Governors, such vacancy would
be filled by the Large Firm Governor Committee \36\ in the case of a
Large Firm Governor vacancy, the New SRO Board in the case of a Mid-
Size Firm Governor vacancy, or the Small Firm Governor Committee \37\
in the case of a Small Firm Governor vacancy; provided, however, that
in the event the remaining term of office of any Large Firm, Mid-Size
Firm, or Small Firm Governor position becomes vacant for more than
twelve months, such vacancy would be filled by the members of the New
SRO entitled to vote thereon at a meeting thereof convened to vote
thereon.\38\ Whether a vacancy is filled by the appropriate committee
for a position that is vacant for twelve months or less or by election
if the vacancy is greater than twelve months, nominations would be made
by the Nominating Committee as described below.\39\
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    \36\ ``Large Firm Governor Committee'' means a committee of the
Board composed of all of the Large Firm Governors. See New SRO By-
Laws, Article I(aa).
    \37\ ``Small Firm Governor Committee'' means a committee of the
Board composed of all the Small Firm Governors. See New SRO By-Laws,
Article I(yy).
    \38\ If a Governor is appointed to fill a vacancy of an elected
Governor position for a term of less than one year, the Governor may
serve up to two consecutive terms following the expiration of the
Governor's initial terms. See New SRO By-Laws, Article VII, Section
5.
    \39\ See New SRO By-Laws, Article VII, Sections 5 and 9.
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    In the event of any vacancy among the Public Governors or among the
Floor Member Governor, the Investment Company Affiliate Governor, or
the Independent Dealer/Insurance Affiliate Governor after the
Transitional Period, such vacancies would be filled by the New SRO
Board from candidates recommended to the Board by the Nominating
Committee.\40\
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    \40\ Id. If a Governor is appointed to fill the vacancy of an
Appointed Governor position for a term of less than one year, the
Governor may serve up to two consecutive terms following the
expiration of the Governor's initial terms. See New SRO By-Laws,
Article VII, Section 5.
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C. Committees of the New SRO Board

1. Committees Generally
    a. During the Transitional Period.
    During the Transitional Period, the New SRO is required to have the
following committees of the Board \41\:

The NASD Group Committee; the NYSE Group Committee; the Small Firm
Governor Committee, and the Large Firm Governor Committee. The New SRO
also is required to have an Audit,\42\ Finance,\43\ and Nominating
Committees and, during the first year of the Transitional Period, or as
may be extended thereafter by the Board, an Integration Committee.\44\
In addition, the New SRO would have an Investment Committee, which
would not be a committee of the Board.\45\
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    \41\ See New SRO By-Laws, Article IX, Section 1(a). These
committees play a role in the filling of vacancies on the Board and
appointing the Chair of the Board of the New SRO. See New SRO By-
Laws, Article XXII, Section 3.
    \42\ The Audit Committee would consist of four or five
Governors, none of whom would be officers or employees of the New
SRO. The Audit Committee would perform the following functions: (i)
Ensure the existence of adequate controls and the integrity of the
financial reporting process of the New SRO; (ii) recommend to the
New SRO Board, and monitor the independence and performance of, the
certified public accountants retained as outside auditors by the New
SRO; and (iii) direct and oversee all the activities of the New
SRO's internal review function, including, but not limited to,
management's responses to the internal review function. See New SRO
By-Laws, Article IX, Section 5.
    \43\ The Finance Committee would consist of four or more
Governors, including the CEO of the New SRO. A Finance Committee
member would hold office for a term of one year. The Finance
Committee would advise the Board with respect to the oversight of
the financial operations and conditions of the New SRO, including
recommendations for the annual operating and capital budgets and
proposed changes to the rates and fees charged by the New SRO. See
New SRO By-Laws, Article IX, Section 6(a)-(c).
    \44\ The Integration Committee would have a term not to exceed
one year from the Closing, unless continued for a longer period by
resolution of the Board. The Chair of the Board would be the Chair
of the Integration Committee unless, in the case of the Integration
Committee continuing beyond one year after the Closing, otherwise
determined by the Board. See New SRO By-Laws, Article IX, Section 7.
    \45\ The majority of the Investment Committee during the
Transitional Period would be composed of members of the Investment
Committee immediately prior to the Closing, unless otherwise
determined by the NASD Group Committee, and a minority of the
Investment Committee during the Transitional Period would be
composed of members of the NYSE Group Committee. See New SRO By-
Laws, Article IX, Section 6(d).
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    Unless otherwise provided in the New SRO By-Laws, any other
committee having the authority to exercise the powers and authority of
the New SRO Board must have a number of Public Governors that is
greater than the number of Industry Governors.\46\ In addition, any
committee of the New SRO Board having the authority to exercise the
powers and authority of the Board (with the exception of the Large Firm
Governor Committee, the Small Firm Governor Committee, the NASD Group
Committee, and the NYSE Group Committee) also must have: (i) A
percentage of members (to the nearest whole number of committee
members) that are members of the NASD Group Committee at least as great
as the percentage of Governors on the Board that are members of the
NASD Group Committee; and (ii) a percentage of members (to the nearest
whole number of committee members) that are members of the NYSE Group
Committee at least as great as the percentage of Governors on the Board
that are members of the NYSE Group Committee.\47\
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    \46\ See New SRO By-Laws, Article IX, Section 1(b).
    \47\ Id.
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    The New SRO Board may appoint an Executive Committee which can
exercise all the powers and authority of the New SRO Board in the
management and affairs of the New SRO between meetings of the New SRO
Board, subject to the limitations in the New SRO's Certificate of
Incorporation \48\ and applicable state law.\49\ The Executive
Committee would consist of no fewer than five and no more than eight
Governors. The Executive Committee would include the CEO of the New SRO
and the Chair of the New SRO Board.\50\
---------------------------------------------------------------------------

    \48\ NASD will be submitting a proposed rule change to amend its
Certificate of Incorporation to reflect the New SRO By-Laws.
    \49\ See New SRO By-Laws, Article IX, Section 4(a).
    \50\ See New SRO By-Laws, Article IX, Section 4(b).
---------------------------------------------------------------------------

    b. After the Transitional Period.
    After the Transitional Period, the New SRO is required to have the
following committees of the Board: The Small Firm Governor Committee
and the Large Firm Governor Committee. New SRO also is required to have
Audit, Finance, and Nominating Committees. The structure and
composition of the Executive Committee, and any other committee having
the authority to exercise the powers and authority of the Board,
remains unchanged from that described above for the Transitional
Period.
2. Nominating Committee
    The Nominating Committee would be a committee of the New SRO Board
and would replace the NASD's National Nominating Committee.\51\
---------------------------------------------------------------------------

    \51\ See New SRO By-Laws, Article I(oo) and Article VII, Section
9.
---------------------------------------------------------------------------

    a. During the Transitional Period.
    For the first annual meeting following the Closing, nominations for
the seven elected industry seats would not be made by the Nominating
Committee. Instead, the NASD Board would make nominations for the Small
Firm Governors positions, the NYSE Group Board would make nominations
for the Large Firm Governors positions, and the NASD Board and NYSE
Group Board jointly would make the nominations for the Mid-Size Firm
Governor position.\52\ In addition, prior to the Closing, the NASD
Board would identify and appoint five Public Governors and the
Independent Dealer/Insurance Affiliate Governor; the NYSE Group Board
would identify and appoint five Public Governors and the Floor Member
Governor; and the NASD Board and the NYSE Group Board would jointly
identify and appoint one Public Governor and the Investment Company
Affiliate Governor.\53\
---------------------------------------------------------------------------

    \52\ See New SRO By-Laws, Article XXII, Section 4.
    \53\ See New SRO By-Laws, Article XXII, Section 3.
---------------------------------------------------------------------------

    During the Transitional Period, members of the Nominating Committee
would be appointed jointly by the New SRO CEO and the CEO of NYSE
Regulation as of Closing (or his duly appointed or elected successor as
Chair of the New SRO Board), subject to ratification of the appointees
by the New SRO Board.\54\ The Nominating Committee would be responsible
solely for nominating persons to fill vacancies in Governor positions
for which the New SRO Board has the authority to fill, namely, the Mid-
Size Firm Governor position, the Investment Company Affiliate Governor
position, and the one Public Governor position that is initially
appointed jointly by the NYSE Group Board and the NASD Board in office
prior to the Closing.\55\
---------------------------------------------------------------------------

    \54\ See New SRO By-Laws, Article XXII, Section 1.
    \55\ See New SRO By-Laws, Article XXII, Section 3.
---------------------------------------------------------------------------

    b. After the Transitional Period.
    Following the Transitional Period, the members of the Nominating
Committee would be determined by the New SRO Board.\56\ At all times,
the number of Public Governors on the Nominating Committee must equal
or exceed the number of Industry Governors on the Nominating
Committee.\57\ In addition, the Nominating Committee must at all times
be composed of a number of Governors that is a minority of the entire
New SRO Board.\58\ The New SRO CEO may not be a member of the
Nominating Committee. The Nominating Committee would be responsible for
nominating persons for appointment or election to the New SRO Board, as
well as nominating persons to fill vacancies in appointed or elected
Governor seats.\59\
---------------------------------------------------------------------------

    \56\ See New SRO By-Laws, Article VII, Sections 9(b) and 9(c).
    \57\ See New SRO By-Laws, Article VII, Section 9(b). At least
20% of the Nominating Committee is expected to be composed of
Industry Governors. See NASD Response Letter, supra note 5, at 7.
    \58\ Id.
    \59\ See New SRO By-Laws, Article VII, Section 9(a).

---------------------------------------------------------------------------

D. Additional Changes

1. Annual Meetings
    a. During the Transitional Period.
    Except for the first annual meeting following the Closing at which
Large Firm Governors, the Mid-Size Firm Governor, and Small Firm
Governors would be elected, there would be no annual meetings of
members during the Transitional Period.\60\ At such first annual
meeting, Small Firm members would be entitled to vote for the election
of Small Firm Governors, Mid-Size Firm members would be entitled to
vote for the election of the Mid-Size Firm Governor, and Large Firm
members would be entitled to vote for the election of Large Firm
Governors.\61\
---------------------------------------------------------------------------

    \60\ See New SRO By-Laws, Article XXI, Section 1.
    \61\ Id. See also New SRO By-Laws, Article XXII, Section 3.
---------------------------------------------------------------------------

    b. After the Transitional Period.
    An annual meeting of members of the New SRO would be held on a date
and at a place as the New SRO Board designates.\62\ The business of the
annual meeting includes the election of the Small, Mid-Size, and Large
Firm Governors of the New SRO Board. Small Firm members would be
entitled to vote for the election of Small Firm Governors, Mid-Size
Firm members would be entitled to vote for the election of the Mid-Size
Firm Governor, and Large Firm members would be entitled to vote for the
election of Large Firm Governors.
---------------------------------------------------------------------------

    \62\ Id. See also New SRO By-Laws, Article XXI, Section 1.
---------------------------------------------------------------------------

2. Chair
    During the Transitional Period, the Chair would be the CEO of NYSE
Regulation as of the Closing as long as he remains a Governor of the
New SRO.\63\ In the event the CEO of NYSE Regulation as of the Closing
ceases to be the Chair during the Transitional Period, subject to the
New SRO Certificate of Incorporation and the By-Laws, the Chair would
be selected by the NYSE Group Committee from among its members,
provided that the Chair so selected may not be a member of the Board of
Directors of NYSE Group nor may the successor CEO of NYSE Regulation
serve as Chair.\64\
---------------------------------------------------------------------------

    \63\ See New SRO By-Laws, Article XXII, Section 2(b).
    \64\ Id.
---------------------------------------------------------------------------

    After the Transitional Period, the Chair would be elected by the
New SRO Board from among its members.\65\
---------------------------------------------------------------------------

    \65\ See New SRO By-Laws, Article VII, Section 4(b).
---------------------------------------------------------------------------

3. Lead Governor
    The New SRO Board would have a Governor who would preside over
executive sessions of the New SRO Board in the event the Chair is
recused (``Lead Governor'').\66\
---------------------------------------------------------------------------

    \66\ See New SRO By-Laws, Article I(bb) and Article VII, Section
4(b).
---------------------------------------------------------------------------

    a. During the Transitional Period.
    During the Transitional Period, the Lead Governor would be selected
by the New SRO Board, after consultation with the New SRO's CEO, but
cannot be a member who is concurrently serving on the NYSE Group
Board.\67\ The New SRO Board, the CEO, the Chair, and the Lead Governor
of the New SRO each would have the authority to call meetings of the
New SRO Board.\68\ Both the CEO and Chair, and for matters from which
the CEO and Chair are recused from considering, the Lead Governor,
would have the authority to place items on the New SRO Board
agendas.\69\
---------------------------------------------------------------------------

    \67\ See New SRO By-Laws, Article I(bb) and Article XXII,
Section 1.
    \68\ See New SRO By-Laws, Article VII, Section 8.
    \69\ Id.
---------------------------------------------------------------------------

    b. After the Transitional Period.
    After the Transitional Period, the New SRO Board would continue to
have a Lead Governor who would preside over executive sessions of the
New SRO Board in the event the Chair is not present or recused.\70\ The
Lead Governor would be elected by the Board but cannot be a member who
is concurrently serving on the NYSE Group Board.\71\ The New SRO Board,
the New SRO CEO, the Chair, and the Lead Governor would have the
authority to call meetings of the New SRO Board.\72\ Both the New SRO
CEO and the Chair, and for matters from which the New SRO CEO and the
Chair are recused from considering, the Lead Governor, would have the
authority to place items on the New SRO Board agenda.\73\
---------------------------------------------------------------------------

    \70\ See New SRO By-Laws, Article VII, Section 4(b).
    \71\ See New SRO By-Laws, Article I(bb).
    \72\ See New SRO By-Laws, Article VII, Section 8.
    \73\ Id.
---------------------------------------------------------------------------

4. Definition of Disqualification
    The New SRO By-Laws also include changes or additions to certain
defined terms. In addition to changes to accommodate the New SRO's new
governance structure, the proposed rule change would amend the
definition of ``disqualification'' in the NASD By-Laws to conform to
the federal securities laws, such that any person subject to a
statutory disqualification under the Exchange Act also would be subject
to disqualification under NASD rules.\74\
---------------------------------------------------------------------------

    \74\ NASD represented that it will file a proposed rule change,
which will be reviewed by the Commission pursuant to Section 19(b)
of the Exchange Act, to address the applicable eligibility
proceedings for persons subject to disqualification as a result of
the proposed change in definition. See Notice, supra note 3.
---------------------------------------------------------------------------

5. References to the NASD
    In addition, NASD proposes other technical changes to its By-Laws.
For example, each reference to ``NASD'' in the NASD By-Laws would be
replaced with ``Corporation'' in contemplation of the change in the
name of the Corporation. In addition, each reference to the ``Rules of
the Association'' in the NASD By-Laws would be replaced with ``Rules of
the Corporation.''
6. Proposed Changes to NASD Regulation By-Laws
    In 2000, NASD created a subsidiary for its mediation and
arbitration functions, NASD Dispute Resolution, pursuant to the Plan of
Allocation and Delegation of Functions by NASD to Subsidiaries
(``Delegation Plan''). NASD proposes to make limited conforming changes
to the NASD Regulation By-Laws solely to reflect the proposed
governance structure of the New SRO Board.
    First, in light of the new proposed composition of the New SRO
Board, the proposed rule change would amend Section 5.2 of the NASD
Regulation By-Laws (Number of Members and Qualifications of the
National Adjudicatory Council (``NAC'')) to eliminate the reference
that the Chairman of the NAC would serve as a Governor of the NASD
Board for a one-year term. Second, because the Chairman of the NAC may
continue to serve as a Director of the NASD Regulation Board, the
proposed rule change would eliminate the requirement in Section 4.3 of
the NASD Regulation By-Laws (Qualifications) that only Governors of the
NASD Board are eligible for election to the NASD Regulation Board.
Finally, NASD proposes to amend the statement in Section 4.3 of the
NASD Regulation By-Laws that provides that the CEO of NASD would be an
ex-officio non-voting member of the NASD Regulation Board, to reflect
that Ms. Schapiro would occupy both the position of CEO of the New SRO
and the President of NASD Regulation. In particular, the proposed rule
change would clarify that where the CEO of the New SRO also serves as
President of NASD Regulation, then the person would have all powers,
including voting powers, granted to all other Directors of NASD
Regulation pursuant to applicable law, the Certificate of Incorporation
of NASD Regulation, the Delegation Plan, and the NASD Regulation By-
Laws.

III. Summary of Comments on the Proposal

    The Commission received a total of 80 comment letters from 72
commenters on the proposal.\75\ Seventeen commenters supported the
proposed New SRO By-Laws,\76\ some of whom believed that the
consolidation proposal would streamline regulation and simplify
compliance with a uniform set of regulations.\77\ Forty-four commenters
urged the Commission not to approve the proposal, generally arguing
that the proposed New SRO By-Laws do not protect investors or provide
enough representation for industry members or smaller member firms.\78\
Three commenters supported the consolidation but opposed the New SRO
By-Laws primarily because of the member voting provisions.\79\ Other
commenters were concerned about the fairness and independence of the
arbitration process and the loss of an arbitration forum resulting from
the consolidation which would allocate sole responsibility for
arbitration and mediation to the New SRO.\80\ One commenter provided
copies of an amended complaint and an order relating to a lawsuit filed
by an NASD member firm against NASD, NYSE Group and certain NASD
officers.\81\ Four commenters raised additional issues relating to the
proposed rule change.\82\ The commenters generally addressed issues
falling into one or more of the categories discussed below.
---------------------------------------------------------------------------

    \75\ Exhibit A to this Order contains a list of comment letters
received by the Commission on the proposal as of July 16, 2007,
including the citations to the comment letters referenced in this
Order.
    \76\ See Vanguard Letter, Kirk Letter, SIFMA Letter, Casady
Letter, Moloney Letter, Stringer Letter, Alsover Letter, Johnstone
Letter, Castiglioni Letter, Robertson Letter, Pictor Letter, NAIBD
Letter, FSI Letter, Bakerink Letter, NSCP Letter, Mungenast Letter,
and NASAA Letter.
    \77\ See Vanguard Letter, SIFMA Letter, Castiglioni Letter, FSI
Letter, NSCP Letter, and Bakerink Letter.
    \78\ See Mortarotti Letter, Lek Letter, Darcy Letter, Jordan
Letter, Blumenschein Letter, Kosinsky Letter, Roberts Letter, Botzum
Letter, Busacca Letter, RKeenan Letters I & II, King Letter, Flater
Letter, Hebert Letter, Schunk Letter, Arnold Letter, High Letter,
Eitel Letters I & II, Cohen Letter, Vande Weerd Letter, Jester
Letters I & II, Schultz Letter, Benchmark Letter, Benchmark/Standard
Letter I, de Leeuw Letter, Elish Letter, Hanson Letter, Horney
Letter, Mayfield Letter, Solomon Letter, Patterson Letter, Daily
Letter, Cray Letter, Biddick Letter, Penrod Letter, Spindel Letter,
Isolano Letter, Lundgren Letters I & II, Haney Letter, Schooler
Letter, Callaway Letter, John Q Letter, Miller Letters, JKeenan
Letter, and Massachusetts Letter.
    \79\ See Kramer Letter, IASBDA Letter, and Wachtel Letter.
    \80\ See e.g., Public Members of SICA Letter, Greenberg Letters
I & II, and Caruso Letter. One commenter who objected to the
consolidation also argued that investor rights would be reduced by
cutting the number of arbitration venues in half. See Lundgren
Letter I. As discussed below, NASD Dispute Resolution responded
directly to one commenter. See NASD Dispute Resolution Letter I,
supra note 5.
    \81\ See Johnny Q Member Letters I & II. The Commission also
received a letter on behalf of Benchmark Financial Services, Inc.
(``Benchmark'') and Standard Investment Chartered, Inc.
(``Standard''), forwarding certain documents and pleadings relating
to the lawsuit filed by Standard against the NASD, the NYSE, and
three individuals defendants (Mary L. Schapiro, NASD's CEO; Richard
F. Brueckner, Presiding Governor of the NASD Board of Governors; and
Barbara Z. Sweeney, NASD's Senior Vice President and Corporate
Secretary) (collectively, with NASD and NYSE, the ``Defendants'') in
the U.S. District Court for the Southern District of New York
(``Standard Lawsuit''). See Benchmark/Standard Letter I.
    The Court recently granted the Defendants' motion to dismiss,
finding that Standard had failed to exhaust its administrative
remedies. See Standard Investment Chartered, Inc. v. National
Association of Securities Dealers, Inc., No. 07-CV-2014 (S.D.N.Y.),
2007 WL 1296712 (May 2, 2007). On July 13, 2007, the Court denied
Standard's motion for reconsideration. See Standard Investment
Chartered, Inc. v. National Association of Securities Dealers, Inc.,
No. 07-CV-2014 (S.D.N.Y.) (July 13, 2007) (denying Plaintiff's
Motion for Reconsideration of the Court's May 2, 2007 Opinion and
Order). Standard's complaint alleged seven state law claims: (1)
That the individual Defendants breached fiduciary duties to the
proposed class in negotiating the proposed Transaction and failing
to disclose all material facts in the proxy statement; (2) that the
Defendants engaged in negligent misrepresentation with respect to
the proxy statement; (3) that the NYSE and the individual Defendants
will be unjustly enriched by the Transaction; (4) that NASD members
have been denied their right to elect Governors of the NASD in
violation of Section 211 of the Delaware General Corporation Law, 8
Del. C. section 211(a); (5) that the Defendants have improperly
converted or, if the Transaction is effected, will have taken the
prospective class members' assets and/or ``Member's Equity''; (6)
that the Defendants have caused a substantial diminution in the
value of NASD membership, with imminent completion of such
diminution; and (7) that the Defendants have deprived the
prospective class members of their voting membership.
    \82\ See Harriman-Thiessen Letter (requesting that the
Commission determine why NASD member firms voted the way they did),
Judith Schapiro Letter (see text accompanying infra note 105),
Schriner Letter (not opposed to reducing regulatory redundancies but
believes that the proposed combination does not satisfy standards of
``just and equitable principles of fair trade''), and Hawks Letter
(see infra note 88).
---------------------------------------------------------------------------

A. Fair Representation

1. Classification of Member Governors
    Some commenters argued that the New SRO should retain the NASD's
current ``one firm, one vote'' election process, whereby each NASD
member is currently entitled to vote for the election of all NASD
Governors (other than the CEO of NASD, the President of NASD
Regulation, the Chair of the NAC, and, if applicable, a second officer
of NASD).\83\ In this regard, several commenters argued that the
proposal would dilute the voting rights of members in New SRO Board
elections, particularly with respect to small member firms.\84\ These
commenters also expressed concern that the New SRO By-Laws would result
in the New SRO's Board being dominated by the large firms at the
expense of the views and concerns of the small firms.
---------------------------------------------------------------------------

    \83\ See Lek Letter, Kosinsky Letter, Roberts Letter, RKeenan
Letter II, Miller Letters, Blumenschein Letter, Eitel Letter II, de
Leeuw Letter, Elish Letter, Patterson Letter, Callaway Letter,
Isolano Letter, Hebert Letter, Biddick Letter, John Q Letter, and
Schriner Letter.
    \84\ See Mortarotti Letter, Jordan Letter, Roberts Letter,
Botzum Letter, Arnold Letter, High Letter, Eitel Letter I, Cohen
Letter, JKeenan Letter, Schultz Letter, Benchmark Letter, Benchmark/
Standard Letter I (adding Standard to the Benchmark Letter to be an
additional objector), Solomon Letter, Isolano Letter, Haney Letter,
Callaway Letter, Cray Letter, Blumenschein Letter, Biddick Letter,
and Wachtel Letter.
---------------------------------------------------------------------------

    One commenter stated that there has been insufficient review to
address the concerns of small independent broker-dealers.\85\ One
commenter maintained that the current NASD By-Laws state that firms,
not the number of representatives or revenues collected, dictate the
``one firm, one vote rule.'' \86\ Other commenters argued that the
proposal is designed to prevent the voices of the small member firms
from being heard \87\ or to eliminate small firms by escalating the
cost of doing business.\88\ Commenters also believed that there is no
rational connection between the ``one firm, one vote'' policy and the
consolidation of regulatory rules and procedures, arguing that ``the
NASD Board has used this regulatory consolidation * * * as a means of
consolidating its power and, in turn, limiting the power of an
institution that has wholly democratic origins.'' \89\
---------------------------------------------------------------------------

    \85\ See Horney Letter.
    \86\ See Blumenschein Letter.
    \87\ See Callaway Letter.
    \88\ See Haney Letter (defining ``small'' firms as those firms
with one to ten representatives). Four commenters were concerned
about burdensome regulation of small broker-dealers generally. See
Penrod Letter (stating that small broker-dealers might be better off
forming another organization designed for small broker-dealers),
Hawks Letter, Roberts Letter, and Callaway Letter.
    \89\ See Benchmark Letter and Benchmark/Standard Letter I
(adding Standard to the Benchmark Letter to be an additional
objector). The Benchmark Letter also noted that it does not dispute
that the regulatory consolidation has some merit. See also Busacca
Letter (arguing that there was no specific reason given by the NASD
or NYSE for ``member firms * * * surrender[ing] their right to vote
for their Board of Governors'').
---------------------------------------------------------------------------

    The FSI, along with two other commenters, expressly supported the
proposed New SRO By-Laws, noting that the New SRO By-Laws would provide
for effective, diverse representation of all members of the securities
industry on the New SRO Board.\90\ These commenters believed that the
proposal is a reasonable way to maintain proper representation on the

New SRO Board. The FSI also believed that the New SRO's governance
structure is designed to insure that neither the largest nor the
smallest broker-dealer firms can dominate the New SRO Board.\91\
Another commenter, which identified itself as a small broker-dealer,
supported the proposal and argued that small members would have
increased representation on the New SRO Board as a result of the
increase in their representation to three seats from the current one
seat.\92\
---------------------------------------------------------------------------

    \90\ See Castiglioni Letter, FSI Letter, and Bakerink Letter.
    \91\ See FSI Letter.
    \92\ See Moloney Letter.
---------------------------------------------------------------------------

2. Appointed Governors
    Commenters were concerned that the majority of the Governors
serving on the New SRO Board would be appointed by the New SRO Board
itself and would not be elected by member firms.\93\ Similarly, some
commenters objected to members no longer having the right to vote for
all Governors.\94\ In addition, one commenter argued that the New SRO
Board structure could create a ``self-perpetuating'' club in which the
New SRO Board's Governors would not be held accountable to serve the
members' needs.\95\
---------------------------------------------------------------------------

    \93\ See Lek Letter, RKeenan Letters I & II, Hebert Letter,
Mayfield Letter, Blumenschein Letter, Eitel Letter II, de Leeuw
Letter, Elish Letter, Patterson Letter, Schriner Letter, Roberts
Letter, and Biddick Letter.
    \94\ See Kramer Letter and Hebert Letter.
    \95\ See Wachtel Letter.
---------------------------------------------------------------------------

    Some of these commenters maintained that the appointment of
Governors is contrary to good corporate governance and questioned the
independence and accountability of the appointed Governors.\96\ Another
commenter was concerned that the Public Governors would be appointed by
the securities industry representatives on the Board.\97\ This
commenter believed that Public Governors should be chosen by the
investing public or their representatives which would ensure that the
views of investors would be heard and that their interests would be
protected.\98\
---------------------------------------------------------------------------

    \96\ See Mayfield Letter, Isolano Letter, Hebert Letter, Wachtel
Letter, and Lek Letter.
    \97\ See Massachusetts Letter.
    \98\ Id.
---------------------------------------------------------------------------

3. Industry Representation
    A number of commenters objected to the proposed composition of the
New SRO Board for failing to include more industry representatives to
serve as Governors.\99\ These commenters stated that the ten Governor
positions allocated to industry representatives are insufficient. These
commenters also opined that the lack of industry representatives on the
Board would defeat the purpose of self-regulation.
---------------------------------------------------------------------------

    \99\ See, e.g., Roberts Letter, Busacca Letter, Blumenschein
Letter, and Miller Letters.
---------------------------------------------------------------------------

    In contrast, one commenter stated that the New SRO Board structure
would have too many industry representatives and not enough Public
Governors.\100\ This commenter noted that, because the New SRO Board
would include ten Industry Governors as well as representatives of the
NASD and NYSE Group on an ex officio basis, Governors who are from the
securities industry would outnumber the Public Governors on the New SRO
Board. Another commenter added that, because the current NASD
definition of Public Governors would be amended, any ex-industry
official or ex-industry regulator would be eligible to be a Public
Governor, thereby biasing the New SRO Board toward industry
interests.\101\
---------------------------------------------------------------------------

    \100\ See Massachusetts Letter.
    \101\ See Blumenschein Letter.
---------------------------------------------------------------------------

    Several commenters supported the regulatory consolidation, noting
that the proposed amendments are intended to maintain adequate
representation on the New SRO Board for industry members.\102\ Two
commenters noted that the proposed composition of the industry members
on the New SRO Board and in New SRO Board committees appears to promote
diversity among industry representation on the Board.\103\ Another
commenter indicated that balanced representation of industry and non-
industry members, as well as large and small firms, would reflect a
broad spectrum of industry experience and would preserve the
constructive feedback of non-industry participants.\104\
---------------------------------------------------------------------------

    \102\ See NAIBD Letter, Vanguard Letter, Moloney Letter, and FSI
Letter.
    \103\ See NAIBD Letter and FSI Letter.
    \104\ See Vanguard Letter.
---------------------------------------------------------------------------

    One commenter noted confusion about the proposed rule change
regarding the eligibility for the ``Independent Dealer/Insurance
Affiliate Governor'' and ``Investment Company Affiliate Governor''
positions.\105\
---------------------------------------------------------------------------

    \105\ See Judith Schapiro Letter.
---------------------------------------------------------------------------

B. State Law and Proxy

1. Timing
    Several commenters claimed that the proxy process was rushed, which
forced members to make quick and uninformed decisions.\106\ Other
commenters stated that the proxy process was deceptive because it was
held over the holiday season and involved alleged procedural omissions
and coercive tactics by the NASD, including the threat of Commission
action if the By-Law revisions were not approved.\107\ Another
commenter did not dispute the results of the vote but expressed
concerns about the lack of discussion of alternative ways to structure
the New SRO Board.\108\
---------------------------------------------------------------------------

    \106\ See Mortarotti Letter, Jordan Letter, Busacca Letter,
Schunk Letter, and Cray Letter.
    \107\ See Benchmark Letter, Benchmark/Standard Letter I (adding
Standard to the Benchmark Letter to be an additional objector),
Daily Letter, Cray Letter, Eitel Letter I, Miller Letters, and John
Q Letter.
    \108\ See IASBDA Letter.
---------------------------------------------------------------------------

    In addition, a few commenters claimed that the NASD did not present
the New SRO By-Laws to the NASD membership for a vote quickly enough,
thereby violating current NASD By-Laws that require a membership vote
within 30 days of the submission of the proposal to the
membership.\109\
---------------------------------------------------------------------------

    \109\ See Jester Letter I, Miller Letters, and Blumenschein
Letter. In response to the NASD Response Letter, Jester submitted a
supplemental comment letter, asserting that the NASD was still
required to comply with Article XVI of the NASD By-Laws which
requires that By-Law amendments must be approved within 30 days of
the submission of the proposal to the membership, even if the By-Law
amendments are approved at a special meeting. See Jester Letter II.
---------------------------------------------------------------------------

2. Disclosure
    Several commenters questioned the adequacy of the proxy
statement.\110\ These commenters indicated that oral statements made by
NASD staff were not contained in the proxy statement, such as
representations that the Commission would force consolidation in the
event the members did not support the proposal \111\ and that the NYSE
required the New SRO By-Law provisions.\112\ Two other commenters
stated that the proxy statement failed to explain why the merger is
connected to the governance changes, specifically the one firm, one
vote policy.\113\ These commenters also believed that the transaction
is unfair to the NASD members who are not also NYSE members.\114\
Another commenter objected to the proposed payments to the NYSE and
believed that proposed

consolidation needed more study by the current NASD members.\115\
---------------------------------------------------------------------------

    \110\ See Darcy Letter, Roberts Letter, Busacca Letter,
Benchmark Letter, Benchmark/Standard Letter I (adding Standard to
the Benchmark Letter to be an additional objector), Benchmark/
Standard Letter II, Cray Letter, Spindel Letter, and Schriner
Letter.
    \111\ See Roberts Letter, Blumenschein Letter, Eitel Letter II,
de Leeuw Letter, Elish Letter, Patterson Letter, Biddick Letter,
Wachtel Letter, Isolano Letter, and Miller Letters.
    \112\ See Wachtel Letter.
    \113\ See Benchmark Letter and Benchmark/Standard Letter I
(adding Standard to the Benchmark Letter to be an additional
objector). Some commenters also noted that they were unable to get
answers to their questions about the consolidation from the NASD.
See, e.g., Miller Letters.
    \114\ Id.
    \115\ See Kramer Letter.
---------------------------------------------------------------------------

3. Payment of $35,000
    Several commenters questioned the calculation and origin of the
$35,000 one-time payment to the NASD members.\116\ Two commenters
specifically posited whether the representation by the NASD that the
payment came from reduced costs is misleading.\117\ Other commenters
expressed concern that the $35,000 amount appears arbitrary and may
have been calculated based on financial information the NASD knows
about its member firms.\118\ One commenter believed that the $35,000 is
a fraction of the value of the NASD,\119\ while other commenters wanted
an explanation as to why a larger payment to members is not
possible.\120\ One of these commenters submitted a supplemental comment
letter in response to the discussion of the proposed $35,000 payment to
NASD members in the NASD Response Letter.\121\ This commenter stated
that, from the perspective of an NASD member, the focus of the proxy
statement was ``the fundamental change in members' voting rights and
the $35,000 that each member is to receive in exchange for
`surrendering' members' equity valued at as much as $300,000, or more,
per NASD member.'' \122\ The commenter believed that the discussion of
the $35,000 in the proposed rule change was inadequate, and stated that
the Commission ``should disapprove the rule change, re-notice the issue
properly or limit its findings to the issues it noticed.'' \123\
---------------------------------------------------------------------------

    \116\ See Kosinsky Letter, Busacca Letter, Benchmark Letter,
Benchmark/Standard Letter I (adding Standard to the Benchmark Letter
to be an additional objector), Benchmark/Standard Letter II, Daily
Letter, Miller Letters, Wachtel Letter, John Q Letter, and Schriner
Letter.
    \117\ See Busacca Letter and Schriner Letter.
    \118\ See Isolano Letter, Blumenschein Letter, Eitel Letter II,
de Leeuw Letter, Elish Letter, Patterson Letter, and Biddick Letter.
    \119\ See Lundgren Letter I.
    \120\ See Benchmark Letter, Benchmark/Standard Letter I (adding
Standard to the Benchmark Letter to be an additional objector), and
Benchmark/Standard Letter II.
    \121\ See Benchmark/Standard Letter II.
    \122\ Id. (also noting that at least 22 comments mentioned or
raised issues relating to the $35,000 payment, which, according to
the commenter, ``clearly demonstrate the materiality of the
representations about the $35,000 payment'').
    \123\ Id.
---------------------------------------------------------------------------

    Some commenters questioned whether the payment was an improper
inducement to members in order to obtain their vote.\124\ One commenter
expressed its concern that NASD member firms would receive funds for
voting in favor of the consolidation, while public investors would not
receive any financial benefit from the anticipated cost savings.\125\
Commenters also inquired whether a fairness opinion was done in
connection with the consolidation or the $35,000 payment \126\ and
whether the Internal Revenue Service gave a legal opinion on this
payment.\127\
---------------------------------------------------------------------------

    \124\ See Eitel Letter II, Blumenschein Letter, Busacca Letter,
Isolano Letter, Spindel Letter, Elish Letter, de Leeuw Letter,
Patterson Letter, and Biddick Letter.
    \125\ See Caruso Letter.
    \126\ See Cohen Letter, Lundgren Letter I, and Miller Letters.
    \127\ See Daily Letter.
---------------------------------------------------------------------------

    Two commenters believed that the monetary aspect of the proposed
consolidation is simply a return of monies to the members for increased
efficiency.\128\ One of these commenters, which identified itself as a
small NASD member firm, believed that the $35,000 payment would benefit
many of the small firms financially.\129\ This commenter did not
believe that members' votes were bought or that members had given up
voting rights because members retain a vote on any future By-Law
changes.\130\
---------------------------------------------------------------------------

    \128\ See Moloney Letter and FSI Letter.
    \129\ See Moloney Letter.
    \130\ Id.
---------------------------------------------------------------------------

4. Delaware Law
    One commenter argued that the proposal violates Delaware law
because the omission in the proxy materials of the merger contract
between NYSE and NASD makes the transaction illegal.\131\ This
commenter further believed that the proposed merger may have violated
Delaware law by providing a proxy statement that allegedly had
conclusory, one-sided statements.\132\
---------------------------------------------------------------------------

    \131\ See Cray Letter.
    \132\ Id.
---------------------------------------------------------------------------

    Another commenter argued that NASD violated Delaware law because it
has not held an annual meeting in 13 months, which, according to the
commenter, is required under Delaware law.\133\ Another commenter
stated that the proposed combination, ``by combining under current
unknown By-Laws,'' violates the NASD's charter as stated on August 7,
1936.\134\
---------------------------------------------------------------------------

    \133\ See John Q Letter.
    \134\ See Blumenschein Letter.
---------------------------------------------------------------------------

5. Antitrust Laws
    Some commenters posited that the proposal violates antitrust
laws.\135\
---------------------------------------------------------------------------

    \135\ See Blumenschein Letter, Eitel Letter II, de Leeuw Letter,
Elish Letter, Patterson Letter, and Biddick Letter.
---------------------------------------------------------------------------

C. Efficiency and Investor Protection

1. Efficiency
    Some commenters explicitly questioned the benefits of the proposed
consolidation.\136\ Three commenters argued that the consolidation
would benefit mainly the larger firms;\137\ two commenters noted
specifically that firms should not have to incur costs to make changes
in advertising, letterhead, and signage because the proposal mainly
would benefit the larger firms.\138\ Several commenters argued that the
proposal would benefit the larger firms, while being disruptive to
small broker-dealers.\139\
---------------------------------------------------------------------------

    \136\ See RKeenan Letter I, Mayfield Letter, and Schooler
Letter.
    \137\ See Vande Weerd Letter, Isolano Letter, and Eitel Letter
II.
    \138\ See Flater Letter (also noting that the $35,000 payment
does not cover the cost of these changes) and Vande Weerd Letter.
    \139\ See Schooler Letter, Biddick Letter, de Leeuw Letter,
Eitel Letter II, Elish Letter, Blumenschein Letter, Isolano Letter,
and Patterson Letter.
---------------------------------------------------------------------------

    One commenter did not believe that the merger would be effective in
reducing duplicative regulation because there are only about 170 firms
subject to both NASD and NYSE rules.\140\ The commenter believed that
it would be easier for those 170 firms to be regulated by NYSE than to
effect the consolidation solely for the benefit of those 170
firms.\141\ One commenter argued that the merger is unnecessary because
most firms already belong to the NASD.\142\
---------------------------------------------------------------------------

    \140\ See Spindel Letter.
    \141\ Id.
    \142\ See Hebert Letter.
---------------------------------------------------------------------------

    Commenters who supported the proposal believed that the proposed
consolidation would benefit investors by streamlining regulation and
simplifying compliance with a uniform set of regulations \143\ or by
increasing efficiency.\144\ In this regard, some of these commenters
believed that the use of two distinct rulebooks has caused unnecessary
redundancy, complication, and conflict, which in their view undermines
basic SRO objectives of effectively and efficiently protecting the
capital markets and investors.\145\ In addition, two commenters
believed that combining the conflicting rules of the two SROs into one
set of rules and

eliminating inconsistent interpretations would be benefit both large
and small firms.\146\
---------------------------------------------------------------------------

    \143\ See Vanguard Letter, SIFMA Letter, Stringer Letter,
Bakerink Letter, NSCP Letter, and FSI Letter. In addition, six
commenters stated their agreement with SIFMA's Letter. See Casady
Letter, Alsover Letter, Johnstone Letter, Robertson Letter,
Mungenast Letter, and Pictor Letter.
    \144\ See Moloney Letter, Kirk Letter, Castiglioni Letter, and
NAIBD Letter.
    \145\ See Vanguard Letter, SIFMA Letter, and NSCP Letter. In
addition, seven commenters stated their agreement with SIFMA's
Letter. See Casady Letter, Alsover Letter, Johnstone Letter,
Robertson Letter, Mungenast Letter, Stringer Letter, and Pictor
Letter.
    \146\ See Bakerink Letter and Vanguard Letter.
---------------------------------------------------------------------------

2. Investor Protection
    Some commenters noted that having one less regulator overseeing the
securities firms that deal with the public would harm investors.\147\
One commenter likened the regulatory consolidation to reducing the
number of ``police departments'' that oversee the markets.\148\ Another
commenter stated that the proposal would remove any competitiveness
between the two SROs and any choice that firms would have.\149\ Yet
another commenter added that having two independent regulatory entities
would create advantages from a regulatory point of view.\150\ This
commenter noted that the NASD and NYSE are able to bring distinct
perspectives to regulating their member firms and that such
independence is vital to preventing SROs and other regulators from
becoming myopic about certain regulatory issues. On the other hand, one
commenter believed that the proposed structure would offer the best
opportunity for balanced and effective regulation in furtherance of
customer protection.\151\
---------------------------------------------------------------------------

    \147\ See King Letter, Eitel Letter II, de Leeuw Letter, Elish
Letter, Patterson Letter, Biddick Letter, and Massachusetts Letter.
    \148\ See King Letter.
    \149\ See Schooler Letter.
    \150\ See Massachusetts Letter.
    \151\ See FSI Letter.
---------------------------------------------------------------------------

    Other commenters believed that the proposal overlooked investor
interests because of the failure to include investors in the merger
talks,\152\ the lack of accountability and control over NASD/NYSE
management by owners,\153\ and the conflict of interest on the part of
the NASD management because of benefits they may receive in connection
with the merger.\154\ Other commenters questioned the effectiveness of
the regulatory oversight of a board whose members are directly funded
by the persons they are regulating.\155\
---------------------------------------------------------------------------

    \152\ See King Letter. One commenter who supported the
consolidation urged that compliance professionals be included in the
consolidation process. See NSCP Letter.
    \153\ See Lundgren Letter I.
    \154\ See Lundgren Letter II, Eitel Letter II, de Leeuw Letter,
Biddick Letter, Elish Letter, Isolano, and Patterson Letter. Several
commenters also questioned the compensation packages of the NASD
management. See, e.g., Isolano Letter, Mayfield Letter, and Daily
Letter.
    \155\ See Biddick Letter, de Leeuw Letter, Eitel Letter II,
Elish Letter, Isolano Letter, and Patterson Letter.
---------------------------------------------------------------------------

D. Arbitration

    Five commenters focused on the effects the merger may have on the
arbitration of customers' disputes with their brokers.\156\ One
commenter urged the Commission to disapprove the merger, stating that
it would reduce investor rights ``by cutting the number of major
available arbitration venues in half.''\157\ Another recommended that
the Commission consider holding public hearings to discuss anticipated
benefits and detriments of consolidating the NASD and NYSE dispute
resolution forums before approving the merger.\158\
---------------------------------------------------------------------------

    \156\ See Caruso Letter, Greenberg Letters I & II, Lundgren
Letter, Massachusetts Letter, and Public Members of SICA Letter.
    \157\ See Lundgren Letter.
    \158\ See Caruso Letter.
---------------------------------------------------------------------------

    One commenter expressed the view that a single SRO arbitration
forum will heighten public investors' suspicion that SRO arbitration is
``less than independent and hence less than fair.'' \159\ This
commenter suggested either creating an ``independent securities
arbitration forum, with SEC oversight and public investor and
securities industry participation'' or providing that public investors
may choose between resolving their disputes in court or in arbitration.
In addition, this commenter stated that the role of the Securities
Industry Conference on Arbitration (``SICA'') should be strengthened
and that public members should compose at least one half of the voting
members of SICA.
---------------------------------------------------------------------------

    \159\ See Public Members of SICA Letter.
---------------------------------------------------------------------------

    Another commenter cited those views with approval, stating that
combining the NASD and NYSE arbitration forum is ``not desirable'' and
called for changes in the arbitration system ``to make it fairer to
investors'' including the elimination of ``industry'' arbitrators.\160\
This commenter also expressed concern about the use of dispositive
motions in SRO arbitration and stated that the New SRO should
incorporate the relevant NYSE rule rather than the NASD rule in its
arbitration code.
---------------------------------------------------------------------------

    \160\ See Massachusetts Letter.
---------------------------------------------------------------------------

    One commenter noted that the NASD and NYSE forums have different
rules, procedures, and administrative practices, and stated this ``can
often have a significant procedural impact on an arbitration
proceeding.'' \161\ Expressing skepticism that a single forum will
provide ``any recognizable benefits'' for public customers, this
commenter stated that a ``notable portion of the anticipated cost
savings'' from the regulatory consolidation should be allocated toward
the reduction of public investors' filing, administrative and forum
fees.
---------------------------------------------------------------------------

    \161\ See Caruso Letter.
---------------------------------------------------------------------------

    As discussed more fully below, NASD responded to comments, in part,
by citing studies and reports analyzing its arbitration forum, and
noting that it is subject to SEC oversight, including through
inspections and the rule approval process.\162\ One commenter
questioned the methodology and impartiality of the studies and reports,
as well as the efficacy of SEC oversight.\163\ This commenter also
noted that he had filed a petition for rulemaking with the Commission
calling for a number of changes in arbitration rules and stated that
these changes would ``correct many aspects of the arbitration process,
which make the process unfair to the investing public.'' \164\
---------------------------------------------------------------------------

    \162\ See NASD Dispute Resolution Letter, supra note 5.
    \163\ See Greenberg Letters I & II.
    \164\ Id. See also Request for rulemaking under the Securities
Exchange Act of 1934 concerning arbitration sponsored by NASD
Dispute Resolution, Submitted by Les Greenberg, Esq., File No. 4-502
(May 13, 2005).
---------------------------------------------------------------------------

E. Other Matters

1. Request for Delay
    Several commenters argued that the proposal should be put on hold
for one year,\165\ while two other commenters \166\ suggested tabling
the proposal until after the resolution of the Standard Lawsuit.\167\
Another commenter suggested that the Commission could approve the
consolidation but require another vote in three years on the
composition of the New SRO Board, after the firms and the public have
had a chance to evaluate the effects of the merger.\168\ This commenter
did not express concern about the voting results

but about the lack of any discussion of other alternatives to the New
SRO Board's composition.\169\
---------------------------------------------------------------------------

    \165\ See Busacca Letter. Three commenters argued that the
proposal should be put on hold and membership should be consulted
and given the opportunity for input. See also Miller Letters, Kramer
Letter, and Hebert Letter.
    \166\ See Benchmark Letter and Benchmark/Standard Letter I
(adding Standard to the Benchmark Letter to be an additional
objector).
    \167\ The Court recently granted the Defendants' motion to
dismiss, finding that Standard had failed to exhaust its
administrative remedies. See Standard Investment Chartered, Inc. v.
National Association of Securities Dealers, Inc., No. 07-CV-2014
(S.D.N.Y.), 2007 WL 1296712 (May 2, 2007). According to the
Benchmark/Standard Letter II, the Plaintiffs filed a motion for
reconsideration on May 17, 2007. See supra note 81. On July 13,
2007, the Court denied Standard's motion for reconsideration. See
Standard Investment Chartered, Inc. v. National Association of
Securities Dealers, Inc., No. 07-CV-2014 (S.D.N.Y.) (July 13, 2007)
(denying Plaintiff's Motion for Reconsideration of the Court's May
2, 2007 Opinion and Order).
    \168\ See IASBDA Letter. This commenter argued that a
reassessment in three years might ``possibly calm the concerns of a
large number of small firms. . .which feel disenfranchised by a
process that shows no discussion of alternatives.''
    \169\ Id. A commenter suggested that, in lieu of this proposed
rule change, it would be ``easier for those firms that are currently
regulated by NYSE to simply not be regulated by NASD at all and to
instead be regulated by NYSE staff using current SEC and NYSE rules
which could be supplemented by NYSE adopting many of the current
NASD rules to which the large New York Stock Exchange member
organizations must currently comply, since they are also NASD
members.'' See Spindel Letter.
---------------------------------------------------------------------------

    Other commenters believed that the proposed regulatory
consolidation should occur as soon as practicable or in the timeframe
announced by the NASD and NYSE Group.\170\ One of these commenters
believed that the regulatory consolidation should proceed because a
majority of the members already have given their approval to the
proposed regulatory consolidation.\171\
---------------------------------------------------------------------------

    \170\ See Johnstone Letter, Casady Letter, SIFMA Letter, Moloney
Letter, Stringer Letter, Alsover Letter, Robertson Letter, and
Pictor Letter.
    \171\ See Moloney Letter.
---------------------------------------------------------------------------

2. Public Hearing
    Two commenters urged the Commission to consider the proposal at a
public hearing.\172\ As noted above, one of these commenters
recommended that the Commission consider holding public hearings to
discuss anticipated benefits and detriments of consolidating the NASD
and NYSE dispute resolution forums before approving the
consolidation.\173\ Another commenter stated that the Commission and
government oversight committees should be part of the discussion of the
consolidation.\174\
---------------------------------------------------------------------------

    \172\ See Harriman-Thiessen Letter and Caruso Letter.
    \173\ See Caruso Letter.
    \174\ See Darcy Letter.
---------------------------------------------------------------------------

IV. NASD Response to the Comment Letters

    NASD submitted two letters to respond to issues raised by the
commenters, including the proposed governance structure, the proxy
statement, the approval process for the By-Law amendments, and the
$35,000 payment.\175\ NASD also submitted two letters providing
opinions of counsel with respect to the approval process of the By-Law
amendments and the $35,000 payment.\176\ In two separate letters, NASD
Dispute Resolution responded to comments regarding the effects of the
consolidation on arbitration of customers' disputes with member firms.
---------------------------------------------------------------------------

    \175\ See NASD Response Letter and NASD Supplemental Response
Letter, supra note 5.
    \176\ See RLF Letter and DPW Letter, supra note 5.
---------------------------------------------------------------------------

A. Fair Representation

    NASD stated that the proposed rule change was designed to provide a
``carefully balanced and calibrated governance structure that was
approved by a majority of the membership,'' rather than the existing
NASD governance structure preferred by a number of commenters.\177\
NASD stated that the proposed By-Law changes satisfy the statutory
requirement for ``fair representation'' pursuant to Section 15A(b)(4)
of the Exchange Act.\178\
---------------------------------------------------------------------------

    \177\ NASD Response Letter, supra note 5, at 4.
    \178\ Id. at 4-5.
---------------------------------------------------------------------------

1. Industry Representation and Classification of Governors
    In response to commenters who contended that the New SRO Board
would have insufficient industry representation, NASD stated that the
proposal ``ensures substantial industry representation, while still
maintaining the overall independence of the New SRO Board and the
numerical dominance of Public Governors'' and ``comfortably fits within
the parameters the Commission has previously articulated to comply with
the fair representation requirement.'' \179\ Specifically, NASD noted
that 40% of the New SRO Board would be composed of industry
representatives.\180\ NASD also noted that the member representation on
the New SRO Board would exceed the member representation of The NASDAQ
Stock Market LLC (``Nasdaq'') (whose Board is composed of 20% member
representatives), NYSE LLC (whose Board is wholly independent), NYSE
Regulation (whose Board is wholly independent \181\), and would be
comparable to member representation of the Chicago Stock Exchange
(``CHX'') (twelve directors, of which five are ``participants'') and
the International Securities Exchange LLC (``ISE'') (14 directors, of
which six are market participants allocated by business types).\182\
---------------------------------------------------------------------------

    \179\ Id. at 5.
    \180\ Id.
    \181\ The Commission notes that all of the directors on the
Board of NYSE Regulation, with the exception of the Chief Executive
Officer, must qualify as independent under the independence policy
of the board of directors of NYSE Euronext. See Second Amended and
Restated By-Laws of NYSE Regulation, Inc., Article III, Section 1.
    \182\ NASD Response Letter, supra note 5, at 5-7. In addition to
the 14 directors cited in the NASD Response Letter, the Commission
notes that the President and CEO of ISE also serves on the ISE Board
of Directors for a total of 15 directors. See ISE Constitution,
Article III, Section 3.2.
---------------------------------------------------------------------------

    In response to commenters who stated that the proposed rule change
would abolish the current ``one-member-one-vote'' governance structure
and the existing right to elect all of the NASD Board seats (with the
exception of the Chair of the National Adjudicatory Council and the
NASD CEO, who hold seats based on position), NASD stated that the
proposed governance structure ensures diversity of member
representation on the New SRO Board by guaranteeing certain seats for
different size firms and those with particular business models.\183\ In
this regard, NASD noted that small firm representation would increase
from one to three guaranteed seats.\184\ NASD also noted that the
``proposed composition of and selection process for the Small Firm
Governors and Large Firm Governors are identical, ensuring fairness and
balance between those firms that make up the largest percentage of
membership and those firms that employ the largest percentage of the
registered representative population.''\185\
---------------------------------------------------------------------------

    \183\ NASD Response Letter, supra note 5, at 5.
    \184\ Id.
    \185\ Id.
---------------------------------------------------------------------------

    NASD noted that the ``New SRO intends to maintain additional member
involvement in the administration of the New SRO's affairs through
representation on District Committees, Standing Committees, the
Advisory Council (consisting of the Chairs of the District Committees
and the Market Regulation Committee), the Small Firm Advisory Board,
disciplinary panels and the National Adjudicatory Council.'' \186\ NASD
also noted that the amended By-Law changes would maintain a one-member-
one-vote-system for all future By-Law changes.\187\
---------------------------------------------------------------------------

    \186\ Id. at 6.
    \187\ Id. at 5.
---------------------------------------------------------------------------

    Finally, NASD noted its belief that the presence of no fewer than
eleven Public Governors, none of which may have a material relationship
with a broker or dealer or registered SRO, satisfies the requirement to
have at least one director representative of issuers and
investors.\188\
---------------------------------------------------------------------------

    \188\ Id.
---------------------------------------------------------------------------

2. Appointed Governors
    In response to commenters who objected to the number of Governors
who would be appointed rather than elected, NASD believed that these
commenters failed to appreciate that the proposed governance structure
``strikes a balance between the necessity of overall independence and
the desire for substantial, meaningful and diverse industry
representation.'' \189\ NASD noted that the proposal provides for the

``Small Firm, Mid-Size Firm, and Large Firm Governors to be elected by
firms of corresponding size, each with an equal vote.'' NASD also noted
that the proposal exceeds the representation and participation
requirements of other SROs whose governance rules have previously been
approved by the Commission. Specifically, NASD noted that the business
combination between New York Stock Exchange, Inc. (``NYSE Inc.'') and
Archipelago Holdings, Inc. satisfied a parallel fair representation
standard pursuant to Section 6(b)(3) of the Exchange Act with the
requirement that members could elect 20% of the boards of New York
Stock Exchange LLC and NYSE Regulation and a provision allowing members
to nominate directly candidates for those seats through a petition
process.\190\ NASD stated that the New SRO By-Laws would allow members
to elect at least 28% of the total number of directors on the
Board.\191\ NASD noted that members may petition to place alternative
candidates on the ballot for their respective member-elected seats.
---------------------------------------------------------------------------

    \189\ Id. at 6.
    \190\ Id. at 5.
    \191\ Id.
---------------------------------------------------------------------------

    NASD noted that the proposed rule change provides for three
additional industry seats, namely, the Investment Company Affiliate
Governor, Independent Dealer/Insurance Affiliate Governor, and Floor
Member Governor.\192\ Moreover, NASD has committed that the Charter of
the New SRO's Nominating Committee provides that at least 20% of the
Committee will be composed of Industry Governors that are associated
with New SRO members.\193\ According to NASD, as a trade-off to
substantial industry participation on the Board and to maintain its
overall independence, ``it is reasonable and sensible to ensure that
public members are selected by a nominating committee and that the
Board is not dominated by the industry.'' \194\ NASD noted that the
three appointed Industry Governors represent seats with distinct
business models and that are important in informing the Board's
deliberations.\195\
---------------------------------------------------------------------------

    \192\ Id. at 7.
    \193\ NASD Supplemental Response Letter, supra note 5, at 4.
NASD also noted that the proposal establishes a Nominating Committee
that would nominate candidates for each seat other than that of the
CEO. The Nominating Committee would be a subset of the Board
determined in number and composition by the Board from time to time,
provided that the number of Public Governors on the committee must
always exceed the number of Industry Governors on it. NASD Response
Letter, supra note 5, at 6.
    \194\ NASD Response Letter, supra note 5, at 7.
    \195\ Id.
---------------------------------------------------------------------------

B. State Law and Proxy

    In response to some commenters who contended that NASD failed to
follow its existing procedures for adopting By-Law amendments,
specifically obtaining approval within the 30-day timeframe as set
forth in Article XVI of the NASD By-Laws,\196\ NASD stated that it
acted in a manner consistent with state law, which provides alternative
means to propose and adopt certain corporate governance changes. NASD
stated that Article XVI of the NASD By-Laws is not an exclusive means
by which member approval of amendments to the By-Laws can be obtained.
NASD noted that ``[m]embers of a Delaware non-stock corporation,
including NASD, may take action at an annual or special meeting held
pursuant to 8 Del. C. Sec.  211(a) or, unless otherwise restricted by
such corporation's certificate of incorporation, by written consent
pursuant to 8 Del. C. Sec.  228.'' NASD explained that, under this
authority, it convened a special meeting of NASD members pursuant to
Article XXI of the NASD By-Laws at which the New SRO By-Law amendments
were approved.\197\ In addition, to further support its position, NASD
submitted an opinion of counsel that, under Delaware law, ``it is
within the authority of the Members to approve proposed amendments to
the By-Laws * * * at a special meeting held more than thirty days after
the proposed By-Laws had been submitted to the Members,'' and that the
vote of NASD members ``was a valid exercise'' of the members''
franchise rights and authorized by Delaware law.\198\
---------------------------------------------------------------------------

    \196\ Article XVI of the NASD By-Laws provides that amendments
to the NASD By-Laws could become effective as of a date prescribed
by the NASD Board, if the amendment is approved by a majority of the
members voting within 30 days after the date of submission to the
membership, and is approved by the Commission.
    \197\ See NASD Response Letter, supra note 5, at 7.
    \198\ See RLF Letter, supra note 5.
---------------------------------------------------------------------------

    NASD took issue with the view of several commenters that the proxy
was incomplete or that certain statements by NASD management regarding
the potential consequences of failing to approve the proposed By-Law
changes were misleading.\199\ NASD noted that all the issues raised by
the commenters were subject to lively debate in advance of the member
vote. Specifically, members received communications from both the NASD
and groups opposing the transaction over a five week period that
included ``28 town hall meetings, conference calls, mailings, emails,
and telephone calls.'' \200\ NASD stated that it ``provided access to
its members contact list to groups opposing the transaction, and
thereby afforded these groups the opportunity to raise all of the
issues to the membership,'' who approved the By-Law amendments after
considering all of these arguments.\201\ In addition, NASD noted that
the ``proxy statement contained an extensive discussion of the
negotiations with NYSE Group, the rationale for the $35,000 payment,
and how the By-Law changes would affect the voting rights of NASD
members.'' \202\ NASD maintained that the statements made prior to the
member vote were consistent with the proxy statement.\203\
---------------------------------------------------------------------------

    \199\ See NASD Response Letter, supra note 5, at 8-9.
    \200\ Id. at 9.
    \201\ Id.
    \202\ Id.
    \203\ Id.
---------------------------------------------------------------------------

    In response to commenters' concerns regarding the amount of the
$35,000 payment to be made to members upon the Closing of the
Transaction, NASD noted that the proxy statement disclosed that the
$35,000 payment was based on the expected future incremental cash flows
that would result from the regulatory consolidation and was consistent
with public guidance from the Internal Revenue Service (``IRS'').\204\
In the NASD Supplemental Response Letter, NASD stated that its
Certificate of Incorporation prohibits NASD from paying dividends to
its members, and that doing so would result in forfeiture of NASD's
tax-exempt status under Section 501(c)(6) of the Internal Revenue
Code.\205\ NASD also explained that the proposed $35,000 member
payments did not constitute a prohibited dividend or comparable
distribution, because they ``are based on (and limited by) expected
future incremental cash flows that would result from the regulatory
consolidation.'' \206\ Further, NASD stated that ``any direct payment
unrelated to those efficiencies would be inconsistent with NASD's tax-
exempt status.'' \207\ NASD determined that ``$35,000 was the maximum
member payment that the IRS could be expected, with a sufficient degree
of confidence, to approve within the timeframe

contemplated for the transaction.'' \208\ NASD requested a private
letter ruling from the IRS approving the proposed regulatory
consolidation, including the $35,000 payment, and, according to NASD,
``[i]t was on this basis that the IRS agreed to issue such a ruling.''
\209\ NASD explained that ``the proxy materials accurately state that
member payments in excess of $35,000 could not be possible because such
a payment, without the IRS's approval, could `seriously jeopardize'
NASD's tax-exempt status.'' \210\ To further support its position, NASD
submitted an opinion of its outside tax counsel that described
generally the case law, statutory provisions, and guidance published by
the IRS relevant to the disclosure in the NASD's proxy statement, and
concluded that if NASD had increased the amount of the $35,000 payment,
there would have been a ``serious risk'' that the IRS would not have
issued the rulings and that NASD could be found to violate the
prohibition against private inurement.\211\ In addition, NASD's outside
Delaware counsel stated that, because the NASD's Certificate of
Incorporation contains a prohibition against inurement, any payment
that violates the federal tax code prohibition against inurement would
also be void under Delaware law.\212\
---------------------------------------------------------------------------

    \204\ Id.
    \205\ See NASD Supplemental Response Letter, supra note 5, at 2
(citing 26 U.S.C. 501(c)(6) (requirement that ``no part'' of an
exempt entity's net earnings inure to any private shareholder or
individual); I.R.S. Gen. Couns. Mem. 39862 (November 22, 1991)
(``There is no de minimis exception to the inurement
prohibition.''); see also Spokane Motorcycle Club v. United States,
222 F. Supp. 15 1, 153-54 (E.D. Wash. 1963) (refreshments provided
at no cost to club members invalidated tax exemption)).
    \206\ See NASD Supplemental Response Letter, supra note 5, at 2.
    \207\ Id. at 3.
    \208\ Id.
    \209\ Id.
    \210\ Id.
    \211\ See DPW Letter, supra note 5.
    \212\ See RLF Letter, supra note 5, at 5.
---------------------------------------------------------------------------

    In response to a commenter's question about the eligibility for the
positions of the Investment Company Affiliate Governor and the
Independent Dealer/Insurance Affiliate Governor, respectively, NASD
stated that the ``proposed rule change is intended to continue the
presence on the New SRO Board of representatives from the particular
business models of independent dealers/insurance companies and
investment companies and to provide the Nominating Committee the
flexibility to fill those Board seats with the best available
candidates affiliated with a firm from those industry segments.'' \213\
---------------------------------------------------------------------------

    \213\ See NASD Response Letter, supra note 5, at 8.
---------------------------------------------------------------------------

C. Efficiency and Investor Protection

    NASD stated that the commenters who stated that the consolidation
would result in less investor protection by reducing the number and
diversity of regulators overseeing the industry overstated the value of
a second, duplicative regulator and understated the benefits of the
regulatory consolidation.\214\ NASD stated that the combination would
achieve ``greater efficiencies, clarity and cost savings in the
regulation of the financial markets'' and that the ``investor
ultimately would be better protected by a single, more efficient
regulator administering a single streamlined set of rules with the
combined resources'' of the two organizations.\215\
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    \214\ Id.
    \215\ Id.
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D. Arbitration

    NASD separately addressed comments regarding the merger of the NASD
and NYSE arbitration forums.\216\ It highlighted the results of studies
commissioned by NASD\217\ and the Commission\218\ during the past
decade, which focused on forum users' perceptions of fairness, as well
as two General Accounting Office reports.\219\ In NASD's view, ``it is
the quality of the forum that dictates fairness rather than an
investor's ability to select one dispute resolution forum over
another.'' \220\ NASD also noted that it currently administers over 94%
of investor disputes with broker-dealers and that over the past decade
the Commission has approved consolidation of the arbitration programs
of other SROs with NASD with no adverse effects.\221\
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    \216\ See NASD Dispute Resolution Letters I & II, supra note 5.
    \217\ NASD Dispute Resolution Letter I, supra note 5 (citing G.
Tidwell, K. Foster and M. Hummell, Party Evaluations of Arbitrators:
An Analysis of Data Collected from NASD Regulation Arbitrations
(August 5, 1999) http://www.nasd.com/web/groups/med_arb/documents/mediation_arbitration/nasdw_009528.pdf
).

    \218\ NASD Dispute Resolution Letter I, supra note 5 (citing M.
Perino, Report to the SEC Regarding Arbitrator Conflict Disclosure
Requirements in NASD and NYSE Securities Arbitrations (November 4,
2002) http://www.sec.gov/pdf/arbconflict.pdf).

    \219\ NASD Dispute Resolution Letter I, supra note 5 (citing
Actions Needed to Address Problem of Unpaid Awards, GAO/GGD-00-115
(June 2000); Securities Arbitration: How Investors Fare, GAO/GGD-92-
74 (May 11, 1992)).
    \220\ See NASD Dispute Resolution Letter I, supra note 5.
    \221\ Id. (citing Securities Exchange Act Release No. 53128
(January 13, 2006), 71 FR 3550 (January 23, 2006) (approving
consolidation with Nasdaq); Securities Exchange Act Release No.
45094 (November 21, 2001), 66 FR 60230 (December 3, 2001)
(International Securities Exchange); Securities Exchange Act Release
No. 40622 (October 30, 1998), 63 FR 59819 (November 5, 1998)
(American Stock Exchange); Securities Exchange Act Release No. 40517
(October 1, 1998), 63 FR 54177 (October 8, 1998) (Philadelphia Stock
Exchange); Securities Exchange Act Release No. 39378 (December 1,
1997), 62 FR 64417 (December 5, 1997) (Municipal Securities
Rulemaking Board)).
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    With respect to the independence of its forum--and the suggestion
for creating an ``independent'' forum--NASD stated that it ``is an
independent forum.'' \222\ NASD explained that the majority of its
Dispute Resolution Board and its National Arbitration and Mediation
Committee are public representatives. It also noted that it is a member
of SICA. In addition, NASD stressed that it is financially self-
sufficient in that it is funded by fees charged to users of the forum--
broker-dealers, their associated persons, and investors.\223\ In this
regard, NASD also stated that although the consolidation should result
in economies of scale and increased efficiencies in administering the
New SRO arbitration forum, investors do not contribute toward
administrative costs.\224\ Rather, NASD stated that investors ``pay
only the marginal (that is, direct) costs attached to their particular
claim.'' \225\
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    \222\ NASD Dispute Resolution Letter I, supra note 5.
    \223\ Id.
    \224\ NASD Dispute Resolution Letter II, supra note 5.
    \225\ Id.
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    Responding to the suggestion that NASD rules provide that public
investors may choose between resolving their disputes in court or in
arbitration, NASD cited Shearson/American Express, Inc. v. McMahon\226\
and subsequent cases in which the Supreme Court upheld the use of pre-
dispute arbitration agreements. In NASD's view, the commenter's
proposal ``seeks to overturn federal case law dating back 20 years.''
\227\ Moreover, NASD stated that ``[w]hen investors (and other parties)
were offered a choice of another arbitration forum under the 2000 SICA
Pilot, there was little interest.'' \228\
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    \226\ 482 U.S. 220 (1987).
    \227\ NASD Dispute Resolution Letter I, supra note 5.
    \228\ Id. In particular, NASD noted ``[t]he SICA Twelfth Report
sums up the pilot's results this way: `From its inception, few
investors (or their attorneys) elected to proceed at a non-SRO
forum.' Based upon responses to a survey of investors, SICA reported
that investors' main reasons for not using the alternative forums
were the higher fees at non-SRO forums, and a general degree of
comfort with existing and more familiar procedures.''
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    NASD also noted that it ``continues to make significant
improvements to the dispute resolution forum to make the process more
transparent, fair, and efficient for investors and others who use the
forum.'' \229\ With respect to a comment on the composition of
arbitration panels, NASD noted that current NASD and NYSE rules provide
that customer arbitrations are resolved either by a single public
arbitrator or by a panel of two public and one non-public
arbitrator.\230\ Moreover, NASD

stated that it and NYSE are working to harmonize their definitions of
``public'' and ``non-public'' arbitrators, and any resulting proposed
rule changes would be filed with the Commission and subject to public
comment at that time.\231\ With respect to the comments regarding the
use of dispositive motions at NASD and NYSE, NASD stated that it
understands that NYSE arbitrators determine whether such motions will
be heard at a hearing as well as the timing of the hearing. In
contrast, NASD proposed a specific rule regarding dispositive
motions.\232\ NASD indicated that it will consider the comments
pertaining to dispositive motions in the context of that specific rule
proposal ``and may further amend the proposal.'' \233\
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    \229\ Id.
    \230\ NASD Dispute Resolution Letter II, supra note 5.
    \231\ Id.
    \232\ Id. (citing Securities Exchange Act Release No. 54360
(August 24, 2006), 71 FR 51879 (August 31, 2006) (File No. SR-NASD-
2006-088)).
    \233\ NASD Dispute Resolution Letter II,supra note 5.
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V. Discussion

    After careful review, and consideration of commenters' views and
the NASD's correspondence responding to comments, the Commission finds
that the proposed rule change is consistent with the requirements of
the Exchange Act and the rules and regulations thereunder applicable to
a national securities association.\234\ In particular, the Commission
finds that the proposed rule change is consistent with Section
15A(b)(2) of the Exchange Act,\235\ which requires a national
securities association to be so organized and have the capacity to
carry out the purposes of the Exchange Act and to enforce compliance by
its members and persons associated with its members with the provisions
of the Exchange Act. The Commission also finds that the proposed rule
change is consistent with Section 15A(b)(4) of the Exchange Act, which
requires that the rules of a national securities association assure the
fair representation of its members in the selection of its directors
and administration of its affairs, and provide that one or more
directors shall be representative of issuers and investors and not be
associated with a member of the exchange, broker, or dealer.\236\
Further, the Commission finds that the proposed rule change is
consistent with Section 15A(b)(6) of the Exchange Act,\237\ in that it
is designed, among other things, to prevent fraudulent and manipulative
acts and practices; 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.
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    \234\ In approving this proposed rule change, the Commission
notes that it has considered the proposed rule's impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
    \235\ 15 U.S.C. 78o-3(b)(2).
    \236\ 15 U.S.C. 78o-3(b)(4).
    \237\ 15 U.S.C. 78o-3(b)(6).
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    Self regulation is the cornerstone of the regulatory system
governing the U.S. securities markets. Over the years, the self-
regulatory system has functioned effectively and has served investors,
the securities industry, and the government well. However, NASD and
NYSE and many of their members believe that the current self-regulatory
system as it applies to member regulation should be simplified and
duplicative rules and conflicting interpretations of such rules should
be eliminated. To that end, NASD and NYSE Group have agreed to
consolidate their regulation of member firms. The proposal before the
Commission, which would amend the NASD By-Laws to establish the By-Laws
of the New SRO, is a key component in effectuating this regulatory
consolidation. These amendments would establish the structure of the
New SRO, which, among other things, would be responsible for reviewing
and harmonizing the duplicative NASD and NYSE rules governing member
firm regulation and conflicting interpretations of those rules. NASD
stated that it expects the New SRO to submit to the Commission within
one year of the date of the Closing proposed rule changes that would
constitute a significant portion of a harmonized rulebook, with the
remaining rules being submitted to the Commission within two years of
the Closing.\238\ The Commission has requested that the New SRO provide
the Commission with quarterly progress reports on the harmonization
project. In the Commission's view, the consolidation of NASD and NYSE
member firm regulation should help reduce unnecessary regulatory costs
while, at the same time, increase regulatory effectiveness and further
investor protection.
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    \238\ See NASD Supplemental Response Letter, supra note 5.
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    The Commission discusses below the significant aspects of the
proposed amendments to the NASD By-Laws.

A. Fair Representation of Members

1. Introduction
    Section 15A(b)(4) of the Exchange Act \239\ requires that the rules
of a national securities association assure the fair representation of
its members in the selection of its directors and administration of its
affairs. This requirement helps to assure that members have a stake in
the governance of the national securities association, which is charged
with self-regulatory responsibilities under the Exchange Act. Under the
New SRO By-Laws, the New SRO Board initially would consist of eleven
Public Governors and ten Industry Governors, including a Floor Member
Governor, an Independent Dealer/Insurance Affiliate Governor, an
Investment Company Affiliate Governor, three Small Firm Governors, one
Mid-Size Firm Governor, and three Large Firm Governors.\240\ The CEO of
the New SRO and, during the Transitional Period, the CEO of NYSE
Regulation, also would be Governors on the New SRO Board.\241\ The
three Small Firm Governors, the one Mid-Size Firm Governor, and the
three Large Firm Governors (collectively, ``Firm Governors'') would be
elected by the members of the New SRO.\242\ 39 42
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    \239\ 15 U.S.C. 78o-3(b)(4).
    \240\ See New SRO By-Laws, Article VII, Section 4 and Article
XXII, Section 2(a).
    \241\ See New SRO By-Laws, Article VII, Section 4, and Article
XXII, Section 2.
    \242\ See New SRO By-Laws, Article I(z), Article I(dd), Article
I(xx), and Article VII, Section 4(a).
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2. Board Composition
i. Classification of Member Governors
    A number of commenters, who are NASD members, argued that the New
SRO should retain the NASD's current ``one firm, one vote'' election
process. These commenters contended that they would be disenfranchised
by the New SRO By-Laws because, instead of being allowed to elect all
Governors, New SRO members would be allowed to elect only those
Governors who are from member firms that are comparable in size to
their own firm.\243\ Other commenters believed that the New SRO By-Laws
would provide for effective, diverse representation of all members of
the securities industry on the New SRO Board.\244\ In response, NASD
stated that the proposed governance structure ensures a diversity of
member representation on the New SRO Board by guaranteeing certain
seats for different size firms and for those firms with particular
business models.\245\NASD also noted that small firm representation on
the Board would increase from one to three guaranteed

seats.\246\ The Commission finds that the structure of the New SRO
Board--specifically the requirement that three Governors be elected by
Small Firm members, one Governor be elected by Mid-Size Firm members,
and three Governors be elected by Large Firm members \247\--is
consistent with the fair representation requirement of the Exchange
Act. In the Commission's view, this structure is a reasonable method to
assure the fair representation of the New SRO's members on the New
SRO's Board by affirmatively providing various New SRO constituencies
with representation on the New SRO Board.\248\ As a result, neither the
largest nor the smallest firms would be able to dominate the New SRO
Board. Moreover, issues or concerns of a particular New SRO
constituency could be brought to the attention of, and considered by,
the New SRO Board.
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    \243\ See, e.g., Lek Letter, Kosinsky Letter, Roberts Letter,
RKeenan Letter II, Miller Letters, Blumenschein Letter, Eitel Letter
II, de Leeuw Letter, Elish Letter, Patterson Letter, Callaway
Letter, Isolano Letter, Hebert Letter, Biddick Letter, John Q
Letter, and Schriner Letter.
    \244\ See Castiglioni Letter, FSI Letter, and Bakerink Letter.
    \245\ See NASD Response Letter, supra note 5, at 5.
    \246\ Id.
    \247\ See New SRO By-Laws, Article I(z), Article I(dd), Article
I(xx), and Article VII, Section 4(a).
    \248\ NASD noted that the proposed composition of and selection
process for the Small Firm Governors and Large Firm Governors are
identical, ensuring, according to the NASD, fairness and balance
between those firms that comprise the largest percentage of
membership and those firms that employ the largest percentage of the
registered representative population. See NASD Response Letter,
supra note 5, at 5.
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    The Commission notes that it has previously approved a governance
structure in which members are entitled to elect only those directors
that are from the same class as the member.\249\ Specifically, Primary
Market Makers, Competitive Market Makers, and Electronic Access Members
on the ISE are entitled to elect two directors each to represent these
categories of ISE's members on the ISE Board.\250\ In approving the
governance structure of the ISE, the Commission found that the
composition of the ISE Board and the selection of directors of ISE
satisfied the fair representation requirement of Section 6(b)(3) \251\
of the Exchange Act.\252\ The Commission believes that New SRO having
Governor positions based on the size of a firm is not dissimilar to the
governance structure of the ISE, which allocates rights to elect Board
seats based on the nature of the member's business.
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    \249\ See Securities Exchange Act Release No. 53705 (April 21,
2006), 71 FR 25260 (April 28, 2006) (relating to the reorganization
of the ISE into a holding company structure, whereby ISE Holdings,
Inc. would be the publicly-traded holding company of ISE, the SRO)
(``Release No. 53705'').
    \250\ The holders of ``PMM Rights,'' which Primary Market Makers
must hold to obtain trading rights on the ISE, are entitled to elect
two directors. The holders of ``CMM Rights,'' which Competitive
Market Makers must hold to obtain trading rights on the ISE, are
entitled to elect two directors. The holders of ``EAM Rights,''
which Electronic Access Members must hold to obtain trading rights
on the ISE, are entitled to elect two directors. Id.
    \251\ 15 U.S.C. 78f(b)(3). Section 6(b)(3) of the Exchange Act
is identical to Section 15A(b)(4) of the Exchange Act, except that
Section 6(b)(3) applies to national securities exchanges and Section
15A(b)(4) applies to national securities associations.
    \252\ See Securities Exchange Act Release No. 53705 (April 21,
2006), 71 FR 25260 (April 28, 2006) (noting that the ISE's proposed
governance structure was substantially the same as that of its
predecessor entity). In approving the governance structure of the
predecessor entity, the Commission found that the selection of six
of the 15 directors on the predecessor entity's board, and the
manner in which such directors are nominated and selected, satisfied
the fair representation requirement of Section 6(b)(3) of the
Exchange Act. See Securities Exchange Act Release No. 45803 (April
23, 2002), 67 FR 21306 (April 30, 2002) (approving the predecessor
entity's governance structure).
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ii. Appointed Governors
    Several commenters expressed concern that, because some Governors
would be appointed, member firms would not have the right to elect all
New SRO Governors.\253\ NASD, however, stated that these commenters
``fail[ed] to appreciate that the proposed governance structure strikes
a balance between the necessity of overall independence and the desires
for substantial, meaningful and diverse industry representation.''
\254\ NASD noted that, under the proposed New SRO By-Laws, members not
only would be entitled to elect at least 28% of the total number of
Governors, but also would be represented through three additional
Industry Governor positions and the potential for member-elected
Governors to serve on the Nominating Committee.\255\ NASD also noted
that the Commission previously approved governance structures that
provided for a lower threshold of member representation regarding the
selection of an SRO's directors and administration of its affairs than
in the proposed New SRO By-Laws. Specifically, NASD noted that the
Commission found consistent with the fair representation requirement
the governance structure of NYSE LLC, whereby members elect 20% of the
wholly independent board of directors of NYSE LLC and have the right to
nominate directly candidates through a petition process.\256\ NASD also
noted that the Commission found that the governance structure of the
Nasdaq, whose Board of Directors also is composed of 20% member
representatives, satisfies the fair representation standard of the
Exchange Act, and that member representation on the proposed New SRO
Board would exceed that of the Nasdaq's Board of Directors.\257\
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    \253\ See Lek Letter, RKeenan Letter I & II, Hebert Letter,
Mayfield Letter, Blumenschein Letter, Eitel Letter II, de Leeuw
Letter, Elish Letter, Patterson Letter, Schriner Letter, Roberts
Letter, and Biddick Letter. See also Johnny Q Member Letters I & II,
Benchmark/Standard Letter I, and Benchmark Letter, which referred to
the Standard Lawsuit, supra note 81.
    \254\ See NASD Response Letter, supra note 5, at 6.
    \255\ Id. at 7.
    \256\ Id. at 5 (citing Securities Exchange Act Release No. 53382
(February 27, 2006), 71 FR 11251 (March 6, 2006) (relating to the
NYSE's business combination with Archipelago Holdings, Inc.)
(``Release No. 53382'')).
    \257\ Id. at 6 (citing Securities Exchange Act Release No. 53128
(January 13, 2006), 71 FR 3550 (January 23, 2006)). NASD also stated
that member representation on the New SRO Board is comparable to
member representation on the Chicago Stock Exchange (twelve
directors, of which five are members) and the International
Securities Exchange (14 directors, of which six are members). Id.
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    The Commission finds that the structure of the New SRO Board, in
which specified Governors are appointed and Firm Governors are elected,
is consistent with the Exchange Act. The Commission notes that New SRO
members will have the right to elect a total of seven Firm Governors
out of 23 Governors (22 after the Transitional Period), or
approximately 30% of all Governors. The Commission previously approved
structures in which members were not guaranteed the right to elect all
directors.\258\ For example, the Commission approved ISE governance
documents that provide that the holding company for ISE, not ISE
members, would elect eight non-industry directors. In addition,
Nasdaq's governance documents provide that Nasdaq members would have
the right to elect 20% of Nasdaq's directors, while the holding company