[Federal Register: July 20, 2006 (Volume 71, Number 139)]
[Notices]
[Page 41291-41305]
[DOCID:fr20jy06-96]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54155; File No. SR-NASDAQ-2006-001]

Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order
Approving a Proposed Rule Change and Amendment No. 1 Thereto and Notice
of Filing and Order Granting Accelerated Approval to Amendment Nos. 2
and 3 Thereto Relating to the Nasdaq Market Center

July 14, 2006.

I. Introduction

    On February 7, 2006, The NASDAQ Stock Market LLC (``Nasdaq'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to integrate the operations of the existing Nasdaq
Market Center, along with Nasdaq's Brut and INET facilities. On March
29, 2006, Nasdaq submitted Amendment No. 1 to the proposed rule change
(``Amendment No. 1''). The proposed rule change, as amended by
Amendment No. 1, was published for comment in the Federal Register on
April 14, 2006.\3\ The Commission received twelve comments regarding
the proposal.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 53583 (March 31,
2006), 71 FR 19573 (``Single Book Proposal'').
    \4\ See letter from Kim Bang, Chief Executive Officer, Bloomberg
Tradebook LLC (``Bloomberg'') (``Kim Bang'') to Brian G. Cartwright,
General Counsel, Commission, dated March 6, 2006 (``Bloomberg
Comment Letter I''); letter from Kim Bang, David Cummings, Chief
Executive Officer, BATS Trading, Inc. (``BATS'') (``David
Cummings''), Ronald Pasternak, President, Direct Edge ECN LLC, and
Martin Kaye, Chief Executive Officer, Track ECN (``Track'')
(``Martin Kaye'') to Robert L.D. Colby, Acting Director, Division of
Market Regulation (``Davision''), Commission, dated March 21, 2006
(``ECN Comment Letter''); letter from Kim Bang to Jonathan G. Katz,
Secretary, Commission (``Jonathan Katz''), dated May 5, 2006
(``Bloomberg Comment Letter II''); letter from David Cummings to
Christopher Cox, Chairman, Commission (``Chairman Cox''), dated May
5, 2006 (``BATS Comment Letter''); letter from Martin Kaye to
Chairman Cox, dated May 5, 2006 (``Track Comment Letter I''); letter
from Leonard J. Amoruso, Senior Managing Director and Chief
Compliance Officer, Knight Capital Group, Inc. (``Knight'') to Nancy
M. Morris, Secretary, Commission (``Nancy Morris''); dated May 5,
2006 (``Knight Comment Letter''); letter from C. Thomas Richardson,
Managing Director, Citigroup Global Markets Inc. (``Citigroup'') to
Nancy Morris, dated May 17, 2006 (``Citigroup Comment Letter'');
letter from Kim Bang to Nancy Morris, dated May 30, 2006
(``Bloomberg Comment Letter II''); letter from David C. Chavern,
Vice President, Capital Markets Program, U.S. Chamber of Commerce
(``USCC'') to Nancy Morris, dated June 8, 2006 (``USCC Comment
Letter''); letter from David Colker, National Stock Exchange
(``NSX'') to Chairman Cox, dated June 20, 2006 (``NSX Comment
Letter''); letter from Kim Bang to Nancy Morris, dated June 23, 2006
(``Bloomberg Comment Letter IV''); and letter from Martin Kaye to
Chairman Cox, dated July 3, 2006 (``Track Comment Letter II'').

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    On July 7, 2006, Nasdaq filed Amendment No. 2 to the proposed rule
change (``Amendment No. 2''). On July 14, 2006, Nasdaq filed Amendment
No. 3 to the proposed rule change (``Amendment No. 3''). This order
approves the proposed rule change, as amended by Amendment No. 1.
Simultaneously, the Commission is providing notice of filing of
Amendment Nos. 2 and 3 and granting accelerated approval of Amendment
Nos. 2 and 3.

II. Description

    Nasdaq proposes to combine the operations of the existing Nasdaq
Market Center with its Brut and INET facilities to create a single
integrated system, with a single pool of liquidity (the ``Integrated
System'' or ``System''). The Integrated System would only accept
automatic executions and would eliminate Nasdaq's current order
delivery functionality. The Integrated System is designed to enable
Nasdaq to operate its execution system as that of a national securities
exchange rather than as a national securities association, pursuant to
the Commission order, dated January 13, 2006, approving Nasdaq's
application to register as a national securities exchange.\5\ In
addition, Nasdaq has designed the Integrated System to comply with the
requirements of Rules 610 and 611 of Regulation NMS under the Act
(``Regulation NMS'').\6\Nasdaq has designated August 28, 2006 as the
initial implementation date for this System.\7\
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    \5\ See Securities Exchange Act Release No. 53128 (January 13,
2006), 71 FR 3550 (January 23, 2006) (``Exchange Application
Order'').
    \6\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496 (June 29, 2005).
    \7\ See Amendment No. 3.
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    Nasdaq currently operates three execution systems: (1) The Nasdaq
Market Center, formerly known as SuperMontage (``NMC Facility''); (2)
the Brut ECN, a registered broker-dealer that is a Nasdaq subsidiary
(``Brut Facility''); and (3) the INET ECN, which is operated by Brut,
LLC, a subsidiary of Nasdaq (``INET Facility'') (collectively, the
``Nasdaq Facilities'').\8\ Currently, the Nasdaq Facilities are all
linked, but separate, each operating pursuant to independent
Commission-approved rules, with the NMC Facility operating under the
4700 Series, the Brut Facility operating under the 4900 Series, and the
INET Facility operating under the 4950 Series.
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    \8\ In its Single Book Proposal, Nasdaq noted that, until
January 31, 2006, INET ATS, Inc. was a registered broker-dealer and
a member of the NASD. On February 1, 2006, the INET broker-dealer
and a member of the NASD. On February 1, 2006, the INET broker-
dealer was merged into the Brut broker-dealer which is a member of
the New York Stock Exchange (``NYSE''). Nasdaq states that it will
continue to operate the Brut Facility and INET Facility under the
rubric of a single broker-dealer until the Integrated System is
fully operational. See Single Book Proposal at 19589.
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    Under the proposal, as amended, Nasdaq seeks to integrate the
matching systems of the three Nasdaq Facilities into a single matching
system, governed by a single set of rules. To ease the transition for
Nasdaq participants, the Integrated System would be accessible through
the same connectivity by which users currently access each of the
Nasdaq Facilities, and use functionality that is already approved and
operating within one or more of the Nasdaq Facilities. For example, the
Integrated System would use slightly modified functionality from the
INET Facility for order entry, display, processing, and routing, and
draw on functionality in the NMC Facility for the opening and closing
processes. Participants would remain subject to general obligations
applicable to all Nasdaq Facilities, including honoring System trades,
complying with all Commission and Nasdaq rules, and properly clearing
and settling trades. The proposed rule change, as amended, is designed
to ensure Nasdaq's readiness to comply with Regulation NMS and
facilitate Nasdaq's operation as a national securities exchange.
    As the proposed rule change merges the three Nasdaq Facilities into
a single platform, it also simplifies Nasdaq's rules by merging five
sets of rules (the 4600, 4700, 4900, 4950, and 5200 Series) into two
(the 4600 and 4750 Series). The proposed 4600 Series would govern
Nasdaq participants, while the proposed 4750 Series would govern the
operation of the Integrated System. The proposed rule change would
delete in the following series of rules in their entirety: Series 4700
(Nasdaq Market Center--Execution Services), Series 4900 (Brut Systems),
Series 4950 (INET System), and Series 5200 (Intermarket Trading System/
Computer Assisted Execution System). The proposed rule change would add
new Series 4750 (Nasdaq Market Center--Execution Services) and modify
current Series 4600 (Requirements for Nasdaq Market Makers and Other
Nasdaq Market Center Participants), including renumbering rules
governing participants' obligations to honor trades and to comply with
applicable rules and registration requirements.
    In addition to reorganizing the rules, and making changes to the
Exchange's rules for exchange and Regulation NMS readiness, the
proposed rule change, as amended, addresses, among other things,
openings and closings, the order display/matching system, order types,
time in force designations, anonymity, routing, book processing,
adjustment of open orders,\9\ and Nasdaq's plan for a phased-in
implementation of the proposed rule change.
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    \9\ See supra note 3.
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    In Amendment No. 2, because of the extension of certain compliance
dates relating to Regulation NMS, Nasdaq proposed to modify certain
rules such that their effectiveness would coincide with the Regulation
NMS compliance dates announced by the Commission. Amendment No. 2 also
contained a number of non-substantive changes and technical corrections
to clarify the proposal.
    In Amendment No. 3, Nasdaq proposed to schedule the implementation
of the System beginning August 28, 2006.\10\ Nasdaq described its
planned phase-in schedule for the Integrated System and intention to
test the System during the month of July and early in August prior to
the transition. Then, beginning August 28, 2006, Nasdaq would
transition Nasdaq-listed securities in three groups over a three-week
period with 15 to 30 Nasdaq-listed stocks the first week, an additional
100-200 Nasdaq-listed stocks the second week, followed by the remaining
Nasdaq-listed stocks the third week. Following the transition of Nasdaq
stocks, Nasdaq would transition all non-Nasdaq-listed securities (i.e.,
NYSE, American Stock Exchange (``Amex''), and regional-listed stocks).
Nasdaq noted that it plans to monitor the implementation and adjust the
schedule as needed to maintain an orderly transition.
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    \10\ The Commission notes that Amendment No. 3 replaces the
August 14, 2006 implementation date that Nasdaq had proposed in
Amendment No. 2.
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III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether Amendment Nos. 2
and 3 are consistent with the Act. Comments may be submitted by any of
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml
); or

     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number SR-NASDAQ-2006-001 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NASDAQ-2006-001. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent amendments,

all written statements with respect to the proposed rule change that
are filed with the Commission, and all written communications relating
to the proposed rule change between the Commission and any person,
other than those that may be withheld from the public in accordance
with the provisions of 5 U.S.C. 552, will be available for inspection
and copying in the Commission's Public Reference Room. Copies of the
filing also will be available for inspection and copying at the
principal office of the Exchange. All comments received will be posted
without change; the Commission does not edit personal identifying
information from submissions. You should submit only information that
you wish to make available publicly. All submissions should refer to
File Number SR-NASDAQ-2006-001 and should be submitted on or before
August 10, 2006.

IV. Summary of Comments Received

    The Commission received twelve comment letters, representing seven
different entities, on the proposed rule change.\11\ Five of the seven
commenters either directly or indirectly operate electronic
communications networks (``ECNs''). Each of the ECN commenters opposed
the proposed rule change. The remaining two commenters did not directly
support or oppose the proposal.
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    \11\ See supra note 4. Other than the Bloomberg Comment Letter
I, all the comment letters discussed not only SR-NASDAQ-2006-001,
but SR-NASD-2006-048 as well. In NASD-2006-048, Nasdaq propoess to
charge an order delivery fee of 10 cents per 100 shares to order
delivery participants on its system. See Securities Exchange Act
Release No. 53644 (April 13, 2006), 71 FR 20149 (April 19, 2006)
(``Order Delivery Fee Proposal''). The summary here focuses on the
comment letter discussions relating to SR-NASD-2006-001, rather than
those relating to the Order Delivery Fee Proposal.
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    Bloomberg submitted four comment letters. The Bloomberg Comment
Letter I was submitted prior to Nasdaq's submission of Amendment No. 1.
In that letter, Bloomberg commented on one provision of the proposal
that would have prohibited members from charging access fees triggered
by the execution of a quotation within the System.\12\ Bloomberg
suggested that such a provision would violate Section 6(e)(1) of the
Act,\13\ which states that ``no national securities exchange may impose
any schedule or fix rates of commissions, allowances, discounts, or
other fees to be charged by its members.'' In addition, the Bloomberg
Comment Letter I asserted that the Form 19b-4 did not adequately
discuss or justify the burdens on competition with respect to the
proposed prohibition on fees.\14\ Bloomberg recommended that Nasdaq
withdraw the provision of the proposal regarding the prohibition of
fees. In Amendment No. 1, Nasdaq eliminated its proposal to prohibit
members from charging access fees.\15\
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    \12\ Bloomberg Comment Letter I at 1-2.
    \13\ 15 U.S.C. 78f(e)(1).
    \14\ Boomberg Comment Letter I at 2-4.
    \15\ See infra Section V.
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    In its second comment letter, Bloomberg objected to proposed Nasdaq
Rule 4623(b)(5), which would eliminate the order delivery functionality
from Nasdaq's rules, because it would expose ECNs to the risk of dual
liability.\16\ Bloomberg said that dual liability was ``a risk that in
the past the Commission found to justify requiring Nasdaq to provide
order delivery as opposed to execution delivery.'' \17\ Bloomberg
opined that eliminating the order delivery functionality, and thereby
requiring all Nasdaq participants to accept automatic execution, would
force ECNs to ``abandon their current business models and begin to act,
involuntarily, as dealers;'' currently, unlike market makers, ECNs act
as agency brokers and do not carry inventory or act as principal.\18\
Bloomberg also asserted that because ECNs do not earn a market maker's
bid-ask spread, being forced to ``eat'' an execution could ``never be
profitable'' for ECNs.\19\ Bloomberg concluded that this aspect of the
proposal would force ECNs out of the Nasdaq market. Bloomberg
questioned how investors and the national market system would be well
served by eliminating the competitive liquidity and investor choices
provided by ECNs from the Nasdaq platform.\20\
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    \16\ Bloomberg Comment Letter II at 1.
    \17\ Bloomberg Comment Letter II at 8-9, note 7 (citing
Securities Exchange Act Release No. 43863 (January 19, 2001), 66 FR
8020 (January 26, 2001) (``SuperMontage Order'')), See also ECN
Comment Letter at 3.
    \18\ Bloomberg Comment Letter II at 4; see also Citigroup
Comment Letter at 1.
    \19\ Bloomberg Comment Letter II at 4.
    \20\ Bloomberg Comment Letter II at 2, 10. Bloomberg noted that
the ``independent ECNs'' at risk represent some 15% of the total
Nasdaq volume.
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    The Bloomberg Comment Letter II took issue with Nasdaq's claim that
the order delivery functionality of ECNs made Nasdaq less competitive
by slowing its execution services. Bloomberg stated that Nasdaq's claim
did not include any data or factual support, and was ``incredible on
its face.'' \21\ Bloomberg noted that Nasdaq market participants
entering orders could effectively choose to have their orders sent to
automatic execution participants; thus, if order delivery ECNs were
consistently slower or less efficient, they would suffer dire business
consequences.\22\ The comment letter also noted that Nasdaq itself
routes orders to other market centers, such as Archipelago, and that
there was no indication that this routing slowed down its system.
Bloomberg stated that its typical response time to incoming Nasdaq
orders was 5-20 milliseconds. Bloomberg posited that slow quotation
updates, rather than order delivery delays, were the true cause of
Nasdaq's system slowdowns. Bloomberg noted that the Nasdaq Quotation
Dissemination Service feed had latencies of 500 milliseconds or more
during periods of high market activity.\23\
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    \21\ Bloomberg Comment Letter II at 5.
    \22\ Bloomberg Comment Letter II at 5-6.
    \23\ Bloomberg Comment Letter II at 6-8.
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    Bloomberg also disagreed with Nasdaq's characterization of the
Division's response to Question 5 of its Responses to Frequently Asked
Questions Concerning Rule 611 and Rule 610 of Regulation NMS.\24\ In
the Single Book Proposal, Nasdaq stated that it did not believe that it
could offer order delivery functionality and also satisfy Question 5's
standard of continuously providing ``a response to incoming orders that
does not significantly vary between orders handled entirely within the
SRO trading facility and orders delivered to the ECN.'' \25\ In
Bloomberg's view, Question

5 does not ``authorize Nasdaq to drop order delivery without
considering the factors the Division cited.'' Bloomberg believed that
the Division suggested that Nasdaq could ``continue to deliver orders
to an ECN as long as Nasdaq's order-handling performance does not
significantly vary between orders handled entirely within the SRO
trading facility and orders delivered to the ECN.'' \26\ Rather than
considering whether it could meet the conditions outlined by the
Division in its NMS FAQs relating to order delivery functionality,
Bloomberg believed that Nasdaq chose not to confront the issue.
Bloomberg believed that the ``facts demonstrate that there is no valid
basis for Nasdaq's proposed deletion of order delivery to ECNs that can
respond within milliseconds.'' \27\
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    \24\ Division of Market Regulation (``Division''), Responses to
Frequently Asked Questions Concerning Rule 611 and Rule 610 of
Regulation NMS, dated January 27, 2006 (``NMS FAQs'') (available at
http://www.sec.gov/divisions/marketreg/rule611faq.pdf).

    \25\ Single Book Proposal at 19591, citing NMS FAQs at Question
5.
    \26\ Bloomberg Comment Letter II at 7.
    \27\ Bloomberg Comment Letter II at 7-8.
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    Bloomberg also argued that the proposed rule change was
inconsistent with the Act, in that Nasdaq's analysis of the proposal's
impact on competition failed to consider ``the liquidity that ECN
participants provide to investors, the advantage this brings to
investors and the internal discipline and drive to innovation within
Nasdaq itself that is provided by the ECNs.''\28\
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    \28\ Bloomberg Comment Letter II at 8.
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    Bloomberg posited that the proposed rule change was inconsistent
with Section 6(b)(5) of the Act \29\ because it discriminated unfairly
against ECNs in that the only order delivery participants on Nasdaq are
ECNs. Bloomberg also opined that the proposed rule change was
inconsistent with Nasdaq's obligations under the Act to promote a free
and open market and a national market system. In addition, Bloomberg
believed that the proposal would violate Section 6(b)(8) of the Act
\30\ by imposing burdens on competition that are not necessary or
appropriate in furtherance of the purposes of the Act. Finally,
Bloomberg noted that Section 3(f) of the Act \31\ requires the
Commission to consider whether the proposed rule change would promote
competition.\32\
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    \29\ 15 U.S.C. 78f(b)(5).
    \30\ 15 U.S.C. 78f(b)(8).
    \31\ 15 U.S.C. 78c(f).
    \32\ Bloomberg Comment Letter II at 9-11.
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    In its comment letter, Citigroup stated its belief that the
National Association of Securities Dealers, Inc.'s (``NASD'')
Alternative Display Facility (``ADF'') currently does not provide a
viable alternative to the Nasdaq platform. Citigroup cited the ADF's
connectivity costs, inability to quote NYSE- and Amex-listed
securities, and inability to display sub-penny quotations to four
decimal places for sub-$1.00 securities. In addition, Citigroup
asserted that the ADF was a more expensive facility for ECNs, because
it charged for quotation updates and did not have a general revenue
sharing plan. Citigroup also believed that the ADF provided inadequate
order protection because it would not provide an aggregate top-of-the-
book quotation with protection under Rule 611 of Regulation NMS.\33\
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    \33\ Citigroup Comment Letter at 2-3.
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    In support of its claim that the ADF is not a viable alternative to
Nasdaq, Citigroup noted that daily volume on the ADF averaged
approximately fifteen million shares compared to the total daily volume
of approximately 1.7 billion shares for Nasdaq securities.\34\ Finally,
Citigroup said that the Commission, in response to various ADF-related
comments in the Nasdaq exchange application context,\35\ indicated that
the ADF was not a viable alternative to the Nasdaq Market Center.\36\
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    \34\ Citigroup Comment Letter at 3.
    \35\ See supra note 5.
    \36\ Citigroup Comment Letter at 3, quoting Exchange Application
Order at 57-58 (referring to comments from the Securities Industry
Association and Instinet).
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    In its third comment letter, responding to Nasdaq's initial comment
response letter,\37\ Bloomberg endorsed the ``main thrust'' of
Citigroup's comment letter, in particular supporting Citigroup's
assertion that the ADF was not a viable alternative to Nasdaq, pointing
to the ADF's connectivity issues and its lack of capability to provide
an aggregate top-of-book quotation under Rule 611 of Regulation
NMS.\38\ Bloomberg also reiterated its disagreement with Nasdaq's
assertion that retaining order delivery would slow down the Nasdaq
market.\39\ In addition, Bloomberg emphasized that several other ECNs
shared their concerns about the proposal.\40\
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    \37\ See infra note 75.
    \38\ Bloomberg Comment Letter III at 1.
    \39\ Bloomberg Comment Letter III at 2.
    \40\ Bloomberg Comment Letter III at 2.
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    Bloomberg stated that, contrary to Nasdaq's assertions in its
initial comment response letter, the existing platform of the NSX is
not a viable venue for multiple participants, particularly in light of
its limited capacity. While acknowledging that BATS had moved from
Nasdaq to NSX, Bloomberg pointed out that, notwithstanding that BATS is
a very new ECN and has a relatively light share volume, BATS
experienced a significant decrease in trading volume following its move
to NSX. In addition, Bloomberg argued that, because the current NSX
platform is unable to attribute quotes for multiple participants,
market participants might be required to build temporary connectivity
to each ECN participating in NSX, which would divert the industry's
attention and resources at a time when implementation of Regulation NMS
and industry consolidation issues were already pushing programming
capacity to its limits.\41\
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    \41\ Bloomberg Comment Letter III at 2-3.
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    Bloomberg also believed that Nasdaq, in its initial comment
response letter, misstated the Commission's duties under the Act.
Bloomberg opined that the Act put a special burden on self-regulatory
organizations (``SROs'') if an SRO such as Nasdaq wished to change an
existing rule or system. Bloomberg believed that Nasdaq must
demonstrate that such change is lawful, does not unfairly discriminate
among members, and that any resulting burden on members is necessary or
appropriate in furtherance of the purposes of the Act, which Bloomberg
contrasted with an SRO's own commercial purposes. In addition,
Bloomberg believed that whether other national securities exchanges had
similar systems should not be relevant to the Commission's
analysis.\42\
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    \42\ Bloomberg Comment Letter III at 4-6.
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    Bloomberg also posited that the data Nasdaq provided in its initial
comment response letter pertaining to order delivery transactions was
contextually insufficient. Bloomberg pointed to the speed of Nasdaq's
quotation updates as a factor in order failures, and noted that Nasdaq
had not provided data regarding the speed of quotation updates during
high volume openings and closings. Bloomberg also suggested that,
rather than removing order delivery functionality from its system,
Nasdaq should establish rules to mandate faster quotation updates. In
addition, Bloomberg proposed that Nasdaq could prevent some ECN
outliers from exceeding its 5-second response time rule by mandating a
500-millisecond or even 50-millisecond rule.\43\
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    \43\ Bloomberg Comment Letter III at 6-8.
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    Bloomberg also noted that, based on public statements of Nasdaq and
the Commission, an order delivery ECN would have reasonably believed
that either order delivery functionality would remain on the Nasdaq
system indefinitely or an order delivery ban would not occur until the
fall of 2006 at the earliest.\44\ Bloomberg contended that it was not
seeking to slow down Nasdaq's Single Book Proposal, but rather Nasdaq
had accelerated the

timing of the new system's roll-out. In addition, Bloomberg noted that
the roll-out of the Single Book Proposal is not necessary to the
commencement of Nasdaq's operation as an exchange and ``would visit
needless disruption and dislocation not only on the independent ECNs
but on the market as a whole'' and would ``unfairly disadvantage
independent ECNs and regional exchange competitors, such as NSX.'' \45\
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    \44\ Bloomberg Comment Letter III at 8-9.
    \45\ Bloomberg Comment Letter III at 9-10.
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    Bloomberg also believed that the elimination of order delivery
functionality would burden competition for order flow in Nasdaq-listed
securities. Bloomberg claimed that Nasdaq acquired INET and Brut ``with
a view to curtailing competition for order flow in Nasdaq securities''
and was now ``attempting to perfect its monopoly by crushing the
remaining independent ECNs.'' \46\ Finally, Bloomberg believed that
Nasdaq, in its initial comment response letter, misstated the
Commission's authority when it said that the Commission lacked the
statutory authority to provide a delay. Bloomberg believed that the
Commission has clear authority to require Nasdaq to provide an adequate
transition period in its proposal, and could request that Nasdaq amend
its proposal to build in such a delay.\47\
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    \46\ Bloomberg Comment Letter III at 10.
    \47\ Bloomberg Comment Letter III at 10-11.
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    The remaining ECN commenters each endorsed the positions set forth
in the Bloomberg Comment Letter II.\48\ Some commenters also expressed
their concern not only about short-term market dislocation and
disruption,\49\ but also regarding the long-term loss of investor
choice.\50\ In particular, Bloomberg stated that, since Nasdaq's
acquisition of the Brut and INET ECNs in the past two years, trading in
the Nasdaq market had become more concentrated and less competitive.
Bloomberg opined that Nasdaq was driving other ECNs off its system to
allow it ``to charge monopoly rents for access to its market and for
market data.'' \51\ In addition, some of the commenters felt that
Nasdaq's proposal represented a for-profit exchange using the
regulatory process to eliminate competition.\52\
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    \48\ See BATS Comment Letter, Track Comment Letter I, Knight
Comment Letter.
    \49\ See BATS Comment Letter, Track Comment Letter I at 1,
Bloomberg Comment Letter II at 2.
    \50\ See BATS Comment Letter, Bloomberg Comment Letter II at 2.
    \51\ See Bloomberg Comment Letter II at 2.
    \52\ See BATS Comment Letter, Track Comment Letter I at 1,
Bloomberg Comment Letter II at 1, 3.
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    Bloomberg also noted that it did not believe that requiring Nasdaq
to maintain its order delivery functionality would imply an affirmative
obligation for other national securities exchanges to provide the
same.\53\ Finally, Bloomberg and Track requested that if the Commission
decided to approve the proposed rule change, more time should be given
to the ECNs to find another venue to operate their business.\54\
Similarly, the USCC encouraged the Commission to, as a matter of good
process, ``consider the need for appropriate transition periods''
should the proposed rule change be adopted.\55\
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    \53\ See Bloomberg Comment Letter II at 11.
    \54\ See Bloomberg Comment Letter II at 11 (delay in the
effective date); Track Comment Letter I at 2 (phased-in approach).
    \55\ See USCC Comment Letter at 1-2.
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    In response to Nasdaq's fourth comment letter regarding technical
difficulties relating to INET's participation in the NSX,\56\ NSX
submitted a comment letter to describe its relationship with Nasdaq and
INET, in particular noting that NSX's dissemination of quotations for
Nasdaq may be slow because of Nasdaq's own internal system delays.\57\
NSX also noted that it intended to build a robust, state-of-the-art
trading system that should help minimize future problems related to the
capacity of, or linkage to, its market.\58\
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    \56\ See infra note 99.
    \57\ See NSX Comment Letter at 1-2.
    \58\ See NSX Comment Letter at 1-2.
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    On June 23, 2006, Bloomberg submitted its fourth comment letter,
welcoming the USCC Comment Letter's call for an appropriate transition
period, and describing Nasdaq's third and fourth response letters \59\
as containing misleading statements and false assertions.\60\ Bloomberg
believed that Nasdaq's characterization in its third comment letter
that the two ECNs operating on NSX (BATS and INET) were cohabitating
with little disruption contrasted with Nasdaq's fourth response letter
which stated that the NSX platform was experiencing severe capacity
overages and delays.\61\ In addition, Bloomberg said that Nasdaq's
claim in its fourth comment letter that the Commission had ordered INET
to cease quoting in NSX by September 1, 2006 was untrue, noting that
the Commission merely recognized a Nasdaq representation that it would
cease quoting in NSX and the correct date was September 30, 2006.\62\
Bloomberg emphasized that the difference between the two dates was
crucial, and stated that the ``Commission understood that additional
time beyond September 30, 2006 might be prudent and necessary.'' \63\
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    \59\ See infra Nasdaq Response Letter III and Nasdaq Response
Letter IV, notes 92 and 99.
    \60\ See Bloomberg Comment Letter IV at 1-2 and 4-5.
    \61\ See Bloomberg Comment Letter IV at 2.
    \62\ See Bloomberg Comment Letter IV at 3 (citing Nasdaq Rule
4720).
    \63\ See Bloomberg Comment Letter IV at 3.
---------------------------------------------------------------------------

    Bloomberg also reiterated its prior arguments regarding the need
for business certainty and that Nasdaq had given the expectation that
its Single Book Proposal would be rolled out in December 2006.
Bloomberg said that, because of the resulting uncertainty and confusion
of Nasdaq's earlier proposed roll-out date, ECNs have had to explore
and develop, at substantial cost, a number of competing alternative
scenarios; for example, Bloomberg has explored an interim migration to
another platform, temporarily participating in Nasdaq while trying to
prevent double execution, and ultimately migrating to an exchange
platform that offers order delivery and quotation display. Bloomberg
stated that the lack of certainty has ``impeded sound business planning
and threatens to constrict investor choice and the development of sound
market alternatives.'' \64\
---------------------------------------------------------------------------

    \64\ See Bloomberg Comment Letter IV at 4.
---------------------------------------------------------------------------

    Bloomberg also disputed Nasdaq's statement regarding its
participation in Nasdaq's Opening and Closing Crosses, stating that it
has had to develop special facilities to integrate during such times
with Nasdaq and that, during those limited periods, Bloomberg simply
operates as an order-routing system.\65\ In addition, Bloomberg also
disputed various characterizations by Nasdaq, including its NSX
participation, percentage of total Nasdaq trading volume attributable
to order delivery executions, and the data Nasdaq presented with regard
to Bloomberg's response times in early May 2006.\66\ Bloomberg also
again suggested that Nasdaq could enforce its 5-second response time
rule or even impose a more stringent 50-millisecond rule.\67\ Finally,
Bloomberg believed that, contrary to Nasdaq's assertions in its
response letters, it was proper for the Commission to consider comment
letters received after the comment period deadline had expired.\68\
---------------------------------------------------------------------------

    \65\ See Bloomberg Comment Letter IV at 5.
    \66\ See Bloomberg Comment Letter IV at 5-7.
    \67\ See Bloomberg Comment Letter IV at 7-8.
    \68\ See Bloomberg Comment Letter IV at 8.
---------------------------------------------------------------------------

    On July 3, 2006, Track submitted a second comment letter to clarify
to the Commission that it was still a participant in the Nasdaq Market
Center, reiterate its comments submitted previously as part of the ECN
Comment

Letter, and support the comment letters of Citigroup, USCC, and
Bloomberg.\69\ Track emphasized that Bloomberg was not the sole party
objecting to aspects of the Single Book Proposal, but that it and other
ECNs were interested parties as well. Track stated that it continued to
execute significant business through Nasdaq's platform. In addition, it
noted that only one percent of its volume was on the ADF, which it did
not believe was a viable place to conduct its business. Track believed
that NSX's trading platform currently under development, which it
expected to include order delivery functionality, would be a viable
alternative. However, Track noted that the new NSX platform was not
scheduled to be ready until September 2006. Adding in two months to
ramp up its volume on the new system, Track requested that it be able
to continue to operate on Nasdaq's platform until the NSX platform is
operational and capable of handling the volumes of business required by
the ECNs. Track also noted that it planned to begin testing on the new
platform in July 2006.\70\ Track stated that its only issue with the
Single Book Proposal was Nasdaq's decision to accelerate its roll-out
timetable for its integrated system because it provided too brief a
period for migration to workable venues, and that ``[a]ll other matters
with regard to Nasdaq's Exchange status are not at issue with Track
ECN.'' \71\
---------------------------------------------------------------------------

    \69\ See Track Comment Letter II at 1.
    \70\ See Track Comment Letter II at 2.
    \71\ See Track Comment Letter II at 2.
---------------------------------------------------------------------------

V. Nasdaq's Response to Comments

    In Amendment No. 1, Nasdaq addressed the Bloomberg Comment Letter I
and the ECN Comment Letter. Nasdaq revised its statement on burden on
competition to state that it operates in an intensely competitive
global marketplace where its ability to compete is ``based in large
part on the quality of its trading systems, the overall quality of its
market and its attractiveness to the largest number of investors, as
measured by speed, likelihood and cost of executions, as well as
spreads, fairness, and transparency.'' \72\ Nasdaq asserted that its
Single Book Proposal would have a pro-competitive effect by reducing
overall trading costs, increasing price competition, and spurring
further initiative and innovation among market centers and market
participants. In addition, Nasdaq believed that its discontinuation of
the order delivery functionality was pro-competitive, because such
functionality harmed its competitiveness vis-[agrave]-vis other
exchanges and reduced the overall quality of its marketplace.
---------------------------------------------------------------------------

    \72\ See Single Book Proposal at 19596.
---------------------------------------------------------------------------

    Nasdaq also defended its proposal to require all of its
participants to accept automatic execution by eliminating its order
delivery functionality. Nasdaq stated that its order delivery
functionality is unique among exchanges and that no other exchange
offers order delivery to its participants. Nasdaq asserted that such
functionality is ``expensive, complex, and detrimental to system
performance, thereby increasing the cost and complexity of Nasdaq's
trading systems and decreasing its performance.'' Nasdaq also believed
that order delivery discourages order flow providers from sending
orders to Nasdaq for processing because market participants cannot
predict whether their orders will be delivered or automatically
executed, thereby hurting Nasdaq's ability to compete with other
markets.\73\
---------------------------------------------------------------------------

    \73\ Id.
---------------------------------------------------------------------------

    In addition, Nasdaq noted that, within its own system, the presence
of order delivery negatively impacts the competition between market
makers, ECNs/alternative trading systems (``ATSs''), and agency broker-
dealers, because market makers and agency broker-dealers (who are
required to participate in Nasdaq via automatic execution) view
themselves as disadvantaged relative to ECNs and ATSs that can choose
to participate either via automatic execution or order delivery. Nasdaq
believed that removing the order delivery functionality would level the
playing field between its market participants. Finally, Nasdaq noted
that its ability to provide the fastest, fairest, and most efficient
system possible was particularly important given the Commission's
adoption of Regulation NMS.\74\
---------------------------------------------------------------------------

    \74\ See Single Book Proposal, supra note 3.
---------------------------------------------------------------------------

    On May 8, 2006, Nasdaq again responded to the comments regarding
the proposed rule change.\75\ Nasdaq stated that the Single Book
Proposal would ``benefit investors by offering a faster, fairer, more
efficient and more transparent system that executes trades in strict
price/time priority; promote competition by allowing Nasdaq to increase
efficiency, decrease overall trading costs, and provide better service
to market participants; promote the development of the national market
system by integrating separate trading systems into a single pool of
exchange liquidity for market participants to access; and improve
regulation by complying with the Regulation NMS Access and Order
Protection Rules to prevent locked and crossed markets and trade
throughs.'' \76\ Nasdaq contended that Bloomberg's sole dispute with
the Single Book Proposal was Nasdaq's proposal to eliminate the order
delivery functionality that is available only to ECNs and available
only on Nasdaq.\77 \
---------------------------------------------------------------------------

    \75\ See Letter from Edward S. Knight, Executive Vice President
and General Counsel, Nasdaq to Morris, dated May 8, 2006 (``Nasdaq
Response Letter I'').
    \76\ Nasdaq Response Letter I at 1.
    \77\ Nasdaq Response Letter I at 2.
---------------------------------------------------------------------------

    Nasdaq stated that Bloomberg was unable to identify any requirement
in the Act that a national securities exchange offer order delivery
functionality, and noted that no other exchange has been required to,
or chosen to, offer such functionality. Nasdaq stated that any
requirement to offer such functionality should apply equally to all SRO
markets.\78\ In addition, Nasdaq rejected Bloomberg's claim that it was
unfairly discriminating against ``independent'' ECNs to the advantage
of its own ECN facilities (i.e., Brut and INET), because this proposal
would integrate the Brut and INET execution facilities with the Nasdaq
Market Center into a single trading platform.\79\
---------------------------------------------------------------------------

    \78\ Nasdaq Response Letter I at 2.
    \79\ Nasdaq Response Letter I at 2.
---------------------------------------------------------------------------

    Nasdaq emphasized that its proposal would not exclude ECNs but
rather it would welcome them to participate in Nasdaq provided that
they accept automatic execution. Nasdaq opined that the ECN commenters'
systems were fully automated, and that they had declined to participate
in Nasdaq via automatic execution to ``isolate orders within [their]
own system[s] and to preserve internal executions as much as
possible.'' \80\ Nasdaq also noted that several agency brokers
participate in Nasdaq, accept automatic executions, and manage their
risk of double executions by cancelling their quote or order on Nasdaq
before matching an order internally.\81\
---------------------------------------------------------------------------

    \80\ Nasdaq Response Letter I at 3.
    \81\ Nasdaq Response Letter I at 3, note 6.
---------------------------------------------------------------------------

    Nasdaq stated that Bloomberg could conduct its business elsewhere
and that the Act does not require Bloomberg to post its orders in
Nasdaq. As an example, Nasdaq noted that other ECNs have elected to
move their business to regional exchanges or the ADF. Nasdaq said that
Bloomberg's contention was based on the false premise of a Nasdaq
monopoly, and that Bloomberg was a privileged Nasdaq participant, as
opposed to a ``prisoner'' of Nasdaq's system.\82\
---------------------------------------------------------------------------

    \82\ Nasdaq Response Letter I at 4.
---------------------------------------------------------------------------

    Nasdaq reiterated its concerns about the delay in executions caused
by order

delivery. Nasdaq stated that order delivery interactions were more time
consuming than automatic execution interactions, and that unlike
automatic execution, orders delivered to an ECN could be rejected if
the shares had been accessed by an ECN's direct subscribers. Nasdaq
also presented data relating to order delivery during the week of March
13, 2006, which included a so-called ``expiration Friday'' on March
17th. During that week, Nasdaq stated that: 100 percent of automatic
execution orders that Nasdaq attempted to execute actually executed; 14
percent of total orders that Nasdaq delivered to order delivery
participants failed to execute and for one order delivery participant
the overall failure rate exceeded 25 percent; 55.6 percent of orders
delivered to order delivery participants prior to 9:30:15 failed to
execute; 27.9 percent of orders delivered to order delivery
participants between 9:30:15 and 9:30:30 failed to execute; 12.7
percent of orders delivered to order delivery participants between
9:30:30 to 3:59:30 failed to execute; and prior to 9:30:15, three order
delivery participants had mean response times of over four, nine, and
twenty seconds per order during that week.\83\
---------------------------------------------------------------------------

    \83\ Nasdaq Response Letter I at 5-6.
---------------------------------------------------------------------------

    In addition to the time and response issues, Nasdaq stated that it
was costly to maintain the order delivery functionality because it
demanded ``disproportionate system capacity and unique specifications,
requirements, and programming not available to or needed by the vast
majority of Nasdaq participants * * *.'' Nasdaq emphasized that these
are costs no other SRO incurs. Nasdaq also believed that ECN response
times and rejection rates created strong disincentives for market
participants to use Nasdaq's systems because of the uncertainty and
reduced speed of an order execution.\84\ In addition, Nasdaq believed
that time and response issues would be exacerbated under Regulation
NMS, and expressed concern again about order delivery making Nasdaq a
``slow'' market or exposing it to ``self-help'' declarations by other
trading centers.\85\
---------------------------------------------------------------------------

    \84\ Nasdaq Response Letter I at 6.
    \85\ Nasdaq Response Letter I at 6.
---------------------------------------------------------------------------

    Finally, Nasdaq objected to Bloomberg's request for a delay in the
effective date of an approval. Nasdaq believed that this would simply
``delay the time when investors receive the benefits offered by a
faster, fairer, more efficient and more transparent system.'' \86\ In
addition, Nasdaq noted that BATS was able to shift its order flow to
the NSX in a matter of weeks, and that Nasdaq's filing provides
Bloomberg with over three months to make the system changes needed for
similar migration. Nasdaq also stated that there was no requirement
under the Act to ``accommodate the business schedule of any individual
market participant'' as it negotiated ``a beneficial arrangement to
post quotes in another venue'' and that the Commission was directed by
Section 19(b) of the Act to ``determine promptly whether a rule
proposal is consistent with the Act and to approve or reject it
accordingly.''\87\
---------------------------------------------------------------------------

    \86\ Nasdaq Response Letter I at 6.
    \87\ Nasdaq Response Letter I at 7.
---------------------------------------------------------------------------

    On May 26, 2006, Nasdaq submitted to the Commission a second
letter, responding to the Citigroup Comment Letter.\88\ Nasdaq
requested that the Commission disregard Citigroup's comment letter
because Nasdaq asserted that it was untimely filed and was an attempt
to use the statutory notice and comment period to delay consideration
of the Single Book Proposal.\89\ Nonetheless, Nasdaq responded to the
substantive elements of the letter and disputed the assertions by
Citigroup regarding the ADF's viability. In particular, Nasdaq noted
that the predecessor of Citigroup's current OnTrade ECN, NexTrade, had
been quoting on the ADF for over three years. Nasdaq also disputed
Citigroup's assertion that the ADF's cost of connectivity was an
``economic disincentive,'' instead characterizing it as ``a cost of
doing business'' and stating that Nasdaq's order routing technology
supports connectivity to any ADF participant whose quotation is
displayed through the ADF in the consolidated quotation.\90\ Nasdaq
also reiterated that, like Bloomberg, Citigroup failed to mention that
scores of agency brokers participate on Nasdaq systems and accept
automatic executions, managing their dual liability risks by cancelling
their quotations or orders on Nasdaq prior to matching their orders
internally. Finally, Nasdaq asserted that Citigroup misstated that
there would be no alternative facility for NYSE- and Amex-listed
securities and distorted the Commission's statements in the Exchange
Application Order, noting that it believed that the passage cited by
Citigroup related to the Commission's requirement that there be an
alternative facility for non-Nasdaq stocks prior to Nasdaq's operation
as an exchange.\91\
---------------------------------------------------------------------------

    \88\ See Letter from Edward S. Knight, Executive Vice President
and General Counsel, Nasdaq to Morris, dated May 26, 2006 (``Nasdaq
Response Letter II'').
    \89\ Nasdaq Response Letter II at 1-2.
    \90\ Nasdaq Response Letter II at 2.
    \91\ Nasdaq Response Letter II at 2.
---------------------------------------------------------------------------

    On June 8, 2006, Nasdaq submitted to the Commission a third letter,
responding to the Bloomberg Comment Letter III.\92\ In this letter,
Nasdaq reiterated its belief that Bloomberg could participate in Nasdaq
via automatic execution, that Bloomberg was technologically capable of
quoting in the NASD ADF ``in a matter of days,'' and that Bloomberg did
in fact have a number of alternatives to being an order delivery
participant in Nasdaq.\93\ Nasdaq also disagreed with Bloomberg's
description of NSX's current operation and pointed out that two ECNs,
INET and BATS, operate in that market with little disruption.\94\ In
addition, Nasdaq reiterated the critical nature of its Single Book
Proposal, given the competition it faces both in the United States and
abroad. Nasdaq stated that Single Book would be ``lightning fast'' and
produce faster, more certain executions. In addition, Nasdaq stated
that the proposal would transform its market into a strict price-time
priority venue, promote competition, decrease overall trading costs,
provide better service to market participants, and allow Nasdaq to
comply with the access and order protection provisions of Regulation
NMS.\95\
---------------------------------------------------------------------------

    \92\ See Letter from Jeffrey S. Davis, Senior Associate General
Counsel, Nasdaq to Morris, dated June 8, 2006 (``Nasdaq Response
Letter III'').
    \93\ Nasdaq Response Letter III at 2-3, 4-5.
    \94\ Nasdaq Response Letter III at 3.
    \95\ Nasdaq Response Letter III at 3-4.
---------------------------------------------------------------------------

    Nasdaq also stated that Bloomberg has a negative impact on Nasdaq's
competitiveness, pointing to the period immediately following the
market's opening as an example.\96\ Nasdaq noted that, during the first
week of May 2006, during the trading period prior to 9:30:15 am,
Bloomberg's mean response time to delivered orders was over 5 seconds
per order.\97\ Finally, Nasdaq disagreed with Bloomberg's contention
that eliminating order delivery was discriminatory, stating that it did
not see ``how requiring all market participants to use identical
automatic functionality [could] be considered discriminatory.'' \98\
---------------------------------------------------------------------------

    \96\ Nasdaq Response Letter III at 4.
    \97\ Nasdaq Response Letter III at 4.
    \98\ Nasdaq Response Letter III at 4-5.
---------------------------------------------------------------------------

    On June 9, 2006, Nasdaq submitted to the Commission a fourth
letter, describing INET's technological problems in NSX.\99\ Nasdaq
stated that, on June 8, 2006, senior officers of the

NSX notified Nasdaq that the NSX was ``experiencing severe capacity
overages and quotation delays in its core systems * * * [and] * * *
requested that Nasdaq cause INET to cease sending quotations to the NSX
and stated that NSX was considering terminating INET's ability to send
quotations to NSX.'' \100\ Nasdaq stated that the possibility of future
technology failures was increasing as message traffic has increased
significantly across the industry. Nasdaq stated that it was taking all
available, prudent steps to avoid future disruptions, and that approval
of the Single Book Proposal would enable it to remove all quotations
from NSX and avoid such technology failures.\101\
---------------------------------------------------------------------------

    \99\ See Letter from Edward S. Knight, Executive Vice President
and General Counsel, Nasdaq to Cox, dated June 9, 2006 (``Nasdaq
Response Letter IV'').
    \100\ Nasdaq Response Letter IV at 1.
    \101\ Nasdaq Response Letter IV at 1-2.
---------------------------------------------------------------------------

VI. Commission's Findings and Order Granting Accelerated Approval of
Amendment Nos. 2 and 3

    As discussed fully throughout this approval order, the Commission
has carefully reviewed the proposed rule change, as amended, the
comment letters, and Nasdaq responses, and finds that the proposed rule
change, as amended, is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to a national
securities exchange and, in particular, the requirements of Section
6(b) of the Act.\102\ Specifically, the Commission finds that the
proposed rule change, as amended, is consistent with Section 6(b)(5) of
the Act \103\ in that it is designed to promote just and equitable
principles of trade, to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general, to
protect investors and the public interest; and is not designed to
permit unfair discrimination between customers, issuers, brokers, or
dealers, or to regulate by virtue of any authority conferred by the Act
matters not related to the purposes of the Act or the administration of
the exchange. The Commission also finds that the proposed rule change,
as amended, is consistent with Section 6(b)(8) of the Act \104\ in that
it does not impose any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act.
---------------------------------------------------------------------------

    \102\ 15 U.S.C. 78f(b).
    \103\ 15 U.S.C. 78f(b)(5).
    \104\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

A. Elimination of Order Delivery Function

    Nasdaq's proposal would require that all Nasdaq participants accept
automatic executions and would eliminate order delivery processing in
the newly integrated system. Nasdaq's primary rationale for this aspect
of the proposal is as follows:
     Order delivery functionality is expensive, complex, and
detrimental to its system and decreases system performance and no other
national securities exchange is required to provide this service;
     Order delivery functionality hampers Nasdaq's ability to
compete by discouraging order flow providers from sending orders to
Nasdaq because market participants cannot predict whether their orders
will be delivered or automatically executed;
     Order delivery functionality negatively impacts
competition between market makers, ECNs/ATSs, and agency broker-
dealers, because market makers and agency broker-dealers (who are
required to participate in Nasdaq via automatic execution) are
disadvantaged relative to ECNs and ATSs that can choose to participate
either via automatic execution or order delivery;
     Nasdaq's system is completely voluntary and ECNs are not
required to quote or participate in Nasdaq; and
     In light of the competition fostered by Regulation NMS,
Nasdaq needs to provide the fastest, fairest, and most efficient
system.
    Nearly all of the commenters opposed the proposed elimination of
Nasdaq's order delivery functionality.\105\ The commenters suggested
that the proposal was inconsistent with Sections 6(b)(5) \106\ and
6(b)(8) of the Act \107\ in that it unfairly discriminated between
brokers or dealers and imposed a burden on competition that is not
necessary or appropriate in furtherance of the purposes of the Act. The
main assertions by the commenters are as follows:
---------------------------------------------------------------------------

    \105\ See, e.g., Bloomberg Comment Letter II at 9; Knight
Comment Letter at 2; Track Comment Letter I at 1.
    \106\ 15 U.S.C. 78f(b)(5).
    \107\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

     The automatic execution requirement would expose ECNs to
dual liability risks;
     The automatic execution requirement would force ECNs out
of the Nasdaq market and have a negative impact on their customers;
     The costs to move to another facility would be burdensome
for ECNs;
     There are no viable alternatives, including the NASD ADF
and regional exchanges, to participation in Nasdaq;
     Nasdaq is using its regulatory status to perfect a
monopoly over Nasdaq-listed securities; and
     Order delivery does not have a negative impact on the
performance of Nasdaq's system, nor would it place Nasdaq at any undue
risk in light of Regulation NMS.
    The Commission finds that this proposal does not unfairly
discriminate among market participants, nor does it impose any burden
on competition that is not necessary or appropriate in furtherance of
the Act.
1. Competition Issues
    The Commission believes that the Single Book Proposal is an
appropriate initiative by Nasdaq to enhance the quality of its exchange
through integrating its three trading platforms into a single unified
system, to add efficiency in executions and to increase overall market
transparency. The Commission has long held the view that ``competition
and innovation are essential to the health of the securities markets.
Indeed, competition is one of the hallmarks of the national market
system.'' \108\ The Commission notes that the notion of competition is
inextricably tied with the notion of economic efficiency, and the Act
seeks to encourage market behavior that promotes such efficiency, lower
costs, and better service in the interest of investors and the general
public.\109\ Therefore, the Commission believes that the appropriate
analysis to determine a proposal's competitive impact is to weigh the
proposal's overall benefits and costs to competition based on the
particular facts involved, such as examining whether the proposal would
promote economically efficient execution of securities and fair
competition between and among exchange markets and other market
centers, as well as fair competition between the participants of a
particular market.
---------------------------------------------------------------------------

    \108\ See SuperMontage Order at 8049.
    \109\ 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Commission notes that Nasdaq operates in a competitive global
exchange marketplace for listings, financial products, and market
services and competes in such an environment with other market centers,
including national securities exchanges, ECNs, and other alternative
trading systems, for the privilege of providing market and listing
services to broker-dealers and issuers. Within Nasdaq's systems, ECNs
and ATSs compete with market

makers and agency broker-dealers for retail and institutional order
flow. Thus, the Commission views Nasdaq as an individual market as well
as a piece of the larger, overall market structure.
    The ECN's opposition to the instant proposal is that it will cause
a disruption to their manner of doing business, and such operational
changes are potentially burdensome and costly. Under the proposal, ECNs
that choose to continue operating in Nasdaq will have to accept
automatic executions and internally manage their quotes to prevent dual
executions of the same order, while ECNs that opt to use another SRO
facility to display their order flow may face reduced connectivity and
higher costs. That a proposed rule change to an SRO's trading system
requires a market participant to reevaluate its business model, develop
new technology, or reprogram its current systems is not something that
is unique to Nasdaq and moreover is not something that is unique to
ECNs. Invariably, any proposed rule change to a fundamental function of
an SRO market (e.g., display, execution, trade-reporting, etc.) will
require certain changes by the affected market participants; and more
than likely such changes must be effectuated by a technological
solution in an increasingly automated national market system.
    As stated above, ECNs currently using Nasdaq's order delivery
functionality may continue to participate in Nasdaq via automatic
execution. Rather than excluding ECNs, Nasdaq is simply requiring ECNs
to participate in Nasdaq on an automatic execution basis, as other
participants are currently required to do. According to Bloomberg,
order delivery is necessary because unlike market makers, ECNs act as
agency brokers and do not carry inventory or act as principal. Without
the order delivery functionality, Bloomberg contends that ECNs would be
exposed to dual liability.\110\ Bloomberg says that ECNs would be
involuntarily forced to act as dealers and abandon their current
business models.\111\ Nasdaq responds that ECNs could participate as
Nasdaq automatic execution participants as agency brokers by managing
dual liability risks by cancelling their quote/order on Nasdaq before
matching the order internally.\112\ This risk management objective
could be technologically achieved by ECNs giving priority to execution
of the publicly displayed order in Nasdaq rather than the order flow
that is only internally available on the ECN books to its
subscribers.\113\ In fact, Nasdaq asserts that agency-brokers on its
system currently operate and manage their dual liability risks in that
manner. The various ECN comment letters opposing the elimination of
Nasdaq's order delivery functionality have not disputed the validity of
this claim.
---------------------------------------------------------------------------

    \110\ Bloomberg Comment Letter II at 4.
    \111\ See, e.g., Bloomberg Comment Letter II at 4.
    \112\ See Nasdaq Response Letter I at 3, note 6.
    \113\ Nasdaq Response Letter I at 3, note 6.
---------------------------------------------------------------------------

    Nasdaq has also stated that its current order delivery
functionality is costly to operate and requires disproportionate system
capacity, unique specifications, and additional programming. In
addition, Nasdaq has emphasized that, though ECNs may provide an
automated evaluation and response to orders, the time required to send
message traffic back and forth between Nasdaq and ECNs involves delays
that do not exist in the case of automatic executions. This potential
for delay, as well the possibility that an order could be rejected by
an order delivery ECN, gives a measure of uncertainty to orders entered
on Nasdaq, which may impede Nasdaq's ability to compete with other
markets and provide faster executions with increased certainty.\114\
---------------------------------------------------------------------------

    \114\ Nasdaq Response Letter I at 4-6. See also Nasdaq Response
Letter III at 3-5.
---------------------------------------------------------------------------

    Nasdaq has stated legitimate regulatory and operational reasons for
eliminating the order delivery service. For instance, Nasdaq is
concerned that order delivery may cause the System to be deemed
``slow'' under Rule 611 of Regulation NMS. Although it appears that
under most operating conditions, order delivery may not pose a
significant risk that the System would be a ``slow'' market or expose
it to the election of the ``self-help'' exception under Rule 611(b)(1)
of Regulation NMS, Nasdaq raises legitimate concerns that, during
periods of increased market activity or system stress, the order
delivery functionality could place its market at risk.
    The Commission recognizes ECNs could pose differing levels of risk
to the Integrated System and that normally ECNs may, as Bloomberg
commented, generally be able to respond within 5-20 milliseconds; \115\
however, Nasdaq has valid concerns over the response times of its
market participants and the potential for such response times to
negatively impact its entire market. Thus, the prospect of a single
participant's slow response time affecting the protected quotation
status of the entire market under Regulation NMS is a valid
consideration in Nasdaq's determination of whether it is best to retain
the order delivery functionality.
---------------------------------------------------------------------------

    \115\ See, e.g., Bloomberg Comment Letter II at 7-8.
---------------------------------------------------------------------------

    ECNs also assert that the proposal is unfairly discriminatory and
it imposes a burden on competition that is not necessary or appropriate
in furtherance of the Act because it would force ECNs to leave the
Nasdaq market to operate either in another SRO facility or the NASD
ADF. The commenters argue there are no viable alternatives for the ECN
business model in the marketplace, and thus the Nasdaq order delivery
service, which accommodates the ECN business model, must be preserved.
The Commission does not share this view.
    As an initial matter, the Commission notes that the Act does not
require Nasdaq to retain a market structure that supports the business
operations of ECNs. Further, ECNs may post their orders in an SRO other
than Nasdaq. The Commission believes that ECNs have a variety of
options if they determine that, as a result of this proposal, they
should forego Nasdaq participation. For example, ECNs may decide to
post their liquidity to another SRO. In the past ECNs such as BATS,
Brut, Instinet, Island, INET, Archipelago, and Attain have moved some
or all of their activities from Nasdaq to other trading venues.
Specifically, INET quotes on NSX; more recently, BATS has also moved
from Nasdaq to NSX. Archipelago, through ArcaEx, became the equities
trading facility of the Pacific Exchange, Inc. Other ECNs, including
OnTrade (and its predecessor, NexTrade), quote in the NASD's ADF.
Before Brut's purchase by Nasdaq, Brut quoted on the Boston Stock
Exchange.
    Accordingly, ECNs that do not want to operate under the Nasdaq's
Exchange Rules have other options at this time, and other alternatives
for ECNs to participate as order delivery systems are emerging. Thus,
while ECNs may not view the presently available alternatives to Nasdaq
to be as appealing as participating on Nasdaq via order delivery, the
Commission nevertheless believes viable alternatives to Nasdaq
participation exist for ECNs.
    a. Alternatives to Nasdaq. In their comment letters, ECNs have been
particularly critical of the capabilities of the NASD ADF and suggested
that it does not constitute a true viable alternative to the Nasdaq
market because it lacks: (1) An execution facility; (2) adequate order
protection and quote attribution; (3) favorable revenue sharing plans;
(4) sub-penny quoting up to four decimal places for securities priced
less than $1.00; and (5) connectivity to ECN participants.

However, the Commission, on various occasions, has determined that the
NASD ADF provides an alternative quotation facility for Nasdaq
securities.\116\ The NASD ADF does not have all the advantages and
liquidity of an active exchange like Nasdaq, and thus may not currently
be the optimal facility for an ECN and its particular business model;
nonetheless, the NASD ADF facility has the basic requirements of a
quotation facility for Nasdaq securities, thus providing market
participants a venue other than Nasdaq in which to display their
quotes.
---------------------------------------------------------------------------

    \116\ See, e.g., Securities Exchange Act Release No. 45156
(December 14, 2001), 67 FR 388 (January 3, 2002).
---------------------------------------------------------------------------

    The history of ECN participation in Nasdaq is instructive. Nasdaq
began as a quotation, and then trading reporting, facility of the NASD,
where quotes and trades of securities not listed on an exchange could
be displayed. Later, Nasdaq displayed quotes and trades of exchange-
listed stocks. Nasdaq satisfied the NASD's obligation to operate a
system to collect quotes and trades arising under now Rules 601 and 602
of Regulation NMS.\117\
---------------------------------------------------------------------------

    \117\ 17 CFR 242.601-02.
---------------------------------------------------------------------------

    In 1996, the Commission adopted the Order Handling Rules,\118\
enabling ECNs to comply with a requirement to publicly display market
maker quotes entered into the ECN by communicating these quotes to an
SRO that was willing to display them in the consolidated quote system.
The Commission said that if no SRO was willing to accept these quotes,
it would take steps to ensure that these ECN quotes were included in
the consolidated quote by an SRO.\119\
---------------------------------------------------------------------------

    \118\ Securities Exchange Act Release Nos. 37619A (September 6,
1996), 61 FR 48290 (``Order Handling Rules'').
    \119\ Id.
---------------------------------------------------------------------------

    Nasdaq, as the competing market maker quotation system for non-
exchange listed stocks operated on behalf of the NASD, chose at that
time to accept ECN quotes in its system. Nasdaq accommodated the ECN
order delivery preferences at their own displayed size even though
market makers in Nasdaq were required (against their wishes) to accept
automatic execution at an NASD-imposed 1,000-share automatic execution
size.\120\
---------------------------------------------------------------------------

    \120\ See Securities Exchange Act Release Nos. 42344 (January
14, 2000), 65 FR 3987 (January 25, 2000) (NASD-99-11).
---------------------------------------------------------------------------

    Nasdaq subsequently eliminated the required 1,000-share automatic
execution size, but retained automatic execution for market
makers.\121\ In SR-NASD-99-53,\122\ Nasdaq recast its execution system
as the SuperMontage system, accepting orders directly from agency
brokers, subject to automatic execution. In response to criticisms
raised by ECNs, SuperMontage retained an order delivery functionality
for ECNs.
---------------------------------------------------------------------------

    \121\  See Securities Exchange Act Release Nos. 45998 (May 29,
2002), 67 FR 39759 (June 10, 2002) (NASD-2001-66).
    \122\ See SuperMontage Order, supra note 17.
---------------------------------------------------------------------------

    Because of concerns raised about the monopoly position of Nasdaq as
the residual quote and trade facility of the NASD, in approving the
SuperMontage, the Commission conditioned its operation on the NASD's
creation of an alternate display facility that would permit NASD
members to operate outside of Nasdaq and still comply with their
regulatory obligations under the Order Handling Rules and Regulation
ATS.\123\ The Commission also required that the NASD ADF be designed to
identify through the central processor the identity of the NASD member
that is the source of each quote and provide a market neutral linkage
to the Nasdaq and other marketplaces, but not an execution
service.\124\ Later, in approving a pilot program for the operation of
the NASD ADF, the Commission re-stated the purpose first raised in the
SuperMontage Order that the ``ADF * * * permits registered market
makers and registered ECNs to display their best-priced quotes or
customer limit orders * * * through the NASD. ADF market participants
are required to provide other ADF market participants with direct
electronic access to their quote * * *. The ADF also serves as a trade
reporting and trade comparison facility. The ADF will therefore allow
market participants to satisfy their order display and execution access
obligations under the Order Handling Rules and Regulation ATS.''\125\
The D.C. Circuit Court of Appeals later stated that the NASD ADF is an
alternative display facility that was created to ``provide an
alternative outlet in which market participants that did not wish to
use SuperMontage could fulfill their order display and trading
reporting obligations under SEC regulations.'' \126\
---------------------------------------------------------------------------

    \123\ See Order Handling Rules, supra note 118 and Securities
Exchange Act Release No. 40760 (December 8, 1998), 63 FR 70844
(December 22, 1998) (``Regulation ATS'').
    \124\ SuperMontage Order at 8024.
    \125\ See Securities Exchange Act Release No. 46429 (August 29,
2002), 67 FR 56862.
    \126\ Domestic Securities, Inc. v. Securities and Exchange
Commission, 333 F.3d 239, 248-249 (D.C. Cir. 2003).
---------------------------------------------------------------------------

    Subsequently, the NASD and Nasdaq chose to sunder their
relationship, and Nasdaq registered as a separate national securities
exchange.\127\ The NASD satisfies its obligations for Nasdaq securities
under Rules 601 and 602 of Regulation NMS through the ADF.
---------------------------------------------------------------------------

    \127\ See supra note 5.
---------------------------------------------------------------------------

    One commenter, Citigroup, suggested that the Commission ``recently
indicated that ADF is not a viable alternative to the Nasdaq Market
Center; referring to comments received in response to the Nasdaq
application for registration as an exchange.'' In this regard, the
Commission believes that its response to Nasdaq exchange application
comments has been misconstrued. The Commission did not intend to imply
that the ADF is not a viable alternative to the Nasdaq Market Center.
Instead, in response to the aforementioned comments the Commission
reiterated its general belief, a theme initially voiced in the
SuperMontage Order and again in the order approving the operation of
the NASD ADF, that it would not be ``consistent with the Exchange Act
to allow the NASD to separate from the [Nasdaq] facilities by which it
satisfies its regulatory obligations without having alternative means
to do what the Exchange Act and the rules thereunder require.
Accordingly, the Nasdaq Exchange may not begin operating as a national
securities exchange and cease to operate as a facility of the NASD
until NASD has the means to fulfill its regulatory obligations.'' \128\
In the Exchange Application Order, the Commission clearly articulates
the statutory and regulatory obligations the NASD must be able to
satisfy prior to Nasdaq commences operation as a national securities
exchange.\129\ In pertinent part, the NASD must represent to the
Commission that control of Nasdaq through the Preferred D Share is no
longer necessary because the NASD can fulfill through means other than
Nasdaq systems or facilities its obligations with respect to CTA Plan
securities under Section 15A(b)(11) of the Act, Rules 602 and 603 of
Regulation NMS, and the national market system plans, i.e., the CTA
Plan, CQ Plan, Nasdaq UTP Plan, the ITS Plan, and the Order Execution
Quality Disclosure Plan, in which the NASD will participate.\130\
---------------------------------------------------------------------------

    \128\  See Exchange Application Order at 3564.
    \129\  See Exchange Application Order at 3562-64, 3566. The
Commission recently modified the requirements for Nasdaq's operation
as an exchange. See Securities Exchange Act Release No. 54085 (June
30, 2006), 71 FR 38910 (July 10, 2006).
    \130\ See Securities Exchange Act Release No. 54085 (June 30,
2006), 71 FR 38910 (July 10, 2006).
---------------------------------------------------------------------------

    Thus, while Citigroup cites to the comparative various operational
differences of the NASD ADF versus the Nasdaq Market Center from a
business perspective, the only regulatory requirement referenced in its
letter is

the ability of the NASD to accept quotes in non-Nasdaq listed
securities, which is a pre-condition to the separation of Nasdaq from
NASD and Nasdaq's Exchange operation that must be achieved by virtue of
the NASD's plan participation.
    The Commission recognizes that participation in the NASD ADF may
require additional connectivity and related development costs for
certain market participants. Again, the notion that innovation or
change to a market's structure or manner of operation will require the
use of technological or developmental resources is neither novel nor
unforeseen. In fact, in approving Rule 610 of Regulation NMS (i.e., the
Access Rule) the Commission extensively discussed the connectivity
requirements for participants in the NASD ADF. The Regulation NMS Order
reads, in pertinent part,\131\

    \131\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496, 37542 (June 29, 2005).
---------------------------------------------------------------------------

    The NASD is not * * * statutorily required to provide an order
execution functionality in the ADF. As a national securities
association, the NASD is subject to different regulatory
requirements than a national securities exchange * * *.The Exchange
Act does not expressly require an association to establish a
facility for executing orders against the quotations of its members,
although it could choose to do so. The Commission believes that
market makers and ECNs should continue to have the option of
operating in the OTC market, rather than on an exchange or The
NASDAQ Market Center. As noted in the Commission's order approving
Nasdaq's SuperMontage trading facility, this ability to operate in
the ADF is an important competitive alternative to Nasdaq or
exchange affiliation * * *.

    The Commission further stated that:

    [R]ule 610(b)(1) requires all trading centers that choose to
display quotations in an SRO display-only quotation facility to
provide a level and cost of access to such quotations that is
substantially equivalent to the level and cost of access to
quotations displayed by SRO trading facilities. Rule 610(b)
therefore may cause trading centers [e.g., ECNs] that display
quotations in the ADF to incur additional costs to enhance the level
of access to their quotations and to lower the cost of connectivity
for market participants seeking to access their quotations.

Thus, the Commission has contemplated the costs related to linking to
and operating in the NASD ADF and who may appropriately bear such
costs.
    The Commission notes that, in addition to the ADF, other SROs such
as NSX may eventually offer ECNs an order delivery quote
functionality.\132\ NSX, in response to Nasdaq Response Letter IV,\133\
stated that it intended to undertake a major trading system initiative
to prepare itself for the market structure changes and growth in volume
anticipated with the implementation of Regulation NMS.\134\ This NSX
statement is in accord with the Commission's belief that efforts to
improve the national market system via technological innovations is,
and will continue to be, a market-wide phenomenon that will ultimately
ensure that ECNs have a variety of viable options not only from a
regulatory perspective, but from an operational and business
perspective as well.
---------------------------------------------------------------------------

    \132\ Bloomberg also questioned the viability of NSX as a
potential venue alternative to Nasdaq due primarily to a lack of
system capacity. See Bloomberg Comment Letter III at 2-3.
    \133\ See supra note 82.
    \134\ Specifically, NSX stated that it intends to implement a
new state-of-the-art trading system, ``NSX Blade,'' that would
increase its systems capacity ten-fold and ``establish a new
standard for speed in the securities industry.'' NSX stated that
broker-dealers would be able to connect to its system ``through
industry-standard FIX protocol or connect through any of the major
extranets.'' Thus, NSX has represented that it intends to address
the capacity and linkage concerns which Bloomberg believes make NSX
an inadequate venue alternative to the Nasdaq Market Center. See NSX
Comment Letter at 2.
---------------------------------------------------------------------------

    Accordingly, the Commission continues to encourage the innovation
of the NASD ADF, SRO facilities, ECNs, and market participants in
general that would enhance participation and interaction between
markets and order flow within the national market system. Nonetheless,
the Commission also believes that Nasdaq must have the flexibility to
rework its structure to permit appropriate responses to the rapidly
changing marketplace. Congress noted that the Commission should seek to
``enhance competition and to allow economic forces, interacting with a
fair regulatory field, to arrive at appropriate variation in practices
and services.'' \135\ In the Commission's view, as an exchange in
competition with other markets, Nasdaq has the right to seek a more
efficient model of doing business. While ECNs may desire certain
functionality accommodating their current mode of participating in the
Nasdaq market, Nasdaq, like other exchanges and market participants,
must be permitted to innovate and adjust to the dynamic nature of
today's securities industry, within the requirements of the Act.
---------------------------------------------------------------------------

    \135\ See S. Rep. No. 94-75, 94th Cong., 1st Sess. 7 (1975) at
8.
---------------------------------------------------------------------------

    The Commission recognizes that ECNs as a group have been among the
most innovative market participants in recent years, introducing a
number of novel trading tools and strategies. In addition, ECNs have
benefited investors by providing cheaper and faster access to valuable
liquidity. However, the Commission does not believe that the
elimination of Nasdaq's order delivery functionality must or should
necessarily have a deleterious impact on ECNs or the national market
system as a whole.
    b. Nasdaq's Position as SRO. Some of the commenters contended that
this proposal is an attempt by Nasdaq to use its position as an SRO and
as a for-profit entity to ``crush'' its ECN competition.\136\
Specifically, some commenters aver that Nasdaq's acquisitions of the
Brut and INET ECNs set this strategy in motion and this proposal would
enable Nasdaq to ``perfect its monopoly.'' Bloomberg, in its second
comment letter, asserted that Nasdaq seeks to eliminate the order
delivery functionality for independent ECNs ``while preserving it for
Nasdaq's own ECN facilities,'' namely Brut and INET, thereby giving its
own ECNs a competitive advantage.\137\ However, the Commission notes
that under this proposal Nasdaq would integrate the Brut and INET
execution systems with the Nasdaq Market Center, utilizing the INET
platform; only Brut's broker-dealer routing functionality would
continue upon the unification of the three trading platforms. Thus,
this proposal could not advantage Nasdaq-affiliated ECNs over other
ECNs because Nasdaq-affiliated ECNs would not exist. In addition, the
Commission notes that Nasdaq's acquisitions of Brut and INET were
reviewed and approved by the Commission as positive developments in the
ever-changing, dynamic market environment.\138\
---------------------------------------------------------------------------

    \136\ See, e.g., Track Comment Letter I at 1; and Bloomberg
Comment Letter II at 1, 5, 8.
    \137\ Bloomberg Comment Letter II at 1.
    \138\ See Securities Exchange Act Release Nos. 51326 (March 7,
2005), 70 FR 12521 (March 14, 2005) and 52902 (December 7, 2005), 70
FR 73810 (December 13, 2005).
---------------------------------------------------------------------------

    The Commission agrees with Nasdaq's statement that there is no
explicit requirement in the Act for a national securities exchange to
offer order delivery participation in their execution systems.\139\ The
Commission does not believe that Nasdaq must continue to offer order
delivery functionality to meet its obligations in the Act and the rules
and regulations thereunder. Although the order delivery functionality
has been a part of Nasdaq's trading platform, the Commission does not
believe Nasdaq is required to retain the functionality going forward,
particularly given the legitimate regulatory reasons for its
discontinuation provided by Nasdaq

including that the functionality could pose significant risks and
costs.
---------------------------------------------------------------------------

    \139\ Nasdaq Response Letter at 2.
---------------------------------------------------------------------------

    In addition, Nasdaq endured significant cost in 2005 to acquire
INET \140\ and, through the Single Book Proposal, Nasdaq seeks to use
the INET platform as the basis for its Integrated System going forward
in order to provide a faster and more efficient system with greater
capacity. As competition increases both in the United States and
globally, and with the Commission's approval of Regulation NMS, nearly
all national securities exchanges are in the process of transforming
their systems to better compete. Through implementation of its Single
Book Proposal, Nasdaq seeks to maximize the advantages of the INET
trading platform--faster executions and increased certainty.
---------------------------------------------------------------------------

    \140\ In its third comment response letter, Nasdaq stated that
it spent close to $1 billion in 2005 to acquire INET from Reuters.
Nasdaq Response Letter III at 3.
---------------------------------------------------------------------------

    As Nasdaq prepares to commence operations as a national securities
exchange, the Commission believes that providing order delivery
functionality is not required of Nasdaq, as with any other exchange. If
another exchange deems such functionality to be advantageous for its
operation as an exchange, it may choose to add it. Notwithstanding the
valuable contributions that ECNs bring to the national market system in
terms of liquidity and innovation, the Commission does not believe that
the Act requires the Nasdaq exchange to continue to separately provide
functionality to accommodate the particularized business choices of the
ECN participants.
2. Claims of Unfair Discrimination
    Some of the commenters assert that the elimination of the order
delivery functionality in the proposed rule change, as amended, is
inconsistent with Section 6(b)(5) of the Act because it would
discriminate unfairly against independent ECNs vis-[agrave]-vis all
other Nasdaq members and it would not promote a free and open market
and a national market system.\141\ The Commission disagrees. ECNs have
been the only Nasdaq participants with the option to use the Nasdaq
order delivery service; all other Nasdaq market participants, i.e.,
market makers, order entry firms, and UTP Exchanges, are currently
required to accept automatic executions. Nasdaq has also maintained
other features of its market exclusively for the benefit of ECNs (e.g.,
the ability to charge quote access fees.) While the Commission approved
these ``ECN-friendly'' measures and found them to be consistent with
the Act, these same provisions were never imposed upon Nasdaq by the
Commission or deemed to be requirements under the Act.
---------------------------------------------------------------------------

    \141\ Bloomberg Comment Letter II at 10.
---------------------------------------------------------------------------

    During its development as a quote facility of the NASD, Nasdaq had
taken a series of actions to accommodate ECN participation and their
particularized business model. In certain respects, ECNs have enjoyed a
privileged status in the Nasdaq market compared to agency brokers and
market maker participants by virtue of their ability to, amongst other
things, accept order delivery instead of automatic execution. The
Commission does not believe that, in removing the order delivery
functionality, the instant proposal would result in unfair
discrimination between customers, issuers, brokers, or dealers. Because
Nasdaq has previously accommodated ECNs, changing features such as the
order delivery function will necessarily impact ECNs
disproportionately. However, the Commission disagrees with the
suggestion that it logically follows that such disproportionate impact
is per se equivalent to unfair discrimination under the Act. In this
case, the Commission believes the proposed rule change is consistent
with the Act and it does not unfairly discriminate between ECNs and
other Nasdaq market participants. Nasdaq is eliminating a disparate
treatment between ECNs and the other Nasdaq market participants by
requiring that all participants accept automatic execution to increase
the efficiency and competitiveness of the Nasdaq exchange.
3. Automatic Execution Function
    The Commission notes that in numerous instances it has approved
automatic execution within the national market system in general, and
Nasdaq in particular. For instance, in the SuperMontage Order, the
Commission affirmed that automatic execution is a reasonable way for
Nasdaq to improve market efficiency and provide many benefits to a
marketplace, particularly speed and certainty of executions.\142\ The
SuperMontage Order said that automatic execution also would promote
investor confidence by increasing the likelihood that orders of
moderate size from large and small investors alike will be filled
almost instantaneously, improve the accuracy of Nasdaq's pricing
systems, promote the timeliness of trade reporting, and help alleviate
locked and crossed markets.\143\ Most recently, in approving Rule 611
of Regulation NMS, the Commission clearly enunciated a view that
automated markets and automated quotes (i.e., automatic execution
functionality), combined with access to such markets and quotes was an
important attribute in a national market system.\144\
---------------------------------------------------------------------------

    \142\ SuperMontage Order at 8049.
    \143\ SuperMontage Order at 8049-50.
    \144\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496 (June 29, 2005).
---------------------------------------------------------------------------

    To this end, Rule 611 of Regulation NMS only protects from trade-
throughs automated quotations of automated markets. An automated
quotation is a quotation that, among other things, is displayed and is
immediately accessible through automatic execution, and that
immediately and automatically cancels any unexecuted portion of an
order marked as immediate-or-cancel without routing the order
elsewhere.\145\ In Question 5 of the Division's NMS FAQs, the Division
said that an SRO trading facility that displays the quotations of order
delivery ECNs can meet the requirements of the definition of an
automated quotation only if such quotations are closely integrated
within the SRO trading facility.\146\ In its comment letter, Bloomberg
asserted that Nasdaq's interpretation of the response to Question 5 of
the Division's NMS FAQs was wrong, in that the Division did ``not
authorize Nasdaq to drop order delivery without considering the factors
the Division cited.'' \147\ The Commission believes that Bloomberg has
misinterpreted the Division's response to Question 5. The response does
not address an exchange dropping its order delivery functionality.
Instead, the response relates to whether a market supporting order
delivery could be considered ``automated,'' and if its quote could be
``protected'' under Regulation NMS. The Division's answer is intended
to clarify how a market would comply with Regulation NMS and does not
control whether Nasdaq keeps or discards its order delivery
functionality.
---------------------------------------------------------------------------

    \145\ Rule 600(b)(3) of Regulation NMS defines an automated
quotation to mean a ``quotation displayed by a trading center that:
(i) Permits an incoming order to be marked as immediate-or-cancel;
(ii) immediately and automatically executes an order marked as
immediate-or-cancel against the displayed quotation up to its full
size; (iii) immediately and automatically cancels any unexecuted
portion of an order marked as immediate-or-cancel without routing
the order elsewhere; (iv) immediately and automatically transmits a
response to the sender of an order marked as immediate-or-cancel
indicating the action taken with respect to such order; and (v)
immediately and automatically displays information that updates the
displayed quotation to reflect any change to its material terms. 17
CFR 242.600(b)(3).
    \146\ NMS FAQs at Question 5.
    \147\ Bloomberg Comment Letter II at 7.

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

4. Implementation Date
    In Bloomberg Comment Letter III, Bloomberg stated that it and other
order delivery ECNs had been led by Nasdaq to believe that the Nasdaq
Market Center's order delivery functionality would be available until
at least fall of 2006 at the earliest, if not on an ongoing basis.\148\
Bloomberg requested that, should the Commission decide to approve the
Single Book Proposal, the Commission delay the effective date of the
rules to provide ECNs an opportunity to migrate to another venue.\149\
The USCC also encouraged the Commission to, as a matter of good
process, ``consider the need for appropriate transition periods''
should the proposed rule change be adopted.\150\ Similarly, Track
requested a phased-in approach to the rules should they be
adopted.\151\ In response to commenter concerns and in order to provide
ECNs with adequate time to program their systems for participation in
Nasdaq or migration to another venue,\152\ Nasdaq has agreed to delay
its implementation and roll-out of the Single Book Proposal until
August 28, 2006.\153\
---------------------------------------------------------------------------

    \148\ Bloomberg Comment Letter III at 8-11.
    \149\ Bloomberg Comment Letter II at 11; see also Bloomberg
Comment Letter III at 11.
    \150\ See USCC Comment Letter at 1-2.
    \151\ Track Comment Letter I at 2.
    \152\ See Bloomberg Comment Letter II at 11; Bloomberg Comment
Letter III at 11; USCC Comment Letter at 1-2; and Track Comment
Letter I at 2.
    \153\ See Amendment No. 3.
---------------------------------------------------------------------------

    In the Commission's approval of Nasdaq's exchange application in
January 2006, the Commission emphasized that Nasdaq's approval was
based on a set of rules with price/time priority.\154\ In addition, the
Commission noted in the Exchange Application Order that the two ECNs
that Nasdaq had recently acquired--Brut and INET--both applied rules
that required their orders to be executed in price/time priority.\155\
As discussed above, the Single Book concept of integrating the three
Nasdaq Facilities was discussed by the Commission in the Exchange
Application Order and the Commission believed that such an integration
would be beneficial, though the Commission permitted the three Nasdaq
Facilities to operate separately for a temporary period, until
September 30, 2006, because the Brut and INET facilities had only been
recently acquired by Nasdaq.
---------------------------------------------------------------------------

    \154\ Exchange Application Order at 3558-59.
    \155\ Exchange Application Order at 3558, note 137. See also
Securities Exchange Act Release Nos. 52902 (December 7, 2005), 70 FR
73810 (December 13, 2005) (``INET Order'') and 51326 (March 7,
2005), 70 FR 12521 (March 14, 2005) (``Brut Order'').
---------------------------------------------------------------------------

    The Commission notes that Nasdaq, independent of its exchange
application and as a NASD subsidiary at the time, had already proposed
to integrate its three facilities by September 30, 2006 in its filing
to establish the rules governing the operation of its INET System.\156\
In the INET Order the Commission approved Nasdaq's proposed commitment
to integrate as of September 30, 2006; \157\ however, that date was not
mandated by the Commission. In addition, the plain language of the INET
Order, NASD Rule 49545(b)(2), and the Exchange Application Order makes
clear that September 30, 2006 was the latest date that Nasdaq, pursuant
to its commitment, could integrate its trading facilities. Neither the
INET Order nor the Exchange Application Order required that integration
be delayed until September 30, 2006, or prohibited Nasdaq integrating
its systems at an earlier date.
---------------------------------------------------------------------------

    \156\ See Securities Exchange Act Release No. 52723 (November 2,
2005), 70 FR 67513 (November 7, 2005)(''INET Notice'').
    \157\ See INET Order at 73811.
---------------------------------------------------------------------------

    The Commission believes that astute market participants, such as
Bloomberg, could have reasonably anticipated the strong possibility of
Nasdaq operating on an automatic-execution only basis prior to
September 30, 2006, based on: (1) Nasdaq's anticipated operation as an
exchange with executions based on price-time priority for all of
Nasdaq's order flow, (2) Nasdaq's acquisition of Brut and INET, both of
which are automatic-execution facilities, and (3) Regulation NMS where
the Commission clearly enunciated a view that automated markets and
automated quotes (i.e., automatic execution functionality), combined
with access to such markets and quotes was an important attribute in a
national market system.
    In addition, formal notice of Nasdaq's intention to create an
Integrated System based on automatic executions prior to September 30,
2006 was clearly given on February 7, 2006, the day Nasdaq filed the
Single Book Proposal with the Commission. At that time, Nasdaq proposed
to commence operation of the Integrated System by as early as May 2006.
Bloomberg submitted an initial comment letter opposing the proposed
rule change dated March 6, 2006, which suggested that it would take
three to six months to complete the systems work required to adapt to a
new venue.\158\ The Commission understands that BATS has already made
and implemented its plans to migrate its liquidity to NSX.\159\ In
addition, in response to comments for a transitional phase-in
period,\160\ Nasdaq has proposed to commence its phased-in
implementation of the Integrated System based on automatic executions
on August 28, 2006; \161\ which is almost seven months after the
proposal was filed, and nearly six months since Bloomberg's initial
comment letter. The Commission believes that order delivery ECNs have
had sufficient time to make alternate plans for quoting in the ADF or
another SRO.
---------------------------------------------------------------------------

    \158\ Bloomberg Comment Letter I at 11.
    \159\ See Nasdaq Response Letter II.
    \160\ See Track Comment Letter I at 2; USCC Comment Letter at 1-
2; and Bloomberg Comment Letter IV at 1.
    \161\ See Amendment No. 3.
---------------------------------------------------------------------------

    Section 19(b)(1) of the Act \162\ requires a SRO to the file with
the Commission ``any proposed rule change in, addition to, or deletion
from the rules of such self-regulatory organization * * * accompanied
by a concise general statement of the basis and purpose of such
proposed rule change. Such proposed rule change must be filed in
accordance with the requirements of Rule 19b-4 under the Act.\163\ The
Commission believes that Nasdaq has filed the Single Book Proposal in
accordance with the requirements of the Act and its rules and
regulations thereunder.
---------------------------------------------------------------------------

    \162\ 15 U.S.C. 78s(b)(1).
    \163\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

    The Commission believes that Nasdaq has met all of the procedural
requirements for the instant proposed rule change and provided the
public in general and interested parties in particular with adequate
notice and opportunity to comment under the Act. The Commission
believes that the Integrated System will promote competition and bring
investors and the national market system benefits through the
efficiencies and transparencies brought about through a single
liquidity pool with price/time priority. The Commission believes that,
given the notice provided by Nasdaq's filings, it is consistent with
the Act for Nasdaq to implement the Integrated System as proposed.

B. Operation as a National Securities Exchange

    The Commission notes that, under the Single Book Proposal, Nasdaq's
trading platform would have an integrated quote/order book operated in
accordance with a unified price/time priority execution algorithm. In
the Exchange Application Order, the Commission acknowledged that,
because of the recent nature of Nasdaq's Brut and INET acquisitions and
because

of the reliance by participants on the continued availability of those
ATSs, it was in the public interest for Brut and INET to be available
for a limited period while Nasdaq worked to integrate them with its NMC
Facility.\164\ The Commission stated that ``it is beneficial for orders
in the same securities directed to an exchange to interact with each
other'' and that ``[s]uch interaction promotes efficient exchange
trading and protects investors by assuring that orders are executed
pursuant to a single set of priority rules that are consistently and
fairly applied.'' \165\ The Commission permitted the Exchange to
operate three separate trading platforms--namely the NMC Facility, Brut
Facility, and INET Facility--for a temporary period prior to September
30, 2006. This proposed rule change, as amended, would enable Nasdaq to
satisfy its Commission-approved commitment to integrate its three
trading facilities prior to September 30, 2006.
---------------------------------------------------------------------------

    \164\ Id at 3559.
    \165\ Id.
---------------------------------------------------------------------------

    In addition, Nasdaq's Single Book Proposal will allow the Exchange
to program its system to operate in compliance with the Exchange
Application Order in additional ways. For example, the Integrated
System would not accept reports of transactions occurring outside the
Integrated System, would interact with the network processors for the
various national market system plans in compliance with Commission
rules governing exchanges, and would fulfill Nasdaq's new role as an
exchange in the national market system plans, including the national
market system plan governing the Intermarket Trading System (``ITS
Plan''). In addition, under the Single Book Proposal, Nasdaq itself
(rather than its individual members) would be bound by the obligations
of the ITS Plan, maintain a single two-sided quotation, and be
responsible for trade-through compliance. The Commission notes that the
proposed rules change, as amended, cannot be operational until Nasdaq
has satisfied all the conditions set forth by the Commission in the
Exchange Application Order.\166\
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    \166\ Exchange Application Order at 3566.
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C. Regulation NMS

    The Commission believes that the proposed rule change should allow
Nasdaq to comply with the requirements of Regulation NMS.\167\ In
proposed Nasdaq Rule 4613(e), Nasdaq proposes to adopt a rule with
regard to locked and crossed markets. The Exchange has also designed
its proposed Book Processing \168\ and Order Routing \169\ rules to
comply with the requirements of Regulation NMS. These proposed rules
include permitting users to designate orders meeting the requirements
of Rule 600(b)(30) of Regulation NMS \170\ as intermarket sweep orders,
which would allow orders so designated to be automatically matched and
executed without reference to protected quotations at other trading
centers.
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    \167\ See supra note 6.
    \168\ See proposed Nasdaq Rule 4757.
    \169\ See proposed Nasdaq Rule 4758.
    \170\ 17 CFR 242.600(b)(30).
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    In addition, Nasdaq has proposed to implement routing options that
its believes are consistent with Rules 610 and 611 of Regulation NMS.
Nasdaq also proposed rules intended to ensure its compliance with Rule
612 of Regulation NMS (i.e., accepting sub-penny prices in $0.0001
increments for securities priced less than $1.00 a share and rejecting
orders in sub-penny increments for securities priced $1.00 or more per
share).\171\ The Commission also notes that proposed Nasdaq Rule
4756(c)(4) addresses situations where Nasdaq has reason to believe it
is not capable of displaying automated quotations, including adopting
policies and procedures for communicating to both its members and other
trading centers about such a situation, as well as receiving and
responding to notices of other trading centers electing the ``self-
help'' exception under Rule 611(b)(1) of Regulation NMS.
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    \171\ Single Book Proposal at 19592. See also proposed Nasdaq
Rule 4613(a)(1)(B).
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D. Other Rules

    The proposed rule change, as amended, would merge five current sets
of rules (the 4600, 4700, 4900, 4950, and 5200 Series) into two (the
4600 and 4750 Series), with the proposed 4600 Series governing System
participants and the proposed 4750 Series governing the operation of
the Integrated System. In addition to reorganizing the rule set, and
making changes to the Exchange's rules for exchange and Regulation NMS
readiness, the proposed rule change, as amended, addresses, among other
things, openings and closings, the order display/matching system, order
types, time in force designations, anonymity, routing, book processing,
adjustment of open orders, and Nasdaq's proposed phase-in plan for the
proposed rules.

E. Impact on Efficiency, Competition, and Capital Formation

    Section 3(f) of the Act requires that the Commission consider
whether Nasdaq's proposal will promote efficiency, competition, and
capital formation.\172\ As discussed in more detail above, the
Commission has carefully considered whether the proposal will promote
efficiency, competition and capital formation and has concluded that
the Single Book Proposal should encourage competition and should not
impede the development of other trading systems or market innovation.
The Commission believes that the Single Book Proposal is an appropriate
undertaking by Nasdaq to enhance the quality of its market by providing
more information to investors, promoting greater efficiency in
executions, and increasing overall market transparency. While the
Single Book Proposal should provide a central means for accessing
liquidity in Nasdaq and non-Nasdaq stocks, it does not represent an
exclusive means, nor does it prevent broker-dealers from seeking
alternative order routing and execution services. In addition, the
Commission believes that the proposal should promote competition and
capital formation by providing its market participants with several
quote and order management options (e.g., Discretionary Orders, Reserve
Orders, Pegged Orders, and Minimum Quantity Order), including order
types which will enable market participants to operate in the post-
Regulation NMS trading environment, such as Intermarket Sweep Orders,
Price to Comply Orders, and Price to Comply Post Orders.
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    \172\ 15 U.S.C. 78c(f).
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F. Accelerated Approval of Amendment Nos. 2 and 3

    As set forth below, the Commission finds good cause to approve
Amendment Nos. 2 and 3 to the proposed rule change, as amended, prior
to the thirtieth day after the amendments are published for comment in
the Federal Register pursuant to Section 19(b)(2) of the Act.
    In Amendment No. 2, Nasdaq modifies the proposed rule language to
reflect the Commission's extension of certain compliance dates relating
to Regulation NMS. Specifically, Nasdaq is modifying proposed rules to
reflect that such rules would not become effective until the applicable
Regulation NMS implementation date of May 21, 2007. Such rules include
Rule 4613(e) (pertaining to locked and crossed markets), Rule 4751(f)
(pertaining to order types), and Rule 4755 (pertaining to intermarket
sweep orders). The Commission finds good cause to accelerate approval
of these changes prior to the thirtieth day after

publication in the Federal Register. The Commission believes this is a
reasonable approach in light of the extension of Regulation NMS
compliance dates and should help to ensure that the appropriate Nasdaq
rules are in place at the time that Regulation NMS compliance is
required.
    In Amendment No. 2, Nasdaq also is making several technical
corrections to the proposed rule change, for example, eliminating
typographical and underlining errors. These changes are non-substantive
and technical in nature and are necessary to clarify the proposal. The
Commission finds good cause to accelerate approval of these changes
prior to the thirtieth day after publication in the Federal Register
because they better clarify Nasdaq's rules, which should assist
members' ability to comply with their requirements, and assist
investors in understanding their application and scope.
    In Amendment No. 3, in response to the comments filed by the U.S.
Chamber of Commerce, Bloomberg, and others, Nasdaq proposes to commence
a phased-in implementation of the Integrated System on August 28,
2006.\173\ In addition, Amendment No. 3 describes Nasdaq's plan to test
securities on the System during July and early August 2006 and phase-in
the operation of the Integrated System with an initial three-week
transition period for Nasdaq-listed stocks, followed by non-Nasdaq-
listed stocks.
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    \173\ The Commission notes that Amendment No. 3 replaces the
August 14, 2006 implementation date that Nasdaq had proposed in
Amendment No. 2.
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    The Commission finds good cause to accelerate approval of this
change prior to the thirtieth day after publication in the Federal
Register. The Commission finds that the change in the proposed
implementation of the Integrated System to a later date than that
originally proposed and published for comment and later than that
proposed by Amendment No. 2, as well as the allowance of a testing
period and phased-in period, would provide a longer transition period
for Nasdaq market participants and other participants in the national
market system. The delay until August 28, 2006 and the phase-in period
should help to ensure that there is an orderly transition to the
Integrated System and provide Nasdaq's market participants, including
many of the commenters, opportunity to decide whether to continue
participating in Nasdaq, or to elect to move their business elsewhere.
The Commission notes that August 28, 2006 represents a period of nearly
seven months from the original filing date of this proposed rule
change. The Commission also notes that, notwithstanding Nasdaq's
proposed August 28, 2006 implementation date, the proposed rules
change, as amended, cannot be operational until Nasdaq has satisfied
all the conditions set forth by the Commission in the Exchange
Application Order.\174\ The Commission believes that August 28, 2006
should provide market participants with adequate time to prepare for
the Implemented System, and would also permit Nasdaq to meet its
commitment to fully integrate its three trading facilities on or before
September 30, 2006.
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    \174\ Exchange Application Order at 3566. The Commission
recently modified the requirements for Nasdaq's operation as an
exchange. See Securities Exchange Act Release No. 54085 (June 30,
2006), 71 FR 38910 (July 10, 2006).
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VII. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\175\ that the proposed rule change (File No. SR-NASDAQ-2006-001),
as amended by Amendment Nos. 1, 2, and 3, be, and hereby is, approved.
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    \175\ 15 U.S.C. 78s(b)(2).

    By the Commission.
Nancy M. Morris,
Secretary.
[FR Doc. 06-6366 Filed 7-19-06; 8:45 am]

BILLING CODE 8010-01-P