

[Federal Register: November 7, 2005 (Volume 70, Number 214)]
[Notices]               
[Page 67513-67523]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr07no05-112]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52723; File No. SR-NASD-2005-128]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing of Proposed Rule Change To Establish 
Rules Governing the Operation of the INET System

November 2, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on November 1, 2005, the National Association of Securities Dealers, 
Inc. (``NASD''), through its subsidiary, The Nasdaq Stock Market, Inc. 
(``Nasdaq''), filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by Nasdaq. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of the 
Substance of the Proposed Rule Change

    Nasdaq intends to purchase INET ATS, Inc. (``INET''), operator of 
the INET ECN (the ``INET System'' or ``System''). Nasdaq proposes to 
establish rules governing the operation of the INET System and fees for 
System services. Below is the text of the proposed rule change. 
Proposed new language is italicized.
* * * * *

4950. INET SYSTEM

4951. Definitions

    Unless stated otherwise, the terms described below shall have the 
following meaning:
    (a) The terms ``The INET ECN System,'' ``INET System,'' or 
``System,'' shall mean the automated system owned and operated by INET, 
which is owned and operated by The Nasdaq Stock Market, Inc., which 
enables Participants to execute transactions in System securities, to 
have reports of the transactions automatically forwarded to the 
appropriate National Market Trade Reporting System for dissemination to 
the public and the industry, to ``lock in'' these trades by sending 
both sides to the applicable clearing corporation(s) designated by the 
System Participant(s) for clearance and settlement, and to provide 
System Participants with sufficient monitoring and updating capability 
to participate in an automated execution environment.
    (b) The term ``System Securities'' shall mean Nasdaq Market Center 
eligible securities as that term is defined in NASD Rule 4701(s) and 
ITS Securities securities as defined in NASD Rule 5210(c).
    (c) The term ``Participant'' shall mean an entity that fulfills the 
obligations contained in NASD Rule 4952 regarding participation in the 
System.
    (d) The term ``Nasdaq Market Center'' shall mean the automated 
system owned and operated by The Nasdaq Stock Market, Inc. pursuant to 
NASD Rule 4700 Series.

[[Page 67514]]

    (e) The term ``System Book Feed'' shall mean a data feed for System 
eligible securities.
    (f) The term ``normal unit of trading'' shall mean one hundred 
(100) shares.
    (g) The term ``mixed lot'' shall mean an order that is for more 
than a normal unit of trading but not a multiple thereof.
    (h) The term ``odd-lot'' shall mean an order that is for less than 
a normal unit of trading.
    (i) The term ``Immediate or Cancel'' or ``IOC'' shall mean, for 
limit orders so designated, that if after entry into the System the 
order (or a portion thereof) is not marketable, the order (or 
unexecuted portion thereof) shall be canceled and returned to the 
entering Participant.
    (j) The term ``Market Day'' or ``Limit Day'' shall mean, for orders 
so designated, that if after entry into the System, the order is not 
fully executed, the order (or the unexecuted portion thereof) shall 
remain available for potential display/execution until 4:00 p.m. 
Eastern Time on the day it was submitted unless cancelled before then 
by the entering party.
    (k) The term ``Extended Day'' shall mean, for orders so designated, 
that if after entry into the System, the order is not fully executed, 
the order (or unexecuted portion thereof) shall remain available for 
potential display and/or execution until 8:00 p.m. Eastern Time.
    (l) The term ``Expire Time'' shall mean, for orders so designated, 
the time until which the System will hold the order for potential 
execution.
    (m) The term ``Limit Order'' shall mean an order to buy or sell a 
stock at a specified price or better.
    (n) The term ``Market Order'' shall mean an un-priced order to buy 
or sell a stock at the market's current best price. A Market Order may 
have a limit price beyond which the order shall not be executed.
    (o) The term ``Discretionary Order'' shall mean an order that has 
both a displayed price and size, as well as a non-displayed 
discretionary price range, at which the entering party, if necessary, 
is also willing to buy or sell. The non-displayed trading interest is 
not entered into the System book but is converted to an IOC order equal 
in size to the displayed size and priced at the most aggressive price 
in the discretionary price range when displayed shares become available 
or an execution takes place at any price within the discretionary price 
range. The generation of this IOC order is accompanied by the 
cancellation of the displayed portion of the Discretionary Order. If 
more than one Discretionary Order is available for conversion to an IOC 
order, the system will convert all such orders at the same time and 
priority will be given to the first IOC order(s) that reaches the 
trading interest on the other side of the market. If an IOC order is 
not executed in full, the unexecuted portion of the order is 
automatically re-posted and displayed in the System book with a new 
time stamp, its original displayed price, and its non-displayed 
discretionary price range.
    (p) The term ``Reserve Order'' shall mean a limit order that has 
both a round-lot displayed size as well an additional non-displayed 
share amount. Both the displayed and non-displayed portions of the 
Reserve Order are available for potential execution against incoming 
orders. If the round-lot displayed portion of a Reserve Order is 
reduced to less than 100 shares, the System will replenish the display 
portion from reserve up to at least a single round-lot amount. A new 
timestamp is created for the replenished portion of the order each time 
it is replenished from reserve, while the reserve portion retains the 
time-stamp of its original entry.
    (q) The term ``Pegged Order'' shall mean, for orders so designated, 
an order that, after entry, has its price automatically adjusted by the 
System in response to changes in the national best bid or offer 
(``NBBO''), as appropriate. A Pegged Order can specify that its price 
will equal the inside quote on the same side of the NBBO (``Primary 
Peg'') or the opposite side of the NBBO (``Market Peg''). In addition, 
Pegged Orders may also establish their pricing relative to the NBBO by 
the selection of one or more $0.01 offset amounts that will adjust the 
price of the order by the offset amount selected. A new timestamp is 
created for the order each time it is automatically adjusted.
    (r) The term ``Displayed Order'' shall mean, for limit orders so 
designated, an order that is displayed in the System, in whole or in 
part, and is available for potential execution against all incoming 
orders until executed in full or cancelled.
    (s) The term ``Non-Displayed Order'' shall mean, for limit orders 
so designated, an order that is not displayed in the System, but 
nevertheless remains available for potential execution against all 
incoming orders until executed in full or cancelled.
    (t) The term ``Minimum Quantity Order'' shall mean, for orders so 
designated, an order that requires that a specified minimum quantity of 
shares be obtained, or the order is cancelled. Minimum Quantity Orders 
may only be entered with a time-in-force designation of Immediate or 
Cancel.

4952. System Participant Registration

    (a) Participation in INET requires current registration with the 
System and is conditioned upon the Participant's initial and continuing 
compliance with the following requirements:
    (1) execution of a System Subscriber Agreement; 
    (2) satisfaction of INET new account policy and procedure 
requirements;
    (3) membership in, or an access arrangement with a participant of, 
a clearing agency registered with the Commission that maintains 
facilities through which System compared trades may be settled;
    (4) acceptance and settlement of each System trade that the System 
identifies as having been effected by such Participant, or if 
settlement is to be made through another clearing member, guarantee of 
the acceptance and settlement of such identified System trade by the 
clearing member on the regularly scheduled settlement date;
    (5) compliance with all applicable rules and operating procedures 
of the Association and the Commission.
    (6) In addition to the above, on or before 60 days after the System 
becomes a facility of Nasdaq, all System Participants shall be members 
of the Association.

4953. Order Entry Parameters

(a) INET System Orders

    (1) General--An INET System order is an order that is entered into 
the System for display and/or execution as appropriate. Such orders are 
executable against marketable contra-side orders in the System as set 
forth in NASD Rule 4955.
    (A) All INET System Orders shall indicate whether they are a Market 
Order or Limit Order and shall indicate if they are a buy, short sale, 
short-sale exempt, or long sale. INET Systems Orders can be designated 
as Immediate or Cancel (``IOC''), Market Day or Limit Day (``DAY''), 
Extended Day (``XDAY''), or Expire Time (``ExT'').
    (B) An INET System order may also be designated as a Reserve Order, 
a Pegged Order, a Non-Displayed Order, a Minimum Quantity Order, or a 
Discretionary Order.
    (2) Short Sale Compliance--INET System orders to sell short shall 
not be executed if the execution of such an order would violate 
Regulation SHO under the Exchange Act, NASD Rule 3350 or, for routed 
orders, the rules of

[[Page 67515]]

the applicable self-regulatory organization governing short selling or, 
in the case of ITS Securities, Rule 10a-1 under the Exchange Act.
    (3) Routing--All INET System orders entered by participants 
directing or permitting routing to other market centers shall be routed 
for potential display and/or execution as set forth in NASD Rule 4956.

4954. Entry and Display of Orders

    (a) Entry of Orders--Participants can enter orders into the System, 
subject to the following requirements and conditions:
    (1) Participants shall be permitted to transmit to the System 
multiple orders at a single as well as multiple price levels. Each 
order shall indicate the amount of reserve size (if applicable).
    (2) The System shall time-stamp an order which shall determine the 
time ranking of the order for purposes of processing the order.
    (3) Orders can be entered into the System (or previously entered 
orders cancelled) between the hours 7 a.m. to 8 p.m. Eastern Time.
    (A) Exception: Orders entered prior to 9:30 a.m. Eastern Time, or 
after 4 p.m. Eastern Time, seeking to be routed to either the New York 
or American Stock Exchanges shall be rejected.
    (B) Exception: Pegged and Market Orders may only be entered between 
9:30 a.m. and 4 p.m. Eastern Time.
    (b) Display of Orders-- The System will display orders submitted to 
the System as follows:
    (1) System Book Feed--orders resident in the System will be 
displayed via the System Book Feed.
    (2) Best Priced Order Display--For each System Security, the best 
priced order to buy and sell resident in the System will be displayed 
via the National Stock Exchange. The System's display of its orders in 
the National Stock Exchange shall not continue beyond September 30, 
2006.
    (3) Exceptions--The following exceptions shall apply to the display 
parameters set forth in paragraphs (1) and (2) above:
    (A) Odd-lots, Mixed Lots, and Rounding--The System Book Feed shall 
be capable of displaying trading interest in odd-lot, round lot and 
mixed-lot amounts and, for orders price under $1.00, in sub-penny 
increments.
    (B) Minimum Increments ``The minimum trading increments for the 
System shall be set forth in NASD Rule 4962.
    (C) Reserve Size--Reserve Size shall not be displayed in the 
System, but shall be accessible as described in NASD Rule 4955.
    (D) Discretionary Orders--The discretionary portion of 
Discretionary Orders shall be made available for execution only upon 
the appearance of contra-side marketable trading interest, and shall be 
executed pursuant to NASD Rule 4955 and NASD Rule 4951(o).
    (E) Non-Displayed Orders--Non-Displayed Orders are not displayed in 
the System, and have lower priority within the System than an equally 
priced Displayed Order, regardless of time stamp, and shall be executed 
pursuant to NASD Rule 4955.
    (F) Trade-Through Compliance and Locked or Crossed Markets--If, at 
the time of entry, a Displayed Order in an exchange-listed security 
that the entering party has elected not to make eligible for routing 
would lock the market, it will be converted by the System into a Non-
Displayed Order. If, at the time of entry, a similar Displayed Order 
would cross the market or would cause a trade-through violation, the 
order will be converted by the System to a Non-Displayed Order and re-
priced to the current low offer (for bids) or to the current best bid 
(for offers). Such Non-Displayed Orders will be cancelled by the System 
if the market moves through the price of the order after the order is 
accepted.

4955. Order Processing

(a) INET Book Order Process

    INET System orders shall be executed through the INET Book Order 
Process as set forth below:
    (1) Default Execution Algorithm--Price/Time--The System shall 
execute equally priced or better priced trading interest within the 
System in price/time priority in the following order:
    (A) Displayed Orders;
    (B) Non-Displayed Orders, the reserve portion of Reserve Orders, in 
price/time priority among such interest;
    (C) The discretionary portion of Discretionary Orders as set forth 
in NASD Rule 4951(o).
    (2) Decrementation--Upon execution, an order shall be reduced by an 
amount equal to the size of that execution.
    (3) Price Improvement--any potential price improvement resulting 
from an execution in the System shall accrue to the taker of liquidity.
Example:
    Buy order resides on INET book at 10.
    Incoming order to sell priced at 9 comes into INET System
    Order executes at 10 (seller get $1 price improvement)

4956. Routing

(a) INET Order Routing Process

    (1) The INET Order Routing Process shall be available to 
Participants from 7 a.m. to 8 p.m. Eastern Time, and shall route orders 
as described below:

(A) Exchange-Listed Routing Options

    The System provides five routing options for orders in exchange-
listed securities. Of these five, only two--DOT Immediate and DOT 
Alternative--are available for orders ultimately sought to be directed 
to either the New York Stock Exchange (``NYSE'') or the American Stock 
Exchange (``AMEX''). The System also allows firms to send individual 
orders to the NYSE Direct + System, and to elect to have orders not be 
sent to the AMEX. The five System routing options for NYSE and/or Amex 
listed orders are:
    (i) DOT Immediate (``DOTI'')--under this option, after checking the 
INET System for available shares, orders are sent directly to the NYSE 
or the AMEX as appropriate. When checking the INET book, the System 
will seek to execute at the better price of either the limit price 
specified in the order, or the best price displayed at that time at the 
NYSE. If no liquidity is available in the INET System, the order will 
be routed directly to the NYSE or AMEX at the limit order price. This 
option may only be used for orders with time-in-force parameters of 
either DAY, IOC, or market-on-open/close. Only limit orders may be used 
with this option.
    (ii) DOT Alternative (``DOTA'')--under this option, after checking 
the INET System for available shares, orders are sent to other 
available market centers for potential execution before the destination 
exchange. Any un-executed portion will thereafter be sent to the NYSE 
or AMEX, as appropriate, at the order's original limit order price. 
This option may only be used for orders with time-in-force parameters 
of either DAY, IOC, or market-on-open/close. Only limit orders may be 
used with this strategy.
    (iii) Reactive Electronic Only (``STGY'')--under this option, after 
checking the INET System for available shares, orders are sent to other 
available market centers for potential execution. When checking the 
INET book, the System will seek to execute at the price it would send 
the order to a non-INET destination market center. If shares remain un-
executed after routing, they are posted on the INET book and are not 
sent to the NYSE or AMEX. Once on the INET book, should the order 
subsequently be locked or crossed by another accessible market center, 
the System shall route the order to the

[[Page 67516]]

locking or crossing market center for potential execution. With the 
exception of the Minimum Quantity order type, all time-in-force 
parameters and order types may be used in conjunction with this routing 
option. This process is one of the routing strategies allowed by the 
System for all securities.
    (iv) Electronic Only Scan (``SCAN'')--under this option, after 
checking the INET System for available shares, orders are sent to other 
available market centers for potential execution. When checking the 
INET book, the System will seek to execute at the price it would send 
the order to a non-INET destination market center. If shares remain un-
executed after routing, they are posted on the INET book and are not 
sent to the NYSE or AMEX. Once on the INET book, should the order 
subsequently be locked or crossed by another accessible market center, 
the System will not route the order to the locking or crossing market 
center. With the exception of the Minimum Quantity order type, all 
time-in-force parameters and order types may be used in conjunction 
with this routing option. This process is one of the routing strategies 
allowed by the System for all securities.
    (v) Aggressive Electronic Only (``SPDY'')--under this option, after 
checking the INET System for available shares, orders are sent to other 
available market centers for potential execution. When checking the 
INET book, the System will seek to execute at the price it would send 
the order to a non-INET destination market center. If shares remain un-
executed after routing, they are posted on the INET book and are not 
sent to the NYSE or AMEX. Once on the INET book, should the order 
subsequently be locked or crossed by another accessible market center, 
the System shall route the order to the locking or crossing market 
center for potential execution. Market orders with the SPDY designation 
will, during a locked or crossed market, have their price adjusted by 
the System to match the best price displayed on the same side of the 
market as the market order (i.e., a buy order to the bid, a sell to the 
offer). If the order is for a security eligible for a de minimis 
exception to the trade-through rule set forth in Section 8 (d)(i) of 
the ITS Plan, the System will ignore AMEX prices when adjusting the 
SPDY order. With the exception of the Minimum Quantity order type, all 
time-in-force parameters and order types may be used in conjunction 
with this routing option. This process is one of the routing strategies 
allowed by the System for all securities.

(B) Nasdaq-Listed Routing Options

    The STGY, SPDY, and SCAN options are the only routing options 
provided by the System for orders in Nasdaq-listed securities not 
sought to be directed to either the NYSE or AMEX.

(C) Priority of Routed Orders

    Regardless of the routing option selected, orders sent by the INET 
System to other markets do not retain time priority with respect to 
other orders in INET's System and the System shall continue to execute 
other orders while routed orders are away at another market center. 
Once routed by the System, an order becomes subject to the rules and 
procedures of the destination market including, but not limited to, 
short-sale regulation and order cancellation. If a routed order is 
subsequently returned, in whole or in part, that order, or its 
remainder, shall receive a new time stamp reflecting the time of its 
return to the System.

4957. Clearance and Settlement

    All transactions executed in the System shall be cleared and 
settled by and between the System Participant and INET, through a 
registered clearing agency using a continuous net settlement system.

4958. Obligation to Honor System Trades

    (a) If a Participant, or clearing member acting on a Participant's 
behalf, is reported by the System, or shown by the activity reports 
generated by the System, as constituting a side of a System trade, such 
Participant, or clearing member acting on its behalf, shall honor such 
trade on the scheduled settlement date.
    (b) INET and/or Nasdaq shall have no liability if a Participant, or 
a clearing member acting on the Participant's behalf, fails to satisfy 
the obligations in paragraph (a).

4959. Compliance with Rules and Registration Requirements

    (a) Failure by a Participant to comply with any of the rules or 
registration requirements applicable to it and its use of the System 
shall subject such Participant to censure, fine, suspension or 
revocation of its registration as Participant or any other fitting 
penalty under the Rules of the Association, or such other action, up to 
and including termination of access to the System.
    (b) If a Participant fails to maintain a clearing relationship, or 
to honor its obligations under NASD Rule 4958, it shall have its access 
to the System restricted until such time as a clearing arrangement is 
reestablished and/or the Participant meets its obligation to honor 
System trades.
    (c) The authority and procedures contained in paragraph (b) do not 
otherwise limit the Association's authority, contained in other 
provisions of the Association's Rules, to enforce its rules or impose 
any fitting sanction.

4960. Anonymity

    (a) Transactions executed in the System shall be cleared and 
settled with INET. The transaction reports produced by the System will 
indicate the details of the transactions, and shall not reveal contra 
party identities other than INET.
    (b) INET shall reveal a Participant's identity in the following 
circumstances:
    (1) when the National Securities Clearing Corporation (``NSCC'') 
ceases to act for a participant, or the Participant's clearing firm, 
and NSCC determines not to guarantee the settlement of the 
Participant's trades;
    (2) for regulatory purposes or to comply with an order of an 
arbitrator or court;
    (3) no later than the end of the day on the date a trade was 
executed, when the participant's order has been decremented by another 
order submitted by that same Participant; or
    (4) if both Participants to the transaction consent.

4961. Clearly Erroneous Transactions

    Commencing no later than 60 days after the System becomes a 
facility of Nasdaq, all matters related to clearly erroneous 
transactions executed in the System shall be initiated and adjudicated 
pursuant to NASD Rule 11890.

4962. Minimum Quotation Increment

    The minimum quotation increment in the INET System for quotations 
of $1.00 or above in Nasdaq-listed securities and in securities listed 
on a national securities exchange shall be $0.01. The minimum quotation 
increment in the INET System for quotations below $1.00 in Nasdaq-
listed securities and in securities listed on a national securities 
exchange shall be $0.001.

4963. Normal Business Hours

    The INET System operates from 7 a.m. to 8 p.m. Eastern Time on each 
business day.

4964. Limitation of Liability

    The Association and its subsidiaries, as well as Nasdaq and INET 
and their subsidiaries, shall not be liable for any losses, damages, or 
other claims arising out of the System or its use. Any losses, damages, 
or other claims, related to a failure of the System to deliver, 
display,

[[Page 67517]]

transmit, execute, compare, submit for clearance and settlement, 
adjust, retain priority for, or otherwise correctly process an order, 
Quote/Order, message, or other data entered into, or created by, the 
System shall be absorbed by the member, or the member sponsoring the 
customer, that entered the order, Quote/Order, message, or other data 
into the System. Notwithstanding the foregoing, the System may, within 
it sole discretion and for a period of time not to exceed 60 days after 
the System becomes a facility of Nasdaq, compensate users for losses 
arising out of the System or its use.
* * * * *
7010. System Services (a)-(v) No Change.

(w) INET System Order Execution

    (1) For a period of time not to exceed 60 days after INET becomes a 
facility of Nasdaq, the following charges shall apply to the use of the 
order execution services of Nasdaq's INET System by Participants for: 

NASDAQ-Listed Securities

Order Execution

    Non-Directed Order that accesses the Quote/Order of a market 
Participant through Nasdaq's INET System:
    Charge to Participant entering order:
    Average daily shares of liquidity provided through Nasdaq's INET 
System by the Participant during the month:
    Greater than 60 million shares accessed or routed and 5 million 
shares provided: $0.0027 per share executed
    Greater than 40 million shares but less than 60 million shares 
accessed or routed and 5 million shares provided: $0.0028 per share 
executed
    Less than 5 million shares provided or less than 40 million shares 
accessed or routed: $0.0030 per share executed
Credit to Participant providing liquidity:
    Average daily shares of liquidity provided through Nasdaq's INET 
System by the Participant during the month:
    Greater than 30 million shares provided or greater than 30 million 
shares accessed or routed or greater than 50 million shares combined 
provided, accessed or routed: $0.0025 per share executed
    Less than or equal to 30 million shares provided and less than or 
equal to 30 million shares accessed or routed and less than or equal to 
50 million shares combined provided, accessed, or routed: $0.002 per 
share executed
    Any order that matches against another order of the same 
Participant: $0.00025 per share per side.

Routed Orders

    Any other order entered by a Participant that is routed outside of 
Nasdaq's INET System: $0.0025 per share executed

AMEX-listed Stocks

Order Execution

    Non-Directed Order that accesses the Quote/Order of a market 
Participant through Nasdaq's INET System:
    Credit to Participant entering order: $0.001 per share executed
    Charge to Participant providing liquidity: $0.0009
    Any order that matches against another order of the same 
Participant: No charge

Routed Orders

    Any order entered by a Participant that is routed outside of 
Nasdaq's INET System through DOT: $0.01 per share executed
    Any order entered by a Participant that is routed outside of 
Nasdaq's INET System other than through DOT: $0.0035 per share executed

AMEX-listed ETFs

Order Execution

    Non-Directed Order that accesses the Quote/Order of a market 
Participant through Nasdaq's INET System:
    Charge to Participant entering order:
    Average daily shares of liquidity provided through Nasdaq's INET 
System by the Participant during the month:
    Greater than 60 million shares accessed or routed and 5 million 
shares provided: $0.0027 per share executed
    Greater than 40 million shares but less than 60 million shares 
accessed or routed and 5 million share executed shares provided: 
$0.0028 per share executed
    Less than 5 million shares provided or less than 40 million shares 
accessed or routed: $0.0030 per share executed
    Credit to Participant providing liquidity:
    Average daily shares of liquidity provided through Nasdaq's INET 
System by the Participant during the month:
    Greater than 30 million shares provided or greater than 30 million 
shares accessed or routed or greater than 50 million shares combined 
provided, accessed or routed: $0.0025 per share executed
    Less than or equal to 30 million shares provided and less than or 
equal to 30 million shares accessed or routed and less than or equal to 
50 million shares combined provided, accessed, or routed: $0.002 per 
share executed
    Any order that matches against another order of the same 
Participant: $0.00025 per share per side.

Routed Orders

    Any order entered by a Participant that is routed outside of 
Nasdaq's INET System through DOT: $0.01 per share executed
    Any order entered by a Participant that is routed outside of 
Nasdaq's INET System other than through DOT: $0.0035 per share executed

NYSE-listed stocks

Order Execution

    Non-Directed Order that accesses the Quote/Order of a market 
Participant through Nasdaq's INET System:
    Credit to Participant entering order: $0.001 per share executed
    Charge to Participant providing liquidity: $0.0009
    Any order that matches against another order of the same 
Participant: No charge

Routed Orders

    Any order entered by a Participant that is routed outside per of 
Nasdaq's INET System through DOT: $0.0005 share executed
    Any order entered by a Participant that is routed outside of 
Nasdaq's INET System other than through DOT: $0.0015 per share executed
* * * * *

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

    In its filing with the Commission, Nasdaq included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. Nasdaq has prepared summaries, set forth in Sections A, 
B, and C below, of the most significant aspects of such statements.

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

1. Purpose

Background

    On April 22, 2005, Nasdaq entered into definitive agreements to 
purchase INET, a registered broker-dealer and member of the NASD \3\, 
and operator of

[[Page 67518]]

the INET System. Nasdaq states that, once formally purchased by Nasdaq, 
the INET System would immediately become a ``facility'' of a national 
securities association subject to the standards set forth in Sections 
15A \4\ and 19(b)(1) \5\ of the Act and would be required to operate 
pursuant to formal system rules approved by the Commission. In order to 
ensure that such rules are in place at the time of closing, Nasdaq has 
filed this proposed set of INET System rules for Commission review and 
approval that includes a description of the INET System, its various 
features, fees, and order processing methods. Nasdaq proposes that 
these rules would be implemented immediately upon formal closing of the 
Nasdaq/INET transaction, and in no event more than two weeks after 
Commission approval.\6\
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    \3\ Nasdaq states that, as a member of the NASD, INET is, and 
remains, subject to all NASD Rules applicable to its activities as a 
broker-dealer. In addition, INET would continue to participate in 
market surveillance and audit trail programs conducted by Nasdaq, 
the NASD, and other self-regulatory organizations. INET would 
continue to act as a counter-party to all trades taking place in its 
system, for anonymity as well as clearance and settlement purposes. 
INET would also continue to provide outbound order routing services 
to other market centers for its subscribers.
    \4\ 15 U.S.C. 78o-3.
    \5\ 15 U.S.C. 78s(b)(1).
    \6\ Nasdaq states that it will provide to the Commission formal 
written notice of the closing date of the transaction. Such closing 
date shall be the start date for the calculation of any temporary 
time period referred to in this filing. Nasdaq states that it will 
thereafter submit rule filings to include such closing date in its 
rules.
---------------------------------------------------------------------------

The INET System

1. Order Display/Matching System

    The INET System allows subscribers to enter market and priced limit 
orders to buy and sell Nasdaq and exchange-listed securities. According 
to Nasdaq, such orders may be in round-lots, mixed-lots, or odd-lots of 
any size up to 999,999 shares. Nasdaq states that INET acts only as an 
agent on behalf of its subscribers and engages in no proprietary 
trading save that necessary to correct system errors. Subscribers may 
enter multiple orders at single or multiple price levels. Subscribers 
have the option to have a portion of their order held in reserve and 
not displayed to the marketplace. INET, in turn, makes available to 
System subscribers and market data vendors a data feed of all 
displayable orders on both the bid and offer side of the market 
(excluding reserve size share amounts) for all price levels at which 
shares are available within its System.
    INET currently provides its best top-of-file prices, and other 
prices, to the National Stock Exchange (``NSX''). In this filing, 
Nasdaq proposes rules under which INET would be permitted to continue 
to provide its best-priced orders to the NSX until the end of the third 
quarter of 2006.\7\ At any time prior to that date, Nasdaq may file 
with the Commission a rule proposal to move the INET System's best-
priced orders, and other orders including up to full depth of book, to 
the Nasdaq Market Center for display, routing, and execution purposes. 
If filed, Nasdaq states that it would seek immediate effectiveness of 
the proposal. In addition, INET would continue to accept sub-penny 
prices in $0.001 increments for securities priced under $1.00 a share. 
Such sub-penny prices are viewable via the System data feed.
---------------------------------------------------------------------------

    \7\ Nasdaq states that, as is the case today, INET would remain 
subject to all applicable rules and regulations of the NSX.
---------------------------------------------------------------------------

2. Access Standards

    Nasdaq states that, to obtain access to the INET System as a system 
participant, a user must execute an INET subscriber agreement and be a 
participant in, or have an access arrangement with a participant in, a 
Commission-registered clearing agency. In addition, the INET subscriber 
must also agree to:
    a. Comply with all applicable rules of the NASD and the Commission; 
and
    b. Accept all INET System trades identified by the System as being 
effected by the subscriber.
    According to Nasdaq, INET also currently provides access to 
approximately 70 non-NASD member broker-dealers. Nasdaq states that it 
intends, for a period of time not to exceed 60 days after the formal 
close of the Nasdaq/INET transaction, to continue to provide such 
entities with sponsored access to the INET System under generally the 
same terms and conditions they enjoy today. This would be accomplished 
through contractual agreements between INET and such subscribers. 
Nasdaq states that, within 60 days after the formal closing of the 
Nasdaq/INET transaction, all participants in the INET System must be 
NASD members.

3. Order Types

    The INET System makes available to subscribers several order types. 
These order types are described below.
    Limit Order--an order to buy or sell a stock at a specified price 
or better.
    Market Order--an un-priced order to buy or sell a stock at the 
market's current best price. A market order may have a limit price 
beyond which the order shall not be executed.
    Reserve Order--a limit order that has both a round-lot displayed 
size as well as an additional non-displayed share amount. Both the 
displayed and non-displayed portions of the Reserve Order are available 
for potential execution against incoming orders. If the round-lot 
displayed portion of a Reserve Order is reduced to less than 100 
shares, the System would replenish the display portion from reserve up 
to at least a single round-lot amount.
    Pegged Order--a limit order that, after entry, has its price 
automatically adjusted by the System in response to changes in the 
national best bid or offer (``NBBO''), as appropriate. A Pegged Order 
can specify that its price will equal the inside quote on the same side 
of the NBBO (``Primary Peg'') or the opposite side of the NBBO 
(``Market Peg''). In addition, Pegged Orders may also establish their 
pricing relative to the NBBO by the selection of $0.01 offset amounts 
that would adjust the price of the order by the offset amount selected.
Example Primary Pegged Order
    The market is $10.00 bid-$10.01 offer. INET receives a non-route 
Primary Pegged buy order. INET would post the order at $10.00. If the 
inside bid moves to $10.01, INET would modify the Pegged Order to the 
$10.01 bid price. A new time stamp is created at the time of this 
modification. If a sell order is subsequently entered at $10.01 or 
lower, the pegged order would execute at $10.01.
Example Market Pegged Order
    The market is $10.00 bid-$10.01 offer. INET receives a Market 
Pegged buy order. INET would post the order at $10.01. If the inside 
offer moves to $10.02, INET would modify the Pegged Order to the $10.02 
offer price. A new time stamp is created at the time of this 
modification.
    Displayed Order--a limit order that is displayed in the System, in 
whole or in part, and is available for potential execution against all 
incoming orders until executed in full or cancelled.
    Non-Displayed Order--a limit order that is not displayed in the 
System, but nevertheless remains available for potential execution 
against all incoming orders until executed in full or cancelled.
    Minimum Quantity Order--an order that requires that a specified 
minimum quantity of shares be obtained, or the order is cancelled. 
Minimum Quantity Orders may only be entered with a time-in-force 
designation of IOC.
Example Minimum Quantity Order
    The market is $10.00 bid-$10.01 offer. INET receives an order to 
buy 1000

[[Page 67519]]

shares, Minimum Quantity of 500 shares, at $10.01. This order can only 
have a time in force of IOC. The INET book has 2 sell orders each for 
300 shares at $10.01. INET executed 600 shares at $10.01 (in two lots) 
and cancels the remaining 400 shares back.
    Discretionary Order--an order that has both a displayed price and 
size, as well as a non-displayed discretionary price range, at which 
the entering party, if necessary, is also willing to buy or sell. The 
non-displayed trading interest is not entered into the System book but 
is converted to an IOC order equal in size to the displayed size and 
priced at the most aggressive price in the discretionary price range 
when displayed shares become available or an execution takes place at 
any price within the discretionary price range. The generation of this 
IOC order is accompanied by the cancellation of the displayed portion 
of the Discretionary Order. If more than one Discretionary Order is 
available for conversion to an IOC order, the system would convert all 
such orders at the same time and priority would be given to the first 
IOC order(s) that reaches the trading interest on the other side of the 
market. If an IOC order is not executed in full, the unexecuted portion 
of the order would be automatically re-posted and displayed in the 
System book with a new time stamp, its original displayed price, and 
its original non-displayed discretionary price range.
Example
    INET receives a Discretionary buy order, with a displayed limit 
price of $10.00 and a display quantity of 1000 shares and a 
discretionary price range of up to $15.00. INET posts the order as 1000 
shares at $10.00. Thereafter, another market participant posts another 
offer to buy at 300 shares at $11.00, creating a buy market as follows:

------------------------------------------------------------------------
                                                    Discretionary price
           Display              Reserve    Price           range
------------------------------------------------------------------------
300..........................         0    $11.00  None.
1000.........................         0    $10.00  $11.00-$15.00.
------------------------------------------------------------------------

Thereafter, another market participant enters a sell order for 500 
shares at $11.00. The resulting executions are as follows:
    1. 300 shares execute immediately at $11.00.
    2. 200 shares to sell at $11.00 is posted to the book.
    3. Both the execution at $11.00 and the posting of the display 
price of $11.00 are events that trigger the processing of the 
discretionary portion of the Discretionary Order.
    4. INET would cancel the 1000 display portion of the Discretionary 
Order and send an IOC order for 1000 shares priced at $15.00 to the 
displayed 200 shares priced at $11.00.
    5. The 200 shares would execute at $11.00, and the 800 share 
remainder of the Discretionary Order would be placed back into the INET 
book at its original order price of $10.00. If there were multiple 
Discretionary Orders available to interact with the 200 shares, all 
such orders would be activated at the same time by the INET system and 
whichever IOC order(s) first reached the 200 shares would get the 
execution.

4. Time in Force Designations

    Orders entered into the INET System may be designated by the 
entering party to remain in force and available for display and/or 
potential execution for varying periods of time. Unless cancelled 
earlier, once these time periods expire, the order (or the unexecuted 
portion thereof) is returned to the entering party. These ``time in 
force'' designations are described below: \8\
---------------------------------------------------------------------------

    \8\ In addition, Nasdaq states that the System also supports On-
Open and On-Close order types for orders being routed directly to 
the NYSE, AMEX, and Nasdaq Market Center.
---------------------------------------------------------------------------

    Immediate or Cancel (IOC)--limit orders with this designation 
execute immediately at the limit price if shares are available. If no 
shares are available, the orders are immediately cancelled. If 
partially executed, un-executed remainders of these orders are 
immediately cancelled.
    Market Day or Limit Day (DAY)--limit orders with these designations 
(or the unexecuted portions of such orders) are held by the INET System 
and remain available for potential display/execution until 4 p.m. 
eastern time on the day they are submitted unless cancelled before then 
by the entering party. If not executed by 4 p.m., the order is 
cancelled and sent back to the entering party.
---------------------------------------------------------------------------

    According to Nasdaq, these orders are not supported or executed 
within the INET System itself. Instead, these order formats are 
designed for processing at their destination market.
---------------------------------------------------------------------------

    Expire Time (ExT)--limit orders with this designation are held by 
the system for potential execution until the expiration of the specific 
time period indicated by the entering party, including time periods 
outside of normal market hours.
    Extended Day (XDAY)--limit orders with this designation (or the 
unexecuted portions of such orders) are held by the INET System and 
remain available for potential execution until 8 p.m. eastern time.
    The INET System operates between the hours of 7 a.m. and 8 p.m. 
Eastern Time. Orders with the above time in force designations may be 
entered into the INET System, or previously entered orders cancelled, 
starting at 7 a.m. eastern time. Only orders with the XDAY designation 
would be retained by the system after 4 p.m. eastern time, with all 
other order types being cancelled back to the entering party.

5. Routing

    The INET System provides the capability to route orders to other 
available market centers. Routing functionality is available to System 
users between the hours of 7 a.m. and 8 p.m. eastern time. In general, 
the System provides users with five optional routing strategies for 
exchange-listed securities. These strategies are summarized below:
DOT Immediate (DOTI)
    After checking the INET System for available shares, orders are 
sent directly to the New York Stock Exchange (``NYSE'') via the DOT 
system. When checking the INET book, the System looks to execute at the 
better price of either the limit price specified in the order, or the 
best price displayed at that time at the NYSE. If no liquidity is 
available in the INET System the order is routed directly to the NYSE 
via DOT at the limit order price for posting. A similar process is 
followed for orders in stocks listed on the American Stock Exchange 
(``AMEX''). This strategy may only be used for orders with time-in-
force parameters of either DAY, IOC, or market-on-open/close.
Example of DOTI Routable Order
    The current NBBO is $10.00 bid x $10.02 offer. Offer size is as 
follows: 300 shares INET displayed, 200 shares INET non-displayed, 100 
shares PCX, 200 shares NYSE. Participant A enters a buy order for 1000 
shares at $10.02. The System would first IOC INET for 1000

[[Page 67520]]

shares at $10.02. Participant A would execute against 300 shares at 
$10.02 displayed and the 200 shares non-displayed. The System would 
route the remaining 500 shares to NYSE. Participant A would receive 200 
shares from NYSE. The remaining 300 shares would reside on the NYSE 
book, per routing instructions.
DOT Alternative (DOTA)
    After checking the INET System for available shares, the order 
would be sent to various available market centers for potential 
execution. Any remaining un-executed portion would thereafter be sent 
to the NYSE or AMEX, as appropriate, at the limit order price for 
posting. This strategy may only be used for orders with time-in-force 
parameters of either DAY, IOC, or market-on-open/close.
Example of DOTA Routable Order
    The current NBBO is $10.00 bid x $10.02 offer. Offer size is as 
follows: 300 shares INET displayed, 200 shares INET non-displayed, 100 
shares PCX, 200 shares NYSE. Participant A enters a buy order for 1000 
shares at $10.02. The System would first IOC INET at $10.02. 
Participant A would execute against 300 shares at $10.02 displayed and 
the 200 shares non-displayed. The System would route the remaining 
shares to PCX. Participant A would receive 100 shares from PCX. The 
System would then route 400 shares to the NYSE. Participant A would 
receive 200 shares from the NYSE. The remaining 200 shares would reside 
on the NYSE book, per routing instructions.
SCAN/STGY/SPDY
    In all of these routing options, after checking the INET System for 
available shares, orders would be sent to various available market 
centers for potential execution. For all these options, when checking 
the INET book, the System would look to execute at the price it would 
send the order to the non-INET destination market center and, if any 
shares remain un-executed after routing, they are posted on the INET 
book and are not sent to the NYSE or AMEX for posting.
    Once returned to the INET book after routing, an order with the 
SCAN designation would not be routed out to an accessible market center 
that subsequently locks or crosses the SCAN order. Orders with STGY and 
SPDY would be routed to an accessible market center that subsequently 
locks or crosses the STGY or SPDY order. While both STGY and SPDY 
orders would route to locking or crossing markets, the SPDY order would 
be re-priced by the System to match on then being displayed on the same 
side of the market by the locking or crossing market center (i.e., a 
buy order to the bid and a sell to the offer).
    With the exception of the Minimum Quantity Order type, all time-in-
force parameters and order types may be used with the STGY, SCAN, and 
SPDY routing options. Nasdaq states that orders routed by INET to 
another market do not retain time priority with respect to other orders 
in INET's System and INET continues to execute other orders while the 
routed order is away at another market. Nasdaq states that, once routed 
by INET, an order becomes subject to the rules and procedures of the 
destination market including, but not limited to, short-sale 
regulation, and order cancellation. According to Nasdaq, orders routed 
to a destination market that are subsequently returned in whole or in 
part to the System would have their time priority based on the time 
they are returned to the System.
Example of STGY Routable Order
    The current NBBO is $10.00 bid x $10.02 offer, size 200 shares at 
the Nasdaq Market Center. INET has a non-display offer of 500 shares at 
$10.01. Participant A enters an order onto INET to buy 1000 shares at 
$10.02. The System would first IOC the INET book for any potential 
orders at or better than the limit price. Participant A would execute 
500 shares on INET at $10.01 (the non-display order on the book). The 
System would then route the order to the Nasdaq Market Center at 
$10.02. 200 shares execute at the Nasdaq Market Center at $10.02. 300 
shares of the order remain unexecuted, and are entered onto the INET 
book at $10.02. 5 seconds later, PCX enters the market with an offer of 
$10.02. The System would cancel the order off the book, and route 300 
shares at $10.02 to PCX. PCX executes 300 shares at $10.02. Participant 
A receives an execution for the remaining 300 shares in the order.
Example of STGY Routable Order (Crossed Market)
    The current NBBO is $10.01 bid x $10.00 offer. INET has 500 shares 
on the offer at $10.00. PCX has 300 shares on the offer at $10.00. 
Participant A enters a market order to buy 1000 shares. The System 
would price the order at $10.00 and IOC the INET book. Participant A 
would receive 500 shares at $10.00. The System would route the 
remaining shares to PCX. Participant A would receive 300 shares at 
$10.00 from PCX. After attempting to exhaust the quotes, the remaining 
200 shares would be posted to the INET book at $10.00.
Example of SCAN Routable Order:
    The current NBBO is $10.00 bid x $10.02 offer, size 200 shares at 
the Nasdaq Market Center. INET has a non-display offer of 500 shares at 
$10.01. Participant A enters an order onto INET to buy 1000 shares at 
$10.02. The System would first IOC the INET book for any potential 
orders at or better than the limit price. Participant A would execute 
500 shares on INET at $10.01 (the non-display order on the book). The 
System would route the order off the book with the remaining shares of 
the order, 500, to the Nasdaq Market Center at $10.02. 200 shares 
execute at the Nasdaq Market Center at $10.02. 300 shares of the order 
remain unexecuted, and are entered onto the INET book at $10.02. 5 
seconds later, PCX enters the market with an offer of $10.02. The 
System would not route the order to PCX, but would keep the order on 
the INET book, per Participant A's routing instructions.
Example of SPDY Routable Order (Crossed Market)
    The current NBBO is $10.01 bid x $10.00 offer. INET has 500 shares 
on the offer at $10.01. PCX has 300 shares on the offer at $10.00. 
Participant A enters a market order to buy 1000 shares. The System 
would price the order at $10.01 and IOC the INET book. Participant A 
would receive 500 shares at $10.01. The System would route the 
remaining 500 shares to PCX. Participant A would receive 300 shares at 
$10.00 from PCX. The remaining 200 shares would be posted to the INET 
book at $10.01.
Other
    Nasdaq states that the System also allows firms to send individual 
orders to the NYSE Direct + System, and to elect to have orders not be 
sent to the AMEX.

6. Execution Algorithm

    Nasdaq states that the INET System has an execution algorithm based 
on price/time priority. For each order, among equally-priced or better-
priced trading interest, the System executes against available contra-
side displayed share amounts in full, in price/time priority, before 
then moving to any non-displayed shares which are likewise executed in 
price/time priority. Below are examples of this algorithm:
Displayed Order
    The current NBBO is $10.00 bid x $10.02 offer. Participant A enters 
a display order on INET to buy 1000 shares at $10.01. NBBO is changed 
to $10.01 x $10.02. Participant B sees the 1000 share order at $10.01 
and enters an

[[Page 67521]]

order to sell 500 shares at $10.01. The orders match at $10.01, with 
500 shares matched. NBBO remains at $10.01 x $10.02 with the size on 
the bid decremented to 500 shares, the amount of shares matched.
Limit Order (with Reserve)
    The current NBBO is $10.01 bid x $10.02 offer. Participant A enters 
an order to buy 1000 shares, display 200, at $10.01. INET bid is 
$10.01, 200 displayed, 800 non-displayed. Participant B enters a 
display buy order for 1000 shares at $10.01. INET bid is $10.01, 1200 
displayed, 800 non-displayed. Participant C enters an order to sell 
1500 shares at $10.01. Participant C receives executions against orders 
as follows: Participant A executes 200 shares at $10.01; Participant B 
executes 1000 shares at $10.01 (display order receives priority over 
non-display even though non-display order was there first); Participant 
A executes 300 shares from non-display portion. Participant C has 
executed a total of 1500 shares. Participant B has executed all 1000 of 
its shares. Participant A has 200 shares remaining in its order, and is 
now displayed, per original instructions.
Routable Order
    The current NBBO is $10.00 bid x $10.02 offer, size 200 shares at 
the Nasdaq Market Center. INET has a non-display offer of 500 shares at 
$10.01. Participant A enters an order onto INET to buy 1000 shares at 
$10.02. The system would first IOC the INET book for any potential 
orders at or better than the limit price. Participant A would execute 
500 shares on INET at $10.01 (the non-display order on the book). The 
System would then route the order off the book with the remaining 
shares of the order, 500, to the Nasdaq Market Center at $10.02. 200 
shares execute at the Nasdaq Market Center at $10.02. 300 shares of the 
order remain unexecuted, and are entered onto the INET book at $10.02.

7. Clearly Erroneous Trade Procedures

    Nasdaq states that currently, INET adjudicates clearly erroneous 
trade disputes for executions taking place exclusively within its 
System. While generally reviewing clearly erroneous trade claims in 
response to subscriber requests, INET currently reserves the right to 
take action on its own initiative if it determines that a trade is 
clearly erroneous and needs to be modified or cancelled. INET currently 
also reserves the right to refuse to review potentially erroneous 
transactions that are brought to its attention more than 20 minutes 
after execution. In the normal course, INET limits its clearly 
erroneous review to INET System trades that execute at prices that are 
certain percentages away from the National Best Bid/Offer at the time 
of execution. These percentages are provided below:
Execution Price Range Away From NBBO
$3 and under: 10%.
Over $3 and under $10: 5%.
$10 to $30: 3%.
Over $30: $1 or more.
    Nasdaq is proposing to continue the above process for a period of 
60 days after the formal close of the Nasdaq/INET transaction. During 
that interim period, Nasdaq states that it would prepare to incorporate 
INET into the current clearly erroneous process of Nasdaq and Brut, 
which is governed by NASD Rule 11890. Nasdaq states that this interim 
period would ensure that sufficient notice is provided to System 
subscribers about their rights and obligations related to clearly 
erroneous trades under NASD Rule 11890, as well as allow Nasdaq to 
train incoming INET staff to properly process such requests. Prior to 
60 days after the formal close of the Nasdaq/INET transaction, Nasdaq 
states that it would file with the Commission a rule proposal making 
INET's clearly erroneous process specifically subject to NASD Rule 
11890. Nasdaq states that it will seek immediate effectiveness of that 
filing.

8. Other System Standards

    Nasdaq is also proposing to establish standards regarding 
operational issues between the Nasdaq Market Center and INET. For 
example, Nasdaq is proposing rules for the INET System codifying 
standards regarding the obligation of users to honor system trades and 
the removal of users for failing to maintain a required clearing 
relationship.\9\ While Nasdaq is proposing that INET have in place at 
closing a general limitation of liability rule, Nasdaq is also 
proposing that INET continue, for a period of time not to exceed 60 
days after the formal close of the Nasdaq/INET transaction, to have the 
discretion to accommodate users of the System for losses arising out of 
the System or its use. Before the end of that time period, Nasdaq 
states that it will file a rule proposal with the Commission so that 
the System's future accommodation of users would be subject to the same 
standards already in place for the Nasdaq Market Center and Nasdaq's 
Brut Facility.\10\ Nasdaq is also proposing to establish rules 
governing the anonymity provided by the system, as well as rules 
governing minimum quote increments. Nasdaq states that the System's 
anonymity standards and proposed minimum quote increment standards are 
substantially similar to those in place in the Nasdaq Market Center and 
Nasdaq's Brut Facility and also provides for allowing sub-penny quotes 
in securities priced under $1.00.
---------------------------------------------------------------------------

    \9\ See proposed NASD Rules 4958 and 4959.
    \10\ See NASD Rule 4705(j) and proposed NASD Rule 4964.
---------------------------------------------------------------------------

9. Pricing

    Nasdaq is also proposing the creation of a fee and rebate schedule 
for the INET System. Nasdaq states that, with exception of eliminating 
fee rates discounts based on the use of the services of the Instinet 
broker-dealer, this fee and rebate schedule is the same as the one 
applicable to current INET subscribers.\11\ Nasdaq proposes that this 
fee schedule remain in place for a period of time not to exceed 60 days 
after the formal close of the Nasdaq/INET transaction. Before the 
termination of such 60-day period, Nasdaq will file with the Commission 
an integrated fee and rebate structure governing the use of all 
Nasdaq's main trading systems (i.e., the Nasdaq Market Center, Nasdaq's 
Brut Facility, and Nasdaq's INET System).
---------------------------------------------------------------------------

    \11\ See proposed NASD Rule 7010(w).
---------------------------------------------------------------------------

10. Trade-Through Compliance and Locked and Crossed Markets

    Nasdaq states that, in order to ensure compliance with the trade-
through rule for listed securities,\12\ the INET system checks the 
prices of orders in listed securities that are not made eligible for 
routing by the entering party before and after an order is entered in 
the System. The process is described in further detail below:
---------------------------------------------------------------------------

    \12\ See Section (8)(d) of the Plan for the Purpose of Creating 
and Operating an Intermarket Communications Linkage Pursuant to 
Section 11A(a)(3)(B) of the Act.
---------------------------------------------------------------------------

    At Order Entry--At the time of order entry, every order would be 
checked to ensure that it does not lock or cross the market, or cause 
an execution at a price that would constitute a violation of the trade-
through rule. If an order locks the market, it would be turned into a 
non-display order so as not to quote a locked market. If an order 
crosses the market, or would cause a trade-through violation, it would 
be re-priced to the current low offer (for bids) or to the current best 
bid (for offers), and turned into a non-display order so as to not 
quote a locked market. Any non-display order that crosses the market 
would be re-priced to the current low offer (for bids) or to the 
current best bid (for offers).

[[Page 67522]]

Example
    The National Best Bid in a listed security is $83.55. INET 
Subscriber enters a non-route order to sell at $83.54. The INET system 
would automatically re-price the order to $83.55 and change it to non-
display.
    After Order Entry--An non-routable order entered for display would 
not be affected by the trade-through rule after it is accepted. To 
prevent trade-throughs, however, a non-display non-routable order 
however, may be cancelled from the INET book with the reason code if 
the market moves through the price of the order after the order is 
accepted.
Example
    The National Best Bid in a listed security is $83.55. INET 
Subscriber enters a non-display non-route order to sell at $83.55. The 
National Best Bid in the security becomes $83.56. The non-display order 
to sell at $83.55 would be cancelled since it cannot be executed 
without causing a trade-through violation.
    Nasdaq states that INET's re-pricing and conversions to non-display 
of orders are done with the knowledge of System subscribers and only 
takes place in connection with orders that subscribers have elected not 
to make eligible for routing.

11. Integration Plan

    Upon the closing of the INET transaction, Nasdaq will be the owner 
and operator of three separate trading systems, the Nasdaq Market 
Center, Nasdaq's Brut Facility, and Nasdaq's INET System. For a period 
of time after the close, Nasdaq states that it will continue to 
separately operate these systems, with each system providing distinct 
order-display, execution, and routing services. Orders entered and 
displayed in a particular system shall have time-priority only with 
regard to other orders in that same system. For a period of time ending 
no later than September 30, 2006, the INET System would continue to 
post its top-of-file quotes through the facilities of NSX.
    Nasdaq's long-term vision is to have all of its systems integrated 
into a single technology platform that would further enhance execution 
quality for market participants. As part of that consolidation plan, 
soon after the formal close of the Nasdaq/INET transaction, Nasdaq 
states that it anticipates that it will merge the INET broker-dealer 
into Nasdaq's Brut broker-dealer and that Brut as a single broker 
dealer would operate both ECNs as separate systems, with separate order 
processing and execution. As such, the NYSE would continue to serve as 
the designated examining authority for financial responsibility 
purposes for Nasdaq's broker-dealer. Nasdaq states that there would 
continue to be no priority in one system for orders entered into the 
other.
    According to Nasdaq, the next step in its current plan is to 
combine all of its three execution systems into a single trading 
platform. Nasdaq states that it expects to accomplish this process 
sometime before the end of the third quarter of 2006. As part of this 
process, Nasdaq would also combine all three of its system books into a 
single integrated book where all orders interact and have time-priority 
against each other. Nasdaq anticipates transitioning quotation and 
execution activity from its systems and other market centers to its 
single system in phases.
    Once Nasdaq's single integrated system is operational and fully 
populated, Nasdaq states that it expects to continue to operate a 
broker-dealer to act as Nasdaq's outbound access broker dealer to reach 
orders displayed in other market centers.\13\
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    \13\ Changes to text made pursuant to phone conversation between 
Thomas P. Moran, Associate General Counsel, Nasdaq, and John C. 
Roeser, Assistant Director, Division of Market Regulation, 
Commission, on November 2, 2005.
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2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of Section 15A of the Act,\14\ in general, and Section 
15A(b)(6) of the Act,\15\ in particular, in that it is designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, remove impediments to a free and 
open market and a national market system, and, in general, to protect 
investors and the public interest.
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    \14\ 15 U.S.C. 78o-3.
    \15\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. Nasdaq states that its proposed 
operation of the INET System must be viewed against the backdrop of 
today's competitive and dynamic market structure. According to Nasdaq, 
the Commission's action in approving the Order Handling Rules, 
Regulation ATS, the creation of NASD's Alternative Display Facility 
(``ADF''), and the recent approval of Regulation NMS \16\ provide 
increased opportunities for market participants to compete vigorously 
for the trading of U.S. equity securities.
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    \16\ See Securities Exchange Act Release Nos. 37619A (August 29, 
1996), 61 FR 48290 (September 6, 1996) (Order Handling Release); 
40760 (December 8, 1998), 63 FR 70844 (December 22, 1998) 
(Regulation ATS Release); 46249 (July 24, 2002), 67 FR 49822 (July 
31, 2002) (ADF Release); and 51808 (June 9, 2005), 70 FR 37496 (June 
29, 2005) (Regulation NMS Release).
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    Nasdaq states that the combination of Regulation NMS's articulation 
of a framework that obligates market participants to seek the best 
price and the availability of technology to display and reach that 
price ensures that all market centers will be able to compete by 
offering the best price. Nasdaq believes that the dynamic market 
structure and the incentives that led to the creation of entities such 
as the INET System ensure that all market centers will continue to 
innovate and compete to serve their customers, and that new competitors 
will be able to enter if they believe it would be profitable for them 
to do so. In this dynamic competitive environment, Nasdaq believes that 
its operation of the INET System will not place any burden on 
competition.

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

    No written comments were either solicited or received.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which Nasdaq consents, the Commission will:
    (A) By order approve such proposed rule change; or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

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

[[Page 67523]]

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-NASD-2005-128 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-NASD-2005-128. 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 such 
filing also will be available for inspection and copying at the 
principal office of Nasdaq. 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-NASD-2005-128 and should be submitted on or before 
November 28, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 05-22227 Filed 11-4-05; 8:45 am]

BILLING CODE 8010-01-P
