

[Federal Register: October 6, 2006 (Volume 71, Number 194)]
[Notices]               
[Page 59173-59178]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr06oc06-107]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54537; File No. SR-NASD-2006-091]

 
 Self-Regulatory Organizations; National Association of 
Securities Dealers, Inc.; Order Approving a Proposed Rule Change and 
Amendment No. 2 Thereto and Notice of Filing and Order Granting 
Accelerated Approval to Amendment No. 3 Thereto to Align NASD Rules 
With Regulation NMS

September 28, 2006.

I. Introduction

    On July 28, 2006, the National Association of Securities Dealers, 
Inc. (``NASD'') 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 align its rules, including those governing the 
Alternative Display Facility (``ADF''), with Regulation NMS under the 
Act (``Regulation NMS'').\3\ On August 4, 2006, NASD filed Amendment 
No. 1 to the proposed rule change. Also on August 4, 2006, NASD 
withdrew Amendment No. 1 and filed Amendment No. 2 to the proposed rule 
change. The proposed rule change, as amended, was published for comment 
in the Federal Register on August 14, 2006.\4\ The Commission received 
no comments on the proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 17 CFR 242.600 et seq. See also Securities Exchange Act 
Release No. 51808 (June 9, 2005), 70 FR 37496 (June 29, 2005) 
(``Regulation NMS Adopting Release'').
    \4\ See Securities Exchange Act Release No. 54277 (August 4, 
2006), 71 FR 46527 (``notice'').
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    On September 27, 2006, NASD filed Amendment No. 3 to the proposed 
rule change.\5\ This order approves the proposed rule change, as 
amended by Amendment No. 2, grants accelerated approval to Amendment 
No. 3 to the proposed rule change, and solicits comments from 
interested persons on Amendment No. 3.
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    \5\ In Amendment No. 3, NASD: (1) Added language to NASD Rule 
4611A(a) stating that the priority for determining the bid and offer 
to be designated the protected quotation on the ADF would be price, 
size, and time and clarified in its Form 19b-4 submission that the 
protected quotation would be associated with a single market 
participant identifier (``MPID''); (2) modified Item 4 of the 
proposed Certification Record to make clear that an ADF Trading 
Center must respond to orders immediately and automatically and must 
respond to intermarket sweep orders (``ISOs'') consistent with 
Regulation NMS; (3) modified Item 10 of the proposed Certification 
Record to make clear that an ADF Trading Center must post its 
relevant connectivity and access technical specifications on its Web 
site; (4) added new Item 13 to the proposed Certification Record 
regarding the self-help exception to Rule 611 of Regulation NMS; (5) 
clarified the definition of ``system outage'' in proposed NASD Rule 
4300A(e)(2); (6) revised proposed NASD Rule 4619A to track more 
closely proposed NASD Rule 4300A(e)(2); (7) indicated that the 
Certification Record and certification procedures will be effective 
upon approval of the proposal; (8) stated that NASD would make its 
approved connectivity provider list available prior to October 16, 
2006; (9) clarified that current ADF Trading Centers would be 
required to publish appropriate technical specifications, consistent 
with the proposed Certification Record, no later than October 16, 
2006; (10) stated that NASD would provide a link to each such ADF 
Trading Center's specifications on its Web site; and (11) made minor 
technical changes to the proposal.
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II. Description

    NASD proposes to amend its rules to comply with Rules 610 and 611 
of Regulation NMS (``Access Rule'' and ``Order Protection Rule,'' 
respectively).\6\ Additionally, NASD proposes to revise its 
Certification Record, which each ADF Trading Center is required to 
complete prior to being permitted to post quotations through the ADF, 
and thereafter, to recertify on an annual basis. NASD also proposes to 
amend its rules that govern quoting, trade reporting, and clearing 
through the ADF to extend this functionality to all NMS stocks, as 
defined in Rule 600(b)(47) of Regulation NMS.\7\ Finally, NASD proposes 
to reorganize the ADF trade reporting rules and make certain technical 
changes to enhance the clarity of the ADF rules.
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    \6\ 17 CFR 242.610 and 242.611.
    \7\ 17 CFR 242.600(b)(47).
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    NASD stated in Amendment No. 3 that the changes to the 
Certification Record and certification procedures will become effective 
upon approval of the proposal by the Commission. All other rule changes 
in the proposal will become effective on the Regulation NMS Trading 
Phase Date--February 5, 2007.

Automated Quotations

    NASD proposes to amend its Rule 4300A(e) to require that an ADF 
Trading Center submit only automated quotations, as defined in Rule 
600(b)(3) of Regulation NMS,\8\ to the ADF, and to specifically state 
that manual quotations, as defined in Rule 600(b)(37) of Regulation 
NMS,\9\ shall not be submitted to the ADF. Pursuant to proposed NASD 
Rule 4300A(a)(4), each ADF Trading Center must demonstrate to NASD that 
it has sufficient technology to automatically update its quotations and 
immediately respond to orders for execution directly against the 
individual ADF Trading Center's best bid or offer (i.e., sufficient 
technology to display automated quotations). In addition, NASD Rule 
4300A(e) would require each ADF Trading Center to adopt policies and 
procedures to ensure that only automated quotations are submitted to 
the ADF, and each ADF Trading Center would be required to monitor its 
systems on a real-time basis to assess whether they are functioning 
properly.
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    \8\ 17 CFR 242.600(b)(3).
    \9\ 17 CFR 242.600(b)(37).
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    NASD also proposes to amend the system outage procedures in its 
Rule 4300A. A system outage would now be defined in NASD Rule 
4300A(e)(2) as an inability to post automated quotations or an 
inability to respond to orders immediately and automatically.\10\ 
Pursuant to proposed NASD Rule 4619A, if an ADF Trading Center were 
unable to submit automated quotations or were unable to respond 
immediately and automatically to orders, it would

[[Page 59174]]

have to withdraw its quotations from the ADF and notify ADF Operations. 
NASD proposes that, pursuant to these rules, ADF Operations would 
determine: (1) When three unexcused outages during a five-day period 
should result in the suspension of an ADF Trading Center from quoting 
in the ADF for a period of 20 days; and (2) in its discretion, whether 
an outage should be excused without limitation. NASD could suspend, 
condition, limit, prohibit, or terminate an ADF Trading Center's 
authority to enter quotations in one or more ADF-eligible securities 
for violations of applicable requirements or prohibitions, pursuant to 
proposed NASD Rule 4621A.\11\
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    \10\ NASD also proposes to delete existing NASD IM-4613A that 
bans the automated update of certain quotations through the ADF. 
NASD originally adopted this IM to address capacity and operation 
concerns, but it no longer believes such a prohibition is necessary.
    \11\ The Commission notes that this remedy is in addition to any 
remedy NASD may pursue against an ADF Trading Center for inadequate 
policies and procedures to ensure that only automated quotations are 
submitted to the ADF. The ADF Trading Center would still have an 
obligation to post only automated quotations, pursuant to NASD Rule 
4300A(e).
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    Only a single quotation of a single ADF Trading Center would be the 
source of a protected bid or a protected offer, as defined in Rule 
600(b)(57) of Regulation NMS.\12\ Among the bids and offers of all ADF 
Trading Centers, the protected bid and protected offer would be 
identified by NASD based upon price, size, and time priority.\13\
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    \12\ 17 CFR 242.600(b)(57).
    \13\ As revised in Amendment No. 3, NASD Rule 4611A(a) would 
provide that the ADF's protected quotation will be identified by 
NASD based upon price, size, and time priority. In addition, NASD 
clarified that the protected quotation would be submitted through 
and associated with a single MPID. See also notice, 71 FR at 46528, 
n.10.
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Access Rule

    NASD proposes to amend its Rule 4300A to promote compliance by ADF 
Trading Centers with the access standards set forth in Rule 610 of 
Regulation NMS. Specifically, pursuant to amended NASD Rules 
4300A(a)(3) and 4300A(a)(5), each ADF Trading Center must: (1) provide 
a level and cost of access to its quotations in an NMS stock displayed 
in the ADF that is substantially equivalent to the level and cost of 
access to quotations in that NMS stock displayed by SRO trading 
facilities; and (2) ensure that it does not impose unfairly 
discriminatory terms that prevent or inhibit any person from obtaining, 
through a registered broker-dealer, efficient access to such 
quotations. In addition, NASD proposes to amend its Rule 4300A to 
require an ADF Trading Center to provide direct electronic access to 
registered broker-dealers, and its Rule 4400A to provide standing for 
any registered broker-dealer, not just an NASD member, to file a 
complaint with NASD alleging a denial of direct or indirect access.
    Amended Rule 4300A(d)(1) would require each ADF Trading Center to 
use communication services that are deemed sufficient by NASD.\14\ To 
facilitate this effort, NASD staff would develop and post on the NASD 
Web site a list of NASD-approved private sector connectivity providers 
(e.g., financial extranet services and direct market access firms).\15\ 
Each ADF Trading Center would be required to be accessible through at 
least two approved connectivity providers. Also, each ADF Trading 
Center would be required to provide a certification regarding its 
ability to make available to market participants a substantially 
equivalent level and cost of access to that offered by SRO trading 
facilities, consistent with the Access Rule.\16\
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    \14\ As stated in the notice, NASD staff would not necessarily 
review the technical functionality of the various connectivity 
providers, but would assess the reliability, cost effectiveness, and 
the extent to which the service is sufficiently prevalent among 
firms that require the ability to route orders to an ADF Trading 
Center to meet their obligations under the Order Protection Rule.
    \15\ See Amendment No. 3, Changes to Form 19b-4, Item 4.
    \16\ See infra note 23 and accompanying text.
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    In addition, NASD proposes to adopt new Rule 4130A that would 
require each member to reasonably avoid displaying any quotation that 
locks or crosses a protected quotation in an NMS stock during regular 
trading hours, unless it meets a specified exception. In light of this 
new rule, NASD would delete certain provisions in existing NASD Rule 
4613A that address locked or crossed intra-market quotations during 
regular trading hours. NASD Rule 4613A would continue to address locked 
or crossed quotation conditions in the ADF prior to market opening 
(i.e., 9:30 a.m. Eastern Time).

Certification Record

    NASD proposes certain changes to its Certification Record and 
certification process to ensure that each ADF Trading Center has the 
capability to comply with the Order Protection Rule and Access 
Rule.\17\ Proposed NASD Rule 4200A(a)(5) provides that an ADF Trading 
Center must execute and continue to comply with its Certification 
Record to be eligible to display quotations through the ADF.
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    \17\ NASD's proposed Certification Record was filed as Exhibit 3 
to its proposal and was published on the Commission's Web site 
(http://www.sec.gov/rules/sro.shtml). The Certification Record is 

described in detail in the notice.
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    The Certification Record would require each ADF Trading Center to 
certify, among other things, that it:
     Monitors in real-time away market protected quotations; 
\18\
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    \18\ See Certification Record, Item 2 (also requiring a clock 
synchronization protocol).
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     Will submit only automated quotations for display on the 
ADF; \19\
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    \19\ See Certification Record, Item 3.
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     Offers immediate-or-cancel order and ISO \20\ execution 
functionality for execution against its protected quotations to those 
required to be granted access to protected quotations consistent with 
Regulation NMS; \21\
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    \20\ See 17 CFR 242.600(b)(30).
    \21\ See Certification Record, Item 4.
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     Offers fair and non-discriminatory access; \22\
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    \22\ See Certification Record, Item 5.
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     Provides a level and cost of access to quotations 
displayed through the ADF that is substantially equivalent to the level 
and cost of access offered by SRO trading facilities generally; \23\
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    \23\ See Certification Record, Item 7. An ADF Trading Center 
would also certify that, to the extent that NASD deems such ADF 
Trading Center not to be granting the requisite level and cost of 
access, that ADF Trading Center would be required by NASD to defray 
the connectivity costs of those persons entitled to access the ADF 
Trading Center. See Certification Record, Item 8. Moreover, if an 
ADF Trading Center charges a fee in excess of the fee cap for 
accessing orders other than protected quotations, it must certify 
that it will provide functionality that prevents market participants 
from inadvertently accessing a non-protected quotation and being 
charged a fee in excess of the fee cap. See Certification Record, 
Item 6.
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     Will make publicly available on its Internet Web site 
relevant connectivity and access technical specifications; \24\ and
     Will transmit to ADF Operations any notification received 
or transmitted by it regarding use of the self-help exception to the 
Order Protection Rule (i.e., Rule 611(b)(1)).
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    \24\ See Certification Record, Item 10. Consistent with 
Regulation NMS, NASD will require current ADF Trading Centers to 
publish such technical specifications no later than October 16, 
2006. See Amendment No. 3, Changes to Form 19b-4, Item 6. NASD will 
identify each ADF Trading Center on NASD's Web site and provide a 
link to the final technical specifications. Id.
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    Documentation would have to be filed with NASD to demonstrate that 
the certifications are reasonably supported. In addition, each 
enumerated item would have to be certified by a duly authorized 
representative of the ADF Trading Center at the time of the initial 
application.\25\ Recertification would be required within 30 days of 
the end of each ADF Trading Center's fiscal year. As provided in 
proposed NASD Rule

[[Page 59175]]

4300A(c), NASD's acceptance of an ADF Trading Center's Certification 
Record would not relieve the ADF Trading Center of any of its ongoing 
obligations and would not constitute an estoppel as to NASD or bind 
NASD in any subsequent administrative, civil, or disciplinary 
proceeding.
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    \25\ Current ADF Trading Centers also would be required to be 
re-certified prior to the implementation of Regulation NMS and 
comply with applicable Regulation NMS requirements prior to the 
Specifications Date--October 16, 2006--and Trading Phase Date--
February 5, 2007. Accordingly, there will be no ``grandfather'' 
allowance for current ADF Trading Centers.
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Extending ADF Functionality to All NMS Stocks

    NASD proposes to extend the ADF's quoting, trade reporting, and 
clearing functionality by changing the definition of ``ADF-eligible 
security'' to include all NMS stocks, not just Nasdaq stocks. In 
addition, NASD proposes to amend the ADF rules to adopt uniform rules 
governing quoting and trade reporting for NMS stocks, and amend certain 
other rules to reflect the inclusion of all NMS stocks in the ADF.\26\ 
Correspondingly, NASD also proposes to delete the NASD Rule 5200 series 
relating to the Intermarket Trading System Plan (``ITS Plan''), 
reflecting the fact that subsequent to the Trading Phase Date--February 
5, 2007--it is expected that the ITS Plan will cease to be 
operative.\27\
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    \26\ NASD would delete the existing NASD Rule 6300 and 6400 
series, relevant portions of which are being incorporated into the 
NASD Rule 4000A series, which governs the ADF.
    \27\ See Securities Exchange Act Release No. 53829 (May 18, 
2006), 71 FR 30038, 30039 (May 24, 2006) (``Regulation NMS 
Compliance Release'').
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Changes to ADF Trade Reporting Rules

    NASD proposes to clarify the ADF trade reporting rules by, among 
other things, amending: (1) NASD Rule 4630A, to provide that a 
transaction executed otherwise than on an exchange would have to be 
reported to the Trade Reporting and Comparison Service (``TRACS''), in 
accordance with NASD Rule 4632A or another pertinent NASD rule, unless 
it were reported to another facility designated by the Commission as 
being authorized to accept trade reports for trades executed otherwise 
than on an exchange; \28\ (2) NASD Rule 4632A(f), to expressly prohibit 
aggregation of individual executions of orders in a security at the 
same price into a single transaction report; and (3) NASD Rule 
4632A(l), to clarify a member's obligation under ADF rules to report 
cancelled trades in a timely manner.\29\
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    \28\ See, e.g., Securities Exchange Act Release No. 54084 (June 
30, 2006), 71 FR 38935 (July 10, 2006) (File No. SR-NASD-2005-087) 
(establishing, among other things, rules for the trade reporting of 
transactions otherwise than on an exchange through the Trade 
Reporting Facility).
    \29\ Corresponding changes are being proposed to NASD's Rule 
6100A series governing the use of TRACS to reflect the inclusion of 
all NMS stocks in the ADF.
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    In addition, proposed NASD Rule 4632A(a)(4) would expressly require 
reporting members to append certain new trade report modifiers to a 
last sale report. In particular, NASD would adopt a new modifier (.X) 
for reporting a trade-through of a protected quotation that qualifies 
for one of certain exceptions or exemptions from the Order Protection 
Rule. The reporting member would also be required to append a separate 
unique modifier, if applicable, to identify the specific applicable 
exception or exemption upon which the member is relying.\30\ Proposed 
NASD Rule 4632A(a)(4) further provides that, to ensure consistency in 
the usage of such modifiers, trades will be identified in accordance 
with the specifications approved by the Operating Committee of the 
relevant national market system plan (``NMS Plan'').\31\ NASD has 
represented that it would provide a comprehensive list of all required 
modifiers when it publishes the ADF technical specifications on or 
before October 16, 2006.\32\
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    \30\ In its proposal, NASD stated that a firm is responsible for 
ensuring that the specific transaction falls expressly into an 
exception set forth in the Order Protection Rule.
    \31\ NASD would require reporting members, including ADF Trading 
Centers, to append additional NASD-specific trade report modifiers 
in certain situations.
    \32\ See notice, 71 FR at 46529; Amendment No. 2, Changes to 
Form 19b-4, Item 6.
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III. Discussion and Commission Findings

    After careful review, the Commission 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 association.\33\ In particular, the Commission finds that 
the proposal is consistent with Section 15A(b)(6) of the Act \34\ in 
that it is designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, and, in 
general, to protect investors and the public interest. In addition, the 
Commission finds that the proposal is consistent with Section 
15A(b)(11) of the Act \35\ in that it is designed to produce fair and 
informative quotations, to prevent fictitious or misleading quotations, 
and to promote orderly procedures for collecting, distributing, and 
publishing quotations. Finally, as discussed in more detail below, the 
Commission believes that the proposal is reasonably designed to conform 
NASD's rules to, and promote ADF Trading Centers' compliance with, the 
requirements of Regulation NMS.
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    \33\ In approving this proposed rule change, the Commission 
notes that it has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
    \34\ 15 U.S.C. 78o-3(b)(6).
    \35\ 15 U.S.C. 78o-3(b)(11).
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A. Rule Changes Related to Regulation NMS

    Rule 611 of Regulation NMS requires every trading center to 
establish, maintain, and enforce written policies and procedures that 
are reasonably designed to prevent trade-throughs on that trading 
center of ``protected quotations'' in NMS stocks (unless an exception 
or exemption applies). A protected quotation is a bid or offer 
displayed by an ``automated trading center'' pursuant to an effective 
national market system plan that, with respect to NASD, is the best bid 
or offer displayed on the ADF.\36\ An automated trading center is a 
trading center that has implemented such systems, procedures, and rules 
as are necessary to render it capable of displaying quotations that 
meet the requirements for ``automated quotations.'' \37\ An automated 
quotation is a quotation displayed by a trading center that, among 
other things, permits an incoming order to be marked immediate-or-
cancel, immediately and automatically executes an order so marked 
against the displayed quotation, or cancels without routing elsewhere, 
immediately transmits a response, and immediately and automatically 
displays information that updates the displayed quotation to reflect 
any change to its material terms.\38\
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    \36\ See 17 CFR 242.600(b)(57).
    \37\ See 17 CFR 242.600(b)(4).
    \38\ See 17 CFR 242.600(b)(3).
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    The ADF was established as a facility of NASD in connection with 
NASD's severing its affiliation with Nasdaq,\39\ which is now 
registered as a national securities exchange.\40\ In approving a major 
market structure change to Nasdaq--the establishment of its 
SuperMontage trading platform--the Commission took the view that market 
participants should not be forced to participate in SuperMontage. 
Therefore, the Commission conditioned its approval of SuperMontage on 
NASD, having a statutory obligation under Section 15A(b)(11) to 
regulate quoting in the over-the-counter (``OTC'') market, establishing 
an ``alternative display

[[Page 59176]]

facility.'' \41\ In its initial approval of the ADF pilot, the 
Commission found that this condition to the SuperMontage approval had 
been met and stated that the ADF ``furthers the public interest by 
ensuring that continuity in the [OTC] market is maintained and that the 
NASD satisfies its statutory obligation to regulate the [OTC] market.'' 
\42\ The Commission's adoption of Regulation NMS imposes certain new 
duties on NASD as operator of the ADF, which currently is the only 
``SRO display-only facility'' in the national market system.
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    \39\ See generally Securities Exchange Act Release Nos. 43863 
(January 19, 2001), 66 FR 8020 (January 26, 2001) (``SuperMontage 
Approval Order''); and 46249 (July 24, 2002), 67 FR 49822 (July 31, 
2002) (``ADF Pilot Approval Order'').
    \40\ See Securities Exchange Act Release Nos. 53128 (January 13, 
2006), 71 FR 3550 (January 23, 2006); and 54085 (June 30, 2006), 71 
FR 38910 (July 10, 2006).
    \41\ See SuperMontage Approval Order, 66 FR at 8053-54.
    \42\ ADF Pilot Approval Order, 67 FR at 49848.
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    First, NASD must identify the ADF's protected quotation so that all 
other market participants can readily see what Rule 611 requires them 
to protect. Unlike with an exchange, where the quotations of two or 
more exchange members can be aggregated to constitute a single 
protected quotation, the best bid of the ADF must reflect a single 
quotation of a single ADF Trading Center, and the best offer of the ADF 
must reflect a single quotation of a single ADF Trading Center.\43\ 
Because the ADF does not provide execution functionality, market 
participants must use private linkages to route orders to individual 
ADF Trading Centers. The Commission's approach prevents market 
participants from having to route orders to multiple ADF Trading 
Centers to fulfill their obligations under Rule 611 to satisfy the 
ADF's protected quotation. This approach treats exchange markets 
comparably with the ADF, as market participants need route only a 
single order to an exchange to fulfill any obligations under Rule 
611.\44\
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    \43\ See Regulation NMS Adopting Release, 70 FR at 37534 (``A 
best bid and best offer must be accessible by routing an order to a 
single market destination. * * *'')
    \44\ See id., 70 FR at 37529.
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    The Commission believes that NASD Rule 4611A(a) is reasonably 
designed to identify the ADF protected quotation in a manner consistent 
with Regulation NMS and the Act generally. NASD clarified that the best 
bid of the ADF will reflect a single quotation of a single ADF Trading 
Center, and the best offer of the ADF will reflect a single quotation 
of a single ADF Trading Center, in each case represented through a 
single MPID.\45\ The Commission further believes that NASD's assignment 
of priority based on price, size, and then time is reasonable and 
consistent with the Act. Furthermore, as directed by the Commission in 
the Regulation NMS Compliance Release, NASD must provide on its Web 
site, on or before the Specifications Date--October 16, 2006--a 
hyperlink to the Web site of each ADF Trading Center that will set 
forth the required technical specifications, with respect to each such 
ADF Trading Center, that are required to be posted by that date.\46\ 
NASD has stated that a link to ADF Trading Centers' technical 
specifications will be posted on NASD's Web site.\47\
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    \45\ See Amendment No. 3, Changes to Form 19b-4, Item 2.
    \46\ See Regulation NMS Compliance Release, 71 FR at 30039.
    \47\ See Amendment No. 3, Changes to Form 19b-4, Item 6. NASD 
will separately require each ADF Trading Center to post its final 
technical specifications on its own Web site setting out, among 
other things, how market participants may link to it, and how orders 
must be coded to enable access to quotations published on the ADF, 
consistent with the Regulation NMS Compliance Release. In this 
regard, NASD will require current ADF Trading Centers to certify 
that they will comply with this requirement and, as appropriate, 
provide ADF Operations with relevant related information.
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    Second, as the regulator of quotations in the OTC market, NASD must 
promote compliance by ADF Trading Centers with the requirements 
relating to automated quotations, which Rule 611 requires market 
participants to protect. NASD has determined to carry out that 
responsibility by permitting ADF Trading Centers to submit only 
automated quotations to the ADF. NASD Rule 4300A(e)(1) prohibits manual 
quotations from being submitted to the ADF and requires every ADF 
Trading Center to establish policies and procedures to ensure that it 
submits only automated quotations to the ADF. In addition, NASD Rule 
4300A(a)(4) requires each ADF Trading Center to demonstrate to NASD 
that it has sufficient technology to automatically update its 
quotations and immediately respond to orders for execution directly 
against its best bid or offer. Furthermore, Items 3 and 4 of the 
Certification Record require an ADF Trading Center to certify that it 
will post only automated quotations to the ADF and that it will be able 
to respond appropriately to incoming orders in accordance with 
Regulation NMS.
    The inability to post automated quotations in the ADF or the 
inability to immediately and automatically respond to orders would 
constitute a ``system outage'' under NASD Rule 4300A(e)(2). An ADF 
Trading Center experiencing a system outage must immediately withdraw 
its quotations and contact ADF Operations, pursuant to NASD Rule 4619A. 
NASD Rule 4621A allows NASD to suspend, condition, or terminate an ADF 
Trading Center's authority to enter quotations for violating this 
requirement.
    The Commission believes that NASD's rules relating to the provision 
of automated quotations to the ADF are reasonable and consistent with 
the Act, and with Regulation NMS in particular. The requirements that 
an ADF Trading Center post only automated quotations to the ADF and, in 
the event of a systems problem, withdraw its quotations immediately 
should minimize the extent to which the systems problems of a 
particular ADF Trading Center interfere with efficient trading 
throughout the national market system. The affirmative duty of each 
automated trading center to identify its quotations appropriately is a 
vitally important element of Regulation NMS. It will help promote the 
smooth and efficient functioning of intermarket price priority and 
trading in general. Timely and accurate identification of quotations 
will give investors, broker-dealers, and other trading centers 
essential information concerning the status of quotations in NMS 
stocks, thereby minimizing the extent to which the systems problems of 
a particular trading center can interfere with efficient trading 
throughout the national market system. For example, when a trading 
center experiencing systems problems promptly fulfills its duty to 
identify its quotations as manual or pulls its quotation altogether, 
and thereby removes them from trade-through protection, it will not be 
necessary for other trading centers or order-routers to invoke the 
self-help exception.
    Third, for the goals of Regulation NMS to be met, NASD must help 
promote efficient access to ADF Trading Centers that wish to be 
eligible for protected quotation status without displaying their 
quotations in an SRO trading center.\48\ In the process leading to the 
Commission's adoption of Regulation NMS, various commenters expressed 
concern that it could be inefficient to establish linkages to numerous 
individual ADF Trading Centers whose quotations are protected under 
Rule 611.\49\ As the Commission itself noted, ``the greater the number 
of ADF Trading Centers, the greater the number of separate connectivity 
points that market participants will need to access to comply with the 
Order

[[Page 59177]]

Protection Rule.'' \50\ To address these concerns, the Commission 
ultimately determined that the cost of such access passed on to users, 
and the level of access generally, must be ``substantially equivalent 
to the level and cost of access to quotations displayed by SRO trading 
facilities.'' \51\ The Commission further stated that ``effective NASD 
oversight of NASD participants'' compliance with [Rule 610] is critical 
to the viability of the access standards * * * given that these 
participants are not accessible through an SRO trading facility.'' \52\
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    \48\ See Regulation NMS Adopting Release, 70 FR at 37543 (``As 
the self-regulatory authority responsible for the OTC market, the 
NASD must act as the `gatekeeper' for the ADF, and, as such, will 
need to closely assess the extent to which ADF Trading Centers meet 
the access standards of Rule 610.'')
    \49\ See Regulation NMS Adopting Release, 70 FR at 37540, nn. 
370, 381.
    \50\ Id., 70 FR at 37541.
    \51\ Id., 70 FR at 37542.
    \52\ Id., 70 FR at 37543.
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    The Commission believes that NASD has reasonably designed the ADF 
rules, Certification Record, and related materials to promote 
compliance by ADF Trading Centers with the requirements of the Access 
Rule. NASD Rule 4300A(a)(3) requires each ADF Trading Center to provide 
a level and cost of access to its quotations in an NMS stock displayed 
in the ADF that is substantially equivalent to the level and cost of 
access to quotations displayed by SRO trading facilities in that NMS 
stock. NASD Rule 4300A(a)(5) prohibits an ADF Trading Center from 
imposing unfairly discriminatory terms that prevent or inhibit any 
person from obtaining, through a registered broker-dealer, efficient 
access to such quotations. Items 5 and 7 of the Certification Record 
require an ADF Trading Center to certify that it is in compliance with 
the requirements of NASD Rules 4300A(a)(5) and 4300A(a)(3). NASD Rule 
4400A(a) allows any registered broker-dealer to file a claim for denial 
of direct or indirect access and, if applicable, authorizes NASD to 
withdraw an ADF Trading Center's quotations until appropriate access is 
provided.
    NASD Rule 4300A(d)(1) requires an ADF Trading Center to provide 
direct electronic access through the use of at least two providers from 
the list of NASD-approved connectivity providers. The Commission 
believes that this is a reasonable approach to promote compliance by 
ADF Trading Centers with the Access Rule and is, therefore, consistent 
with the Act. NASD also has stated that it would review the list 
periodically and update it on an as-needed basis. Therefore, the 
Commission believes that the maintenance of this list does not impose 
any burden on competition not necessary or appropriate in furtherance 
of the purposes of the Act, as required by Section 15A(b)(9) of the 
Act.\53\
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    \53\ 15 U.S.C. 78o-3(b)(9).
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    Each ADF Trading Center must demonstrate its compliance with the 
Access Rule, and in particular that it will provide a level and cost of 
access substantially equivalent to the level and cost of access to 
quotations displayed by SRO trading facilities. NASD, as the regulator 
of quotations in the OTC market, must evaluate ``substantially 
equivalent cost of access'' on a per-transaction basis.\54\ In its 
proposal, NASD has indicated that it will consider costs related to 
directly accessing SRO trading facilities generally, and more 
specifically, ADF Trading Center and SRO connectivity costs such as 
line costs and port charges. In addition, NASD stated that it would 
consider costs associated with SRO membership in evaluating 
substantially equivalent costs. The Commission expects NASD to provide 
appropriate guidance in accordance with these principles to ADF Trading 
Centers, as necessary, in connection with their demonstration of 
substantially equivalent access.
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    \54\ The Commission has previously stated that, in evaluating 
access, a $1,000 port charge for an ECN participating in the ADF 
that trades one million shares per day would not be substantially 
equivalent to a $1,000 port fee charged by an SRO trading facility 
trading 100 million shares per day. See Regulation NMS Adopting 
Release, 70 FR at 37543.
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    Furthermore, the Commission has stated that NASD must make an 
affirmative determination that existing ADF Trading Centers are in 
compliance with the requirements of the Access Rule, and that, if an 
ADF Trading Center were not so complying, NASD would have a 
responsibility to stop publishing its quotations until it comes into 
compliance.\55\ In the Notice, NASD represented that it will comply 
with this directive.
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    \55\ See Regulation NMS Adopting Release, 70 FR at 37543.
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    Fourth, paragraph (d) of the Access Rule \56\ requires each 
national securities exchange and national securities association to 
establish, maintain, and enforce written rules that require its members 
reasonably to avoid displaying quotations that lock or cross any 
protected quotation in an NMS stock and are reasonably designed to 
assure the reconciliation of locked or crossed quotations in an NMS 
stock. NASD Rule 4130A requires every NASD member to reasonably avoid 
displaying, or engaging in a pattern or practice of displaying, any 
quotations that lock or cross a protected quotation and any manual 
quotations that lock or cross a quotation previously disseminated 
pursuant to an effective NMS Plan, subject to certain exceptions.\57\ 
In addition, the rule would require a member displaying a manual 
quotation in an NASD facility other than the ADF \58\ that locks or 
crosses a quotation previously disseminated pursuant to an effective 
NMS Plan to promptly withdraw the quotation or route an ISO to execute 
against the full displayed size of the locked or crossed quotation. The 
Commission believes that NASD Rule 4130A is reasonably designed to 
fulfill NASD's obligations under Rule 610(d) of Regulation NMS and is, 
therefore, consistent with the Act.
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    \56\ 17 CFR 242.610(d).
    \57\ The Commission notes that existing NASD Rule 4613A will 
continue to address locked or crossed quotation conditions in the 
ADF prior to market opening.
    \58\ As described above, manual quotations shall not be 
submitted to the ADF. See proposed NASD Rule 4300A(e)(1).
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B. Other Rule Changes

    Currently, the ADF accommodates the quoting, trade reporting, and 
clearing of only Nasdaq securities. NASD proposes to amend its Rule 
4200A(a)(2) to define ``ADF-eligible security'' to include any NMS 
stock, thereby extending the ADF quoting, trade reporting, and clearing 
functionality to NMS stocks other than those listed on Nasdaq. 
Correspondingly, NASD is deleting the existing Rule 6300 and 6400 
series, which govern the quoting and trade reporting of exchange-listed 
securities, because these rules would no longer be necessary. NASD also 
will update certain other rules to reflect the inclusion of all NMS 
stocks in the ADF.
    As originally conceived, the ADF would have accommodated the 
quoting, trade reporting, and clearing of exchange-listed securities as 
well as Nasdaq securities, and would have made participation in the ITS 
Plan voluntary for OTC market makers.\59\ At the time of the proposal, 
commenters expressed concern with allowing OTC market makers for 
exchange-listed securities to participate in the ITS Plan on a 
voluntary basis.\60\ Subsequently, NASD revised the ADF proposal to 
eliminate the quoting of exchange-listed securities, and proposed 
operating the ADF on a pilot basis for Nasdaq securities only.\61\ With 
the Access Rule of Regulation NMS, however, the Commission adopted a 
private linkage approach to promote efficient interaction among market 
participants. This approach is expected to replace the

[[Page 59178]]

ITS linkage, thus eliminating the concern originally expressed by 
commenters. Therefore, the Commission believes that it is reasonable 
and consistent with the Act to eliminate the restriction on quoting 
non-Nasdaq NMS stocks in the ADF.
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    \59\ See Securities Exchange Act Release No. 45156 (December 14, 
2001), 67 FR 388 (January 3, 2002).
    \60\ See Securities Exchange Act Release No. 46249 (July 24, 
2002), 67 FR 49822 (July 31, 2002) at 49848, n.26.
    \61\ See Securities Exchange Act Release No. 46249 (July 24, 
2002), 67 FR 49822 (July 31, 2002).
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    NASD has proposed to delete its Rule 5200 series relating to the 
ITS Plan effective upon the Trading Phase Date. On the Trading Phase 
Date, it is expected that the ITS Plan will cease to be operative, and 
NASD's rules related to the ITS Plan will thus no longer be necessary.
    NASD also proposes to amend ADF transaction reporting requirements. 
Among other things, NASD Rule 4632A(a)(4) expressly requires reporting 
members to append certain new trade report modifiers to a last sale 
report to more closely align NASD modifiers with the exceptions and 
exemptions from the Order Protection Rule. The Commission believes that 
these rules are consistent with the Act and should enhance consistency 
for trades that are executed in reliance on an exception or exemption 
from Rule 611. The use of identical modifiers across all markets should 
facilitate surveillance and promote transparency in the 
marketplace.\62\
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    \62\ See Regulation NMS Adopting Release, 71 FR at 37507, n.73 
(``Such modifiers would greatly enhance transparency and minimize 
the potential for false appearances of violations of Rule 611.'')
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    NASD also has proposed other changes to the ADF trade reporting 
rules, including Rules 4300A, 4630A, and 4632A, to enhance their 
clarity. In addition, NASD is correcting cites to the Commission's 
national market system rules that were renumbered by Regulation NMS. 
These changes are reasonable and consistent with the Act.

IV. Accelerated Approval of Amendment No. 3

    Pursuant to Section 19(b)(2) of the Act,\63\ the Commission may not 
approve any proposed rule change, or amendment thereto, prior to the 
30th day after the date of publication of notice of the filing thereof, 
unless the Commission finds good cause for so doing and publishes its 
reasons for so finding.
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    \63\ 15 U.S.C. 78s(b)(2).
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    In Amendment No. 3, the NASD added language to its NASD Rule 
4611A(a) stating that the priority for determining the bid and offer to 
be designated the protected quotation on the ADF would be price, size, 
and time, and clarified in its Form 19b-4 submission that the best bid 
and best offer would be determined based on quotations submitted 
through individual MPIDs. NASD also modified Item 4 of the proposed 
Certification Record to make clear that an ADF Trading Center must 
respond to orders immediately and automatically and must respond to 
ISOs consistent with Regulation NMS, modified Item 10 of the proposed 
Certification Record to make clear that an ADF Trading Center must post 
its relevant connectivity and access technical specifications on its 
Web site, and added new Item 13 to the proposed Certification Record 
that requires an ADF Trading Center to certify that it will transmit to 
ADF Operations any notification received or transmitted by it regarding 
use of the self-help exception to the Order Protection Rule. In 
addition, NASD clarified the definition of system outage in proposed 
NASD Rule 4300A(e)(2), revised proposed NASD Rule 4619A to track more 
closely that definition, and made minor technical changes to the 
proposal. Finally, NASD clarified that the Certification Record and 
process for certifying ADF Trading Centers will be effective upon 
Commission approval of the proposal, that the NASD-approved list of 
connectivity providers will be made available prior to October 16, 
2006, that current ADF Trading Centers would be required to publish 
appropriate technical specifications no later than October 16, 2006, 
that it would provide a link to each such ADF Trading Center's 
specifications on its Web site and that effectiveness of the other 
proposed rules will be the Trading Phase Date--February 5, 2007. The 
Commission believes that these changes clarify the proposed rules and 
Certification Record and do not raise any significant or novel 
regulatory issues. Accordingly, the Commission hereby finds good cause 
for approving Amendment No. 3 to the proposed rule change prior to the 
30th day after publishing notice of Amendment No. 3 in the Federal 
Register.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 3, including whether Amendment No. 3 
is consistent with the Act. Comments may be submitted by any of the 
following methods:

Electronic Comments

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

File Number SR-NASD-2006-091 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-NASD-2006-091. 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 NASD. 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-2006-091 and should be submitted on or before October 27, 2006.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\64\ that the proposed rule change (File No. SR-NASD-2006-091), as 
amended by Amendment No. 2, be, and hereby is approved, and that 
Amendment No. 3 to the proposed rule change be, and hereby is, approved 
on an accelerated basis.
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    \64\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\65\
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    \65\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
[FR Doc. E6-16548 Filed 10-5-06; 8:45 am]

BILLING CODE 8011-01-P
