
[Federal Register: January 20, 2010 (Volume 75, Number 12)]
[Notices]               
[Page 3263-3270]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr20ja10-110]                         

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SECURITIES AND EXCHANGE COMMISSION

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

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

January 13, 2010.

I. Introduction

    On December 30, 2008, The NASDAQ Stock Market LLC (``Nasdaq'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to modify its rule governing electronic access to 
the Exchange's order execution systems. On January 28, 2009, Nasdaq 
filed Amendment No. 1 to the proposed rule change. The proposed rule 
change, as modified by Amendment No. 1, was published for comment in 
the Federal Register on January 29, 2009.\3\ The Commission received 
thirteen comment letters on the proposal.\4\ On October 19,

[[Page 3264]]

2009, Nasdaq filed Amendment No. 2 to the proposed rule change and 
responded to the comment letters. On October 23, 2009, Nasdaq filed 
Amendment No. 3 to the proposed rule change. This notice and order 
provides notice of filing of Amendment Nos. 2 and 3, and grants 
accelerated approval to the proposed rule change, as modified by 
Amendment Nos. 1, 2, and 3.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 59275 (January 22, 
2009), 74 FR 5193.
    \4\ Letters to Elizabeth M. Murphy, Secretary, Commission, from 
Harvey Cloyd, Chief Executive Officer, Electronic Transaction 
Clearing, Inc., dated February 5, 2009 (``ETC Letter''); John 
Jacobs, Director of Operations, Lime Brokerage LLC, dated February 
17, 2009 (``Lime I Letter''); Manisha Kimmel, Executive Director, 
Financial Information Forum, dated February 19, 2009 (``FIF 
Letter''); Ted Myerson, President, FTEN, Inc., dated February 19, 
2009 (``FTEN I Letter''); Michael A. Barth, Executive Vice 
President, OES Market Group, dated February 23, 2009 (``OES 
Letter''); Jeff Bell, Executive Vice President, Clearing and 
Technology Group, Wedbush Morgan Securities, dated February 23, 2009 
(``Wedbush Letter''); Stuart J. Kaswell, Executive Vice President & 
General Counsel, Managed Funds Association, dated February 24, 2009 
(``MFA Letter''); Ann Vlcek, Managing Director and Associate General 
Counsel, Securities Industry and Financial Markets Association 
(``SIFMA''), dated February 26, 2009 (``SIFMA I Letter''), Nicole 
Harner Williams, Vice President, Associate General Counsel, Penson 
Financial Services, Inc., dated February 27, 2009 (``Penson 
Letter''); Samuel F. Lek, Chief Executive Officer, Lek Securities 
Corporation, dated June 15, 2009 (``Lek Letter''); letter to David 
S. Shillman, Associate Director, Division of Trading and Markets 
(``Division''), James A. Brigagliano, Associate Director, Division, 
and A. Duer, Meehan, Associate Director, Office of Compliance 
Inspections and Examinations, Commission, from Gary LaFever, Chief 
Corporate Development Officer, FTEN, Inc., dated April 29, 2009 
(``FTEN II Letter''); letter to James Brigagliano, Co-Acting 
Director, David Shillman, Associate Director, John Roeser, Assistant 
Director, Marc McKayle, Special Counsel, Division, Commission, from 
John Jacobs, Chief Operations Officer, Lime Brokerage LLC, dated 
June 30, 2009 (``Lime II Letter''); and letter to David S. Shillman, 
Associate Director, Division, from Ann Vlcek, Managing Director and 
Associate General Counsel, SIFMA, dated November 23, 2009 (``SIFMA 
II Letter'').
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II. Description of the Proposed Rule Change, as Modified by Amendment 
Nos. 1, 2, and 3 Thereto

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

A. Contractual Provisions

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

[[Page 3265]]

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

B. Financial Controls

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

C. Regulatory Controls

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

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

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[[Page 3266]]

A. Definition of Sponsored Access and Scope of the Proposal

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

[[Page 3267]]

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

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

C. Financial Controls

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

[[Page 3268]]

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

D. Regulatory Controls

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

[[Page 3269]]

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

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

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

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

[[Page 3270]]

the Sponsored Access system, and the ability for either the Sponsoring 
Member or Nasdaq to terminate Participant access.
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    \56\ See supra note 32.
    \57\ Id.
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    Nasdaq also responds to comments regarding the financial and 
regulatory controls provisions of the Original Proposal. Commenters 
argue that the procedures and controls meant to prevent certain conduct 
should be ``reasonably designed,'' rather than impose a strict 
liability standard; \58\ and that the regulatory controls provision 
should not include a non-exclusive list of regulatory requirements that 
would potentially confuse market participants.\59\ In Amendment No. 2, 
Nasdaq agrees with both points, and modifies the proposed rule change 
to require ``reasonably designed'' procedures and controls, and to 
eliminate the non-exclusive list of regulatory requirements. Nasdaq 
also clarifies that trading activity reports would be reviewed by 
``appropriate supervisory personnel.'' The Commission finds that 
Nasdaq's proposed changes in response to commenter concerns in 
Amendment No. 2 are consistent with the Act.
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    \58\ See supra notes 39-41 and 45.
    \59\ See supra note 48.
---------------------------------------------------------------------------

    In Amendment No. 3, Nasdaq modifies language in the proposed rule 
change to clarify the requirement that when a Sponsoring Member 
provides another person or entity with access to Nasdaq, it must do so 
either through a Sponsored Access System or a Member System. By 
providing such access through either of these two types of systems, 
Sponsoring Members are responsible for all trading conducted pursuant 
to that arrangement to the same extent as trading directly conducted by 
the Member for its customers.\60\ The Commission believes that this 
proposed change sufficiently clarifies the significant responsibilities 
that the Sponsoring Members must assume for any Sponsored Access 
arrangements. The Commission believes that Nasdaq's proposed changes in 
response to commenter concerns in Amendment No. 3 are consistent with 
the Act.
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    \60\ See proposed Nasdaq Rule 4611(d).
---------------------------------------------------------------------------

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

V. Solicitation of Comments

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

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File No. SR-NASDAQ-2008-104 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NASDAQ-2008-104. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Room, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 am and 3 pm. Copies of such filing also will be available for 
inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-NASDAQ-2008-104 and should 
be submitted on or before February 10, 2010.

VI. Conclusion

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

    \64\ 17 CFR 200.30-3(a)(12).

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

