
[Federal Register Volume 78, Number 58 (Tuesday, March 26, 2013)]
[Notices]
[Pages 18393-18402]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-06882]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69195; File No. SR-NASDAQ-2012-137]


Self-Regulatory Organizations; the NASDAQ Stock Market LLC; Order 
Granting Approval of a Proposed Rule Change, as Modified by Amendment 
Nos. 1 and 3 Thereto, To Establish the Market Quality Program

March 20, 2013.
    On December 7, 2012, The NASDAQ Stock Market LLC (``Exchange'' or 
``NASDAQ'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to establish the Market Quality 
Program (``MQP'' or ``Program'') on a pilot basis.\3\ On December 20, 
2012, the

[[Page 18394]]

Exchange submitted Amendment No. 1 to the proposed rule change, which 
replaced and superseded the proposed rule change in its entirety. The 
proposed rule change, as modified by Amendment No. 1 thereto, was 
published for comment in the Federal Register on December 31, 2012.\4\ 
The Commission initially received two comment letters on the proposed 
rule change.\5\ On February 7, 2013, the Exchange submitted Amendment 
No. 2 to the proposed rule change. On February 8, 2013, the Exchange 
withdrew Amendment No. 2 and filed Amendment No. 3 to the proposed rule 
change.\6\ On February 14, 2013, the Commission extended the time 
period during which it must approve the proposed rule change, 
disapprove the proposed rule change, or institute proceedings to 
determine whether to disapprove the proposed rule change, to March 31, 
2013.\7\ The Commission subsequently received one additional comment 
letter on the proposed rule change.\8\ This order grants approval of 
the proposed rule change, as modified by Amendment Nos. 1 and 3.\9\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19-4.
    \3\ The Exchange states that SR-NASDAQ-2012-137 replaces SR-
NASDAQ-2012-043, which was withdrawn by the Exchange. See Securities 
Exchange Act Release Nos. 66765 (Apr. 6, 2012), 77 FR 22042 (Apr. 
12, 2012) (SR-NASDAQ-2012-043) and 68378 (Dec. 6, 2012), 77 FR 74042 
(Dec. 12, 2012). See also Notice, infra note 4, at 77141, n.3.
    \4\ Securities Exchange Act Release No. 68515 (Dec. 21, 2012), 
77 FR 77141 (Dec. 31, 2012) (``Notice'').
    \5\ See Letter From Rey Ramsey, President & CEO, TechNet, dated 
Jan. 22, 2013 (``TechNet Letter'') and Letter From Daniel G. Weaver, 
Ph.D., Professor of Finance, Rutgers Business School, dated Jan. 30, 
2013 (``Weaver Letter'').
    \6\ The Exchange withdrew Amendment No. 2 due to a technical 
error in the amendment. In Amendment No. 3, the Exchange clarified 
that: (i) The Exchange may limit on a Program-wide basis the number 
of Exchange-Traded Funds (``ETFs'') per MQP Company that can 
participate in the MQP, and that the Exchange would not be limiting 
the number of actual shares issued by an MQP Company for a 
particular ETF participating in the Program; (ii) the Exchange will 
provide in the monthly public report to the Commission relating to 
the MQP (a) information on the market quality of MQP Securities 
after they exceed the threshold and ``graduate'' from the Program 
pursuant to proposed Rule 5950(d)(1)(A), and (b) its analysis of the 
information to be included in the report and its assessment of the 
efficacy of the MQP; and (iii) the Exchange will provide to the 
Commission data and analyses about comparable ETFs that are listed 
on the Exchange but that are not in the MQP, as well as any other 
MQP-related data and analyses requested by Commission staff for the 
purpose of evaluating the efficacy of the MQP. Amendment No. 3 
provides clarification to the proposed rule change, and because it 
does not materially affect the substance of the proposed rule 
change, Amendment No. 3 does not require notice and comment.
    \7\ See Securities Exchange Act Release No. 68925 (Feb. 14, 
2013), 78 FR 12116 (Feb. 21, 2013).
    \8\ See Letter from Albert J. Menkveld, Associate Professor of 
Finance, VU University Amsterdam, dated Feb. 18, 2013 (``Menkveld 
Letter'').
    \9\ Today the Commission also is granting exemptive relief from 
Rule 102 under Regulation M concerning the MQP. See Securities 
Exchange Act Release No. 69196 (March 20, 2013) (Order Granting a 
Limited Exemption from Rule 102 of Regulation M Concerning the 
NASDAQ Stock Market LLC Stock's Market Quality Program Pilot 
Pursuant to Regulation M Rule 102(e)).
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I. Description of the Proposal

    As set forth in more detail in the Notice,\10\ the Exchange is 
proposing to amend its rules to add NASDAQ Rule 5950 (Market Quality 
Program) to establish an MQP listing fee and related market maker 
incentive program, and to adopt interpretation IM-2460-1 to exempt the 
MQP from NASDAQ Rule 2460 (Payment for Market Making), on a pilot 
basis. The MQP will be a voluntary program, and participation in the 
program will be at the discretion of each MQP Company (as defined 
below), subject to the requirements set forth in the proposed rule.
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    \10\ See Notice, supra note 4.
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A. Proposed NASDAQ Rule 5950 (Market Quality Program)

    The Exchange states that the proposed MQP is a voluntary program 
designed to promote market quality in certain securities listed on the 
Exchange (``MQP Securities'').\11\ MQP Securities will consist of ETF 
securities issued by an MQP Company \12\ and listed on the Exchange 
pursuant to NASDAQ Rule 5705.\13\ In addition to the standard (non-MQP) 
Exchange listing fee applicable to an MQP Security set forth in the 
NASDAQ Rule 5000 Series (consisting of NASDAQ Rules 5000-5999), an MQP 
Company may incur a fee (``MQP Fee''), on behalf of an MQP Security, to 
participate in the Program.\14\ The Exchange represents that an MQP Fee 
will be used for the purpose of incentivizing one or more Market Makers 
\15\ in the MQP Security (``MQP Market Maker'') to enhance the market 
quality of the MQP Security.\16\ Subject to the conditions set forth in 
the proposed rule, this incentive payment will be credited (``MQP 
Credit'') to one or more MQP Market Makers that make a high-quality 
market in the MQP Security pursuant to the MQP.\17\
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    \11\ See proposed Rule 5950 Preamble.
    \12\ The term ``MQP Company'' means the trust or company housing 
the ETF or, if the ETF is not a series of a trust or company, then 
the ETF itself. See proposed Rule 5950(e)(5).
    \13\ See proposed Rule 5950(e)(1) (defining the term ``MQP 
Security'' to mean an ETF security issued by an MQP Company that 
meets all of the requirements to be listed on the Exchange pursuant 
to Rule 5705). The term ``Exchange Traded Fund'' includes Portfolio 
Depository Receipts and Index Fund Shares, which are defined in 
NASDAQ Rule 5705. See proposed Rule 5950(e)(2).
    \14\ See proposed Rules 5950 Preamble and 5950(b)(2). MQP Fees 
for MQP Securities will be paid by the Sponsors associated with the 
MQP Companies. See proposed Rule 5950(e)(5). See also proposed Rule 
5950(b)(2)(C)(i) (requiring that the MQP Fee in respect of an ETF be 
paid by the Sponsor(s) of the ETF). The term ``Sponsor'' means the 
registered investment adviser that provides investment management 
services to an MQP Company or any of the adviser's parents or 
subsidiaries. See proposed Rule 5950(e)(5).
    \15\ The term ``Market Maker'' has the meaning given in NASDAQ 
Rule 5005(a)(24). See proposed Rule 5950(e)(3).
    \16\ See proposed Rule 5950 Preamble.
    \17\ See proposed Rule 5950 Preamble. The MQP Credit will be 
paid to eligible MQP Market Maker(s) based on quoting and trading 
activity in the MQP Security, as discussed in further detail below. 
See infra notes 47-55 and accompanying text.
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1. Application and Withdrawal
    An MQP Company that wants to have its MQP Security participate in 
the MQP, and a Market Maker that wants to participate in the MQP, will 
each be required to submit an application in the form prescribed by the 
Exchange.\18\ The Exchange can, on a program-wide basis, limit the 
number of MQP Securities that any one MQP Company may have in the 
MQP.\19\ In determining whether to limit the number of MQP Securities 
per MQP Company, the Exchange will consider all relevant information, 
including whether a restriction, if any, is consistent with the goals 
of the MQP and in the best interest of the Exchange, the MQP Company, 
and investors.\20\ The Exchange can also, on a program-wide basis, 
limit the number of MQP Market Makers permitted to register in an MQP 
Security.\21\ If such a limit is established, the Exchange will 
allocate available MQP Market Maker registrations in a first-come-
first-served fashion based on successful completion of an MQP Market 
Maker application.\22\
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    \18\ See proposed Rule 5950(a)(1).
    \19\ See proposed Rule 5950(a)(1)(A). The Exchange clarified 
that this provision is intended to allow the Exchange, on a Program-
wide basis, to limit the number of ETFs that any one MQP Company may 
have in the MQP, and that this provision would not allow the 
Exchange to limit the number of actual shares issued by any MQP 
Company for a particular ETF participating in the MQP. See Amendment 
No. 3, supra note 6.
    \20\ See proposed Rule 5950(a)(1)(B). Factors that could be 
considered by the Exchange include, but are not limited to, the 
current and expected liquidity characteristics of MQP Securities; 
the projected initial and continuing market quality needs of MQP 
Securities; and the trading characteristics of MQP Securities (e.g., 
quoting, trading, and volume). See proposed Rule 5950(a)(1)(B)(i).
    \21\ See proposed Rule 5950(c)(3).
    \22\ See proposed Rule 5950(c)(3)(A).
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    The Exchange will provide notification on its Web site regarding: 
(i) The acceptance of an MQP Company (on behalf of an MQP Security) and 
an MQP Market Maker into the MQP; (ii) the total number of MQP 
Securities that any one MQP Company may have in the MQP; (iii) the 
names of MQP Securities and the MQP Market Maker(s) in each MQP 
Security, and the dates that an MQP Company, on behalf of an MQP 
Security, commenced participation in and withdrew or was terminated 
from

[[Page 18395]]

the MQP; and (iv) any limit on the number of MQP Market Makers 
permitted to register in an MQP Security.\23\
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    \23\ See proposed Rule 5950(a)(1)(C) and proposed Rule 
5950(c)(3). The Exchange also will include on its Web site a 
statement about the MQP that sets forth a general description of the 
MQP as implemented on a pilot basis and a fair and balanced 
summation of the potentially positive aspects of the MQP (e.g., 
enhancement of liquidity and market quality in MQP Securities) as 
well as the potentially negative aspects and risks of the MQP (e.g., 
possible lack of liquidity and negative price impact on MQP 
Securities that withdraw or are terminated from the MQP), and 
indicates how interested parties can get additional information 
about products in the MQP. See proposed Rule 5950(a)(1)(C)(iv).
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    After an MQP Company, on behalf of an MQP Security, has been in the 
MQP for not less than two consecutive quarters but less than one year, 
it can voluntarily withdraw from the MQP on a quarterly basis.\24\ An 
MQP Company seeking to withdraw from the MQP must notify the Exchange 
in writing not less than one month prior to withdrawing from the MQP. 
The Exchange can determine to allow an MQP Company to withdraw from the 
MQP earlier.\25\ In making this determination, the Exchange may take 
into account the volume and price movements in the MQP Security; the 
liquidity, size quoted, and quality of the market in the MQP Security; 
and any other relevant factors.\26\ After an MQP Company, on behalf of 
an MQP Security, has been in the MQP for one year or more, it can 
voluntarily withdraw from the MQP on a monthly basis, provided that it 
has notified the Exchange in writing not less than one month prior to 
withdrawing from the MQP.\27\ After an MQP Company, on behalf of an MQP 
Security, has been in the MQP for one year, the MQP and all obligations 
and requirements of the MQP will automatically continue on an annual 
basis, unless: (a) The Exchange terminates the MQP by providing not 
less than one month prior notice of intent to terminate; (b) the MQP 
Company, on behalf of an MQP Security, withdraws from the MQP pursuant 
to the proposed rule; (c) the MQP Company is terminated from the MQP 
pursuant to proposed Rule 5950(d); \28\ or (d) the pilot Program is not 
extended or made permanent pursuant to a proposed rule change approved 
by the Commission under Section 19(b) \29\ of the Exchange Act.\30\
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    \24\ See proposed Rule 5950(a)(2)(A).
    \25\ Id.
    \26\ Id.
    \27\ See proposed Rule 5950(a)(2)(B).
    \28\ Proposed Rule 5950(d) states, in part, that the MQP will 
terminate in respect of an MQP Security under the following 
circumstances: (A) An MQP Security sustains an average daily trading 
volume (consolidated trades in all U.S. Markets) of one million 
shares or more for three consecutive months; (B) an MQP Company, on 
behalf of an MQP Security, withdraws from the MQP, is no longer 
eligible to be in the MQP pursuant to the proposed rule, or its 
Sponsor ceases to make MQP Fee payments to the Exchange; (C) an MQP 
Security is delisted or is no longer eligible for the MQP; (D) an 
MQP Security does not have at least one MQP Market Maker for more 
than one quarter; or (E) an MQP Security does not, for two 
consecutive quarters, have at least one MQP Market Maker that is 
eligible for the MQP Credit.
    \29\ 15 U.S.C. 78s(b).
    \30\ See proposed Rule 5950(a)(3).
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    After an MQP Market Maker has been in the MQP for not less than one 
quarter, the MQP Market Maker can withdraw from the MQP on a quarterly 
basis. The MQP Market Maker must notify the Exchange in writing one 
month prior to withdrawing from the MQP.\31\
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    \31\ See proposed Rule 5950(a)(2)(C).
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    The Exchange will provide notification on its Web site when it 
receives notification that an MQP Company, on behalf of an MQP 
Security, or an MQP Market Maker intends to withdraw from the MQP, 
including the date of actual withdrawal or termination from the 
MQP.\32\
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    \32\ See proposed Rule 5950(a)(2)(D).
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2. MQP Company Eligibility and Fee Liability
    For an MQP Company, on behalf of an MQP Security, to be eligible to 
participate in the MQP, the following conditions must be satisfied: (i) 
The Exchange must have accepted the MQP Company's application in 
respect of the MQP Security and must have accepted the application of 
at least one MQP Market Maker in the same MQP Security; (ii) the MQP 
Security must meet all requirements to be listed on the Exchange as an 
ETF; (iii) the MQP Security must meet all Exchange requirements for 
continued listing at all times the MQP Security is in the MQP; and (iv) 
while an MQP Company lists an MQP Security, the MQP Company must, on a 
product-specific Web site for each product, indicate that the product 
is in the MQP and provide the link to the Exchange's MQP Web site.\33\
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    \33\ See proposed Rule 5950(b)(1).
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    An MQP Company participating in the MQP will incur an annual basic 
MQP Fee of $50,000 per MQP Security (``Basic MQP Fee''), which must be 
paid to the Exchange prospectively each quarter.\34\ An MQP Company may 
also, on an annual basis, voluntarily select to incur an annual 
supplemental MQP Fee per MQP Security (``Supplemental MQP Fee''), which 
must be paid to the Exchange prospectively each quarter.\35\ The Basic 
MQP Fee and Supplemental MQP Fee cannot exceed $100,000 per year when 
combined.\36\ The amount of the Supplemental MQP Fee, if any, for each 
MQP Security will be determined by the MQP Company initially and will 
remain the same for one year.\37\ The Exchange will provide 
notification on its Web site regarding the amount, if any, of any 
Supplemental MQP Fee determined by an MQP Company per MQP Security.\38\
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    \34\ See proposed Rule 5950(b)(2)(A). MQP Fees for MQP 
Securities will be paid by the Sponsors associated with the MQP 
Companies. See supra note 14.
    \35\ See proposed Rule 5950(b)(2)(B). As noted above, MQP Fees 
for MQP Securities will be paid by the Sponsors associated with the 
MQP Companies. See supra notes 14 and 34.
    \36\ Id.
    \37\ See proposed Rule 5950(b)(2)(B)(i).
    \38\ See proposed Rule 5950(b)(2)(B)(ii).
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    The Basic MQP Fee and Supplemental MQP Fee, if any, will be in 
addition to the standard (non-MQP) NASDAQ listing fee applicable to the 
MQP Security and will not offset the standard listing fee.\39\ The 
Exchange will prospectively bill each MQP Company for the quarterly MQP 
Fee for each MQP Security.\40\ Basic MQP Fees and the Supplemental MQP 
Fees will be credited to the NASDAQ General Fund.\41\
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    \39\ See proposed Rule 5950(b)(2)(C).
    \40\ See proposed Rule 5950(b)(2)(D). As discussed above, the 
MQP Fee for an MQP Security will be paid by the Sponsor(s) 
associated with the MQP Company. See supra note 14.
    \41\ See proposed Rule 5950(b)(2)(E).
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3. MQP Market Maker Eligibility and MQP Credit Distribution
    For a Market Maker to be eligible to participate in the MQP, the 
Exchange must have accepted the Market Maker's application in respect 
of an MQP Security and must have accepted the application of the MQP 
Company in respect of the same MQP Security.\42\ In addition, to be 
eligible to receive a periodic MQP Credit out of the NASDAQ General 
Fund, MQP Market Makers must, when making markets in an MQP Security, 
meet the applicable Market Maker obligations pursuant to NASDAQ Rule 
4613 \43\ and must also

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meet or exceed the following requirements on a monthly basis with 
respect to an MQP Security: (i) For at least 25% of the time when 
quotes can be entered in the Regular Market Session,\44\ as averaged 
over the course of a calendar month, maintain at least 500 shares of 
attributable, displayed quotes or orders at the National Best Bid 
(``NBB'') or better, and at least 500 shares of attributable, displayed 
quotes or orders at the National Best Offer (``NBO'') or better; and 
(ii) for at least 90% of the time when quotes can be entered in the 
Regular Market Session, as averaged over the course of a month, 
maintain at least 2,500 shares of attributable, displayed posted 
liquidity on the NASDAQ Market Center \45\ that are priced no wider 
than 2% away from the NBB, and at least 2,500 shares of attributable, 
displayed posted liquidity on the NASDAQ Market Center that are priced 
no wider than 2% away from the NBO.\46\
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    \42\ See proposed Rule 5950(c)(1)(A). The Exchange also could 
accept the MQP applications of multiple MQP Market Makers in the 
same MQP Security, subject to any limitation on the number of MQP 
Market Makers established pursuant to the proposed rule. Id.
    \43\ NASDAQ Rule 4613 states that market making obligations 
applicable to NASDAQ members that are registered as Market Makers 
include, among other things, the following quotation requirements 
and obligations: For each security in which a member is registered 
as a Market Maker, the member shall be willing to buy and sell the 
security for its own account on a continuous basis during regular 
market hours and shall enter and maintain a two-sided trading 
interest (``Two-Sided Obligation'') that is identified to NASDAQ as 
the interest meeting the obligation and is displayed in NASDAQ's 
quotation montage at all times. Interest eligible to be considered 
as part of a Market Maker's Two-Sided Obligation shall have a 
displayed quotation size of at least one normal unit of trading (or 
a larger multiple thereof); provided, however, that a Market Maker 
may augment its Two-Sided Obligation size to display limit orders 
priced at the same price as the Two-Sided Obligation. Unless 
otherwise designated, a ``normal unit of trading'' shall be 100 
shares. After an execution against its Two-Sided Obligation, a 
Market Maker must ensure that additional trading interest exists in 
NASDAQ to satisfy its Two-Sided Obligation either by immediately 
entering new interest to comply with this obligation to maintain 
continuous two-sided quotations or by identifying existing interest 
on the NASDAQ book that will satisfy this obligation. See Notice, 
supra note 4, at 77148, n.68.
    \44\ The term ``Regular Market Session'' has the meaning given 
in NASDAQ Rule 4120(b)(4)(D). See proposed Rule 5950(e)(6).
    \45\ The term ``NASDAQ Market Center'' has the meaning given in 
NASDAQ Rule 4751(a). See proposed Rule 5950(e)(4).
    \46\ See proposed Rule 5950(c)(1)(B). The Exchange provides the 
following examples to illustrate these market quality requirements:
    Regarding the first market quality standard (25%), in an MQP 
Security where the NBBO is $25.00 x $25.10, for a minimum of 25% of 
the time when quotes can be entered in the Regular Market Session as 
averaged over the course of a month, an MQP Market Maker must 
maintain bids at or better than $25.00 for at least 500 shares and 
must maintain offers at or better than $25.10 for at least 500 
shares. Thus, if there were 20 trading days in a given month and the 
MQP Market Maker met this requirement 20% of the time when quotes 
can be entered in the Regular Market Session for 10 trading sessions 
and 40% of the time when quotes can be entered in the Regular Market 
Session for 10 trading sessions then the MQP Market Maker would have 
met the requirement 30% of the time in that month.
    Regarding the second market quality standard (90%), in an MQP 
Security where the NBBO is $25.00 x $25.10, for a minimum of 90% of 
the time when quotes can be entered in the Regular Market Session as 
averaged over the course of a month, an MQP Market Maker must post 
bids for an aggregate of 2,500 shares between $24.50 and $25.00, and 
post offers for an aggregate of 2,500 shares between $25.10 and 
$25.60. Thus, if there were 20 trading days in a given month and the 
MQP Market Maker met this requirement 88% of the time when quotes 
can be entered in the Regular Market Session for 10 trading sessions 
and 98% of the time when quotes can be entered in the Regular Market 
Session for 10 trading sessions then the MQP Market Maker would have 
met the requirement 93% of the time in that month.
    See Notice, supra note 4, at 77148-49, n.71.
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    MQP Credits for each MQP Security will be calculated monthly and 
credited out of the NASDAQ General Fund quarterly on a pro rata basis 
to one or more eligible MQP Market Makers.\47\ Each MQP Credit will be 
allocated 50% to a ``Quote Share Payment'' that is based on ``Qualified 
Quotes,'' and 50% to a ``Trade Share Payment'' that is based on 
``Qualified Trades.'' \48\ A ``Qualified Quote'' represents 
attributable and displayed liquidity (either quotes or orders) entered 
by an MQP Market Maker in an MQP Security that is posted within 2% of 
the NBBO.\49\ A ``Qualified Trade'' represents a liquidity-providing 
execution in an MQP Security by an MQP Market Maker of a Qualified 
Quote on the NASDAQ Market Center.\50\ Quote Share Payments will be 
based in equal proportions on: (a) Average quoted size at or better 
than the NBBO; and (b) average time spent quoting at or better than the 
NBBO.\51\ Trade Share Payments will be based upon each MQP Market 
Maker's share of total Qualified Trades in an MQP Security executed on 
the NASDAQ Market Center.\52\ Quote Share Payments and Trade Share 
Payments will be composed of Basic MQP Fees and Supplemental MQP Fees, 
if any.\53\
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    \47\ See proposed Rule 5950(c)(2). If only one MQP Market Maker 
meets its obligations under the proposal with respect to an MQP 
Security, the entire MQP Credit available for that MQP Security will 
be distributed by the Exchange to that MQP Market Maker out of the 
NASDAQ General Fund. If multiple MQP Market Makers satisfy their 
obligations with respect to an MQP Security, the available MQP 
Credit for the quarter will be distributed pro rata among them. See 
Notice, supra note 4, at 77150. If no MQP Market Maker is eligible 
to receive an MQP Credit, the MQP Fee relating to the MQP Security 
will remain in the Exchange's General Fund. See id. at 77147.
    \48\ See proposed Rule 5950(c)(2)(A).
    \49\ See proposed Rule 5950(c)(2)(A)(i).
    \50\ See proposed Rule 5950(c)(2)(A)(ii).
    \51\ See proposed Rule 5950(c)(2)(B)(ii).
    \52\ See proposed Rule 5950(c)(2)(B)(i).
    \53\ See proposed Rule 5950(c)(2)(B)(iii). As discussed above, 
MQP Credits will be credited out of the NASDAQ General Fund. See 
supra note 47 and accompanying text.
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    An MQP Credit will be credited quarterly to an MQP Market Maker on 
a pro rata basis for each month during the preceding quarter that an 
MQP Market Maker is eligible to receive a credit pursuant to the 
proposed rule.\54\ The calculation to establish the eligibility of an 
MQP Market Maker will be done on a monthly basis.\55\
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    \54\ See proposed Rule 5950(c)(2)(C).
    \55\ Id. For example, if during a quarter an MQP Market Maker 
was eligible to receive a credit for two out of three months, the 
MQP Market Maker would receive a quarterly pro rata MQP Credit for 
those two months. Id.
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4. Termination of the MQP
    The MQP will terminate in respect of an MQP Security under any of 
the following circumstances: (i) The MQP Security sustains an average 
daily trading volume (consolidated trades in all U.S. markets) 
(``ATV'') of 1,000,000 shares or more for three consecutive months; 
(ii) an MQP Company, on behalf of an MQP Security, withdraws from the 
MQP, is no longer eligible to be in the MQP, or its Sponsor ceases to 
make MQP Fee payments to the Exchange; (iii) the MQP Security is 
delisted or is no longer eligible for the MQP; (iv) the MQP Security 
does not have at least one MQP Market Maker for more than one quarter; 
or (v) the MQP Security does not, for two consecutive quarters, have at 
least one MQP Market Maker that is eligible for MQP Credit.\56\ Any MQP 
Credits remaining upon termination of the MQP in respect of an MQP 
Security will be distributed on a pro rata basis to the MQP Market 
Makers that made a market in the MQP Security and were eligible to 
receive MQP Credits pursuant to the proposed rule.\57\ Termination of 
an MQP Company, MQP Security, or MQP Market Maker from the MQP will not 
preclude the Exchange from allowing re-entry into the MQP where the 
Exchange deems proper.\58\
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    \56\ See proposed Rule 5950(d)(1).
    \57\ See proposed Rule 5950(d)(2). As discussed above, if no 
Market Maker is eligible to receive MQP Credits pursuant to the 
proposed rule, the MQP Fee will remain in the Exchange's General 
Fund. See supra note 47.
    \58\ See proposed Rule 5950(d)(3).
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5. Pilot Basis
    To provide the Exchange, the Commission, and other interested 
parties an opportunity to evaluate the impact of the MQP on the quality 
of markets in MQP Securities, the Exchange has proposed to implement 
the MQP as a one-year pilot program that will commence when the MQP is 
implemented by the Exchange's acceptance of an MQP Company, on behalf 
of an MQP Security, and relevant MQP Market Maker into the MQP. The MQP 
will end one year after implementation, unless extended pursuant to a 
proposed rule change approved by the Commission under Section 19(b) of 
the Exchange Act.\59\
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    \59\ See proposed Rule 5950(f).

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    During the pilot period, the Exchange will periodically provide 
information to the Commission about market quality in respect of the 
MQP. Specifically, the Exchange will submit monthly reports to the 
Commission about market quality in respect of the MQP (and will make 
these monthly reports public). The reports will include data and 
analysis with respect to MQP Securities that are in the Program, as 
well as data and analysis about the market quality of MQP Securities 
that exceed the one million ATV threshold and ``graduate'' from the 
Program pursuant to proposed Rule 5950(d)(1)(A).\60\ The reports will 
compare, to the extent practicable, securities before and after they 
are in the MQP, and will include information regarding the MQP such as: 
(i) Rule 605 metrics; \61\ (ii) volume metrics; (iii) the number of MQP 
Market Makers; (iv) spread size; and (v) the availability of shares at 
the NBBO.\62\ These reports also will include the Exchange's analysis 
of the information and assessment of the efficacy of the MQP.\63\ In 
addition, the Exchange will provide similar data and analyses to the 
Commission about comparable ETFs that are listed on the Exchange but 
that are not in the MQP, as well as any other MQP-related data and 
analyses requested by Commission staff for the purpose of evaluating 
the efficacy of the MQP.\64\ The Exchange will post the monthly reports 
on its Web site.\65\ The first report will be submitted within sixty 
days after the MQP becomes operative.\66\
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    \60\ See Amendment No. 3, supra note 6.
    \61\ 17 CFR 242.605.
    \62\ See Notice, supra note 4, at 77149. See also Amendment No. 
3, supra note 6.
    \63\ See Amendment No. 3, supra note 6.
    \64\ See Notice, supra note 4, at 77149. See also Amendment No. 
3, supra note 6.
    \65\ See Notice, supra note 4, at 77149.
    \66\ Id.
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B. Proposed Interpretation IM-2460-1 (Market Quality Program)

    As part of its proposal to establish the MQP by adding Rule 5950, 
the Exchange is amending NASDAQ Rule 2460 (Payments for Market Making), 
which prohibits direct or indirect payment by an issuer to a Market 
Maker, to adopt a new interpretive provision to the rule.\67\ 
Specifically, the Exchange is proposing to adopt new interpretation IM-
2460-1 (Market Quality Program) to provide that Rule 2460 will not be 
applicable to a member that is accepted into the MQP pursuant to 
proposed Rule 5950 (or to a person that is associated with that member) 
for its conduct in connection with the MQP.\68\
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    \67\ In relevant part, Rule 2460 provides that ``[n]o member or 
person associated with a member shall accept any payment or other 
consideration, directly or indirectly, from an issuer of a security, 
or any affiliate or promoter thereof, for publishing a quotation, 
acting as market maker in a security, or submitting an application 
in connection therewith.''
    \68\ See proposed IM-2460-1. The Exchange notes that, based on 
discussions with the Financial Industry Regulatory Authority 
(``FINRA''), it expects FINRA to file a proposed rule change to 
exempt the MQP from FINRA Rule 5250. See Notice, supra note 4, at 
77141, n.7. Similar to NASDAQ Rule 2460, FINRA Rule 5250 (formerly 
NASD Rule 2460) prohibits FINRA members from directly or indirectly 
accepting payment from an issuer of a security for acting as a 
market maker. See Securities Exchange Act Release No. 38812 (July 3, 
1997), 62 FR 37105 (July 10, 1997) (SR-NASD-97-29) (``NASD Rule 2460 
Approval Order'').
---------------------------------------------------------------------------

C. Information Bulletin and Surveillance

    The Exchange will issue to its members an information bulletin 
about the MQP prior to operation of the Program.\69\
---------------------------------------------------------------------------

    \69\ See Notice, supra note 4, at 77149.
---------------------------------------------------------------------------

    The Exchange represents that its surveillance procedures are 
adequate to properly monitor the trading of the MQP Securities on the 
Exchange during all trading sessions and to detect and deter violations 
of the Exchange's rules and applicable federal securities laws. Trading 
of the MQP Securities through the Exchange will be subject to FINRA's 
surveillance procedures for derivative products including ETFs.\70\ The 
Exchange may obtain information through the Intermarket Surveillance 
Group (``ISG'') from other exchanges that are members or affiliates of 
ISG and from listed MQP Companies and public and non-public data 
sources such as, for example, Bloomberg.
---------------------------------------------------------------------------

    \70\ FINRA surveils trading on the Exchange pursuant to a 
regulatory services agreement with the Exchange. The Exchange states 
that it is responsible for FINRA's performance under this regulatory 
services agreement. See Notice, supra note 4, at 77149, n.79.
---------------------------------------------------------------------------

II. Summary of Comment Letters

    The Commission received three comment letters in support of the 
proposed rule change.\71\
---------------------------------------------------------------------------

    \71\ See TechNet Letter, Weaver Letter, and Menkveld Letter, 
supra notes 5 and 8.
---------------------------------------------------------------------------

    One commenter believes that the proposed MQP would be an important, 
positive first step towards addressing the lack of liquidity for many 
securities in today's market.\72\ This commenter states its belief that 
the MQP is designed to encourage liquidity where it generally has not 
flourished, and would make securities that participate in the Program 
more attractive to a broader range of investors.\73\ This commenter 
also believes that the MQP has the potential to benefit promising tech 
companies that today may lack liquid, quality markets.\74\
---------------------------------------------------------------------------

    \72\ Id.
    \73\ Id.
    \74\ Id.
---------------------------------------------------------------------------

    Another commenter states that it fully supports NASDAQ's proposal 
and urges the Commission to adopt a stance allowing direct payment 
between issuers and market makers.\75\ This commenter states that 
direct payments from issuers to market makers are used in a number of 
markets outside of the U.S., and argues that such programs are very 
successful, resulting in lower transaction costs, lower volatility, and 
higher depth for investors.\76\ This commenter points to academic 
studies finding that such programs applied to common stocks generally 
improve market quality and benefit social welfare.\77\ This commenter 
cites an article finding that narrower spreads arising from designated 
market makers with an affirmative obligation to set spreads narrower 
than would exist otherwise will induce both uninformed and informed 
traders to trade more, which in turn will lead to increased price 
efficiency and faster price discovery.\78\ This commenter also 
discusses his own study of payments from issuers of common stock to 
market makers and concludes that market makers entering into these 
types of agreements provide liquidity buffers against supply and demand 
shocks.\79\ This commenter states that there have been no reports of 
manipulation attempts by issuers or abuses by market makers relating to 
paid-for market making arrangements abroad, and argues that the 
implementation of paying market makers to improve market quality in 
other countries probably improved investor confidence, as evidenced by 
the increase in volume and order size observed by

[[Page 18398]]

researchers.\80\ The commenter further argues that the payments made to 
MQP Market Makers under the Exchange's proposal will not be of 
sufficient size to provide enough incentive for manipulation.\81\
---------------------------------------------------------------------------

    \75\ See Weaver Letter, supra note 5, at 1.
    \76\ See id. at 1, 3-4 (citing Euronext, Deutsche Borse, NASDAQ 
OMX's European exchanges, and the Oslo Stock Exchange as markets 
where such programs have been successful).
    \77\ See id. at 1-2 (citing to the following studies: D.G. 
Weaver and A. Anand, ``The Value of the Specialist: Empirical 
Evidence from the CBOE'' Journal of Financial Markets, Vol. 9, no. 
2, 100-118 (2006); D.G. Weaver, A. Anand, and C. Tanggaard ``Paying 
for Market Quality'' Journal of Financial and Quantitative Analysis, 
Vol. 44, 1427-1457 (2009) (``Weaver Study''); H. Bessembinder, J. 
Hao, and M. Lemmon ``Why Designate Market Makers? Affirmative 
Obligations and Market Quality'' Working paper, University of Utah 
(2006) (``Bessembinder Study''); and A. Charitou and M. Panayides, 
``Market Making in International Capital Markets'' International 
Journal of Managerial Finance, Vol. 5, 50-80 (2009).
    \78\ See id. at 3 (citing to the Bessembinder Study, supra note 
77).
    \79\ See id. at 2 (citing to the Weaver Study, supra note 77).
    \80\ See id. at 4 and 6.
    \81\ See id. at 7.
---------------------------------------------------------------------------

    Another commenter is supportive of an MQP pilot study and believes 
that the MQP could create value for an issuer by enabling an issuer to 
essentially guarantee liquidity in its stock.\82\ The commenter views 
the proposed MQP as a form of ``liquidity insurance'' through which 
shareholders in the issuer agree ex ante to pay for a minimum liquidity 
guarantee to insure against uncertain future liquidity.\83\ The 
commenter states that if future liquidity for a security is less 
uncertain, more investors should participate in the market for the 
security, creating a beneficial equilibrium of increased liquidity and 
increased investor participation.\84\ Thus, the commenter asserts, the 
MQP could be a way to jump-start trading in a particular product at 
launch, and if there is intrinsic interest in the product, the product 
launch should have a better chance of being successful.\85\ This 
commenter cites his own study of designated market maker contracts for 
common stocks at Euronext for the finding that such contracts on 
average improve the liquidity level, reduce liquidity risk, and reduce 
the size of pricing errors in such stocks, among other things,\86\ and 
states that his study complements the generally favorable evidence from 
other European markets on designated market maker contracts.\87\
---------------------------------------------------------------------------

    \82\ See Menkveld Letter, supra note 8, at 2.
    \83\ Id.
    \84\ Id.
    \85\ Id.
    \86\ See id. at 1-2 (citing to A.J. Menkveld & T. Wang, ``How do 
designated market makers create value for small-caps?'' Manuscript, 
VU University, Amsterdam (2011)).
    \87\ See id. at 2 (citing to the Weaver Study, supra note 77; M. 
Nimalendran & G. Petrella, ``Do `Thinly-Traded' Stocks Benefit from 
Specialist Intervention?'' Journal of Banking and Finance, Vol. 27, 
1823-54 (2003); and K. Venkataraman & A. Waisburd, ``The Value of 
the Designated Market Maker'' Journal of Financial and Quantitative 
Analysis, Vol. 42, 735-58 (2007)).
---------------------------------------------------------------------------

    This commenter further notes that the risk that insider information 
at an issuer could reach an MQP Market Maker is low because the terms 
of the Program are fixed and specific, there is no need for 
communication between an issuer and the MQP Market Maker after the 
Program is in place, the Exchange monitors the performance of the MQP 
Market Makers, and the securities proposed for inclusion in the MQP 
(ETPs) are baskets of securities and therefore less likely to be 
affected by such insider information risk.\88\ Finally, this commenter 
suggests that the pilot have a staggered introduction of MQP Securities 
with a randomized sequence, and a long enough pre-and post-event period 
(e.g., three months) for each introduction to identify an effect, and 
that the Exchange provide the Commission with detailed reporting of all 
trades and quotes in all securities for a pre-event period and a post-
event period (with MQP Market Maker trades and quotes flagged).\89\
---------------------------------------------------------------------------

    \88\ Id. at 3.
    \89\ Id. at 4-5.
---------------------------------------------------------------------------

III. Discussion and Commission Findings

    The Commission has carefully considered the proposed rule change, 
as modified by Amendment Nos. 1 and 3 thereto, and finds that the 
proposed rule change, as modified by Amendment Nos. 1 and 3 thereto, is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to national securities exchanges. In 
particular, as discussed below, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(4) of the Act,\90\ which 
requires that the rules of a national securities exchange provide for 
the equitable allocation of reasonable dues, fees, and other charges 
among its members and issuers and other persons using its facilities, 
and with Section 6(b)(5) of the Act,\91\ 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 that the rules not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers. 
Further, as required by Section 3(f) of the Act, the Commission has 
considered the proposed rule's impact on efficiency, competition, and 
capital formation.\92\
---------------------------------------------------------------------------

    \90\ 15 U.S.C. 78f(b)(4).
    \91\ 15 U.S.C. 78f(b)(5).
    \92\ See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The MQP, as proposed to be implemented on a pilot basis, is 
designed to benefit investors, issuers and market participants by 
improving the market quality for ETFs that participate in the MQP. As 
proposed by the Exchange, to remain in the MQP and to receive quarterly 
MQP Credit payments out of the NASDAQ General Fund, each MQP Market 
Maker will be required to comply with monthly quoting requirements that 
are higher than the standard quoting requirements applicable to market 
makers in ETFs on the Exchange.\93\ Each MQP Market Maker that complies 
with these heightened quoting obligations will receive a share of the 
MQP Credit based upon its size quoted, and time spent quoting, at or 
better than the NBBO, and based on its liquidity-providing executions 
of such quotes. In addition, the Program is separately designed to 
incentivize MQP Market Makers to compete with each other to receive the 
MQP Credit payments, as the payments will be distributed based on each 
MQP Market Maker's average quoted size and time spent quoting at or 
better than the NBBO as compared to other MQP Market Makers, and its 
share of total Qualified Trades in an MQP Security executed on the 
Exchange. Thus, the proposal is designed to incentivize MQP Market 
Makers to quote more often, and in greater quoted size, at the NBBO, 
potentially improving the market quality of the MQP Securities that 
participate in the MQP. This potential improved market quality, were it 
to occur, could benefit investors in the form of enhanced liquidity, 
narrowed spreads, and reduced transaction costs.\94\
---------------------------------------------------------------------------

    \93\ Specifically, with respect to the monthly quoting 
requirement, an MQP Market Maker must quote at least 500 shares of 
attributable, displayed liquidity at the NBB or NBO 25% of the time 
during the Regular Market Session, and at least 2,500 shares of 
attributable, displayed liquidity within 2% of the NBB or NBO 90% of 
the time during the Regular Market Session.
    \94\ In support of the proposal, the Exchange argues that the 
MQP will, among other things, lower transaction costs and enhance 
liquidity in both ETFs and their components, making both more 
attractive to a broader range of investors, and that, in so doing, 
the MQP will help companies access capital to invest and grow. See 
Notice, supra note 4, at 77142. The Exchange asserts that being 
included in a successful ETF can provide the stocks of these 
companies with enhanced liquidity and exposure, enabling them to 
attract investors and access capital markets to fund investment and 
growth. See id. at 77142, n.12 and 77145, n.37-38 and accompanying 
text (citing to the testimony of Eric Noll, Executive Vice 
President, NASDAQ OMX, Before the Securities Subcommittee of the 
Senate Banking Committee October 19, 2011). Two commenters agree 
with the Exchange that the MQP will benefit the operating companies 
underlying ETFs in the MQP, in addition to the ETFs themselves. See 
Weaver Letter, supra note 5, at 4-5, and Menkveld Letter, supra note 
8, at 3-4. As constructed, any potential benefit to operating 
companies from the MQP could be derived from the company being 
included within an index or other benchmark that underlies an ETF 
that participates in the MQP.
---------------------------------------------------------------------------

    In addition, because the quoted bid-ask spread in a security 
represents one of the main drivers of transaction costs for investors, 
and because high price volatility should generally deter

[[Page 18399]]

investors from trading low-liquidity ETFs, the MQP, were the potential 
benefits of the program to occur, should facilitate a more-efficient 
and less-uncertain trading environment for investors.\95\ Furthermore, 
were the potential benefits of the MQP to occur, improving the 
liquidity of certain low-volume ETFs may help those ETFs better compete 
with more established ETFs that cover the same underlying assets and 
that have an advantage over new market entrants because they have 
already attracted a significant amount of liquidity.\96\
---------------------------------------------------------------------------

    \95\ Transaction costs are generally defined as the penalty that 
an investor pays for transacting. Transaction costs have four 
components: commissions; bid/ask spread; market impact; and 
opportunity cost. See Grinold, Kahn. Active Portfolio Management, 
Second Edition, Chapter 16. An increase in bid-ask spreads will 
inevitably increase the transaction costs of an investor. In 
addition, transactions in low-liquidity securities have a higher 
market impact when compared to other more liquid securities. See 
Albert Kyle's (1985) measure of market impact (Kyle's Lambda), 
defining an inverse relationship between volume and price impact. 
Therefore, the lower the volume of the ETF or stock, the higher the 
market impact of any transaction in that stock. This last effect 
acts as a disincentive to trading that security. Therefore, an 
environment where an ETF trades more often and with a larger number 
of shares will reduce transaction costs both through the narrowing 
of spreads and lower market impact.
    \96\ This phenomenon can be described as economies of scale in 
the management of ETFs. Given that most ETFs track an index, it 
costs little more to run a fund with $20 billion in assets under 
management than one with $200 million in assets under management. As 
a result, ETFs that have established large asset holdings can be 
offered to investors with lower management fees, which in turn 
reinforces the cycle of growth for the large ETFs. See Latzko, David 
A., ``Economies of Scale in Mutual Fund Administration.'' 
Pennsylvania State University, York Campus, 1998 (available at 
http://www.personal.psu.edu/~dxl31/research/articles/mutual.pdf) 
(analyzing economies of scale in mutual fund administration). See 
also Rompotis, Gerasimos Georgiou, ``The German Exchange Traded 
Funds (December 4, 2012). The IUP Journal of Applied Finance, Vol. 
18, No. 4, October 2012, pp. 62-82 (available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2184748) (analyzing 
economies of scale in German ETFs).
---------------------------------------------------------------------------

    While the Commission believes that the Program has the potential to 
improve market quality of the MQP Securities participating in the 
Program, the Commission is concerned about unintended consequences of 
the Program. For example, the MQP could have the potential to distort 
market forces because the Program may act to artificially influence 
trading in ETFs that otherwise would not be traded. Similarly, the 
Commission recognizes concerns about the potential negative impact on 
an MQP Security, such as reduced liquidity and wider spreads, when an 
MQP Company withdraws or is terminated from the Program. While the 
Commission is mindful of these concerns, the Commission believes, for 
the reasons described below, that certain aspects of the Program could 
help mitigate these concerns.\97\
---------------------------------------------------------------------------

    \97\ The concurrent exemptive relief the Commission is issuing 
today from Rule 102 under Regulation M concerning the MQP also 
contains additional disclosure requirements. See Securities Exchange 
Act Release No. 69196 (March 20, 2013), supra note 9.
---------------------------------------------------------------------------

    First, the proposal contains disclosure provisions that will help 
to alert and educate potential and existing investors in the MQP 
Securities about the Program. Specifically, the Exchange will disclose 
on its Web site the following information: (i) The identities of the 
MQP Companies, MQP Securities, and MQP Market Makers accepted into the 
MQP; (ii) any limits the Exchange may impose on the number of MQP 
Securities per MQP Company or MQP Market Makers per MQP Security in the 
MQP; (iii) for each MQP Security, the amount of the Supplemental MQP 
Fee, if any, per MQP Security that would be in addition to the fixed 
Basic MQP Fee of $50,000; (iv) any notification received by the 
Exchange that an MQP Company, on behalf of an MQP Security, or MQP 
Market Maker intends to withdraw from the MQP; and (v) the dates that 
an MQP Company, on behalf of an MQP Security, commences participation 
in and is withdrawn or terminated from the MQP. The Exchange also will 
include on its Web site a statement about the MQP that sets forth a 
fair and balanced summation of the potentially positive and negative 
aspects of the MQP. Furthermore, an MQP Company will be required to 
disclose on a product-specific Web site that the MQP Security is 
participating in the MQP and will be required to provide a link on that 
Web site to the Exchange's MQP Web site. This disclosure will help to 
inform investors and other market participants which securities are 
participating in the MQP, which and how many MQP Market Makers are 
assigned to each MQP Security, the amount of MQP Fees an MQP Company 
will incur as a result of participating in the MQP, the amount of MQP 
Credits the MQP Market Makers could potentially receive from the 
Exchange under the MQP, and the potential benefits and risks of the 
MQP. A wide variety of ETFs are currently listed and trading today, and 
the Commission believes that such disclosure could be helpful for 
investors and other market participants to discern which ETFs listed on 
the Exchange are and are not subject to the MQP and to make informed 
investment decisions with respect to ETFs.
    Second, the Program is targeted at a subset of ETFs, namely those 
ETFs that are generally less liquid and which the Exchange believes 
might benefit most from the Program.\98\ Specifically, as proposed, 
ETFs that are otherwise eligible for the Program will not be eligible 
if they have an ATV of 1,000,000 shares or more for three consecutive 
months. Likewise, the Program will terminate with respect to a 
particular MQP Security if the MQP Security sustains an ATV of 
1,000,000 shares or more for three consecutive months.
---------------------------------------------------------------------------

    \98\ The Exchange has stated that the proposal is designed to 
provide market quality support to smaller, less frequently traded 
ETFs. See Notice, supra note 4, at 77145.
---------------------------------------------------------------------------

    Finally, as proposed by the Exchange, the MQP will be limited to a 
one-year pilot. The Commission believes that it is important to 
implement the MQP as a pilot. Operating the MQP as a pilot will allow 
assessment of whether the MQP is in fact achieving its goal of 
improving the market quality of MQP Securities, prior to any proposal 
or determination to make the Program permanent.\99\ In addition, 
approval on a pilot basis will allow the assessment, prior to any 
proposal or determination to make the program permanent, of whether the 
MQP has any unintended impact on the MQP Securities, securities not in 
the MQP, or the market or market participants generally.
---------------------------------------------------------------------------

    \99\ The Exchange has indicated that if the MQP is successful, 
it will seek to expand the program to small cap stocks and other 
similar products that may need liquidity enhancement. See Notice, 
supra note 4, at 77145. The Exchange would be required to file any 
similar proposal applicable to small cap companies pursuant to 
Section 19(b) of the Exchange Act and the rules and regulations 
thereunder. Such a filing would be published for comment in the 
Federal Register pursuant to Section 19(b) and Rule 19b-4.
---------------------------------------------------------------------------

    The Exchange has represented that during the pilot it will submit 
monthly reports to the Commission about market quality in respect of 
the MQP and that these reports will be posted on the Exchange's public 
Web site and will compare securities before and after they are in the 
MQP, to the extent practicable, and provide information regarding MQP 
Security volume metrics, the number of MQP Market Makers in MQP 
Securities, quotation spread and size statistics, and data and analysis 
about the market quality of MQP Securities that exceed the threshold 
and ``graduate'' from the Program pursuant to proposed Rule 
5950(d)(1)(A), among other information and analyses.\100\ The Exchange 
also has represented that it will provide to the Commission similar 
data and analyses about comparable products listed on the Exchange that 
are not participating in the MQP, as well as any other MQP-

[[Page 18400]]

related data and analyses the Commission staff requests from the 
Exchange for the purpose of evaluating the efficacy of the MQP.\101\ 
This information will help the Commission, the Exchange, and other 
interested persons to evaluate whether the MQP has resulted in the 
intended benefits it is designed to achieve, any unintended 
consequences resulting from the MQP, and the extent to which the MQP 
alleviates or aggravates the concerns the Commission has noted, 
including previously-stated Commission concerns relating to issuer 
payments to market makers.\102\
---------------------------------------------------------------------------

    \100\ See supra notes 60-64 and accompanying text.
    \101\ Id.
    \102\ See infra notes 108-111 and accompanying text.
---------------------------------------------------------------------------

    For example, the Exchange and the Commission will look to assess 
what impact, if any, there is on the market quality of MQP Securities 
that withdraw or are otherwise terminated from the MQP.\103\ One way 
for an MQP Security to be terminated from the MQP is if it exceeds the 
1,000,000 ATV threshold included within the rules.\104\ The Exchange 
states that past trading data indicate that ``graduation'' from the MQP 
during the pilot at a 1,000,000 ATV threshold should occur more 
frequently than at a 2,000,000 ATV threshold, which was the threshold 
proposed in its original filing relating to the MQP (which was later 
withdrawn).\105\ The Commission recognizes that the MQP may not, in the 
one-year pilot period, produce sufficient data (i.e., a large number of 
MQP Securities that enter and exit the MQP) to allow a full assessment 
of whether termination (or withdrawal) of an MQP Security from the 
Program has resulted in any unintended consequences on the market 
quality of the MQP Security or otherwise.\106\ However, the Commission 
believes that the proposal strikes a reasonable balance between (i) 
setting the threshold for ``graduation'' from the MQP high enough to 
encourage participation in the MQP and (ii) setting the threshold low 
enough to have a sufficient number of MQP Securities graduate from the 
Program within the pilot period so that the Exchange, the Commission, 
and other interested persons can assess the impact, if any, of the MQP, 
including ``graduation'' of MQP Securities from the Program.
---------------------------------------------------------------------------

    \103\ See Notice, supra note 4, at 77140 (stating that the 
1,000,000 ATV threshold would ``better provide NASDAQ and the 
Commission with an opportunity to observe the impact, if any, on MQP 
Securities that exceed the threshold and `graduate' from the 
Program'').
    \104\ See proposed Rule 5950(d)(1)(A).
    \105\ See supra note 3. The Exchange provided statistics on the 
number of ETFs that would have graduated annually at the 1 million 
ATV and 2 million ATV volume thresholds from the MQP had it been in 
existence over the period of 2001 to 2012. Specifically, (i) in 
2001, 2 ETPs would have graduated from the MQP under the 2 million 
ATV threshold, while 3 ETPs would have graduated under the 1 million 
ATV threshold; (ii) in 2002, 1 ETP would have graduated under the 2 
million ATV threshold, while 4 ETPs would have graduated under the 1 
million ATV threshold; (iii) in 2003, 3 ETPs would have graduated 
under the 2 million ATV threshold, while 5 ETPs would have graduated 
under the 1 million ATV threshold; (iv) in 2004, 2 ETPs would have 
graduated under the 2 million ATV threshold, while 5 ETPs would have 
graduated under the 1 million ATV threshold; (v) in 2005, 7 ETPs 
would have graduated under the 2 million ATV threshold, while 14 
ETPs would have graduated under the 1 million ATV threshold; (vi) in 
2006, 10 ETPs would have graduated under the 2 million ATV 
threshold, while 20 ETPs would have graduated under the 1 million 
ATV threshold; (vii) in 2007, 23 ETPs would have graduated under the 
2 million ATV threshold, while 24 ETPs would have graduated under 
the 1 million ATV threshold; (viii) in 2008, 38 ETPs would have 
graduated under the 2 million ATV threshold, while 48 ETPs would 
have graduated under the 1 million ATV threshold; (ix) in 2009, 20 
ETPs would have graduated under the 2 million ATV threshold, while 
27 ETPs would have graduated under the 1 million ATV threshold; (x) 
in 2010, 10 ETPs would have graduated under the 2 million ATV 
threshold, while 16 ETPs would have graduated under the 1 million 
ATV threshold; (xi) in 2011, 12 ETPs would have graduated under the 
2 million ATV threshold, while 16 ETPs would have graduated under 
the 1 million ATV threshold; and (xii) in 2012, 3 ETPs would have 
graduated under the 2 million ATV threshold, while 5 ETPs would have 
graduated under the 1 million ATV threshold. See Notice, supra note 
4, at 77145. These statistics, however, assume that all eligible 
securities actually participate in the Program.
    \106\ One commenter suggests that the pilot have a staggered 
introduction of MQP Securities with a randomized sequence, and a 
long enough pre- and post-event period (e.g., three months) for each 
introduction to identify any effects of the MQP. See Menkveld 
Letter, supra note 8, at 4; see also supra note 89. The Commission 
believes that the way the Exchange has structured the pilot is 
reasonable and consistent with the Act. As discussed above, the 
Exchange has represented that it will (a) provide reports to the 
Commission that include information about MQP Securities that exceed 
the threshold and ``graduate'' from the Program (and make these 
reports public) and (b) provide information to the Commission about 
other ETPs not in the Program and any other MQP-related data and 
analysis Commission staff requests. Such information should be 
useful in the evaluation of the effects of the MQP.
---------------------------------------------------------------------------

    Furthermore, the pilot structure of the MQP will provide 
information to help determine whether any provisions of the MQP should 
be modified. For example, based on data from the pilot, the Exchange 
may determine that the 1,000,000 ATV termination threshold is not an 
appropriate threshold on which to base eligibility for the MQP or that 
the Program should be time-limited.\107\
---------------------------------------------------------------------------

    \107\ One commenter, addressing whether a 2,000,000 ATV 
threshold would be appropriate, noted that such a termination 
threshold would be ``an arbitrary number that is no better or worse 
than any other large number'' and that the threshold may need to be 
adjusted after the MQP has been implemented. See Weaver Letter, 
supra note 5, at 8.
---------------------------------------------------------------------------

    The Commission believes that the design of the MQP and the public 
disclosure requirements, coupled with implementation of the proposal on 
a pilot basis, should help mitigate potential concerns the Commission 
has noted above relating to any unintended or negative effects of the 
MQP on the ETF market and investors.
    The Commission also believes that proposed interpretation IM-2460-
1, which would exempt the MQP from the Exchange's general prohibition 
on payments by an issuer to a Market Maker contained in Exchange Rule 
2460, is consistent with the Act. Exchange Rule 2460 is almost 
identical to, and is based on, FINRA Rule 5250. FINRA Rule 5250 
(formerly NASD Rule 2460) was implemented, in part, to address concerns 
about issuers paying market makers, directly or indirectly, to 
improperly influence the price of an issuer's stock and because of 
conflict of interest concerns between issuers and market makers.\108\ 
FINRA Rule 5250 was designed to preserve ``the integrity of the 
marketplace by ensuring that quotations accurately reflect a broker-
dealer's interest in buying or selling a security.'' \109\ 
Specifically, in the NASD Rule 2460 Approval Order, the Commission 
found that the ``decision by a firm to make a market in a given 
security and the question of price generally are dependent on a number 
of factors, including, among others, supply and demand, the firm's 
expectations toward the market, its current inventory position, and 
exposure to risk and competition. This decision should not be 
influenced by payments to the member from issuers or promoters. Public 
investors expect broker-dealers' quotations to be based on the factors 
described above. If payments to broker-dealers by promoters and issuers 
were permitted, investors would not be able to ascertain which 
quotations in the marketplace are based on actual interest and which 
quotations are supported by issuers or promoters. This structure would 
harm investor confidence in the overall integrity of the marketplace.'' 
\110\ The Commission also added that ``such payments may be viewed as a 
conflict of interest since they may influence the member's decision as 
to whether to quote or make a market in a security and, thereafter, the 
prices that the member would quote.'' \111\
---------------------------------------------------------------------------

    \108\ See NASD Rule 2460 Approval Order, supra note 68, at 
37107.
    \109\ See NASD Rule 2460 Approval Order, supra note 68, at 
37107.
    \110\ See id.
    \111\ See id. at 37106.
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    The Commission believes that a number of aspects of the MQP 
mitigate the concerns that FINRA Rule 5250 and

[[Page 18401]]

Exchange Rule 2460 were designed to address.\112\ First, the Commission 
believes that the terms of the MQP are generally objective, clear, and 
transparent. The standards for the MQP are set forth in proposed NASDAQ 
Rule 5950 (further described above) \113\ and describe the application 
and withdrawal process, the fee and credit structure, the market 
quality standards that an MQP Market Maker must meet and maintain to 
secure an MQP Credit, and the MQP termination process. These 
requirements apply to all MQP Securities, MQP Companies, and MQP Market 
Makers.\114\
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    \112\ Two commenters have stated that the design and overall 
transparency of the Program adequately address concerns relating to 
manipulation. See Weaver Letter, supra note 5, at 6-7, and Menkveld 
Letter, supra note 8, at 3.
    \113\ See supra Section I.A.
    \114\ While the Exchange will have some amount of discretion 
pursuant to the proposed rules to limit the number of MQP Securities 
that any one MQP Company may list in the MQP, if such a limit is in 
the best interest of the Exchange, the MQP Company and the goals of 
the MQP, or investors, and/or to limit the number of MQP Market 
Makers in an MQP Security, the Commission believes such limits would 
not be unfairly discriminatory, as they would be imposed on a MQP-
wide basis. In addition, the Commission believes that it is 
reasonable and consistent with the Act for the Exchange to have some 
amount of flexibility to limit the number of MQP Securities or MQP 
Market Makers, to protect investors and the ETF market.
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    Second, the Exchange also will provide notification on its public 
Web site regarding the various aspects of the MQP. As discussed above, 
this notification will include: (i) The names of the MQP Companies and 
the MQP Market Makers that are accepted into the MQP; (ii) the specific 
names of the MQP Securities that are participating in the MQP; (iii) 
the identity of the MQP Market Makers in each MQP Security; (iv) any 
limits the Exchange may impose on the number of MQP Securities per MQP 
Company or MQP Market Makers per MQP Security in the MQP; (v) the 
amount of the Supplemental MQP Fee of each MQP Security, if one is 
established by an MQP Company; (vi) any notification received by the 
Exchange that an MQP Company, on behalf of an MQP Security, or MQP 
Market Maker intends to withdraw from the MQP; and (v) the dates that 
an MQP Company, on behalf of an MQP Security, commences participation 
in and is withdrawn or terminated from the MQP; and (vii) a statement 
about the MQP that sets forth a fair and balanced summary of the 
potentially positive and negative aspects of the MQP. In addition, an 
MQP Company will be required to disclose that the MQP Security is 
participating in the MQP and to provide a link to the Exchange's MQP 
Web page on the MQP Security's Web site.
    And third, MQP Securities will be traded on the Exchange, which is 
a regulated market, pursuant to the current trading and reporting rules 
of the Exchange, and pursuant to the Exchange's established market 
surveillance and trade monitoring procedures. The Exchange will 
administer the application and acceptance of the MQP Companies and MQP 
Market Makers into the MQP and will manage the payment of the MQP 
Credit to MQP Market Makers. The Exchange has represented that the 
recipient MQP Market Makers of the MQP Credits and the size of the MQP 
Credits will be determined solely by the Exchange pursuant to objective 
criteria, and MQP Companies will have no role in selecting the MQP 
Market Maker recipients or in determining the specific amount, if any, 
of their MQP Credits. Furthermore, the MQP Fees will be paid into 
NASDAQ's General Fund, and the MQP Credits will be paid out of NASDAQ's 
General Fund. If no MQP Market Maker is eligible to earn an MQP Credit 
for a particular MQP Security during a quarter, the MQP Fee will remain 
in NASDAQ's General Fund, and no MQP Fees or any portion thereof will 
be rebated with respect to any MQP Security, regardless of the 
performance of the MQP Security's assigned MQP Market Makers. The 
Commission believes that these factors, taken together, should help to 
mitigate the conflict of interest and other concerns that the 
Commission has previously identified \115\ relating to issuers paying 
for market making.\116\
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    \115\ See NASD Rule 2460 Approval Order, supra note 68, and 
supra notes 108-111. See also Securities Act Release No. 6334 (Aug. 
6, 1981), 46 FR 42001 (Aug. 18, 1981), at Section IV.B (Treatment as 
Statutory Underwriter). In addition, only index-based ETFs are 
eligible to participate in the MQP. The Exchange notes that the 
prices of ETFs are generally linked back to the underlying 
securities and that the ETF trust structure acts as an insulating 
wall between market maker and product. See Notice, supra note 4, at 
77145, n.36.
    \116\ Until FINRA files a proposed rule change to exempt 
payments made pursuant to the MQP from FINRA Rule 5250 and the 
proposed rule change becomes effective, receipt of payments pursuant 
to the MQP by a market maker that is a FINRA member would be in 
violation of FINRA Rule 5250.
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    The Commission believes that it is reasonable and consistent with 
the Act for the Exchange to limit the MQP to certain types of 
securities to allow the Exchange, through a pilot, to assess whether 
the Program will have the desired effect of improving the market 
quality of these securities before implementing the Program on a wider 
scale. The Commission believes that it is reasonable and consistent 
with the Act for the Exchange to limit the MQP to products under the 
1,000,000 ATV threshold, to support the Exchange's stated purpose to 
provide market quality support to less frequently traded ETFs.
    The Commission believes that the MQP Fees are an equitable 
allocation of reasonable fees. First, participation in the MQP is 
voluntary. An entity is free to determine whether it would be 
economically desirable to pay the MQP Fee, given the amount of the fee, 
the trading characteristics of the ETF (if applicable) and the 
anticipated benefit. If an MQP Company chooses to participate in the 
MQP with respect to an MQP Security, it will incur the Basic MQP Fee of 
$50,000, and the MQP Company will have discretion to incur the 
Supplemental MQP Fee in an amount up to an additional $50,000. The MQP 
Fees will be paid for by the Sponsors associated with the MQP 
Companies. Thus, the MQP Fees will be incurred and paid for by an 
issuer and its sponsor, as applicable, that have chosen to participate 
in, and that may potentially benefit from, the MQP.\117\ An entity that 
chooses not to participate will not be required to pay any additional 
fee beyond the standard listing fees. Further, the MQP Fees will be the 
same for any MQP Company wishing to participate in the program.
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    \117\ Issuers of ETFs registered under the 1940 Act are 
prohibited from paying directly or indirectly for distribution of 
their shares (i.e., directly or indirectly financing any activity 
that is primarily intended to result in the sale of shares), unless 
such payments are made pursuant to a plan that meets the 
requirements of Rule 12b-1 under the 1940 Act. Although the services 
at issue could be primarily intended to result in the sale of fund 
shares, the Commission has stated that such a determination will 
depend on the surrounding circumstances. See Payment of Asset-Based 
Sales Loads by Registered Open-End Management Investment Companies, 
Investment Company Act Release No. 16431 (June 13, 1988) (``1988 
12b-1 Release''). As the Commission has noted previously, if a fund 
makes payments that are ostensibly for a non-distribution purpose, 
and the recipient of those payments finances distribution, the 
question arises whether the fund's assets are being used indirectly 
for distribution. The Commission has stated that there can be no 
precise definition of what types of expenditures constitute indirect 
use of fund assets, and this determination is based on the facts and 
circumstances of each individual case. In addition, fund directors, 
particularly independent directors bear substantial responsibility 
for making that judgment. See Bearing of Distribution Expenses by 
Mutual Funds, Investment Company Act Release No. 11414 (October 28, 
1980).
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    The Commission also believes that availability of the discretionary 
Supplemental MQP Fee is consistent with the Act. Each MQP Company 
participating in the MQP will have the choice of whether or not to 
incur, as well as the exact amount (up to $50,000) of, the Supplemental 
MQP Fee. Not all ETFs are alike, and trading in certain products may be 
riskier or more costly

[[Page 18402]]

than trading in others. The Commission believes that it is reasonable 
to allow each MQP Company to choose to participate in the Program and 
to determine whether it is desirable to incentivize MQP Market Makers 
through the Supplemental MQP Fee to improve the market quality of 
certain MQP Securities. Further, as discussed above, the payment of the 
Supplemental MQP Fee will be transparent to the marketplace, as this 
information will be disclosed on the Exchange's Web site.\118\
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    \118\ See supra note 38 and accompanying text.
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IV. Section 11(d)(1) of the Exchange Act

    Section 11(d)(1) of the Exchange Act \119\ generally prohibits a 
broker-dealer from extending or maintaining credit, or arranging for 
the extension or maintenance of credit, on shares of new issue 
securities, if the broker-dealer participated in the distribution of 
the new issue securities within the preceding 30 days. The Commission's 
view is that shares of open-end investment companies and unit 
investment trusts registered under the 1940 Act, such as ETF shares, 
are distributed in a continuous manner, and broker-dealers that sell 
such securities are therefore participating in the ``distribution'' of 
a new issue for purposes of Section 11(d)(1).\120\
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    \119\ 15 U.S.C. 78k(d)(1).
    \120\ See, e.g., Exchange Act Release Nos. 6726 (Feb. 8, 1962), 
27 FR 1415 (Feb. 15, 1962) and 21577 (Dec. 18, 1984), 49 FR 50174 
(Dec. 27, 1984).
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    The Division of Trading and Markets, acting under delegated 
authority, granted an exemption from Section 11(d)(1) and Rule 11d1-2 
thereunder for broker-dealers that have entered into an agreement with 
an ETF's distributor to place orders with the distributor to purchase 
or redeem the ETF's shares (``Broker-Dealer APs).\121\ The SIA 
Exemption allows a Broker-Dealer AP to extend or maintain credit, or 
arrange for the extension or maintenance of credit, to or for customers 
on the shares of qualifying ETFs subject to the condition that neither 
the Broker-Dealer AP, nor any natural person associated with the 
Broker-Dealer AP, directly or indirectly (including through any 
affiliate of the Broker-Dealer AP), receives from the fund complex any 
payment, compensation, or other economic incentive to promote or sell 
the shares of the ETF to persons outside the fund complex, other than 
non-cash compensation permitted under NASD Rule 2830(l)(5)(A), (B), or 
(C). This condition is intended to eliminate special incentives that 
Broker-Dealer APs and their associated persons might otherwise have to 
``push'' ETF shares.
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    \121\ See Letter from Catherine McGuire, Chief Counsel, Division 
of Trading and Markets, Securities and Exchange Commission to 
Securities Industry Association (Nov. 21, 2005) (``SIA Exemption'').
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    The MQP will permit certain ETFs to voluntarily incur increased 
listing fees payable to the Exchange. In turn, the Exchange will use 
the fees to make incentive payments to market makers that improve the 
liquidity of participating issuers' securities, and thus enhance the 
market quality for the participating issuers. Incentives payments will 
be accrued for, among other things, executing purchases and sales on 
the Exchange. Receipt of the incentive payments by certain broker-
dealers will implicate the condition of the SIA Exemption from the new 
issue lending restriction in Section 11(d)(1) of the Exchange Act 
discussed above. The Commission's view is that the incentive payments 
market makers will receive under the proposal are indirect payments 
from the fund complex to the market maker and that those payments are 
compensation to promote or sell the shares of the ETF. Therefore, a 
market maker that also is a Broker-Dealer AP for an ETF (or an 
associated person or an affiliate of a Broker-Dealer AP) that receives 
the incentives will not be able to rely on the SIA Exemption from 
Section 11(d)(1). This does not mean that Broker-Dealer APs cannot 
participate in the MQP; it merely means they cannot rely on the SIA 
Exemption while doing so. Thus, Broker-Dealer APs that participate in 
the MQP will need to comply with Section 11(d)(1) unless there is 
another applicable exemption.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\122\ that the proposed rule change (SR-NASDAQ-2012-137), as 
modified by Amendment Nos. 1 and 3 thereto, be, and it hereby is, 
approved.
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    \122\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\123\
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    \123\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-06882 Filed 3-25-13; 8:45 am]
BILLING CODE 8011-01-P


