
[Federal Register Volume 78, Number 159 (Friday, August 16, 2013)]
[Notices]
[Pages 50123-50126]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-19907]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70159; File No. SR-NASDAQ-2013-102]


Self-Regulatory Organizations; The NASDAQ Stock Market LLC; 
Notice of Filing of a Proposed Rule Change to Assume Operational 
Responsibility for Certain Surveillance Activity Currently Performed by 
FINRA Under the Exchange's Authority and Supervision

August 12, 2013.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on July 31, 2013, The NASDAQ Stock Market LLC (``NASDAQ'' or the 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change as described in Items I, II and 
III below, which Items have been prepared by the Exchange. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASDAQ is proposing to assume operational responsibility for 
certain surveillance activity currently performed by the Financial 
Industry Regulatory Authority (``FINRA'') under the Exchange's 
authority and supervision.

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

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

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

1. Purpose
    Section 6 of the Act requires that national securities exchanges 
enforce their members' compliance with federal securities laws and 
rules as well as the exchanges' own rules.\3\ As a self-regulatory 
organization (``SRO''), NASDAQ must conduct surveillance of trading on 
the Exchange as part of a comprehensive regulatory program that also 
includes member examinations and investigation and prosecution of 
suspicious activity. Since it became a national securities exchange, 
NASDAQ has contracted with FINRA through various regulatory services 
agreements to perform certain surveillance and other regulatory 
functions on its behalf. However, as the Commission has made clear, 
``the Nasdaq Exchange bears the responsibility for self-regulatory 
conduct and primary liability for self-regulatory failures, not the SRO 
retained to perform regulatory functions on the Exchange's behalf.'' 
\4\
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    \3\ 15 U.S.C. 78f.
    \4\ Securities Exchange Act Release No. 53128 at 28 (January 13, 
2006), 71 FR 3550, 3556 (January 23, 2006).
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    Notwithstanding its use of FINRA, the Exchange has also retained 
operational responsibility for a number of surveillance and other 
regulatory functions including real-time surveillance, qualification of 
companies listed on NASDAQ and most surveillance related to its 
affiliated options markets. Historically NASDAQ retained operational 
responsibility in areas where NASDAQ's expertise regarding its own 
markets, technology and listed companies enhanced regulation. For the 
reasons outlined

[[Page 50124]]

below, NASDAQ now proposes to reallocate operational responsibility 
from FINRA to NASDAQ Regulation for a limited number of equities 
surveillance patterns and related review functions focused on:
     Manipulation patterns that monitor solely NASDAQ activity, 
including patterns that monitor the Exchange's opening and closing 
crosses and compliance with minimum bid listing requirements, and
     monitoring of compliance by member firms with elements of 
Regulation M and NASDAQ Rule 4619 compliance.
    FINRA operates a full suite of equities surveillance patterns on 
behalf of NASDAQ that covers many types of potential misconduct. In 
recent years FINRA, with NASDAQ's oversight and approval, modified a 
number of these NASDAQ patterns to incorporate data from markets 
operated by NYSE Euronext. NASDAQ plans to continue to participate in 
this cross-market surveillance performed by FINRA, some of which 
focuses on identifying similar violative activity, which will not be 
impacted by this proposal. However, a limited number of FINRA's 
patterns only review NASDAQ market data and detect conduct occurring 
only on the Exchange. These patterns incorporate unique elements of 
NASDAQ's market structure and focus on trading activity in the NASDAQ 
opening and closing cross process, as well as NASDAQ minimum bid 
listing standards, an area already regulated by NASDAQ. An additional 
pattern monitors attempts to manipulate NASDAQ using small orders to 
advantage larger orders placed on the opposite side of the NASDAQ 
market at an improved price (often referred to as ``odd lot 
manipulation'' or ``mini-manipulation'').
    NASDAQ believes that its expertise in its own market structure 
coupled with its continued monitoring of these activities in real-time 
will enable it to enhance existing patterns to better detect improper 
activity on its market. In addition, these patterns, the underlying 
rules, and analytical requirements are similar to patterns NASDAQ 
regulatory personnel already operate for affiliated options markets. 
For example, NASDAQ regulatory personnel routinely monitor affiliated 
options markets for market closing activity and other patterns designed 
to detect various types of price influence.
    NASDAQ also proposes to assume operational responsibility for real-
time monitoring of compliance by market makers that are members of an 
underwriting syndicate with the quoting and trading restrictions in 
Rules 101 and 103 under the Act \5\ and NASDAQ Rule 4619. Lead 
underwriters affected by the rules file a Regulation M Commencement 
Notification at the beginning of a secondary offering and subsequent 
Underwriter Activity Report for the offering. The surveillance pattern 
monitors quoting and trading of firms that are designated as 
participants in the secondary offering and alerts regulatory staff if a 
firm that has requested passive market making exceeds its trading 
thresholds or an excused withdrawal has traded in a way that could lead 
to violations of the rules. The activity is monitored in real-time and 
firms are called upon receipt of regulatory alerts to prevent potential 
or further violations. This is the only real-time surveillance function 
performed by FINRA and NASDAQ believes that this responsibility is more 
properly handled by NASDAQ's MarketWatch group that handles all other 
real-time surveillance of the NASDAQ market. MarketWatch already has 
responsibility for monitoring similar activity on NASDAQ OMX BX by 
market makers participating in secondary offerings, although this 
surveillance is not currently active as BX does not have any registered 
market makers.
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    \5\ 17 CFR 242.101 and 17 CFR 242.103.
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    NASDAQ plans to operate the surveillance patterns referenced above 
in the SMARTS surveillance system. SMARTS is a state-of-the-art 
surveillance platform used in 26 markets and by 9 government regulators 
around the world. NASDAQ plans to use SMARTS for both real-time 
monitoring and the limited non-real time surveillance covered by this 
proposal. Running the patterns in real-time will permit an expedited 
review of critical alerts that previously would not have been completed 
the same day. It will now be easier to quickly compare unusual activity 
noted as part of NASDAQ's operations monitoring of market activity with 
surveillance alerts. NASDAQ anticipates being able to refer a broader 
cross section of problematic activity to FINRA for expedited review 
than was previously the case.
    NASDAQ Regulation intends to leverage its existing staff of 
experienced analysts, lawyers, programmers and market structure experts 
to perform the new functions covered by this proposal. This group is 
working with NASDAQ's regulatory technology group to develop and test 
the surveillance patterns that will run in the SMARTS system. This 
distribution of responsibilities was the result of detailed discussions 
between NASDAQ and FINRA that focused on reallocating responsibilities 
based on the core competencies of each organization. NASDAQ Regulation 
and FINRA have developed comprehensive plans covering the transition 
and the groups have met regularly over more than nine months to ensure 
a smooth transition of the work and prevent any gaps in surveillance 
coverage. NASDAQ and FINRA anticipate a phased transition of patterns, 
with NASDAQ formally relieving FINRA of operational responsibility for 
each pattern once testing, training, procedures and other preparations 
are completed. FINRA will retire each pattern once relieved of 
responsibility. After the transition, NASDAQ Regulation will review 
surveillance alerts and refer potentially violative conduct to FINRA 
using existing processes and systems. FINRA will continue to have 
operational responsibility for the vast majority of surveillances 
involving NASDAQ's equity market as well as examination and enforcement 
matters, subject to NASDAQ's supervision and ultimate responsibility.
    The provisions of NASDAQ Rule 0150 require that NASDAQ obtain 
Commission approval if regulatory functions subject to the regulatory 
services agreement in effect at the time NASDAQ became a national 
securities exchange are no longer performed by FINRA or another 
independent self-regulatory organization. For the reasons stated above, 
NASDAQ believes that the reassignment of operational responsibility for 
a limited number of equities surveillance patterns will further its 
regulatory program and benefit investors and the markets. Commission 
approval of the proposal would allow NASDAQ OMX to better leverage data 
and systems across its three equities exchanges, including NASDAQ OMX 
PHLX, an affiliate of NASDAQ, that does not have an equivalent to Rule 
0150 requiring Commission approval for this reallocation.
    In addition, NASDAQ notes that its proposal is consistent with, but 
more limited than, surveillance work performed by other national 
securities exchanges. The SEC has previously approved several 
applications for registration as national securities exchanges in which 
the SRO proposed to perform its own surveillance function. For example, 
the SEC approved BATS Exchange's application where BATS performed most 
surveillance for its markets, finding in its approval order that it was 
consistent with the Act for BATS Exchange to contract with FINRA to 
perform regulatory functions limited to ``examination, enforcement, and

[[Page 50125]]

disciplinary functions.'' \6\ Similarly, NASDAQ understands that Miami 
International Securities Exchange (``MIAX'') performs the majority of 
its surveillance operations in-house. This is consistent with MIAX's 
Form 1, which states that the new exchange entered into a regulatory 
services agreement with CBOE that is limited to ``conducting certain 
market surveillances'' in addition to other regulatory work.\7\
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    \6\ Securities Exchange Act Release No. 34-58375 (August 18, 
2008), 73 FR 49498 (August 21, 2008).
    \7\ Securities Exchange Act Release No. 34-68341 (December 3, 
2012), 77 FR 73065 (December 7, 2012) (emphasis added).
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2. Statutory Basis
    NASDAQ believes that the proposed rule change is consistent with 
the provisions of Section 6 of the Act,\8\ in general and with Sections 
6(b)(5) of the Act,\9\ in particular in that it is designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest. The Exchange believes that 
this proposal is in keeping with those principles by leveraging the 
SMARTS technology system that has the ability to operate in real-time 
and, as a consequence, will permit NASDAQ to react more quickly to 
potential manipulation in the applicable regulatory areas covered by 
this proposal. The surveillance patterns to be reallocated to NASDAQ 
involve solely activity on NASDAQ's own market. NASDAQ believes that 
its expertise in its own market structure, coupled with its existing 
monitoring of these activities in real-time, will enable it to enhance 
current patterns to better detect improper activity on its market. In 
addition, NASDAQ will be able to leverage the knowledge and the 
regulatory staff that already perform similar work for affiliated 
options markets.
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    \8\ 15 U.S.C. 78f.
    \9\ 15 U.S.C. 78f(b)(5).
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    NASDAQ will continue to refer potentially violative conduct to 
FINRA for further review. Moreover, FINRA will continue to perform the 
vast majority of surveillance activity for NASDAQ's equities markets, 
in many cases using patterns that incorporate data from other market 
centers. FINRA will also perform examination and enforcement work, 
subject to NASDAQ's supervision and ultimate responsibility.
    NASDAQ also believes the proposal is consistent with the Act 
because, as the Commission has made clear on many occasions, an SRO 
cannot delegate its ultimate responsibility for surveillance in the 
absence of an SEC-approved agreement under Section 17(d)(2) of the Act, 
and therefore must remain involved and responsible for its regulatory 
program. In addition, NASDAQ notes that its proposal is consistent 
with, but more limited than, surveillance work performed by other 
national securities exchanges. As noted above, the SEC has previously 
approved several applications for registration as national securities 
exchanges in which the SRO proposed to perform its own surveillance 
function.\10\ NASDAQ believes it would therefore be consistent with the 
Act for NASDAQ to perform a much more limited surveillance function 
than has been approved for other exchanges and, in fact, more limited 
than surveillance functions NASDAQ already performs for non-cash 
equities markets.
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    \10\ See supra notes 6 and 7, and accompanying text discussing 
the surveillance work by BATS and MIAX.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

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

    Written comments were neither solicited nor received.

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

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission shall: (a) By order approve 
or disapprove such proposed rule change, or (b) institute proceedings 
to determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

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

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-NASDAQ-2013-102 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-2013-102. This 
file number should be included on the subject line if email 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549 on official business days between the hours of 
10:00 a.m. and 3:00 p.m. 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-2013-102, and should 
be submitted on or before September 6, 2013.


[[Page 50126]]


    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-19907 Filed 8-15-13; 8:45 am]
BILLING CODE 8011-01-P


