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November 29, 2005

Nasdaq Says It Has An Exchange Solution

By Gregory Bresiger

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  • Nasdaq Says It Has An Exchange Solution

Nasdaq officials say they are now "optimistic" that their extended exchange application will be approved by the end of the year. But that doesn't necessarily mean that Nasdaq's competitors will quietly accept its unique proposal for transforming itself into a national securities exchange.

The Securities and Exchange Commission recently asked for public comment on two new exchange application amendments. The amendments were the result of protracted negotiations with the SEC over the tricky issue of how Nasdaq can become a national securities exchange, but still allow some internalization.

Historically, exchanges have not been allowed to provide trade-reporting services for those who internalize. These prohibitions go back to Great Depression era regulations. Exchanges traditionally have not been allowed to provide trade reports out of time sequence, New York Stock Exchange officials have noted in critiquing the controversial Nasdaq exchange application.

However, Nasdaq officials have said that the rules on these points have been interpreted in various ways. Rather than try to change the rules, Nasdaq offered another solution to the problem: changing its corporate structure.

"Nasdaq's internalization policy appears to have changed through a creative process," said one trading industry official familiar with the application.

"Nasdaq," said one official involved in the marathon negotiations, "decided to change its corporate structure. And Nasdaq created two subsidiaries. One for the exchange, which has price/time priority matching, but it left the trade reporting requirements where they are today-with the NASD."

Nasdaq, in the recent SEC filing, promises to limit the scope of its new exchange to "those transactions that occur in the Nasdaq Market Center, formerly known as SuperMontage, and Brut." Nasdaq has also proposed that all transactions on the Nasdaq Market Center be executed in price/time priority.

"Trades executed in the internal systems of NASD members," according to the amendments, "would be reported under NASD rules to NASD's Alternative Display Facility or a proposed new NASD facility." The latter would be jointly owned by Nasdaq and NASD. But it would be under the regulatory control of the NASD, which is a national securities association.

"What is ingenious about Nasdaq's approach is that they're trying to have their cake and eat it too," said Jamie Selway, a founder and managing director of White Cap Trading. Selway, an economist, is also a former Archipelago official. "They're trying to say that only the NASD, as an association, can facilitate and regulate internalization. So as an exchange, we'll enter into a relationship with the NASD in which the trade reports will go to them," Selway said.

Nasdaq would also require members to comply with NASD's Order Audit Trail requirements. A new independent committee of Nasdaq's Board, the Regulatory Oversight Committee (ROC), will ensure compliance.

Will these changes be enough to resolve the internalization and other regulatory questions that have dogged and delayed the seemingly interminable exchange application? That's not clear. Indeed, the SEC in a release soliciting comments for the re-packaged Nasdaq market, asks if the proposed new regulatory structure solves the internalization problem.