Wednesday, January 28, 2009

Equity Regulatory Alert #2009 - 3
Updated: New Sponsored Access Rule Published by the SEC for Comment

What has been published?

In order to develop a new sponsored access rule that could be consistently applied across all markets, NASDAQ^® has filed a proposal with the Securities and Exchange Commission (SEC) to modify the requirements for members that provide sponsored access. On January 22, 2009, the SEC issued a Notice asking for comment on NASDAQ’s proposed rule change.

How does the new rule define sponsored access?

The proposed new rule defines sponsored access as the practice by a member firm (Sponsoring Member) of providing access to NASDAQ to another firm or customer (Sponsored Participant).

Sponsored access arrangements include, but are not limited to:

• Direct Market Access: The Sponsored Participant’s orders pass through the Sponsoring Member’s systems prior to reaching NASDAQ.
• Sponsored Access: The Sponsored Participant enters orders directly into NASDAQ via a dedicated port provided by the Sponsoring Member.
• Third Party Sponsored Access: A service bureau or other third party provides Sponsored Participants with technology to access NASDAQ under the auspices of and via an arrangement with the Sponsoring Member.

What requirements will change under the new rule?

NASDAQ Rule 4611(d) currently governs sponsored access to NASDAQ and requires both a User Agreement for Sponsored Access and a Notice of Consent. Even though Rule 4611(d) is still in effect, Sponsoring Members will not be required to submit User Agreements or Notices of Consent while the proposed new rule is being developed. In addition, at this time, Sponsoring Members will not be required to obtain unique Market Participant Identifiers (MPIDs) for Sponsored Participants.

Instead of the User Agreement and Notice of Consent, the proposed new rule will require Sponsoring Members that provide Direct Sponsored Access or Third Party Sponsored Access to execute agreements with each Sponsored Participant. A Sponsoring Member that provides Third Party Sponsored Access must also execute and maintain agreements with each service bureau or other entity that facilitates Third Party Sponsored Access, and the Third Party must enter into agreements with Sponsored Participants for the benefit of the Sponsoring Member. Agreements are not required between Members that provide Direct Market Access and their Sponsored Participants.

What are the new requirements under the new proposed rule?

We suggest you review the SEC Notice, which includes the text of the new rule and a detailed explanation of the proposed new requirements. The new requirements include the following:

• There is an explicit requirement in the proposed new rule requiring members to ensure that the Sponsored Access system includes controls that systemically limit the member firm’s financial exposure.
• The proposed new rule requires Sponsoring Members to have systemic controls in place to ensure compliance by Sponsored Participants with applicable rules.
• The proposed new rule requires Sponsoring Members to ensure that compliance personnel receive timely reports of all Sponsored Participant trading activity to permit the Member to comply with all applicable rules and to monitor for illegal activity.

What is the timing for the requirements?

The proposed new rule will take effect upon SEC approval.

How can I file comments with the SEC on the proposed new rule?

Comments may be submitted by any of the following methods. All submissions should refer to File Number SR-NASDAQ-2008-104 and should be submitted by February 19, 2009./p>

Electronic Comments:

• Use the SEC’s Internet comment form
• Send an e-mail to rule-comments@sec.gov.

Paper Comments:

Send paper comments in triplicate to:

Elizabeth M. Murphy
Secretary, Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549-1090.

What is the text of the proposed new rule?

4611. Nasdaq Market Center Participant Registration

(a) – (c) No change.
(d) Members may provide “Sponsored Access” to the Nasdaq Market Center in accordance with the provisions below:

(1) Definition. Sponsored Access is the practice by a member firm (“Sponsoring Member”) of providing access to Nasdaq to another firm or customer (“Sponsored Participant”). Sponsored Access takes multiple forms, including but not limited to: (a) direct market access, where the Sponsored Participant’s orders pass through the Sponsoring Member’s systems prior to reaching Nasdaq (“Direct Market Access”), (b) sponsored access, where the Sponsored Participant enters orders directly into Nasdaq via a dedicated port provided by the Sponsoring Member (“Direct Sponsored Access”), and (c) direct access where a service bureau or other third party provides Sponsored Participants with technology to access Nasdaq under the auspices of and via an arrangement with the Sponsoring Member (“Third Party Sponsored Access”).

(2) Compliance. Irrespective of the form of Sponsored Access provided, Sponsoring Members are responsible for the conduct of their Sponsored Participants as if the conduct were their own. To ensure that Sponsored Access is consistent with high market quality and the protection of investors, Sponsoring Members shall at a minimum comply with the Contractual Provisions, Financial Controls, and Regulatory Controls set forth in sections (3), (4), and (5) below.

(3) Contractual Provisions. A Sponsoring Member that provides Direct Sponsored Access or Third Party Sponsored Access shall execute and maintain agreements with each Sponsored Participant containing the commitments below. A Sponsoring Member that provides Third Party Sponsored Access must execute and maintain agreements with each service bureau or other entity that facilitates such Third Party Sponsored Access providing that such entity will execute and maintain agreements with each Sponsored Participant containing the commitments below for the benefit of the Sponsoring Member.

(A) All trading activity by the Sponsored Participant shall comply with all applicable federal securities laws and rules and Exchange rules, including but not limited to the Nasdaq Certificate of Incorporation, Bylaws, Rules and procedures with regard to the Nasdaq Market Center (“Regulatory Requirements”).
(B) Sponsored Participant shall provide Sponsoring Member with access to its books and records promptly upon request, and otherwise cooperate with the Sponsoring Member in furtherance of Sponsoring Member’s compliance with applicable Regulatory Requirements. (C) Sponsored Participant shall maintain its trading activity within the credit, product or other financial limits specified by the Sponsoring Member.
(D) Sponsored Participant shall maintain all technology permitting sponsored access to Nasdaq in a physically secure manner and may not permit unauthorized individuals to use or obtain access to Nasdaq. Sponsored Participant shall familiarize its authorized individuals with the Regulatory Requirements and will provide appropriate training prior to use or access to Nasdaq.
(E) Sponsored Participant shall provide the Sponsoring Member complete and current corporate and financial information about the Sponsored Participant.
(F) Sponsored Participant shall agree that the Sponsoring Member or Nasdaq may immediately terminate the Sponsored Access if the Sponsored Participant or third party access provider fails to abide by its commitments.

(4) Financial Controls. Each Sponsoring Member shall establish adequate procedures and controls that permit it to effectively monitor and control the Sponsored Access to systemically limit the Sponsoring Member’s financial exposure. At minimum, the Sponsored Access system shall:

(A) Prevent each Sponsored Participant from entering orders that in aggregate exceed appropriate pre-set credit thresholds. Sponsoring Members may also set finely-tuned credit thresholds by sector, security or otherwise.
(B) Prevent Sponsored Participants from trading products that the Sponsored Participant or Sponsoring Member is restricted from trading.
(C) Prevent Sponsored Participants from submitting erroneous orders by providing for the rejection of orders that exceed certain price or size parameters, on an order-by-order basis or over a short period of time, or that indicate duplicative orders.

(5) Regulatory Controls.

(A) Each Sponsoring Member shall have systemic controls to ensure compliance by the Sponsored Participant with applicable Regulatory Requirements, including but not limited to compliance with rules relating to short selling; trading halts; proper uses of order types; proper use of Intermarket Sweep Orders; trading ahead of customer limit orders; prohibitions against manipulative trading practices, including wash sales and marking the close; restricted lists of securities for purposes of SEC Rule 10b-18; and applicable margin rules.
(B) Each Sponsoring Member shall ensure that compliance personnel receive timely reports of all trading activity by its Sponsored Participants sufficient to permit the Sponsoring Member to comply with applicable Regulatory Requirements, and to monitor for illegal activity such as market manipulation or insider trading. At minimum, the member firm’s compliance unit should receive immediate post-trade execution reports of trading activity of its Sponsored Participants, including their identities; all required audit trail information by no later than the end of the trading day; all information necessary to create and maintain the trading records required by Regulatory Requirements by no later than the end of the trading day.

Where can I get additional information?

• Refer to the Sponsored Access page on the NASDAQ OMX Trader^® website.
• Contact Subscriber Services +1 212 231 5180.
• Contact NASDAQ Market Sales at +1 800 846 0477.