<<Optimark will crush them, they can't even get the stock stuff off of the ground>>
Dude,
you really are clueless here, and its so reminiscent of GNET days. Next time look before you leap.
Ashton is in the right place, at the right time, with the right product.
August 23, 1999
Richard Strasser
Assistant Director
Division of Market Regulation
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: File Nos. SR-NASD-98-85
Dear Mr. Strasser:
This letter addresses points raised by the Nasdaq Stock Market ("Nasdaq") in a letter dated July 26, 1999 responding to comments submitted by the Clearing Firms Committee ("Committee")1 of the Securities Industry Association ("SIA")2 regarding the Nasdaq application of the OptiMark System (the "Application"). In that letter, Nasdaq states that the Nasdaq Application poses no more risk than trading in the Pacific Stock Exchange ("PCX") Application, or any other system operating in the U.S. securities markets today. Nasdaq therefore believes that the issues raised by the Committee should not keep the Commission from approving the filing as proposed. We respectfully disagree.
First, Nasdaq argues that "legal provisions and automated tools more than adequately control for risk in trading through the Application." This is a startling statement for several reasons. The "legal provisions" that Nasdaq refers to are simply the requirement that only an NASD member with an effective clearing arrangement in place with a clearing firm can trade on the Application combined with the contracts for "Users" and "Designated Brokers." As far as the Committee is aware, this is the first time that the legal underpinnings for dealing with systemic risk issues in the securities markets are being relegated to the domain of state contract law. Further, if indeed Nasdaq believes the contracts are intended to address systemic risk issues, the Committee believes that this is an unauthorized delegation of self-regulatory organization duties and responsibilities, and an attempt to conduct sub rosa rulemaking. The agreements have not been subject to public comment or to Commission approval and, in the opinion of the Committee, cannot be used to control for the types of risk created by trading in the Nasdaq Application.
Second, Nasdaq maintains that clearing firms can establish systematically monitored trading limits for each user in the system. Although credit limits typically can be an effective tool in managing risk, they are largely illusory when users can trade anonymously throughout the trading day. More important is the ability to monitor continually on a real-time basis the trading activity of each correspondent and authorized user. In developing the Automated Confirmation Transaction Service ("ACT"), the SEC and the NASD each recognized the importance of real-time monitoring in the Nasdaq market and established the ACT Risk Management System. In the listed market, where there is significant depth and liquidity, real-time monitoring is not as critical because a clearing firm can, if necessary due to the failure of a correspondent or user, easily trade out of a position. In the dealer market, many issues are thinly traded and natural liquidity may not exist, leaving clearing firms with an unacceptable level of risk.
ACT Risk Management allows a clearing firm to view the trading activity of their correspondents during the trading day. It has proven to be an effective tool for clearing firms to monitor the trading activity of their correspondents in the Nasdaq market. Clearing firms generally will set credit limits on their correspondents and through ACT will closely monitor those limits throughout the trading day. At certain levels, the clearing firm must affirmatively accept a transaction before it can be reported through ACT. The counterparty, concentrated positions, and liquidity of the issue are all factors considered in risk management. If the clearing firm detects unusual trading activity, risk management personnel can pick up the telephone and discuss the situation with the correspondent. If they determine that the correspondent poses risk, they can simply block new transactions from being entered into ACT.
No such protections will be available in the Nasdaq Application. Indeed, where users have not agreed to release their identities at the time of execution, no trade data is released until the time the information is to be submitted for clearing at approximately 4:20 p.m. on trade date. This makes it virtually impossible for a clearing firm to effectively monitor the trading activity of their correspondents and users, or for Nasdaq to effectively control systemic risk.
In a somewhat disingenuous manner, Nasdaq states that a clearing firm can mitigate the risk associated with a correspondent's use of the Application by simply not allowing the correspondent to trade in the Nasdaq Application. This presumption is, however, destroyed by the fact that Nasdaq already has sent out User and Designated Broker Agreements to NASD members requiring them to have these third party contracts completed. When a regulator tells its regulated entities that they must enter into a contract with a third party it would not appear to be an option for a clearing firm to refuse authorization. As stated earlier, these contracts of adhesion appear to be a means of subverting the normal rulemaking process, and should be subject to public comment and Commission review.
The Committee strongly believes that rules cannot eliminate or manage risk—strong, effective systems are required. In the absence of real-time trade information flowing into the ACT Risk Management System, clearing firms have no way of knowing until approximately 4:30 p.m. if users, which can include both retail and institutional customers, have exceeded credit limits established by the correspondent that would jeopardize the correspondent and, in turn, the clearing firm. Without an automated capability to change designated credit limits when the situation warrants, clearing firms will be pressured to set those limits at high levels. Notification at designated alert levels may come too late where a user has traded irresponsibly.
Again, the Committee appreciates the commitment of Nasdaq and OptiMark officials to work with clearing firms to resolve these concerns. We believe it is critical to the national clearance and settlement system to develop enhancements that integrate trading activity in the Nasdaq Application into ACT Risk Management on a real-time basis. As we noted in our previous letter, without such enhancements, responsible clearing firms will restrict access to the Application. Users might nevertheless find access to the Application through broker-dealers with less capital and less sophisticated risk management systems. A "weak link" might be particularly susceptible to failure, causing a domino effect throughout the industry.
The Committee notes that Nasdaq has indicated that our concerns seem to be associated solely with the anonymous nature of the Nasdaq Application and that the same issues are raised by Electronic Communications Networks ("ECNs") and Alternative Trading Systems ("ATSs") operating in the Nasdaq market. This is simply not true. The Committee does believe that the fact that OptiMark is not a regulated entity increases concerns and risks about ultimate authority and oversight. Unlike every ECN and ATS, OptiMark is not a registered broker-dealer. It is not subject to inspection and examination by the SEC; it is not required to have regulatory capital and to meet other basic standards of broker-dealer regulation; it is not required to comply with the safeguards of Regulation ATS; and, since the NASD is an investor, it is not subject to any independent oversight. If OptiMark fails to fulfill its responsibilities, there are no regulatory ramifications. At most, there is simply an action for breach of contract.
Elisse Walter, Chief Operating Officer of NASD Regulation, recently noted the importance of strong risk management procedures. In a joint statement issued by the SEC, NYSE, and NASD3 , she said, "Risk management procedures implemented by member firms are critical to the protection of investors and the integrity of the market." The Committee wholeheartedly agrees and strongly encourages the Commission to delay approval of this filing until systems enhancements that will provide clearing firms the ability to effectively monitor trading and exposure can be developed.
If you have any questions or would like to discuss our views further, please contact the undersigned or Tom Monahan, staff advisor to the Committee, at 212-608-1500.
Sincerely,
W. Dennis Ferguson
Chairman
Clearing Firms Committee
CC:
Annette Nazareth, SEC
Belinda Blaine, SEC
Eugene Lopez, Nasdaq
Footnotes:
1 See letter to Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, from W. Dennis Ferguson, Chairman, SIA Clearing Firms Committee, dated July 22, 1999.
2 The Securities Industry Association brings together the shared interests of more than 740 securities firms throughout North America to accomplish common goals. SIA member firms (including investment banks, broker-dealers, and mutual fund companies) are active in U.S. and foreign markets and in all phases of corporate and public finance. The U.S. securities industry manages the accounts of more than 50-million investors directly and tens of millions of investors indirectly through corporate, thrift and pension plans. The industry generates more than $300 billion of revenues yearly in the U.S. economy and employs more than 600,000 individuals.
3 SEC, NYSE and NASD Joint Statement on Broker-Dealer Risk Management Practices, July 29, 1999. |
