[ by Howard Haykin ] The Nasdaq Stock Market proposes to amend Rule 4626.  The text of the proposed rule change will be published in the Federal Register. Nasdaq Staff Contacts. Direct questions and comments on the proposed rule change to: Thomas Moran, VP, Assoc. General Counsel; or John Yetter, VP, Deputy General Counsel, at (301) 978-8400.   I. INTRODUCTION The Proposal Nasdaq is seeking the SEC’s approval of a voluntary accommodation policy for claims arising from system difficulties that Nasdaq experienced during the initial public offering (“IPO”) of Facebook, Inc. (“Facebook” or “FB”) on 5/18/12. In the weeks since the Facebook IPO, Nasdaq has reviewed the events of May 18 with the goal of proposing a fair and equitable accommodation policy that is consistent with the Exchange Act and Nasdaq’s self-regulatory obligations. This proposal reflects Nasdaq’s effort:  (i) to identify the categories of investors and members that Nasdaq’s system difficulties caused objective, discernible harm, and the type and scope of such harm;  and,  (ii) to propose an objectively reasonable and regulatorily balanced plan for accommodating Exchange members and their investor customers for such harm.  Nasdaq has undertaken this effort notwithstanding the liability protections afforded by its contractual limitations of liability, common law immunity, and Rule 4626 – the rule that Nasdaq proposes to modify. Rule 4626 limits the liability of Nasdaq and its affiliates with respect to any losses, damages, or other claims arising out of the Nasdaq Market Center or its use and provides for limited accommodations under the conditions specified in the rule.  Subsection (b)(1) provides that for the aggregate of all claims made by market participants related to the use of the Nasdaq Market Center during a single calendar month, Nasdaq’s payments under Rule 4626 shall not exceed the larger of $500,000 or the amount of the recovery obtained by Nasdaq under any applicable insurance policy. Subsection (b)(2) states that for the aggregate of all claims made by market participants related to systems malfunctions or errors of the Nasdaq Market Center concerning locked/crossed compliance, trade through protection, market maker quoting, order protection, or firm quote compliance, during a single calendar month Nasdaq’s payments under Rule 4626 shall not exceed the larger of $3,000,000 or the amount of the recovery obtained by Nasdaq under any applicable insurance policy. On 5/18/12, Nasdaq experienced system difficulties during the Nasdaq Halt and Imbalance Cross Process (the “Cross”) for the FB IPO. These difficulties delayed the completion of the Cross from 11:05 a.m. until 11:30 a.m. Based on its assessment of the information available at the time, Nasdaq concluded that the system issues would not have any effects beyond the delay itself. In an exercise of its regulatory authority, Nasdaq determined to proceed with the IPO at 11:30 a.m. rather than postpone it. As a result of  the system difficulties, however, certain orders for FB stock that were entered between 11:11:00 a.m. and 11:30:09 a.m. in the expectation of participating in the Cross – and that were not cancelled prior to 11:30:09 – either did not execute or executed after 1:50 p.m. at prices other than the $42.00 price established by the Cross.  (Other orders entered between 11:11:00 a.m. and 11:30:09 a.m., including cancellations, buy orders below $42.00, and sell orders above $42.00, were handled without incident.)  System issues also delayed the dissemination of Cross transaction reports from 11:30 a.m. until 1:50 p.m. At 1:50 p.m., Nasdaq system difficulties were completely resolved.  Nasdaq’s analysis indicates that only a small percentage of the FB orders received by Nasdaq on May 18 were directly affected by Nasdaq system difficulties. In the period between 11:30 a.m. and 1:50 p.m., although system issues had prevented Nasdaq from disseminating Cross transaction reports, Nasdaq determined not to halt trading in FB stock. Nasdaq believed that the system issues would be resolved promptly. Moreover, after 11:30 a.m. there was an orderly, liquid, and deep market in FB stock, with active trading on all markets. Halting trading on a market-wide basis in these circumstances would have been unprecedented, and, in Nasdaq’s view, unjustified. In any event, in Nasdaq’s regulatory judgment, the conditions after 11:30 a.m. did not warrant a halt of trading.  As a result of these unique circumstances, Nasdaq is proposing to accommodate members for losses attributable to the system difficulties on 5/18/12, in an amount not to exceed $62 million. Nasdaq also proposes standards for orders to qualify for accommodation. For the reasons explained below, Nasdaq proposes to make accommodation payments in respect of:

1. SELL Cross orders that were submitted between 11:11 a.m. and 11:30 a.m. on 5/18/12 that were priced at $42.00 or less, and that did not execute;
2. SELL Cross orders that were submitted between 11:11 a.m. and 11:30 a.m. on 5/18/12, that were priced at $42.00 or less, and that executed at a price below $42.00;
3. BUY Cross orders priced at exactly $42.00 and that were executed in the Cross but not immediately confirmed; and
4. BUY Cross orders priced above $42.00 and that were executed in the Cross but not immediately confirmed, but only to the extent entered with respect to a customer that was permitted by the member to cancel its order prior to 1:50 p.m. and for which a request to cancel the order was submitted to Nasdaq by the member, also prior to 1:50 p.m.

The modifications proposed in this rule change are not intended to and do not affect the limitations of liability set forth in Nasdaq’s agreements or SEC-sanctioned rules, or those limitations or immunities that bar claims for damages against Nasdaq as a matter of law. Rather, as noted above, they reflect Nasdaq’s determination to adopt a fair and equitable accommodation policy that takes into account the impacts of Nasdaq’s system issues on the investing public and members. In the two sections that follow, Nasdaq provides: (i) background information concerning Nasdaq’s IPO process generally, the system difficulties Nasdaq experienced with the Facebook IPO process on 5/18/12, and the impacts that those system difficulties had on certain orders; and (ii) Nasdaq’s accommodation proposal, including the standards to be applied to claims for accommodation, the rationale for those standards, the proposed procedure for the submission and evaluation of claims, and the proposed payment process. II. BACKGROUND The IPO Cross Process The Nasdaq Cross, which is set forth in Nasdaq Rule 4753 (Nasdaq Halt and Imbalance Crosses), was developed in consultation with market participants and is designed to provide fair executions for investors to begin secondary market trading in IPO shares. The purposes of the Cross are set forth in the filings with the Commission that implemented Rule 4753.8 In approving the Cross, the Commission found that the Cross process, as described in Nasdaq’s filing seeking approval of the Cross, “should provide useful information to market participants and increase transparency and order interaction at the opening,” and “should result in the public dissemination of information that more accurately reflects trading in a particular security.”

• See Securities Exchange Act Release Nos. 53488 (3/15/06), 71 FR 14272 (3/21/06) (NASD Rule Filing 06-015); 54248 (7/31/06), 71 FR 44738 (8/7/06) (Nasdaq Rule Filing 06-019).

The Commission additionally concluded that the Cross, as described in Nasdaq’s filing, is consistent with the requirements of the Act and the rules and regulations thereunder generally, and particularly with the requirement that rules be designed to facilitate transactions in securities and to remove impediments to and perfect the mechanism of a free and open market.10 The Commission also found that the Cross, as described in Nasdaq’s filing, was “based on the Nasdaq opening cross, which the Commission approved in a prior filing.” The Cross is an open and transparent process that identifies a single price based on supply and demand as represented by orders submitted to the Cross process. The Cross process is integrated with the Nasdaq order book to provide a smooth transition for orders from the Cross to continuous trading. In the Cross process, all members have the ability to enter orders and observe the evolution of the prospective auction price through Nasdaq’s dissemination of auction imbalance information, and thereby to participate in the price discovery process. Cross-eligible shares determine the auction price as the price nearest to the offering price that will execute all market order shares, all limit order shares with superior prices to the auction price, and as many limit order shares as possible with limit prices equal to the auction price. Nasdaq begins accepting Cross orders at the system start time of 7:00 a.m. During the interval between the system start time and the start of the Display-only period, orders can be entered or cancelled freely, and information on Cross orders is not publicly disseminated. The Display-only period begins 15 minutes prior to the scheduled release time of the IPO. Once the Display-only period begins, Nasdaq disseminates  indicative information about the auction price and auction volume via Net Order Imbalance Indicator (“NOII”) messages on Nasdaq’s public data feeds at five-second intervals. The Display-only period can be extended (up to 6 times) in 5-minute increments. During the extension period, imbalance information continues to be disseminated and orders may be entered or canceled. It is relatively common for the Display-only period of an IPO to be extended. Members may enter and cancel orders during the Display-only period. As the effects of order entry and cancellation are disseminated to the public, participants may respond with further order entry, modification, or cancellation instructions. Over the course of the Display-only period, market participants develop an understanding of the state of supply and demand, changes in the indicative price typically become smaller, and the indicative volume typically increases.  Once there are no further five-minute extensions of the Display-only period, the IPO Cross executes, the Nasdaq official opening price is disseminated, a bulk trade execution is sent to the consolidated tape, and messages confirming individual executions for Cross-executed shares are sent to market participants.  In accordance with market participants’ instructions, orders not executed in the Cross are either canceled or populate the Nasdaq electronic order book. Nasdaq believes that the benefits of the Cross include optimizing an opening price and allowing investors to cancel their orders at the last possible moment before a Cross is calculated.  Moreover, as the Commission found when it approved the Cross, the Cross process, as described in Nasdaq’s filing, was designed as described above 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 in various ways.15   The Commission further noted that “[i]n approving the proposed rule change, the Commission . . . considered its impact on efficiency, competition, and capital formation.” Accommodation Standards. Nasdaq’s proposal is to provide accommodation within a framework that seeks to replicate what the expected execution prices of orders would have been had the Cross not experienced unexpected and unprecedented difficulties, limited by the expectation that embers would exercise reasonable diligence to respond and mitigate losses once made aware that their Cross orders had not executed, or had executed at unexpected prices.  Thus, Nasdaq proposes to make accommodation payments in respect of: (i) SELL Cross orders that were submitted between 11:11 a.m. and 11:30 a.m. on 5/18/12, that were  priced at $42.00 or less, and that did not execute;  (ii) SELL Cross orders that were submitted between 11:11 a.m. and 11:30 a.m. on 5/18/12, that were priced at $42.00 or less, and that executed at a price below $42.00;  (iii) BUY Cross orders priced at exactly $42.00 and that were executed in the Cross but not immediately confirmed; and  (iv) BUY  Cross orders priced above $42.00 and that were executed in the Cross but not immediately confirmed, but only to the extent entered with respect to a customer that was permitted by the member to cancel its order prior to 1:50 p.m. and for which a request to cancel the order was submitted to Nasdaq by the member, also prior to 1:50 p.m.  These are the situations in which Nasdaq has concluded that its systems issues could have impacted market participants’ reasonable expectations in an objectively discernible manner. In these situations, Nasdaq proposes to offer as an accommodation the loss differential for a qualified order – that is, the difference between the price that was reasonably expected  and the subsequent execution price actually obtained, or the price available at the point when the market participant could have taken steps to mitigate its losses or otherwise adjust its position. As described above, Nasdaq believes that it reasonably determined not to suspend the IPO or halt trading in FB stock, and Nasdaq’s FB-related systems issues were fully resolved at 1:50 p.m., when Nasdaq disseminated all delayed Cross execution confirmation messages. At that point, Nasdaq believes that member firms were in possession of all the information needed to evaluate their positions and obligations to customers, and take steps accordingly. Accordingly, for the orders described in (i), (iii), and (iv) above, Nasdaq proposes to establish a uniform benchmark price of $40.527, the price at which Nasdaq has concluded a reasonably diligent member could have obtained shares to mitigate any unexpected losses or to liquidate unanticipated positions coming out of the Cross. Nasdaq calculated this price using the volume-weighted average price of FB stock during the first 45 minutes of trading after execution reports were delivered to firms (i.e., 1:50 p.m. to 2:35 p.m.). For the orders described in (ii) above, Nasdaq proposes to offer as an accommodation the difference between the price that was reasonably expected (i.e., $42.00) and the execution price actually obtained, because the immediate execution of these orders precluded a member from taking reasonable actions to mitigate losses.  Nasdaq believes that this method provides a reasonable time period for firms to have taken actions to mitigate losses after receiving the Cross transaction reports, as well as a reasonable maximum loss price parameter for determining accommodation payments. Additional alleged losses incurred beyond that benchmark price, regardless of their cause, will remain the responsibility of the member. If a member suffered a lesser loss than that calculated based on the foregoing method, based on the difference between the expected execution price of the order in the Cross process establishing an opening print of $42.00 and the actual execution price received, the member shall not receive more than the lesser actual loss  suffered. A member’s direct trading losses, as calculated in accordance with these parameters, are referred to in the proposed rule as the “Member’s Share.” Alleged losses from other causes shall not be considered eligible for accommodation payments under the proposed rule change. Thus, for example, Nasdaq does not propose to make accommodation payments in respect of alleged losses attributable to: orders received after the commencement of continuous regular trading in FB; individual member firm technology issues or system failures, or member firm operational issues or operational failures; affirmative trading actions taken by member firms on their own behalf or to accommodate their customers after the Cross, except as otherwise provided in the proposed rule; alleged or speculative lost trading opportunities had been executed; and a member firm’s failure to adequately and appropriately mitigate losses or adjust trading positions. Nasdaq is not asking any firm to offset its claims under these criteria with any economic gains experienced because of the relevant system issues as outlined at footnote 22. Examples below show how accommodation standards would apply. Example 1: A member submitted an IPO Cross order to SELL 1000 shares priced at market (i.e., willing to sell at any price or otherwise equivalent to $0.01) with a Time in Force (TIF) of Immediate or Cancel (IOC), entered at 11:15 a.m. Because the order was priced lower than the opening price, it should have been filled at $42.00 in the Cross, but failed to execute because it was entered after 11:11 a.m. Nasdaq transmitted the order confirmation of the failure to the member at 1:50 p.m., at which time the member covered its position (i.e., sold the 1000 shares it had expected to sell in the Cross) at a price of $41.15. Because the member was able to sell its shares at a higher price than the benchmark price Nasdaq has established ($40.527), the member will be accommodated for the difference between the opening price and the covering execution’s price. The amount of loss is 1000 x ($42.00-$41.15) = $850.00. Example 2: A member submitted an IPO Cross order to SELL 1000 shares priced at market with a TIF of IOC, entered at 11:15 a.m. Because the order was priced lower than the opening price, it should have been filled at $42.00 in the Cross, but failed to execute because it was entered after 11:11 a.m. Nasdaq transmitted the order confirmation message noting the failure to execute to the member at 1:50 p.m., but the member did not cover its position until later in the day at an average price of $39.00. Because the member’s covering execution price was lower than the benchmark price Nasdaq has established ($40.527), the member will be accommodated for the difference between the opening price and the benchmark price. The amount of loss is 1000 x ($42.00-$40.527) = $1,473.00. Example 3: A member submitted an IPO Cross order to SELL 1000 shares priced at market with a TIF of DAY, entered at 11:15 a.m. Because the order was priced lower than  the opening price, it should have been filled at $42.00 in the Cross, but failed to execute in the Cross because it was entered after 11:11 a.m. The order was entered into the continuous book at 1:50 p.m., at which time it executed at a price of $41.05. Nasdaq transmitted the order confirmation message to the member at 1:50 p.m. Because the order executed at an inferior price to the opening price, the member will be accommodated for the difference  between the opening price and the actual execution price. The amount of loss is 1000 x ($42.00-$41.05) = $950.00. Example 4: A member submitted an IPO Cross order to SELL 1000 shares priced at market with a TIF of DAY, entered at 11:15 a.m. Because the order was priced lower than the opening price, it should have been filled at $42.00 in the Cross, but failed to execute in the Cross because it was entered after 11:11 a.m. The order was entered into the continuous book at 1:50 p.m., at which time it executed at a price of $40.00. Nasdaq transmitted the order confirmation message to the member at 1:50 p.m. Because the order executed at an inferior price to the opening price, the member will be accommodated for the difference between the opening price and the actual execution price. The amount of loss is 1000 x ($42.00-$40.00) = $2,000.00. Example 5: A member submitted an IPO Cross order to SELL 1000 shares priced at market with a TIF of DAY, entered at 11:15 a.m. Because the order was priced lower than  the opening price, it should have been filled at $42.00 in the Cross, but failed to execute in the Cross because it was entered after 11:11 a.m. The member cancelled the order at 12:30 p.m., after the Cross had taken place at 11:30:09 a.m. but before the order was delivered to the continuous book or a confirmation message was delivered. The order cancelled back to the member at 1:50 p.m. based on the request sent at 12:30 p.m. Because the member’s order should have been executed in the Cross, the fact that the member cancelled the order at 12:30 p.m. is not relevant for purposes of determining that the order was directly disadvantaged, and the member will be accommodated for the difference between the opening price and the benchmark price. The amount of loss is 1000 x ($42.00-$40.527) = $1,473.00. Example 6: A member submitted an IPO Cross order to BUY 1000 shares priced at $42.00 with a TIF of DAY, entered at 11:00 a.m. The order was filled at $42.00, but because the order’s price was exactly the opening price, the member could not have reasonably known that the order was filled until 1:50 p.m. As a result, the member acquired an unexpected long position of 1000 shares that resulted in a loss when the position was covered at a price of $40.15. Because the member’s covering execution price  was worse than the benchmark price Nasdaq has established ($40.527), the member will  be accommodated for the difference between the opening price and the benchmark price.  The amount of loss is 1000 x ($42.00-$40.527) = $1,473.00. Example 7: A member submitted an IPO Cross order to BUY 1000 shares at $42.00 with a TIF of IOC, entered at 11:15 a.m. The order was not filled at $42.00 because it was entered after 11:11 a.m., but because the order’s price was exactly the opening price, the member could not have reasonably known that the order was not filled until 1:50 p.m. As a result, the member discovered it unexpectedly lacked 1000 shares at 1:50 p.m. At that time, the member could have purchased shares at prices lower than the opening price. Consequently, the member was not directly disadvantaged by Nasdaq’s system error and there is no loss amount. Example 8: A member submitted an IPO Cross order to BUY 1000 shares at $42.50 with a TIF of IOC, entered at 11:15 a.m. The order was not filled at $42.00 because it was entered after 11:11 a.m., but because the order’s price was higher than the opening price, the member should have expected the order was filled until it received a confirmation to the contrary at 1:50 p.m. As a result, the member discovered it unexpectedly lacked 1000 shares at 1:50 p.m. At that time, the member could have purchased shares at prices lower  than the opening price. Consequently, the member was not directly disadvantaged by Nasdaq’s system error and there is no loss amount. Example 9: A member submitted an IPO Cross order for a customer to BUY 1000 shares at $42.50 with a TIF of IOC, entered at 11:05 a.m. and a cancel request was submitted by the member before 1:50 p.m. for the order. The order was filled at $42.00 as expected. Because it was priced higher than the opening price, the member should have expected that the order was filled, which was confirmed electronically at 1:50 p.m.  In light of the  confirmation delay, however, the member received a request to cancel the order from the customer prior to 1:50 p.m., accommodated that request by allowing the customer to cancel the order, and sent a cancellation request for the order to Nasdaq before 1:50 p.m. When confirmation of the customer’s order execution in the Cross was received by the member at 1:50 p.m., the member held a long position of shares for which it no longer had a recipient. Although the decision to accommodate the customer’s cancellation request was exclusively that of the member, Nasdaq has determined to provide a limited accommodation amount equaling 70% of the member’s loss up to maximum loss amount of 0.70 x 1000 x ($42.00-$40.527) = $1,031.10. Example 10: A member submitted an IPO Cross order to BUY 1000 shares at $42.50 with a TIF of IOC, entered at 11:05 a.m. The order was filled at $42.00 as expected.  Because it was priced higher than the opening price, the member should have expected that the order was filled, which was confirmed electronically at 1:50 p.m. As a result of the delay in confirmation, however, the member purchased additional shares before the confirmations arrived. This resulted in an unintended long position of 1000 shares.  Although the member incurred a loss when covering the unintended position, Nasdaq correctly executed the member’s order and the member should have expected the original IPO Cross order to be filled because of its price. Consequently, the member was not directly disadvantaged by Nasdaq’s system error and there is no loss amount. Example 11: A member submitted an IPO Cross order to BUY 1000 shares at $42.50 with a TIF of IOC, entered at 11:05 a.m. The order was filled at $42.00 as expected.   Because it was priced higher than the opening price, the member should have expected that the order was filled, which was confirmed electronically at 1:50 p.m. Later in the day, the member sold the position at $40.00. The member claims that it would have been able to sell at a higher price if had received the confirmation sooner. Nasdaq correctly executed the member’s order. The claim of loss is premised on an alleged or speculative lost trading opportunity rather than the actual failure by Nasdaq to process an order correctly.  Consequently, the member was not directly disadvantaged by Nasdaq’s system error and there is no loss amount. Procedure for Submission and Evaluation of Claims. All members seeking accommodation under this proposal will be required to submit their claims to Nasdaq in writing not later than seven days after the approval of For further details, go to:  [Nasdaq Rule Filing 12-90, 7/23/12].