Self Regulatory Organizations; Order Approving Proposed Rule Change by the National Association of Securities Dealers, Inc. Amending the Nasdaq By-Laws

I. Introduction

On January 22, 2001, the National Association of Securities Dealers, Inc. (“NASD”) through its subsidiary, The Nasdaq Stock Market, Inc. (“Nasdaq”) filed with the Securities and Exchange Commission (“SEC” or “Commission”) pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”), and Rule 19b-4 thereunder, a proposed rule change amending the Nasdaq By-Laws. The proposed rule change was published for comment in the Federal Register on February 8, 2001. On February 8, 2001, Nasdaq filed Amendment No. 1 with the Commission. The Commission received no comments on the proposal. This order approves the proposal, as amended.

II. Description of the Proposal

Nasdaq proposes to amend its By-Laws regarding the Nasdaq Board of Directors (the “Board”) by designating up to two officers of Nasdaq who will be treated as “neutral” Board members for classification and composition purposes. Nasdaq also proposes to create new Nasdaq Management Compensation, Audit, and Nominating Committees, and to amend its By-law provisions regarding the composition and operation of certain other Nasdaq committees. Finally, Nasdaq seeks to make certain changes to conform its By-Laws to Delaware law and to reflect the new corporate relationship between the NASD and Nasdaq.

The proposed rule change further implements the Restructuring Plan approved by NASD members on April 14, 2000 (the “Restructuring”). The Restructuring broadens the ownership in Nasdaq through a two-phase private placement of common stock and warrants to NASD members, Nasdaq issuers, and certain others. Prior to the private placement, the NASD owned 100 percent of Nasdaq. Now after the closing of the private placement, Nasdaq has numerous shareholders, but the NASD retains voting control over Nasdaq. Concurrent with the ongoing Restructuring, Nasdaq submitted an application to the Commission to register as a national securities exchange (“Form 1”) under section 6 of the Act. Prior to its registration as a national securities exchange, however, Nasdaq will continue to operate under the Plan of Allocation and Delegation of Functions by the NASD to its Subsidiaries (the “Delegation Plan”), as approved by the Commission. Nasdaq is also subject to the provisions and requirements of the NASD's August 8, 1996 settlement order with the Commission (“1996 Order”).

Summary of Amendments

Article I

Article IV, Section 4.3 of the Nasdaq By-Laws requires that the number of Non-Industry Directors equal or exceed the number of Industry Directors. Currently, Nasdaq officers who serve on the Board are treated as Industry Directors for purposes of calculating the compositional balance of the Nasdaq Board. Nasdaq proposes that up to two officers of Nasdaq who may be elected to the Board be treated as “neutral” for purposes of calculating the balance between Industry and Non-Industry Directors. To effectuate this change, Nasdaq proposes to exclude from the definitions of Industry Director and Non-Industry Director up to two Nasdaq officers who are elected to the Board (the “Staff Directors”). Thus, if the stockholders elect one or two Nasdaq officers to the Board, they would be deemed “neutral” Staff Directors and would not be included in calculating the balance between Industry and Non-Industry Directors on the Nasdaq Board. If the stockholders elect three or more officers to the Board, then the Board, in its discretion, would designate two of the officers as “neutral” Staff Directors and the others would be considered Industry Directors for compositional purposes.

Article IV

Nasdaq proposes to modify its By-Law provision establishing the balancing requirements between Industry and Non-Industry Directors, by removing references to Nasdaq officers who may be elected to the Board. The effect of this amendment, in conjunction with the amendments to the definitions of Industry and Non-Industry Directors described above, would be to ensure that the two “neutral” Staff Directors are not counted when calculating the Industry/Non-Industry balance of the Board.

In addition, certain Nasdaq By-Laws relating to committees currently require resolutions to be adopted by a majority vote of the whole Board (e.g., to appoint, fill vacancies, fix the term of office of a committee member, or remove a committee member). Nasdaq proposes to remove this high vote requirement because it is no longer required for Nasdaq under applicable Delaware law. Under the amended By-Laws, only a vote of the Board would be necessary to adopt such resolutions.

Nasdaq also proposes several amendments to section 4.13 relating to committees. Nasdaq proposes to create a new Nominating Committee, Management Compensation Committee, and Audit Committee. Currently the NASD Nominating Committee nominates candidates for the Nasdaq Board and the Nasdaq Listing and Review Council. In light of the broadening of the ownership of Nasdaq, Nasdaq proposes that a committee of its Board, rather than a committee of the board of the NASD, would be the appropriate nomination body for Nasdaq. Nasdaq has also proposed to make conforming amendments throughout its By-Laws to replace references to the NASD's National Nominating Committee with references to Nasdaq's Nominating Committee. The new Audit and Management Compensation Committees each require that the majority of Committee members be Non-Industry Directors, and the Nominating Committee requires that the number of Non-Industry members on the Committee equal or exceed the number of Industry members on the Committee. With respect to the existing Nasdaq Executive and Finance Committees, Nasdaq proposes to remove limitations on the size of these committees. As currently provided in the By-Laws, the Executive Committee would continue to have balancing requirements for industry, Non-Industry, and Public Directors, but no such requirements would apply to the Finance Committee.

Under Delaware law, the Board of a stockholder-owned corporation must appoint the Directors who serve on Board committees. Moreover, Board committees must be comprised solely of Directors to be validly constituted as such under Delaware law. Therefore, Nasdaq proposes to remove the By-Law provision that requires the Nasdaq Chief Executive Officer to serve on the Executive and Finance Committees because it is inconsistent with the Board's exclusive authority in this respect and inconsistent with the requirement that such committees be comprised solely of Directors. In the future, any Nasdaq officer elected to the Board may be appointed to these Committees.

Article VII

Section 7.1 currently provides that none of the principal officers of Nasdaq, except the Chair and Chief Executive Officer, need to be Directors. Nasdaq proposes to remove the reference to the Chief Executive Officer to provide the flexibility to have a Chief Executive Officer who is not a Director.

Other Changes To Conform the By-Laws to Nasdaq's New Corporate Relationship With the NASD; To Delete Unused Terms; and To Conform Nasdaq's By-Laws With Delaware Law

Other changes to the By-Laws are made to reflect Nasdaq's new ownership structure and to institute procedures necessary for Nasdaq to operate as a corporation. For example, Nasdaq proposes to delete Section 4.3 of Article IV, which requires that certain Directors be drawn from candidates proposed to the National Nominating Committee by a majority of the Non-NASD stockholders of Nasdaq. This provision is no longer operative because Nasdaq has already solicited the recommendations of the non-NASD stockholders and has mailed a ballot to non-NASD stockholders asking them to vote on such candidates. Also, definitions for “Amex Floor Governors,” “Nasdaq-Amex,” and “Amex Board” are deleted because the terms are no longer used in the Nasdaq By-Laws. Finally, Nasdaq proposes certain amendments to the By-Laws to conform to applicable Delaware law. For example, under Article IV, Section 4.16, Nasdaq Directors would now be permitted to take action without a meeting.

III. Discussion

The Commission has reviewed the NASD's proposed rule change and finds, for the reasons set forth below, that the proposal is consistent with the requirements of section 15A of the Act and the rules and regulations thereunder applicable to a national securities association. Specifically, the Commission believes the proposal is consistent with Sections 15A(b)(2), (b)(4) and (b)(6) of the Act. Section 15A(b)(2) requires that the association be so organized and have the capacity to be able to carry out the purpose of the Act and to comply, and to enforce compliance by its members and persons associated with its members, with the provisions of the Act. Section 15A(b)(4) requires that the rules of an association assure a fair representative of its members in the selection of its Directors and administration of its affairs and provide that one or more Directors shall be representative of issuers and investors and not be associated with a member of the association, broker, or dealer. Section 15A(b)(6) requires, among other things, that the association's rules be designed to prevent fraudulent and manipulative acts and practices, 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. The proposed rule change is also consistent with the Delegation Plan, and ensures that Nasdaq continues to meet its obligations under the 1996 Order.

Section 15A(b)(4) of the Act requires fair representation of an association's members in the selection of its Directors and administration of its affairs, and provides that one or more Directors shall be representative issuers and investors and not be associated with a member of the association, broker, or dealer. The NASD, through the Delegation Plan, has the responsibility for ensuring that the Nasdaq Board fulfills the fair representation and public participation requirements. The fair representation requirement helps to ensure that no particular constituency is subject to the unfair, unfettered actions of another constituency, and helps to ensure that the NASD, including its Nasdaq subsidiary, is administered in a way that is equitable to all NASD members.

The Commission finds that the proposed composition of the Board meets the fair presentation and public participation criteria as set forth in Section 15A(b)(4) of the Act. The proposed rule change does not change the requirement that the number of Non-Industry Directors equal or exceed the number of Industry Directors. Thus, the instant proposal continues to ensure that all interests, Industry, Non-Industry and Public will be adequately represented on the Board; that the decisions by the Board are not unfairly discriminatory between customers, issuers, brokers, or dealers; and that the protection of investors and the public interest is considered consistent with the requirements of the Act. Moreover, as staff representatives of Nasdaq, the two “neutral” Staff Directors should represent the interest of all members, including Industry, Non-Industry, and Public market participants.

The Commission also finds that Nasdaq's proposal to designate up to two officers of Nasdaq who may be elected to the Board as “neutral” for purposes of calculating the composition of Industry and Non-Industry Directors on the Board is consistent with Section 15A(b)(4) of the Act and with the 1996 Order. In particular, the Commission notes that the remainder of the Board will continue to maintain a majority of Non-Industry/Public representation. Moreover, the Staff Directors should represent the interest of the entire Nasdaq organization, which includes Industry, Non-Industry, and Public market participants. The Commission further notes that this portion of Nasdaq's proposal permits the Nasdaq board to be reduced in size and thus operate more efficiently.

The Commission also finds that Nasdaq's amendments to Section 4.13 of the Nasdaq By-Laws relating to committees are consistent with the requirements of Section 15A(b)(2) and Section 15A(b)(4) of the Act. The Commission notes that the establishment of these committees should result in the more efficient operation and administration of Nasdaq, particularly as Nasdaq moves forward in its efforts to complete its exchange registration and become a self-regulatory organization separate from the NASD. The composition provisions of the Executive Committee and the new Nasdaq Committees ensure public participation in the Committees' decision-making process and provide for the fair representation of NASD members. Like the proposed changes to the structure and composition of the Board, the requirement that the number of Non-Industry Directors equal or exceed the number of Industry Directors, and the requirement that Public Directors be present helps to ensure that the decisions by the Executive Committee and the new Nasdaq committees take into account the public interest.

The Commission notes that the composition of the new Management Compensation, Audit, and Nominating Committees, are consistent with the specific compositional requirements for the mirror NASD committees, as set forth either in the Delegation Plan or the 1996 Order, and as implemented by the NASD By-Laws. For example, the composition of the proposed Management Compensation Committee fulfills the compositional requirements set forth in the 1996 Order that a majority of the committee members shall be Non-Industry Directors. The Management Compensation Committee also reflects other compositional requirements as set forth in the Delegation Plan, which designates that Nasdaq's CEO will be an ex-officio, non-voting member of the committee and that each committee member will hold office for one year.

The composition of the proposed Audit Committee fulfills the compositional requirements set forth in the 1996 Order that a majority of the committee members shall be Non-Industry Directors. In addition, the provisions of the Audit Committee mirror those of the NASD By-Laws, which also requires that a majority of the Audit Committee members shall be Non-Industry Directors; that the Audit Committee shall include two Public Directors; and that a Public Director shall serve as chair of the Committee.

Finally, the Nasdaq Nominating Committee's compostional requirements would mirror the compositional requirements for the NASD Nominating Committee and comply with the requirements of the 1996 Order. The composition of the proposed Nominating Committee would continue to fulfill the compositional requirements set forth in the 1996 Order that a majority of the committee members shall be Non-Industry Directors. In addition the Nasdaq Nominating Committee reflects the mirror NASD Committee, where the number of Non-Industry members on the Nominating Committee equals or exceeds the number of Industry members on the Nominating Committee.

The Commission therefore finds that the composition and operation of these Nasdaq committees are consistent with section 15A(b)(2) and 15A(b)(4) of the Act, which require that the Association, and through the Delegation Plan, Nasdq, be so organized and have the capacity to carry out the purposes of the Act, and that Nasdaq's key committees provide for the fair representation of all members. The Commission notes further that the Nasdaq Committees mirror the equivalent NASD committee requirements as set forth in the Delegation Plan and 1996 Order and as reflected in the applicable NASD By-Laws, and are consistent with Section 15A(b)(2) and 15A(b)(4) of the Act. The Commission emphasizes that all actions undertaken by these Nasdaq committees remain subject to the review, ratification, or rejection by the NASD Board in accordance with procedures set forth and implemented pursuant to the Delegation Plan.

The Commission also finds that the proposed amendments, reflecting the new corporate relationship between the NASD and Nasdaq, deleting unused terms, and conforming the Nasdaq By-Laws to recent amendments to Delaware law, are consistent with Section 15A(b)(2) and (4) of the Act. The changes to the By-Laws reflect Nasdaq's new ownership structure and institute procedures necessary for Nasdaq to operate as a corporation. For example, Nasdaq proposes to delete section 4.3 of Article IV, which requires that certain Directors be drawn from candidates proposed to the National Nominating Committee by a majority of the non-NASD stockholders of Nasdaq. This provision is no longer operative because Nasdaq has already solicited the recommendations of the non-NASD stockholders and has mailed a ballot to non-NASD stockholders asking them to vote on such candidates. In addition, definitions for “Amex Floor Governors,” “Nasdaq-Amex,” and “Amex Board” are deleted because the terms are no longer used in the Nasdaq By-Laws. Other amendments, such as permitting Directors to take action without a meeting (Article IV, Section 4.16 of the Nasdaq By-Laws); permitting resignations in a form other than writing (Article IV, section 4.5 and Article VII, section 7.5 of the Nasdaq By-Laws);” no longer requiring a waiver of certain notices to be in writing (Article X, section 10.3 of the Nasdaq By-Laws); and no longer requiring that resolutions be adopted by a majority vote of the whole Board (e.g., to appoint a committee, fill vacancies on the committee, fix the term of office of a committee member, or remove a committee member), conform the Nasdaq By-Laws to applicable Delaware law. The Commission finds that these proposed changes are generally consistent with the purposes of the Act.

IV. Conclusion

It is Therefore Ordered, pursuant to section 19(b)(2) of the Act, that the proposed rule change (SR-NASD-00-78) is approved, as amended.