Louis J. Karcher, Pipeline Trading Systems LLC

Staff grants exemption from the Short Sale Rule for certain transactions executed through a member's passively-priced trading system.

April 3, 2007

Mr. Louis J. Karcher
Principal & Chief Compliance Officer
Pipeline Trading Systems LLC
60 East 42nd Street, Suite 624
New York, NY 10165-0006

Re: NASD Rule 5100: Request for Exemptive Relief

Dear Mr. Karcher:

This is in response to your February 16, 2007 letter, on behalf of Pipeline Trading Systems LLC ("Pipeline"), in which you request that NASD grant an exemption from the short sale rule set forth in Rule 5100 for certain short sale transactions in NASDAQ Global Market (NGM) securities executed through Pipeline's matching system as described in your letter and discussed below.1

Pursuant to paragraph (j) of Rule 5100, NASD staff may exempt, unconditionally or on specified terms and conditions, any transaction (or class of transactions) from the provisions of the rule. For the reasons set forth below, NASD staff grants your request for an exemption, subject to the conditions set forth below.


In your letter and our subsequent telephone conversations, you have made the following representations, among others, regarding Pipeline and the operation of its matching system:

  1. You state that Pipeline operates an alternative trading system that allows buyers and sellers of large size to interact with each other's orders entered into Pipeline on a completely anonymous basis. You also state that the matching system is a block trading system that operates outside of the continuous, quote-driven trading environment and, therefore, you indicate that it is less susceptible to price manipulation of the type that concerned NASD in creating its short sale rule.
  2. You state that Pipeline orders must be submitted electronically, subject to certain limited exceptions described in your letter. You indicate that buy and sell orders are pegged to the midpoint of the national best bid and offer (NBBO) and sized at a minimum of 10,000 shares. In addition, you indicate that all orders entered into Pipeline's matching system are firm and priced orders are held by the matching system in strict time priority. Moreover, you state that all orders are confidential, subject to certain limited exceptions described in your letter, noting that no one is able to see the identity of any subscribers placing orders, the price and size at which an order is entered, or the side (buy or sell) on which an order is entered. You indicate that in the matching system, the price of a match is passively and independently derived from the NBBO.
  3. You state that all orders placed in the Pipeline matching system are completely anonymous and confidential and that price discovery takes place in a neutral, block-driven mechanism in which counter-parties cannot see the price and size at which matching system subscribers are willing to trade. You also state that no subscriber, or Pipeline employee, can know precisely when a match may occur, and no subscriber that enters an order can know for certain that the order will be executed. Therefore, you indicate that a short seller cannot be certain when or even whether an order that has been placed may be executed.
  4. You state that Pipeline has created procedures to monitor for signs of manipulation by examining changes in the bids and offers posted within the matching system and, if detected, you indicate that you will immediately report such activity to NASD.


Rule 5100 governs short sales in NGM securities.2 Rule 5100 generally provides that, with respect to trades reported to the Alternative Display Facility (ADF) or a Trade Reporting Facility (TRF), no member shall effect a short sale in an NGM security otherwise than on an exchange at or below the current national best (inside) bid when the current national best (inside) bid is below the preceding national best (inside) bid. IM-5100(b) further provides that, to effect a "legal" short sale when the current best bid is lower than the preceding best bid, the short sale must be executed at a price of at least $0.01 above the current inside bid when the current inside spread is $0.01 or greater.

All short sales in NGM securities effected otherwise than on an exchange must comply with Rule 5100 or qualify for an exception to or exemption from the rule. Accordingly, absent the requested relief, orders involving short sales executed in Pipeline for NGM securities would violate Rule 5100 if a match price of orders occurs on a down bid at less than $0.01 above the best bid.

Based on the facts and representations made in your letter, without necessarily concurring with your analysis, the staff is granting a temporary exemption3 from the requirements in Rule 5100 for short sale transactions executed through Pipeline's matching system. Consistent with the exemptive relief granted by the SEC, this exemption is subject to each of the following terms and conditions:

  1. All short sale orders will be marked in accordance with Rule 200(g) of Regulation SHO under the Exchange Act;4
  2. Persons relying on this exemption will not be represented in the consolidated market offer or otherwise attempt to influence the consolidated NBBO at the time of the transaction;
  3. Transactions effected through the Pipeline matching system will not be made for the purpose of creating actual or apparent active trading in or depressing or otherwise manipulating the price of any security;
  4. Except as described in your letter with regard to the "heat map" functionality,5 there will be no solicitation of orders from customers, nor any communication to customers that the match has not yet occurred;
  5. The exemption applies only to securities that qualify as an "actively-traded security" as defined in Regulation M under the Exchange Act or is one of the securities that comprise the S&P 500 Index. If the security is not an "actively-traded security" or an S&P 500 Index security, the exemption will apply only if the transaction is part of a basket transaction of 20 or more securities in which the subject security does not comprise more than 5% of the value of the basket traded;6 and
  6. Pipeline will maintain and provide to NASD, upon request, written records pertaining to each short sale transaction in an NGM security effected through its matching system, including the date, time, security, price and size of each transaction.

This letter responds only to the issue you have raised based on the facts as you have described them, and does not address any other rule or interpretation of NASD, or all the possible regulatory and legal issues involved. Any changes in the facts or representations as you have described them will require further consideration and may cause us to reach a different conclusion. You should contact NASD immediately if there is a change in any of the facts or representations contained in your letter. In addition, this exemption is subject to modification or revocation if at any time NASD determines that such action is necessary or appropriate for the protection of investors.

If there are any questions concerning this exemption, please contact me at (202) 728-8156.


Andrea D. Orr
Assistant General Counsel

cc: Stephanie M. Dumont (NASD)
Richard Wallace (NASD)
Gene Lopez (Fenwick Consulting)

1  In your letter, you note that Pipeline has requested and received similar relief from the Securities and Exchange Commission ("SEC") relating to Rule 10a-1 under the Securities Exchange Act of 1934 ("Exchange Act") for NYSE and Amex-listed securities in its matching system. NASD notes that the SEC granted such exemption to Pipeline, subject to certain conditions. See letter from James A. Brigagliano, SEC, to Louis J. Karcher, Pipeline Trading Systems LLC, dated February 2, 2007.

2  For purposes of Rule 5100, the term "short sale" has the same meaning as contained in Rule 200 of Regulation SHO under the Exchange Act. See 17 CFR 242.200. See also NASD Rule 5100(k)(1).

3  Unless otherwise extended, this exemption will expire on February 2, 2008, which coincides with the expiration date of the SEC's relief from Rule 10a-1 under the Exchange Act for short sales in NYSE and Amex-listed securities effected through Pipeline's trading system. See letter from James A. Brigagliano, SEC, to Louis J. Karcher, Pipeline Trading Systems LLC, dated February 2, 2007. 

4  See 17 CFR 242.200. 

5  You indicate that when an order is entered close to the current market prices, Pipeline activates a "heat map" for that stock to try to attract additional liquidity that is looking to trade inside the spread. You further indicate that once both a buyer and seller are present, the trade executes if both parties' limit prices are satisfied by the current midpoint. Moreover, you indicate that when the heat map is activated that no information about the order is revealed, including price, size, side, and order sender. 

6  See 17 CFR 242.101(c)(1).