|Footnotes for this article are available for download in the formatted PDF at the end of this page.
When Jay Clayton was sworn in as chairman of the U.S. Securities and Exchange Commission (“SEC”) on May 4, 2017, he came with an apparent agenda. Specifically, Clayton sought to reduce the prices that national securities exchanges (“NSE” or “NSEs”)—which sell proprietary market-data products, including what are called “depth-of-market” data products—may charge the buyers of those products, including investment banks, broker-dealers, and asset management companies (collectively “Market Participants”). The Market Participants that use these NSEs to execute their buy and sell orders want access to proprietary data for less, little, or no cost to themselves. If they (via the sponsoring SEC) are successful, the loss in the NSEs’ revenue will increase the profits of the Market Participants.
The SEC has buried this objective among a variety of purported concerns and proposals, including the desire “to modernize” the market for market-data. The operative strategy included an SEC-hosted roundtable on market-data held in October 2018, as well as a series of proposed rules that would effectively shift profits from market-data sellers—the NSEs—to the Market Participant buyers. These rules would not, of course, reduce the fees the NSEs must pay twice annually to the SEC based on the aggregate dollar amount of certain Market Participants’ sales of securities. Within the past month, the federal Court of Appeals for the District of Columbia Circuit (“DC Circuit”) has interrupted at least two other approaches the SEC and the Market Participants’ trade association have employed to accomplish this joint objective.
The New York Stock Exchange, LLC (“NYSE”) and the Nasdaq Stock Market LLC (“Nasdaq”) are the largest securities exchanges in the United States and the world. They are privately owned and registered as NSEs with the SEC, as required by the Securities and Exchange Act of 1934 (“Exchange Act”). Being NSEs, they are also self-regulatory organizations (“SROs”) and, as such, possess the authority to set their own rules and regulations for their industry members and operations. The SEC, through its Division of Trading and Markets (“T&M”), oversees the exchanges’ operations and, under Section 19 of the Exchange Act, can approve SROs’ rule changes, which can include fee structures for SRO products. According to the SEC, and as discussed below, NSEs’ market-data plans generated $500 million on an annual basis in 2017, which is a trickle of the Market Participants’ trades, collectively totaling multiple tens of billions of dollars on a daily basis on the NSEs.
We start with the SEC’s recent effort to reduce the NSEs’ service fees for executing transactions. This provides a glimpse into the extent of the SEC’s efforts to represent one set of market enterprises against the financial enterprises—and, in so doing, facilitating the aims of Wall Street investment banks under the guise of aiding the so-called “main street investor.”
SEC’s Recent Effort to Reduce NSEs’ Service Fees
The SEC’s Proposed Rule 610T
On December 19, 2018, Jay Clayton’s SEC adopted a new Rule 610T of Regulation NMS, the “Transaction Fee Pilot,” which was an experiment to reduce stock market transaction fees. In this experiment, the SEC took almost 1,500 NSE-listed stocks[ and split them into three groups: first, a group in which the listing NSE(s) had to reduce transaction fees by 67%, from $0.003 to $0.001 per share per transaction; second, a group in which the SEC prohibited the listing NSEs from sending rebates to broker-dealers who used that NSE for trade execution; and third, a control group in which securities were traded on an alternative trading system (“ALT”). These were subject to no price restrictions.
The DC Circuit’s Rejections of Rule 610T
In mid-February 2019, the NSEs challenged Rule 610T, and ultimately succeeded. On June 16, 2020, the DC Circuit issued its opinion in the consolidated matter, New York Stock Exchange, LLC v. SEC., noting that “[t]he [SEC’s] Pilot Program emanates from an aimless ‘one-off’ regulation, i.e., a rule that imposes significant, costly, and disparate regulatory requirements on affected parties merely to allow the Commission [purportedly] to collect data to determine whether there might be a problem worthy of regulation.” The DC Circuit struck down Rule 610T, holding that SEC lacked Congressionally-delegated authority under section 23(a)(1) of the Exchange Act (15 U.S.C. § 78w(a)(1)).
SEC’s Efforts to Reduce NSEs’ Depth-of-Market Product Fees
Securities Market Data
We may take for granted the consolidated tape that runs at the bottom of the screen on financial programs, unaware that it is a finished product constructed from the raw material of customer orders and trades—stock market-data—submitted to each NSE. Upon the NSE’s receipt and recording of orders and transactions on orders, this raw material is distributed from the NSE’s data center to the appropriate data center of the NSE-chosen exclusive securities information processor (“SIP” or “SIPs”). The SIP in turn sorts and consolidates certain of the raw data into market-data products (“MDPs”) for distribution to information consumers, including sellers and buyers in the securities market and other market participants. The NSE also uses this raw data to construct its own MDPs for each of its listed securities (“NMS stock”), which it offers for sale to market participants.
Raw market data (for securities generally and for stock in particular), which consist of the order and trading activity of each of the NSE-listed securities, are critical to decisions made by the sellers and buyers of these securities. Agents of buyers and sellers of each security submit orders to NSEs, which record and collect these orders in that security’s order book and convert orders into executed transactions when and as appropriate.
NSE Order Books
For each security, an NSE maintains an electronic order book that lists incoming sell orders, buy orders, and documents orders the NSE has matched (executed) for customers. The unexecuted orders identify the party (if not anonymous), the number of units (shares) offered or bid, and the price asked or bid. They are listed in the sequence of proposed prices: for buyers, the list begins with the order showing the lowest offer price (“ask”) by a willing seller (called a “quotation”), after which the order with the next lowest offer price appears, and so on. For sellers, however, the list begins with the order showing highest offer price (“bid”) by a willing buyer (again, a “quotation”), after which the order with the next highest offer price appears, and so on.
“Top-of-Book” and “Depth-of-Book” Market Data
For each NMS stock, the lowest asking price quoted and the highest bidding price quoted—which are at the top of the lists of unexecuted orders—are together called the “top of the book” or, more formally, the best bid and offer (“BBO”). The best BBO among the NSEs that list that security is called the national best bid and offer (“NBBO”). Outstanding (unexecuted, but still valid) limit orders below the top of the list constitute the “depth-of-book.” Data concerning the NBBO and the most recent executed trade, which have a single price and unit-volume for the security transacted, are considered core market data, while depth-of-book is considered non-core market or proprietary data of the NSE.
Under the current centralized consolidation model of Regulation National Market System (“Regulation NMS”), which the SEC adopted and began applying to NSEs in 2005, each NSE or SRO selects an exclusive SIP. Under three offered Equity Data Plans, the SIP provides order (quote) and transaction (trade) data for each NSE-listed security to that SIP, which consolidates and live-streams “core data” to customers, including: (1) the most recent transaction (price, number of shares, and executing NSE); (2) each NSE’s BBO and the number of shares available at those two prices; and (3) the NBBO. The core data includes only top-of-book information for each security, not depth-of-book information, which is the NSEs’ proprietary data and which they sell directly as a separate product.
SEC’s Efforts to Reduce the Cost of NSE Depth-of-Market Data Products
The SEC’s 2018 Roundtable
On September 24, 2018, T&M announced that it would host a two-day roundtable on October 25 and 26, 2018, called the Roundtable on Market Data and Market Access (“Roundtable”). Of seven scheduled panels, the sixth concerned assurance that “fees and revenues [for core data products] are fair, reasonable, and not unreasonably discriminatory,” and the seventh discussed information available to the public about data products and access services, including “their associated fees, revenues, costs, and respective latencies.” In order to support and justify its efforts to reduce NSE revenue and thereby reduce costs to financial enterprises of obtaining data, the SEC has relied on statements made by representatives of the latter.
The SEC’s Roundtable Reaction
On March 8, 2019, Markets Media published an article discussing a presentation that chairman Jay Clayton and T&M director Brett Redfearn made at Fordham University on “concerns raised during the regulator’s market-access and market-data roundtable, held on October 25, 2018.” The article quoted Clayton as saying that panelists had “noted that, given the centralized infrastructure of core data, it could no longer be considered timely in today’s high-speed markets, and that the content of core data may not provide some key information necessary to trade optimally,” while some panelists “went further and asserted that they did not believe that core data was sufficient for brokers to achieve the best execution for their customers.” Core data was not merely non-optimal—it was insufficient.
The SEC’s Order to NSEs
On January 8, 2020, the SEC issued a notice of proposed order directing NSEs to develop and submit jointly to the SEC, within ninety days of the order’s issuance, “a proposed new single national market system data plan, which will replace the three ‘Equity Data Plans’ that govern the public dissemination or real-time, consolidated equity market data for national market system stocks.” The order stated that the SEC believes that “changes in the market” since 2005—including electronic trading, demutualized NSEs that offer proprietary data products, and corporate exchange groups—have “heightened an inherent conflict of interest” between NSEs’ collective responsibilities in overseeing the Equity Data Plans, over which they have exclusive control, and “their individual interests in maximizing the viability of proprietary data products that they sell to market participants.” The SEC asserted that “[t]he SIPs have significant market power in the market for core and aggregated market data products and are monopolistic providers of certain market information.”
The SEC’s Proposed Rule 614
On February 14, 2020, the SEC issued a notice of proposed rulemaking (“NPRM”) to amend Rules 600 and 603 and adopt a new Rule 614 of Regulation NMS, “Market Data Infrastructure,” to expand the content of the market data required to be collected, consolidated, and disseminated and further to introduce “a decentralized consolidation model” in which competing consolidators would replace exclusive SIPs (“Decentralization Consolidation Model”). The SEC published the proposed rule in the Federal Register on March 24, 2020, and comments were due by May 26, 2020.
The SEC’s Decentralization Model
The SEC’s proposed Decentralization Model would require NSEs to make NMS information now available to a chosen SIP available to competing consolidators and self-aggregators. The SEC asserted in the NPRM that “[d]espite the evolution of latency-sensitive markets, the provision of NMS information that is centrally consolidated and disseminated by the Equity Data Plans is meaningfully slower than certain proprietary market data products [e.g., depth-of-market data products] products distributed by the exchanges.” The NPRM went on to note that “[t]oday, the exchanges sell proprietary data products that are fast, low-latency products designed for automated trading systems and include content, such as a depth of book and order imbalance information for opening and closing auctions (‘proprietary DOB products’) that are not provided under the Equity Data Plans.” This new rule would expand the meaning of “core data” to capture “proprietary data,” including depth-of-market data.
The SEC’s Procurement of DOJ’s Endorsement of Rule 614
On June 22, 2020, following the second DC Circuit decision of June 16, 2020 (discussed below), the SEC and the Antitrust Division of the Department of Justice (“DOJ”) announced a joint effort to reduce the costs that financial enterprises pay for market-data products. On that day, the SEC and the Antitrust Division announced execution of an “historic” Memorandum of Understanding (“MOU”) by means of a virtual forum. At the forum, SEC chairman Clayton and T&M director Brett Redfearn made a presentation entitled “Modernizing U.S. Equity Market Structure,” and Makan Delrahim, DOJ’s assistant attorney general of the Antitrust Division, made a presentation entitled “A Discussion on Equity Market Structure.”
T&M’s Redfearn noted that in October 2019, the SEC published a proposal to change NMS plan fees, which “exceeded $500 million in 2017.” Clayton made the points that one of the SEC’s “‘most important responsibilities is to preserve the integrity and affordability of’ NMS market data,” and that “Main Street investors” require NMS market data, at a minimum, to participate in the U.S. equity markets. Clayton also noted that NMS data may no longer be “adequate” for the needs of investors, “both retail and institutional.” “Various market participants,” Clayton stated, “felt compelled to purchase proprietary depth of book data products.”
In his statement, Delrahim identified the apparent purpose of the MOU and announcement in a single sentence: “The proposed [SEC pro-competition] rule most directly relevant to our discussion today is entitled Market Data Infrastructure.” This proposed rule, which the SEC had published on March 24, 2020, is the SEC’s most recent use of regulatory fiat to transfer revenues from NSEs’ to financial enterprises by reducing the latter’s costs of obtaining market data, particularly with respect to NSEs’ depth-of-market data products. In his praise, Delrahim opined that this proposed SEC rule “reduc[es] the existing disparity in content and latency between market data consolidated by securities information processors, referred to as SIP Data, and exchange-specific Prop [proprietary] Data products.”
Thus, the SEC, having failed to benefit Wall Street institutions at the expense of NSEs through rule-making fiat (because the federal courts stepped in to stop this effort), has now enlisted the Department of Justice in its determined efforts on behalf of a very specific slice of the industry. Over the remainder of this article, we provide needed context to the SEC’s efforts and identify one of the SEC’s objectives: to reduce costs that financial enterprises, including Wall Street investment banks and other financial enterprises, incur to obtain NSEs’ proprietary data products, particularly “depth-of-market” data products. Reducing the costs for customers reduces the revenues to NSEs.
It Is About Paying for Depth-of-Book Market Products
On June 5, 2020, in its opinion in NASDAQ Stock Market, LLC v. SEC, the DC Circuit blunted another maneuver that Market Participants employed to stop paying “too much” for depth-of-book market data products. The relevant story, however, began in 2006, when NYSE Arca submitted a proposed rule change to charge access to its proprietary “depth-of-book” product, ArcaBook.
The First DC Circuit Decision on Depth-of-Book Products
In 2006, after the SEC had adopted Regulation NMS in 2005, NYSE Arca submitted—as required under section 19(b)(1) of the Exchange Act—a proposed rule with the SEC pursuant to Rule 19b-4 to charge a monthly fee for access to the ArcaBook data feed, which contains depth-of-market data products. Previously, this data product had been provided without cost to Market Participants. The SEC approved the proposal and NetCoalition (“NC”), as representative for certain Market Participants, petitioned to have the SEC’s order reviewed. On August 6, 2010, the DC Circuit granted NC’s petitions for review because the record before the court was insufficient for it to conduct a review under the Administrative Procedure Act to confirm that the ArcaBook fees were “fair and reasonable” and complied with the Exchange Act.
The Second DC Circuit Decision on Depth-of-Book Products
While this matter was still pending, on July 21, 2010, Congress enacted the Dodd-Frank Wall Street Reform and Protection Act of 2010 (“Dodd-Frank Act”). The Dodd-Frank Act changed the SRO rule-change approval process, and as a result, NSEs no longer had to obtain SEC pre-approval, leaving the possibility of petitioning the SEC’s approval as had been done in the NetCoalition case. In other words, upon an SRO’s filed rule change, if the SEC did not suspend the proposed rule and institute proceedings to determine whether the rule should be approved or disapproved within sixty days of its filing, the rule defaulted into acceptance.
Following the DC Circuit’s NetCoalition decision in August 2010, NASDAQ and NASDAQ OMX PHLX joined NYSE Arca in filing proposed changes to their fee-setting rules concerning the sales of non-core market data products, including their depth-of-book products. In response, NC and the Securities Industry and Financial Markets Association (“SIFMA”) (a regional member of the Global Financial Markets Association (“GFMA”) which characterizes itself as “the leading trade association for broker-dealers, investment banks and asset managers” and “the voice of the nation’s securities industry”) petitioned the SEC to suspend the rules under section 19(b)(3)(C) of the Exchange Act, claiming that the rules were unlawful under the court’s earlier NetCoalition decision. Again, the case rose to the DC Circuit.
The SEC and the interveners, the NSEs, declined to take a position on the merits and asserted that the DC Circuit lacked jurisdiction. The DC Circuit noted that Congress had “jettisoned” the requirement that the SEC pre-approve a proposed rule change before it became effective, and as such held that the SEC’s non-response to the NSEs’ filed, proposed rule changes did not constitute “action” under section 25(a)(1) of the Exchange Act so as to provide the Court of Appeals with statutory authority to review the NSEs’ new rules. The court also noted that the SEC contends that sections 19(d) and (f) of the Exchange Act permit a party aggrieved by the fees to challenge the rules as being inconsistent with the “fair and reasonable” requirement that the Exchange Act imposes on SROs before the SEC; the court further noted that the SEC’s unfavorable disposition of section 19(d) claims is itself judicially reviewable.
The Third DC Circuit Decision on Depth-of-Book Products
After the second decision proved unfavorable, SIFMA took the advice given in that decision and, in May 2013, again challenged the depth-of-book fees, this time under section 19(d) of the Exchange Act. SIFMA claimed that the NSEs’ charging of fees for their depth-of-book market data constituted a disciplinary action against the Market Participants under section 19(d)(1) because the fees “constitutes a limitation on access to the Exchange’s services for purposes of Section 19(d) and (f) by limiting access to critical market data for anyone unwilling or unable to pay the onerous, supracompetitive fees the Exchange is charging.” As a disciplinary action, the SRO should have filed notice with the SEC to enable the SEC to review the action.
The SEC’s ALJ Decision
In response to SIFMA’s claims, the NSEs argued that section 19(d)(1) could not apply because the NSEs had imposed these fees on all Market Participants, and because section 19(d) is limited to actions that target specific members. The SEC rejected that argument and ordered an Administrative Law Judge (“ALJ”) to hear the matter. The ALJ ruled in favor of the NSEs, finding that pricing for the depth-of-book market data is subject to significant competitive forces. SIFMA argued, in part, that the “high depth-of-book data fees paid by broker-dealers increased overall costs for ordinary investors,” that is, for “Main Street Investors.” The ALJ found this speculative, unconvincing, and contrary to SIFMA’s own expert, who, as “a retail investor with four brokerage accounts, was unconcerned as to whether any [of his four] brokers had access to depth-of-book data, because they would route their orders to a wholesaler who did.”
The SEC’s Remand to the ALJ
SIFMA appealed the ALJ finding and the SEC opted to reverse the ALJ and rule for SIFMA, as a representative of the Market Participants. On November 30, 2017, the SEC had to reappoint all of its ALJs, and on that same day, remanded the matter to the ALJ “to conduct a de novo reconsideration and reexamination of the record to determine whether to ratify or revise in any respect any prior action that she took.” The remand was a consequence of the SEC’s reversal. Three weeks later, on December 21, 2017, the ALJ “ratified all of her prior actions and determinations, including the initial decision, following which the parties were given the opportunity to file briefs before the Commission ‘addressing any further matters they deem[ed] pertinent.’”
The SEC’s Reversal of the ALJ
SIFMA challenged the ALJ’s ratification of her findings of fact to the Commission. On October 16, 2018, with chairman Clayton at the helm, the outcome was not in doubt and the Commission’s decision was overdetermined—that is, it had many independently sufficient justifications or causes for the same outcome. First, the Commission’s opinion ignored section 19(d)’s title, “Notice of disciplinary action taken by self-regulatory organization against a member or participant.” The Commission implicitly held that section 19(d) allows it to review the NSEs’ rules because any fee effectively “prohibits or limits any person in respect to access to services aggrieved thereby.” Second, the Commission found section 19(f) of the Exchange Act applicable. According to the SEC, that section “provides that to sustain an SRO fee constituting a prohibition or limitation of access, [the Commission] must find, among other things, that the SRO rule imposing the fee is consistent with the purposes of the Exchange Act.” The Commission’s order notes that section 19(f), which assumes applicability of 19(d), states that “[i]n any proceeding to review . . . the prohibition or limitation by a self-regulatory organization of any person with respect to access to services offered by the self-regulatory organization or any member thereof,” consisting “solely of consideration of the record before the SRO” where the SEC finds “(1) that the specific grounds on which such. . . prohibition or limitation is based exist in fact; (2) that such . . . prohibition or limitation is in accordance with the rules of the self-regulatory organization, and (3) that such rules are, and were applied in a manner, consistent with the purposes of this title, such appropriate regulatory agency, by order, shall dismiss the proceeding.” Only if the SEC “finds that such . . . prohibition or limitation imposes any burden on competition not necessary or appropriate in furtherance of the purposes of this title, such appropriate regulatory agency, by order, shall set aside the action of the self-regulatory organization and require it to . . . grant such person access to service.”
The provisions of section 19(d) and (f) clearly are intended to relate to a NSEs’ unjustified and discriminatory action against a particular member of the SRO, thereby unfairly causing the member to be competitively disadvantaged relative to other members. The SEC seems to have stretched these provisions, however, to require that NSEs not discriminate in what market data they distribute to all members: “Where, as here, an exchange functions as an ‘exclusive processor’ of its own data, it must distribute that data [all core and non-core data] on ‘fair and reasonable’ and ‘not unreasonably discriminatory’ terms.
The Commission stated that the NSEs, to defeat SIFMA’s challenges, had the burden to show their depth-of-book fees were “fair and reasonable.” In conclusion, the Commission set aside the NSEs’ fees, finding that “the record does not support the position of the exchanges,” and that the exchanges failed to meet “their burden to demonstrate that the fees are fair and reasonable and not unreasonably discriminatory.” The Commission noted, peculiarly, that its findings are not that “the fees are not fair and reasonable,” but instead that “the factual record submitted and the theories based on that record put forward by the exchanges are insufficient to support a finding that the fees at issue meet the statutory test.”
The DC Circuit’s Reversal of the SEC
This time, the NSEs were petitioners to the DC Circuit. In NASDAQ Stock Market, LLC v. SEC, naming the SEC as respondent and SIFMA as intervenor, the Court noted that the “first issue presented is the only one we decide today: whether the Commission erred in concluding that a generally-applicable fee rule may be challenged as a ‘limit[ation] on ‘access to services’ under Section 19(d) of the Exchange Act.” Interpreting section 19(d), the DC Circuit held that even though a generally applicable fee “limits” access to services, the text of section 19(d) “does not evince an intent by Congress to allow challenges to generally applicable fee rules,” in part because it does not even mention fees. Secondly, section 19(d) refers to a limitation that is “targeted at specific people.” Finding the SEC’s arguments wholly unconvincing, the DC Circuit granted the petitions for review, vacated the Commission’s decision, and remanded the matter for proceedings consistent with its opinion.
DOJ Antitrust-SEC MOU Part of Ongoing SEC Quest
Thus, the string of cases outlined above provides context for the SEC-DOJ MOU announced on June 22, 2020. Properly framed, the SEC’s enlistment of the DOJ Antitrust division is simply the latest gambit in the SEC’s ongoing quest to lower costs for large Wall Street banks at the expense of the NSEs. Every single federal court that has reviewed the SEC’s efforts in this regard has, thus far, found the SEC guilty of overreach or failure to follow its own statutes. The SEC appears now to have persuaded the Antitrust division that its efforts may be relevant to the competition laws. Whether this latest gambit succeeds will no doubt be determined in further federal court litigation.
The SEC’s efforts to shift profits from NSEs to Market Participants seem wholly unprincipled. This outcome is not based on the existing law and, as discussed above, the applicable law seems to have been an impediment to the SEC’s agenda and its objective, in particular under its current chairman, Jay Clayton. We anticipate future efforts and associated litigation with interest.