Federal Advisory Committee on Market Information:
DATEK ONLINE HOLDINGS CORP.
To SEC's Questions
1. Q. What role do you see for the SEC in assuring the fairness and reasonableness of fees? What about in markets for securities where one exchange dominates? Should any such SEC oversight be limited to SROs, or should it extend to large ECNs and market makers as well? How can you be confident that accurate and timely market data will continue to be widely available to market participants?
A. Please note that the Datek proposal would leave in place the current system whereby market participants are required to make market data available to their SROs without charge. SRO SIPs would continue to distribute consolidated data on a non-discriminatory basis to vendors and broker dealers and charge a "fair and reasonable" fee so long as they are the exclusive processor (realizing that adjustments may be made to that process as a result of deliberations set in motion by the 1999 Concept Release and this committee). The SEC would continue its current role in assuring that all persons have access to such data on terms that are "not unreasonably discriminatory" and would continue to prohibit the distribution of deceptive or fraudulent information. Consequently, we would expect that the same market data would continue to be available as is available now from SROs and their affiliated SIPs without any diminution in the quality of such information.
Our proposal would further enhance the existing regulatory scheme, however, by allowing non-SRO SIPs to acquire market data directly from market participants and to compete with the present exclusive SRO SIPs in the distribution of such information. Such non-SRO SIP data would be made available to the public and market professionals on terms determined by the marketplace. The SEC would not be involved in setting rates for non-SRO SIP market data, although the SEC would continue its role in assuring that all persons have access to such data on terms "not unreasonably discriminatory," and would, of course, continue its role in preventing deceptive or fraudulent information. In our view, the introduction of such competition will both enhance the information that has been made available to investors since the 1975 Amendments and obviate the need, as reflected in section 11A(c)(1)(C) where there is an exclusive processor, for the SEC to engage in a fairness inquiry with respect to any SRO or independent SIP's fees.
Further, we believe that market forces will exert a sufficient counterweight against any attempt to convert dominance as a venue for trading in any securities into a stream of exorbitant market data fees. With the repeal of NYSE Rule 390 and the growth of all electronic trading venues, intermarket competition has been enhanced. Any attempt to realize increased market data fees in a non-discriminatory manner will fall equally upon direct market participants (members) and members of the public (non-members). An exchange that pursues such a course of action would thus induce market participants to shift their trading to market venues that offered reduced overall costs.
2. Q. SRO members would continue to be required to provide their data - presumably free of charge - to their SRO, but in addition could sell their data separately to SIPs. It seems that, in your view, there is joint ownership of the data between the market center and the SRO. Please explain your theory. Would you permit an exchange, for example, to prohibit its specialists from separately selling their data?
A. Our proposal does envision that market participants will have the right to sell data (and, under the proposal, exchanges could not prevent specialists from separately selling data). However, in this context, the issue of who owns the data is not germane. Rather, the question is whether the Commission has the authority to regulate the collection and dissemination of market information and those involved in that process. In this regard, the answer is clear -- as the Concept Release acknowledges, the 1975 Amendments provide the Commission with ample authority.1
3. Q. Also, permitting market participants to separately sell their data clearly would put downward pressure on the value of the SROs' market information stream. How would the SROs continue to adequately fund their SRO functions?
A. As a preliminary matter, it should be noted that the staff's question appears to be premised on at least two assumptions - first, that non-SRO SIPs will be able to sell market data at a lower price or provide a more valuable product than the SRO SIPs, and, second, that other SRO fees are insufficient to fund SRO functions. It is unclear to us whether either of these two assumptions is entirely valid.
To assume that permitting non-SRO SIPS to compete directly with SRO SIPs will put downward pressure on the value of an SRO's market information stream is also to assume that non-SRO SIPs can collect and distribute market data more efficiently and that they can offer more useful or valuable information to the investing public than the SRO SIPs currently do. While we certainly hope that this will be the case, we do not believe that we should be required to shoulder the burden of advising the SROs on how to become more competitive, particularly in this case, where the SRO SIPs would appear to have the competitive advantage. SRO SIPs would appear to have at least two advantages over non-SRO SIPs. First, non-SRO SIPs will have to contend with start-up costs not faced by SRO SIPs, which have already made significant investments in infrastructure since the 1975 Amendments. And, second, unlike SRO SIPs, non-SRO SIPs will almost certainly have to compensate market participants for their market data. In these circumstances, the competitive advantage would seem to lie with the SROs and their affiliated SIPs; not their competitors.
The second assumption inherent in the above question is that other existing SRO revenue streams are, or will be, insufficient to finance SRO functions. To our knowledge, no conclusive evidence has ever been made publicly available by the SROs or the SEC that would show that the SROs' other revenue streams are, or would be, insufficient. Indeed, as the 1999 Concept Release acknowledges, SRO internal cost structures lack transparency and most SRO financial statements do not associate costs with their respective functions or the services they provide.2 While the 1999 Concept Release cites revenue numbers, information concerning expenses is conspicuously absent. Because the SROs have not fully disclosed how they use market data fees, the Commission itself is unable to explain in the release how the exchanges spend or invest the fees they enjoy from market data. As the Securities Industry Association has emphasized, there is a need for increased public disclosure of information concerning costs and the use of revenue.3
Indeed, Charles Schwab and Nextrade have asserted that the NYSE has sufficient net revenues to pay for critical functions even if market data were disseminated at cost. While the NYSE has countered that the costs identified in the 1999 Concept Release represent only a fraction of the expenses incurred to develop, maintain and operate its order processing systems, it has not provided sufficient information to allow that claim to be assessed.
In our view, neither assumption should be made unless an adequate factual basis is first established and made publicly available in a way that permits interested parties to review the facts and test the claims made. That basis should be established before the conclusion is reached, as implied in your question, that additional funding sources will be needed and before rejecting Datek's proposal because of any presumed effect on revenues or otherwise.
Assuming solely for the sake of argument that the above assumptions are true, we believe that there are at least two alternatives available to the SROs to remedy any deficiency: (1) conduct their SRO functions more efficiently to offset any decrease in market data revenues, and/or (2) increase the fees charged for SRO functions or impose new fees to cover the SRO functions that would otherwise not be funded.
Charging fees to support the SROs' performance of various Exchange Act functions is not unknown to the SROs; in point of fact, this fee structure has already been widely implemented by the SROs to underwrite their regulatory functions. The NASD, by way of illustration, imposes a wide range of fees on its members, issuers and persons whose orders are executed in its markets in connection with various Exchange Act functions. Such fees include transaction and issuer service fees, registration and qualification fees, issuer annual fees, member assessments, regulatory service fees and fines, arbitration fees, and corporate finance fees. There are charges for services related to the Nasdaq Workstation II, SelectNet, and SOES, to name but a few. The use of this fee structure shows that SROs can allocate (and reallocate) fees to satisfy their funding requirements by charging those who avail themselves of various services and products in order to underwrite any related SRO function. In our view, a fee structure where users are charged for the services and products they receive best satisfies the Congressional mandate that the rules of the SROs "provide for the equitable allocation of reasonable dues, fees, and other charges among members and issuers and other persons" using the SROs' facilities.4
Equally important, allowing others to compete directly with the SROs and their affiliated SIPs in the collection and dissemination of market data as we propose is consistent with the principles and goals of the 1975 Amendments - including fair competition, market transparency, best execution, and efficiency - and will be beneficial to investors.
First, eliminating reliance solely on SRO SIPs is consistent with the House Conference Report to the 1975 Amendments that states Section 11A does not "constitute a mandate for a single securities information processor at any stage in the processing of quotation or transactional data."
- History and experience have demonstrated that increased competition results in prices and services that better serve the investor. Datek's proposal keeps the current consolidated system in place, but offers alternative services, price structures, and opportunities to the marketplace. Under Datek's proposal, greater competition and innovation will allow consumers to choose the services that they want and from whom they want to buy.
- Transparency will improve by providing the public greater access to market information. The introduction of competition and innovation to the market data regulatory framework will provide the investing public more tools than currently available.
4.1. Q. If consolidation were optional, how would this impact the best execution obligations of broker-dealers? If a broker-dealer elected to receive market information only from the largest market center, could this be sufficient for best execution? Or is the concept of best execution meaningless without an NBBO?
A. The concept of Best Execution antedates the National Market System amendments of 1975. It operates as well in options and fixed-income markets that do not disseminate an NBBO. Moreover, the SEC's recent pronouncements emphasize that, due to the many changes in the equity markets, firms should not assume that executions at the NBBO guarantee that a firm has satisfied its Best Execution obligation. Our advocacy of the repeal of the Consolidated Display Rule, in order to open a window for innovation, is grounded upon the experience of broker-dealer competition for the public's trust and business. Market forces guarantee that competing agents will continue to offer the most useful market information in order to attract customers.
4.2. Q. And what impact would this have on investors? If, for example, retail online investors were provided quotes from only one market center - that might have prices well away from the best - would they regularly and unwittingly trade at inferior prices?
A. Spurred by new technologies and new competitors (e.g., ECNs and online brokers), the strong current of our markets is toward greater transparency and public participation. If there ever was any doubt about an agent's duty to report to his customer about how his or her order was handled, it is settled by the enactment of SEC Rule 11Ac1-6(c) which requires that this information be provided upon request. Today's investors enjoy greater access to information and are better informed than they have ever been-and this will not change after the repeal of the Display Rule. The best execution duty, market forces and antifraud rules all operate to prevent a broker-dealer from misrepresenting incomplete BBO information to the public as complete. Firms that do not serve their investors will suffer a blizzard of defections, complaints and litigation-they will deservedly fail
4.3. Q. If users were permitted to pick and choose the market centers from which they receive information, some might decide to pay for data only from the largest market center in a security. If this became prevalent, what would the competitive impact be on the smaller market centers? Would they be able to survive? Would it be feasible for new competitors to emerge?
A. It is certainly true that broker-dealers seek market data from market venues with the greatest liquidity and that liquidity tends to attract liquidity. Yet the emergence of ECNs demonstrates that competition can create new liquidity pools. The debate in the first half of 2000 was, in fact, whether fragmentation imperiled our equity markets-with a consensus reached that it did not pose a threat in light of other integrative technologies. We advocate removing rules that deter inter-market competition and oppose using regulatory processes to confer advantages upon any market center. In sum, competition, augmented by the SEC authority over misleading practices and unreasonably discriminatory prices is the most efficient regulator. We oppose using any regulatory process to establish market centers or subsidize them via an allocation of market data fees that the marketplace itself would withhold.
4.4. Q. Or would this lead to monopolies in the trading of individual securities? And what would this do to incentives to innovate, improve execution quality and reduce trading costs?
A. As noted in response to 4.2 and 4.3, we do not foresee the market forces abating that have spurred inter-market competition, innovative information displays, lowered trading costs and improved execution quality.
4.5 Q. How can the SEC assure best execution and efficient price discovery without mandatory consolidated market information?
A. The SEC has many tools, short of rulemaking, to encourage the dissemination of timely market information and best execution practices. In fact, there is no rule at the present time that forbids broker-dealers from disseminating 15 minute delayed (free) quotes to their customers in preference to real-time quotes, provided of course that the information is correctly identified as delayed. The SEC should continue to address these issues, as it has in the context of changing market conditions, in a variety of communications to the marketplace, from speeches of the Chairman, Commissioners and Division Chiefs, to special studies and interpretive rulings. If a "rogue" broker persisted in practices that were misleading or violative of their responsibilities to customers the SEC should make an example of the firm via an enforcement proceeding.
5. Q. Your model relies on disclosure to adequately inform market data users on the limits of the information provided. Can you provide an example of the type of disclosure you believe would adequately inform all users about the risks of relying solely upon data from, e.g., a single minor market center?
A. There are a number of providers today of free, unconsolidated data to the public. The disclosure made by these providers usually describes the elements that are included in the display and that the display does not purport to be the current NBBO. We are not aware of any instances of investor confusion that have arisen from these unconsolidated displays.
6. Q. What are the roles of SIPs and data vendors in your proposal? Are the notice filings you describe sufficient to adequately regulate non-exclusive SIPs? Will these assure the marketplace of the consistency and quality of data being disseminated by the SIPs, and with the accuracy of their disclosures?
A. Under a competitive model we envision that some, and hopefully many, current data vendors would become SIPs. Our proposal seeks to construct minimal regulatory entry barriers to the role of a SIP. Market forces will determine the success of SIPs by the market's scrutiny of the usefulness and reliability of the competing vendors products.
7. Q. In your model, it appears that non-SIP data vendors also would be consolidating market data. Shouldn't these vendors be subject to the same regulatory oversight as SIPs?
A. We believe that exclusive SRO SIPs require continued SEC oversight, as exists under the current model because they consolidate data obtained via the exercise of SRO and SEC rules. Under the Datek proposal, price will be determined through free market negotiation and contracts, and we believe SEC regulation need not be as pervasive as it is for SRO SIPs (please see our response to your first question).
8. Q. You suggest replacing the NYSE's trade-through rule with a trade-through disclosure rule. How would the trade-through disclosure rule work without an NBBO or mandatory consolidation?
A. The Trade-through Rule is a component of the Intermarket Trading System Plan that generally governs the trading of securities listed on a registered exchange. The effect of the trade through rule is to inhibit competition and innovation and prevent electronic agency markets from competing with traditional marketplaces. Given the anti-competitive effects of the trade through rule, Datek supports its complete elimination.
The Commission, however, concerned that the obligation of best execution is not sufficient, by itself, to ensure that customers receive the best-quoted price, has advanced the concept of trade through disclosure. Under this concept, a broker that provides a customer an execution outside of the best-advertised price would be required to disclose to its customer the quoted market at the time of the execution. This additional disclosure is intended to protect customers from inferior executions.
If the Commission formally proposes a rule conditioning the ability to "trade through" on disclosing the NBBO at the time, brokers would need to obtain the NBBO from vendors or SIPs. Despite the lack of an "official" NBBO, market forces are sufficient to ensure the production of an NBBO. Market professional, for example, need the NBBO to trade in the most efficient manner possible. Thus, vendors producing a consolidated NBBO will find a ready market for such data.
|1|| Regulation of Market Information Fees and Revenues, Exchange Act Release No. 42208 (Dec. 9, 1999) (the "Concept Release") at Section III.B.|
|2|| The Concept Release at 20.|
|3|| Letter from Marc Lackritz, President, SIA, to Jonathan G. Katz, Secretary, SEC (April 11, 2000) on file in 2000 Comment Letters at www.sia.com.|
|4|| 15 U.S.C. 78f(b)(4) and 15 U.S.C. 78o-3(b)(5).|