Table of Contents

Letter in Response to Securities and Exchange Commission Concept Release on "Regulation of Market Information Fees and Revenues" (Release No. 34-42208; File No. S7-28-99)

Introduction

Organization of Submission

Part 1: Alternative Cost Allocation Models and Their Statutory Basis

A. Congress Did Not Authorize a Market Data Rate-Making Process
B. Distortions, Costs and Pernicious Effects of Government Utility Rate-Making

Part 2: The Track Record of the NYSE Board

A. Availability of Network A Data in the Marketplace
B. Constituent Governance
C. Fair Allocation of Costs: Nobody Does It Better

Part 3: Consolidation Technology, Free Markets and Constituent Boards

Appendix A: Map of Exchange Responses to the Issues as to which the Concept Release Seeks Comment

Appendix B: Legislative History and Subsequent Administration of Securities Exchange Act Section 11A (Prepared by Debevoise & Plimpton)

Appendix C: Comments on Cost Based-Regulation (Prepared by PHB Haigler Bailly, Inc.)

Appendix C-1: Issues Surrounding Cost-Based Regulation of Market Data Prices (Prepared by PHB Haigler Bailly, Inc.)

Appendix C-2: The Economic Perspective on Regulation of Market Data Prices (Prepared by PHB Haigler Bailly, Inc.)

Appendix D: Network A in Perspective: 1975-2000
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Appendix E: Comments On Fee Disparities, Plan and SRO Disclosure, Administration and Pilot Programs

April 10, 2000

Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549-0609

Re: Market Data Concept Release (December 9, 1999), File S7-28-99

Dear Mr. Katz:

The Exchange wishes to thank the Commission for providing a forum for a serious discussion of a critical subject, and for providing us this opportunity to participate. Market data is our core product. When two investors trade, the execution is important to just them. But the price of the trade is important to millions of others around the world - for deciding their next market action, for pricing their portfolios, for valuing their stock options and for providing a report card on how well management is discharging its responsibilities to them as shareholders.

We are also eager to comment because we believe that the Concept Release raises issues well beyond market data - issues ranging from the basic governance, funding and operational stability of our securities markets to the neutrality of a self-regulatory organization ("SRO") toward different broker-dealer business models and the equitable allocation of costs versus "free-riding".

Below, we attempt to comment comprehensively on the substantive issues raised in the Release. However, we believe that it is equally important to place this discussion in its proper context.

The issue is not, nor has it ever been, about investors' access to real-time data for NYSE-listed issues. Professional investors have access to an endless supply of such data at a cost that, in real terms, has consistently and dramatically declined over the past 25 years. Indeed, we are not aware of any issue having been raised by users with regard to professional display unit fees for data made available by the markets that trade NYSE-listed securities ("Network A").

Similarly, individual investors, and the general public for that matter, have access to unlimited real time data through a wide variety of delivery systems - PC's, telephone, television, PDA's, pagers, automated teller machines, etc. Market data is available in the home and in public places - libraries, schools, airports, restaurants, train stations, shopping malls and literally on the street. In contrast to commentators who imply that investors are struggling for access to real-time data, in truth it is hard to avoid it. Simply stated, the data is pervasive and, from many sources, absolutely FREE.

So if this exercise is not about investors' access to market data, what is it about?

Well, it's about competitive positioning by brokers. It's about a few on-line brokers trying to gain competitive advantage by shifting to their competitors the cost of the markets' operations and infrastructure investments. It's about a broker-dealer business model that depends on access to (1) primary market-discovered prices on which to base internalized executions, (2) a deep pool of liquidity within which to lay-off proprietary positions, and (3) a network and order processing complex that provides unrivaled capacity and reliability - and that seeks to pay little or nothing for those services. Mostly, it's about trying to use the government to gain competitive advantage.

But there is another perspective, that of the markets that produce and distribute the data. From that perspective, the issues raised in the Concept Release are about governance - about the efficacy of self-determination within a SRO, where all constituents are represented and where majority rules. And the issues are about fair allocation of costs - about all users paying their fair share and not allowing some to "free-ride" while others pay more than they should. And the issues are about funding technical infrastructure investments needed to receive, process and safe-store the orders, quotations and trade reports that give rise to the data in the first place. Because under-investing in the capacity, redundancy and reliability of order processing systems is not an option for the New York Stock Exchange.

Today, the task of fairly allocating the costs of operating the markets among market constituents resides with the constituent boards of the SROs, subject to approval by the Commission after public comment. Cost allocation occurs pursuant to constituent governance procedures that the Securities Exchange Act of 1934 ("1934 Act") mandates, and that the Commission has approved and continually monitors. The Concept Release proposes to subordinate today's cost allocation by consensus to utility rate-making, and to overlay existing market governance with a new, supra-SRO bureaucracy.

In this letter and its appendices, we show how inserting the government directly into the fair allocation task will divert market resources, stifle productivity and innovation, increase industry costs, and significantly burden the Commission staff. In fact, in our opinion the proposal is simply unworkable. We also show how, in vitiating our constituent-driven process, utility rate-making will restrike the balance created by negotiation, compromise and consensus among our diverse constituents. Such a governmental intervention would thereby reallocate costs, produce "winners" and "losers", and favor one business model over another, all without providing measurable benefit to the investing public.

It is clear from the Concept Release that the Commission is concerned that the decision made in the 1970s to consolidate and disseminate market data pursuant to joint SRO plans produces revenue allocations to the regional exchanges and the National Association of Securities Dealers ("NASD") that do not relate either to the costs of running the regional and third markets or to the value of the derivative prices those markets produce.¹ The Exchange has long accepted that inefficiency as a price of achieving the statutory mandate of a national market system.

Now, the Commission seems committed to addressing the negative consequences of that decision. However, rather than create a new, supra-SRO bureaucracy coupled with utility rate-making, we propose that we eliminate the source of the problems -- the joint dissemination arrangement itself.

To catalyze a pro-competitive solution that takes advantage of today's technology, our Board of Directors has authorized our withdrawal from the CTA and CQ Plans.

ORGANIZATION OF SUBMISSION

To make this submission manageable for the Commission staff, this cover letter serves as an executive summary to a series of detailed appendices.² It is divided into three parts.

In Part 1, "Alternative Cost Allocation Models and Their Statutory Basis", we challenge the notion that the Commission staff has somehow been derelict for 25 years in failing to engage in rate-making. We maintain instead that the Commission has approached market data prices precisely as Congress contemplated, and in a manner which other regulators in other industries have come to recognize as vastly superior to traditional rate-making regulation. In Part 1 we also discuss the rate-making model presented by the Commission in the Concept Release, and describe the market distortions, costs and other pernicious effects it would produce, and the government micro-management of business processes it would entail.

Part 2, "The Track Record of the NYSE Board", begins by summarizing the many accomplishments under the Commission's 25-year stewardship of market data and clarifying some of the misconceptions that have arisen about the Network A fee structure. Then we discuss the extraordinary inclusiveness of the governance arrangements that prevail at the SROs today. We show that the constituent boards of the markets, through negotiation, compromise and consensus, demonstrate the verity of Winston Churchill's oft-quoted observation that "[D]emocracy is the worst form of Government except all those other forms that have been tried from time to time."³ We also take a close look at a cost allocation decision that the Concept Release highlights - telephones and registered representatives ("RRs") versus PCs and the Internet - and show why none of the proposed alternative cost allocation models could reach a fairer result.

Finally, in Part 3, "Consolidation Technology, Free Markets and Constituent Boards", we review the inefficiencies which the Commission has identified as inherent in the current SRO joint ventures. We then argue that the solution lies in dissolving the ventures, harnessing technology and freeing the markets to compete in the market data arena as they do in all others. We further argue that market forces and the markets' constituent boards, under Commission oversight, would assure the fair allocation of market costs.

PART 1: ALTERNATIVE COST ALLOCATION MODELS AND THEIR
STATUTORY BASIS

A. Congress Did Not Authorize a Market Data Rate-Making Process

As the Concept Release recognizes, Congress was not writing on a clean slate when it enacted the Securities Act Amendments of 1975 (the "1975 Amendments")⁴. The Commission had already approved the consolidated transaction plan filed by the

Exchange and the other markets during the previous year pursuant to newly-adopted Rule 17a-15 under the 1934 Act. That rule expressly provided that the SROs could impose "reasonable, uniform charges" for the distribution of market data. The CTA Plan extended to the consolidated networks the fee structures that had previously been in place for the ticker systems of the NYSE and the American Stock Exchange ("Amex").⁵

Because market data revenues were an established source of SRO funding at the time the 1975 Amendments were enacted, one must assume that any congressional intent to eliminate them, or to subject them to some type of cost-based justification process, would have been expressly set forth in the statute or in the accompanying legislative history. There is no evidence, however, that Congress intended such a result.

As set forth in the memorandum entitled "Legislative History and Subsequent Administration of Securities and Exchange Act Section 11A" (prepared by Debevoise & Plimpton and attached as Appendix B), the legislative history makes clear that the relevant provisions of Section 11A were designed to ensure that the Commission had clear statutory authority to address the types of problems that had delayed the development of a consolidated transaction reporting system over the previous three years. The Commission had been forced to referee disputes among the markets regarding many aspects of the consolidated reporting system, and the legislative history repeatedly cites the subjects of these disputes as examples of the types of problems that the rule-making authority provided to the Commission was designed to address. The fees charged for market data were not among the disputed items, and there is no indication that Congress sought to establish a standard more restrictive than the "reasonable, uniform charges" standard already in place under existing Exchange Act Rule 17a-15.

The Concept Release suggests that a congressional intent to subject market data fees to some type of cost-based justification process may be inferred from the fact that Congress referred to an exclusive processor of securities information as being "in effect, a public utility." It is clear from the context of the discussion in the legislative history, however, that this reference was in no way made for the purpose of explaining why market data fees need to be subjected to utility-type rate making proceedings: the reference was emphasizing the importance of ensuring that an exclusive processor functions in a manner that is "absolutely neutral" with respect to competing markets and firms. In short, Congress was concerned, not about the size of market data fees as such, but about the possibility that an exclusive processor might be dominated by a particular exchange and engage in practices that placed other markets or firms at a competitive disadvantage.

The conclusion that Congress was primarily concerned about non-price restrictions that would be anti-competitive or discriminatory, and did not intend to subject market data to a rate-making regime, is buttressed by the fact that Congress did mandate a cost-based justification process in another provision of the same legislation. In the context of eliminating fixed commission rates, Congress provided in Section 6(e)(1)(B) of the Exchange Act that the Commission could approve a schedule of fixed commission rates only if it made a finding that the rates "are reasonable in relation to the costs of providing the service for which such fees are charged." This illustrates that Congress knew how to write legislation that clearly requires a cost-based justification process when it intended to do so.

The Commission has administered the provisions of Section 11A for 25 years without subjecting market data fees to any sort of cost-justification process, except in the situation where an exclusive processor of securities information also acts as a vendor of that information.⁶ The legislative history provides no basis for the Commission to abandon this long-standing policy and take a fundamentally different approach to the review of market data.

B. Distortions, Costs and Pernicious Effects of Government Utility Rate-Making

We are also convinced that the cost-based approach suggested by the Commission simply will not work. It would inappropriately burden both the government and the industry, stifle competition and innovation, and in the end, raise costs and, potentially, fees.

To assist us in analyzing the effects of the Commission's approach, we retained economic and regulatory experts at the consulting firm of PHB Hagler Bailly, Inc. ("PHB"). They have prepared two extensive analyses which support in depth our concerns about the fairness and viability of the cost-based approach. To enable the Commission and its staff to study these analyses in detail, we have attached them in their entirety as Appendix C.⁷ For ease of reference, PHB has highlighted its findings in a cover letter, which we also include in Appendix C.⁸

The economists and rate-regulation experts at PHB make several points that we consider essential to any discussion of how to approach governmental involvement in the pricing of market data. To start with, they observe that the Commission has thoughtfully applied the mandate of the 1975 Amendments in overseeing the administration of market data production and distribution, and has beneficially regulated market data in a way that is currently the goal of many other regulatory bodies in other industries. In fact, PHB points out, other regulated industries are actually moving away from cost-based rate-making. The PHB experts are surprised to observe the Commission proposing to move against the trend,⁹ and note that this can only be regarded as retrogressive.¹⁰

They see the Commission's proposal for "flexible cost-based" regulation as conceptually flawed and practically impossible. Simply put, they say there is no "short cut" like "flexible costing". Any cost-based regulatory scheme must be grounded on a thorough, rigorous analysis of the costs of all the markets supplying market data. Any such analysis requires the creation of a uniform system of accounts for deciding what to include and exclude. If some sort of "flexibility" is then introduced, it will only breed endless disputes as parties bicker over rate-making decisions based on a vague set of standards.

The PHB experts also observe that it is impossible to regulate market data prices in isolation from other prices charged by markets for other services. Market data and transaction execution are what the economists refer to as "joint products", linked in a way that pricing of one inevitably affects pricing of the other. If rate regulation were to reduce the revenues that could be realized from market data fees, then other fees - transaction fees or, in the case of the primary markets, listing fees - would have to be increased to maintain the same infrastructure and level of services. However, since the three types of fees fall differently on broker-dealers following different business models and differently on broker-dealers, institutional investors and listed companies, the result is a reallocation of market costs based, not on competition and constituent governance, but coming as a side-effect of governmental intervention.

In addition, PHB is able to speak with authority about the likely administrative burdens that cost-based regulation will place on all parties, especially the Commission itself. Extrapolating from what they observe in other industries, in PHB's expert opinion, the administrative burden would be "enormous". They note the large number of participants to be regulated. They describe the extraordinary amounts of information, accounts and reports that will have to be standardized and analyzed to make determinations that will stand the scrutiny and challenges to which rate-making decisions are subject.¹¹ And even when the preliminary work is diligently done, litigation is inevitable, if only to delay a decision unfavorable to one party or another. PHB also notes that rate regulation must allow the regulated entities to recover the administrative costs of regulation, adding to the costs that must be reflected in the rates charged for market data.

Cost-based rate regulation introduces other inefficiencies as well, and these inefficiencies equal additional cost. PHB observes from experience that cost-based regulation encourages cost-padding, and provides no incentive to reduce costs through operating or administrative efficiencies. Again, since the rates being regulated must themselves provide for recovery of related costs, this kind of regulation of market data prices will quite possibly lead to increases in those prices. Without a strong need to move to this form of regulation, such a result cannot be justified.

A very important point that PHB brings out in its analysis is that rate regulation is never aimed solely at minimizing rates to consumers, since very low rates may affect the attractiveness of the business to competitors and potential competitors, or the level of service provided. So the regulator must determine what is a "fair" rate of return that provides a suitable incentive for service providers while protecting consumers as well. Of course, this is what market competition usually does, and PHB reminds us that rate regulation implies a belief that market forces cannot be relied upon. As is clear from our comments, we strongly believe that constituent boards and customer control have in fact provided the discipline that any government would expect and desire in the area of market data services and fees, and that such inefficiencies as do exist arise from the decision to impose a joint venture arrangement for market data dissemination.

PHB also tells us that modern regulatory theory realizes that a more effective regulatory model is one that tries to mimic competition. This is the theory of "Ramsey pricing", which accounts for consumer welfare while meeting the need to keep the supplier viable. Most significantly, Ramsey prices cannot be deduced from cost data alone. In fact, prices for any one service are arrived at by assessing the elasticity of demand for that service, not by a simple accounting allocation of cost. The service with less elastic demand - market data, in our case - can be expected to bear a higher price compared with a service with more elastic demand - such as execution services. (See Appendix C-2.)

PHB's discussion of this concept is significant in two ways. First, it shows, contrary to the presumptions in the Concept Release and the arguments of certain commentators, that economic theory about cost-based recovery would shift the recovery of more of the market costs to market data fees and away from transaction and listing fees. Second, it prompts the question, "Why should government rate regulation, rather than constituent self-determination, dictate a shift among constituents as to how they bear the costs of the markets?"

In summary, we believe, and our experts confirm, that the cost-based approach suggested in the Release will inevitably stifle competition and innovation, and entangle both the industry and the Commission in time-consuming, expensive and ultimately fruitless proceedings and data analysis. PHB demonstrates that even in industries historically subject to utility regulation, cost-based rate making has been discredited. PHB also shows that market data dissemination is far from an ordinary utility function, and that cost-based regulation is particularly inappropriate here.

The markets whose data have been consolidated through CTA are fierce competitors. Cost-based rate regulation has consistently been seen in other industries to lead to poor cost control at best and, more often, to outright waste and mismanagement. The incentives on competitors to wring easy profits from a cost-regulated segment will be magnetic, and represent a real danger that will demand extensive government involvement. In contrast to the dramatic decline in market data costs over the past quarter century, under cost-based regulation, it is quite possible we would experience over time frequent rate increases based on escalating expense levels.

PHB includes a quote that we think captures the overall essence:

Regulation, at best, is a pallid substitute for competition. It cannot prescribe quality, force efficiency, or require innovation . . . . Regulation fails to encourage performance in the public interest by offering rewards and penalties. Competition offers both."¹²

PART 2: THE TRACK RECORD OF THE NYSE BOARD

The cost-benefit analysis necessary to justify acceptance of the market distortions, costs and other pernicious effects of the "pallid substitute" would need to show that the pro-competitive alternatives had failed to realize the public policy goals of the 1934 Act. In fact, the record of constituent self-determination is one of exponentially increasing data access accompanied by consistent and dramatic declines in market data fees. In this Part 2, we look at the track record.¹³

A. Availability of Network A Data in the Marketplace

In 1975, Congress declared that market data would lie at the heart of the national market system. For the last 25 years, the Network A markets, under the Commission's stewardship, have sought to produce high-quality market data and to disseminate that data widely and on terms that are not unreasonably discriminatory and that are fair and reasonable.

How have they fared?

As the year 2000 began,

• 100 million people had on-line access to free real-time Network A data on public web sites;

• 70 million cable television subscribers had free access on their television screens;

• 12 million nonprofessional investor accounts had on-line access from their brokers, most free of charge;

• Industry professionals had access on 420,000 display devices located in offices around the globe; and

• 350,000 nonprofessional subscribers had signed up for unlimited real-time services with vendors and broker-dealers.

Are fees deterring widespread access to Network A data (as the Concept Release asks)? This record speaks for itself. As the Commission noted on the eve of the present controversy in the context of approving fees for the redistribution of options market data:

Competition among technology and information providers continues to thrive. Over the past few years, individual investors have enjoyed unprecedented access to market data through varied media, including CNN, CNBC, satellite services, on-line computer services, the World Wide Web, and the Internet.¹⁴

Today, an investor has access to real-time Network A data by means of his or her PC, hand-held computer, telephone audio voice response, cellular phone, pager device, automated teller machine and public ticker display. They can see it while dining in a restaurant, while passing through Grand Central Station, while standing in Times Square, while shopping at a mall, while flying in a plane, or while watching television. In short, Network A has fashioned policies and practices that have released the Internet and cable television to democratize market data. As a result, real-time Network A data is ubiquitous, inexpensive to vendors and available to consumers for free.

In addition, system investments have created such redundancy and dependability that both the Consolidated Tape System ("CTS") and the Consolidated Quotation System ("CQS") have compiled uptime percentages that have remained above 99.9 percent ever since the systems commenced operations in the 1970's. And the markets have invested billions of dollars in technical infrastructure that enables last sale prices and quotations to be delivered to CTS and CQS for distribution to broker-dealers and vendors without queues regardless of increases in volume due to market volatility, decimalization or other changes.

As for Congress's goal of dissemination on terms that are not unreasonably discriminatory, Network A's policies and uniform contract terms assure that no one gets better terms of access than anyone else. Network A imposes the same market data fees on broker-dealers regardless of their SRO membership, and subjects all vendors, broker-dealers and investors to the same fee schedule, regardless of geographical location.

Network A's fee structure does differentiate among different classes of data recipients and provides volume discounts and an enterprise cap. However, in each instance, the markets' diverse constituents and the Network A participants' constituency-laden boards of directors, indicated that they viewed the disparities in Network A fees as reasonable and appropriate, as has the Commission.

As for distribution on "fair and reasonable" terms, the numbers make the case for the fairness and reasonableness of Network A fees. Since 1985, the securities industry's cost per transaction for each Network A real-time trade or quote message has shrunk from $1.00 to 23 cents. Taking into account inflation, all classes of fees have been consistently and dramatically reduced over the last 25 years. The repeated explicit and implicit price reductions have had the desired effect - extraordinary growth in market data usage. Yet, even with that growth, the revenues from those fees fund the same portion of the Exchange's operations (14-17 percent) as they did a quarter of a century ago.

Above all, Network A fees are "fair and reasonable" because the process by which the fees are determined is fair and reasonable. Network A fees are the product of the consensus building, compromise and negotiation process described below. Constituent boards have approved them all. The Commission, after subjecting each fee or fee change to public comment, has approved it or declined to abrogate. This process ensures that it is the consensus view, rather than the "outlier", that prevails.

Constituent self-determination has succeeded in fulfilling Congress's market data objectives by coupling advancing technology with innovation and adaptation. Application of new technology to the auction process has successfully accommodated massive increases in capacity demands, while making high-quality data available on a very reliable basis to retail investors at zero cost.

The heart of the national market system never misses a beat.

B. Constituent Governance

Market data dissemination is governed today by the industry and the investing public, operating through the representative boards of the SROs. The checks and balances in the current system insure that any latent market power is not exercised. It would upset the balance of this system and introduce significant inefficiencies if the Commission were to impose an additional layer of governance, or were to insist that market data fees should be earmarked for particular purposes, such as market regulation, to the exclusion of others.

Decisions by markets regarding the pricing of market data (indeed, all pricing decisions for all services) involve input and controls from a wide variety of industry participants and investors through the constituent boards of the various markets. These boards include CEOs of member firms and institutions, and leaders drawn from the general public. In the case of the primary listing markets, they include listed company CEOs as well.

For example, the NYSE board is carefully balanced to include both member and non-industry representatives, and among the members, to include representatives from various business segments, floor and upstairs, institutional and retail, regional and national, discount and full service. This extraordinary body comprises some of the most knowledgeable and influential people in the securities industry and, indeed, in the world of business as a whole.

As is commonly the case, the NYSE Board acts by majority vote. However, as is also common in business today, there is a real emphasis on achieving consensus, so that any serious concern or objection from a constituent will prompt an effort to satisfy the concern through negotiation and compromise before taking the contemplated action. One dissatisfied customer may not be able to force a change, but when a critical mass of our constituents voice a point of view, the Exchange's view is changed. It is in this way that any latent monopoly pricing power or power to discriminate among users with respect to market data is in fact controlled, directly or indirectly, by representatives of the very customers who use and pay for that data.¹⁵

CTA today is a forum in which markets can discuss issues that exist among them; it is not where pricing decisions are made. Those decisions are made by the boards of the participant SROs, where the customers and the representatives of the public reach consensus on pricing and other terms.¹⁶ With respect to Network A, the NYSE will typically take the lead on pricing proposals, vetting new proposals not only with the other participants, but also with various users, and with trade and industry groups. This dialogue often results in modifications which improve or reevaluate the original concept. Proposals are then taken before the NYSE Board and the boards of the other CTA participants for approval.

And, of course, pricing and other rule changes are subject to the approval process at the Commission after public comment. In addition, both SRO and Commission rules provide procedures for broker-dealer members (in the case of SROs) and any person who believes his or her access has been limited (in the case of the Commission) to seek redress of their grievances.

Superimposing yet another layer of governance would stifle self-determination, not enhance it. This is especially true if that layer is added at a level where, by definition, the governors are removed from an immediate and full understanding of market costs and expenses, and are instead myopically focused on minimizing market data fees. Moreover, it seems inevitable that broker-dealer and institutional investor representatives on such a special-function body would be drawn from the ranks of their administrative and technical employees. This kind of representative cannot be expected to have the "big picture" view found in the chief executives who serve on the boards of the markets and who bring that broader perspective to the board deliberations on various fees, including market data fees. It would make no sense to permit a less qualified group to effectively strip cost allocation decisions from the user chief executives found on the boards of the NYSE and the other markets.

C. Fair Allocation of Costs: Nobody Does It Better

Has our constituent-driven process for allocating costs done so fairly? From some media accounts over the past three years, one would think that the process foundered on the issue of cost allocation between on-line brokers and full-service brokers. But the facts tell a different story.¹⁷

The on-line brokers believe that it is the obligation of a for-profit company to "exploit every economic advantage".¹⁸ Therein lies the truth about the recent history of this allocation process.

It is the story of the attempt by one category of broker-dealer to foist the costs of operating the markets onto other categories of broker-dealers or onto listed companies. The on-line brokers seek to escape the market data fees that apply to their business model, to confine market data fees to the recovery of a narrow band of marginal costs, or to vaporize market data fees altogether. Until recently, the main thrust of this campaign was against our allocation of costs between those broker-dealers that provide market data to customers during telephone calls with their RRs, and those that provide market data to customers on-line.

The on-line brokers' campaign began in 1997 with an attack on Network A's penny-per-quote filing. When, at the Commission's request, we re-channeled the penny-per-quote fee into a new pilot, the lobbyists for the on-line brokers carried the campaign to Capitol Hill, arguing that "The Data Belong to the People". Ostensibly seeking to protect consumers from charges of a few pennies per day, the lobbyists neglected to mention that no on-line customer pays for market data unless the broker chooses to pass through the markets' charges.¹⁹

When the campaign to nationalize market data bogged down on the Capitol steps, the on-line brokers opened a new front. "The subject Consolidated Tape Association/ Consolidated Quotation (CTA/CQ) plans and the comparable fees imposed by NASD . . . are levied only on brokerage customers electronically accessing market information. Such fees are not levied on investors that receive quotation information verbally from their brokers over a telephone."²⁰ This time, they had to retreat outright, conceding that, when a firm's RR gives a customer a quote over the phone, it is conceptually the same as when the firm gives the same quote to the same customer on-line.²¹

With their discovery that market data is free to consumers and that broker-dealers are paying for both the telephone/RR channel and the on-line channel, the on-line brokers had to open a third front. Now, they assert that "triple billing" and "multiple channel penalties" are discouraging "innovation, efficiency and convenience of investor access."²²

Are they?

We have charged separately for separate "channels" since the interrogation device augmented the ticker in 1960. It is just one of the many tools that NYSE's constituent board uses to fairly allocate its costs among constituents. Clearly, to the extent that two competing constituents pursue different business models that rely on different dissemination channels, we could not impose fees on one channel while leaving the other one free of fees, and still fairly allocate costs and avoid unreasonable discrimination. If one customer receives a certain amount of data through three channels, and a second receives the same amount though one channel, how is it "triple billing" if we charge the provider of data to the first customer the same amount as we charge the provider to the second customer?

Moreover, over time, vendors and broker-dealers shift channels - even if we have been successful in setting our fees neutrally between the two. For example, over the past 30 years, the interrogation device channel has largely supplanted the ticker channel in the professional category.²³ That channel shift was attributable to the inherent limitations in ticker technology: ticker throughput is governed by the speed at which a human eye can perceive moving characters.

Clearly, if we are to recover a fair share of our costs through market data revenue, we must be able to charge for the supplanting channel. Fortunately for fair allocation, during the 1970's, no one was able to convince the Commission that charging for the interrogation device channel was in some way inimical to the public interest.

Today, a channel shift is going on within the non-professional category from the telephone/RR channel to the on-line channel. There appear to be two principal reasons. The first is similar to the one that led to the marginalization of the ticker channel: today's individual investor wants the same analytical abilities as the professional; plummeting technology and communication costs have brought those analytical tools within the reach of his or her wallet; and a stream of electronically-delivered dynamically-updated data is essential to that capability.

The second reason has no counterpart in the earlier channel shift: the brokerage firms are pushing their customers into the on-line channel because self-help by customers reduces RR payroll and other overhead.²⁴

If achieving fair cost allocation and avoiding unreasonable discrimination requires extending fee liability to new channels, then the question becomes one of "how." If we were comparing "apples to apples" (as was implicit in the example above), then "1X times 3 channels = 3X times 1 channel", and one can apply the same price tag to each unit of data.

Unfortunately, in allocating costs between the two nonprofessional channels, we must compare "apples to oranges". In the "telephone/RR" model, a firm tasks an RR to work from a fee-liable interrogation device to telephonically provide a customer with a small, discrete number of quotes. In the on-line model, the firm arms the self-help customer with an array of information and analytic tools that allows the customer to access and manipulate large numbers of quotes. Thus, the quality, nature and use of the data are different.²⁵

We approached this allocation task in several steps as experience educated us. In 1984, we established an "all-you-can-eat" device fee for non-professional subscribers at a fraction of the professional device fee. By the early 1990's, changing technology and business models were militating for alternative fee approaches.

We responded, first, by holding the professional device fees nominally constant and piloting three on-line fee alternatives: flat-rate, connect-time and per-quote. Second, when the per-quote alternative proved the best, we adopted it.²⁶ Third, as the use of the channel increased and, therefore, our revenue from the channel increased, we twice rebalanced against the telephone/RR channel by reducing the fees attributable to on-line receipt.²⁷ Fourth, we introduced quote-volume discounts and per-customer caps, providing to the on-line channel the same benefits of discounts as are available to the telephone/RR channel.²⁸ Fifth, we added an enterprise cap applicable to all channels, which ameliorates the issue for any firm that reaches it.²⁹

We think the Exchange's constituent-driven process has done a good job of meeting the fair allocation challenge presented by the emergence of the on-line channel.³⁰ In particular, we avoided favoring one broker-dealer business model over another. We also expect that the growing homogenization of the brokerage industry in its use of on-line data dissemination will tend to moot the issue. Moreover, while we would gladly consider other approaches, we suspect that the array of channel fees, discounts and caps now in place position us with the tools necessary to easily re-balance the cost allocation between the telephone/RR channel and the on-line channel for a third time, should that again become necessary.

But, above all, we believe that no government rule-making bureaucracy or supra-SRO governing body, even if it could have achieved neutrality and escaped co-option, could have done a better job.

PART 3: CONSOLIDATION TECHNOLOGY, FREE MARKETS AND
CONSTITUENT BOARDS

After 25 years of data dissemination through SRO joint ventures, the Commission is right to ask whether changes in technology and in the competitive landscape ought to change who should allocate market costs among users, and how. The Concept Release proposes introducing a form of price controls by adding one or more levels of government or superimposing a supra-SRO bureaucracy.

We think just the opposite tack - dissolving the joint ventures - offers the best solution. Here, as in other areas of the economy, the best answer lies in unleashing market forces and relying on constituent self-determination. If we unbundle the data and dissolve CTA and the other joint ventures, we will free the markets to compete in the data arena - as they do in all others - by pricing and selling their product individually.³¹ The very act of dissolving the joint ventures will give full reign to the markets' constituent boards to control market costs and to fairly allocate those costs among constituents within the Commission's framework of mandatory dissemination and mandatory consolidated display of the data.³²

While there was a technological reason for forming an SRO joint venture to create a consolidated tape in the mid-1970s, technology has long since removed the systemic and economic barriers to consolidation either by each vendor or broker-dealer independently or by non-exclusive service bureaus performing the function at market rates. In the related context of his proposal for consolidated dissemination of limit orders, Chairman Levitt recognized this feasibility in his call for vendors and others to create consolidated displays of limit orders.³³ We see no reason why a market solution for consolidation that appears both workable and consistent with the goals of the 1934 Act for limit orders would not be equally workable and consistent for bid-asked quotations and last sale prices. ³⁴

A market solution coupled with constituent self-determination under Commission oversight addresses the Commission's concerns about undesirable effects of the current joint dissemination arrangement. For example, the Commission is concerned about whether the revenue received by the regional exchanges and the third market exceeds the value of their data.³⁵ We assume that market forces will readily address any value distortions inherent in the joint venture arrangement if the markets are freed to compete among themselves in separately pricing their market data. We have also seen in a variety of contexts the Commission's desire to increase quote competition. Intermarket competition in the market data arena will create incentives for more competitive quotations in order to create the value proposition necessary to make market data users willing to pay for the data.³⁶

The Commission also expresses concern in the Concept Release about the lack of correspondence between the joint venture's revenue allocation and the costs of operating the regional exchanges and the third market. As noted above, this lack of correspondence arises because the plan fees are based upon the more extensive costs of the infrastructure of the Exchange and the other primary markets, but shared with the regional exchanges and the NASD according to a formula that is not correlated with the costs of the regional and third markets or the value of the derivative prices those markets produce. Subjecting each market separately to the test of competition would flush out any systemic inefficiencies built into market data pricing by the joint venture arrangement.

Shutting down the joint ventures would also moot a variety of other controversies that have been plaguing the markets and the Commission - none of which is unresolvable, but all of which place additional demands on scarce Commission resources. For example, because the CTA Plan - drafted at a time when all exchanges had physical trading floors - provides a fee exemption for terminals on trading floors, the Commission is faced with an appeal by a floor-less exchange. Another participant filed a petition with the Commission last year regarding a dispute over whether a particular security was eligible for revenue sharing under the Plan. The options exchanges have been arguing with a new, floor-less entrant as to whether it should be able to directly provide its own last sale prices and quotations to its members. In addition, the options antitrust investigations and lawsuits have impaired the functioning of meetings of the joint ventures because businesspeople are afraid to talk to one another unless they have an antitrust lawyer on one side and a Commission staff member on the other.

The collateral effects extend to fundamental issues about the self-regulatory structure. The motivations of some of the ECNs to register as national securities exchanges include sharing in the joint venture revenue, forcing the Commission staff to devote considerable resources to help the ECNs meet the daunting statutory standards for registration. In turn, the prospect that the Commission would then have to regulate the ECNs directly contributes to the call for the creation of a monolithic SRO cleaved from the primary markets. And the question of the amounts that the new joint-venture entrants should reimburse the existing co-venturers has caused the Antitrust Division of the US Department of Justice to weigh in.³⁷

These changes should also benefit the overall competitiveness of the US capital market. This Commission has led the way in recognizing how changes in technology and in the economy have enabled market solutions to replace the non-market solutions of the last generation. Examples include increasing non-industry participation on the boards of the NASD and Philadelphia Stock Exchange; opening the NASDAQ markets to competition from order-match systems by imposing the order handling rules; breaking open the single-exchange order-routing channels left behind by the options allocation plan; enhancing listing competition by removing shareholder approval requirements for delisting; proposing alternatives to exchange rules that address fragmentation and internalization by confining proprietary trading to exchanges; and decimalization. Ending the SRO joint ventures would extend this Commission's pro-market legacy.

The Concept Release suggests that the Commission may be coming to the view that the competitive costs of the joint ventures now outweigh their benefits. Predecessor Commissions found that the joining of the competing markets into these ventures was necessary or appropriate under the 1934 Act and that other 1934 Act purposes outweighed the competitive burdens. On the other hand, the sea change in technology over the last 25 years has clearly enabled solutions that were previously unavailable, and we can understand that this Commission may take a different view today. While we were and are willing to deal with the existing inefficiencies of the joint ventures if that is required, we would welcome the unfettering of competitive forces.

In sum, we believe that all of these factors mean that it is time to dissolve the joint ventures. While there are many transitional issues that must be addressed, we believe they are all manageable. Working with the Commission staff, with the other participants in the market data plans, and with the brokerage firms, vendors and other data recipients, we believe an orderly transition to competitive dissemination of market data could be effected by the end of this year.

*    *    *

We hope that this letter and its appendices at last bring facts and clarity to the debate and assist the Commission in making choices that will have a significant impact on the vitality, viability and operational stability of the U.S. securities markets in the years to come. We have shown that cost-based pricing by a Government bureaucracy is "a pallid substitute for competition", untenable as a way of assuring adequate and fair funding of the markets, costly and without statutory foundation. We have also shown that the retention of the joint ventures, not to mention the superimposing of a supra-SRO body, exacerbates the issues discussed and implied by the Concept Release. We have pointed out how prolonging the joint ventures only serves to impede the market forces and the constituent self-determination that provide the key to resolution of these issues.

We believe that dissolution of the joint ventures is the appropriate solution. Accordingly, we have been authorized by our Board to seek the Commission's approval to withdraw from the CTA and CQ Plans.

Sincerely yours,

James E. Buck