Feb. 28, 2000
14341 Spa Drive
Huntington Beach, CA 92647
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Comment on S7-28-99, Market Data Fees, Via E-mail
Dear Mr. Katz:
Thank you for taking comment on S7-28-99. The Commission should be congratulated on addressing the issue of market data fees. This release, however, takes a serious wrong turn in pursuing a regulatory--rather than economic--approach to data-fee policy.
In sum, market data fees are unreasonably high. Current pricing schemes cannot be economically justified and are in contradiction to the '34 Act's mandate for fairness and rigorous competition.
Commission Errors in Neglecting Economic Evaluation of Market Data
The regulatory accounting approach being floated is the incorrect response to the market data issue. The correct methodology is economic analysis. Unfortunately, the Commission has not attempted any economic analysis of market data costs. The only economic assumption made in this release is a flawed conclusion that the collection and dissemination of market data is a natural monopoly.
Economic analysis will show the cost of supplying market data to be much lower than current rates charged. Importantly, the Commission must determine what the marginal costs are to the collection and dissemination of market data. These marginal costs are likely zero, or arguably less than zero. For example, the release makes clear that professional investors can buy unlimited market data with flat-rate pricing. In fact, this flat-rate pricing falls as the number of terminals increases. Flat-rate pricing, especially declining flat-rate pricing, indicates that little or no marginal cost is incurred in providing data. Further, all market centers (NYSE, Nasdaq, etc.) gather and use market data to run their markets, so there is little or no marginal cost for regurgitating this existing data for public use.
Indeed, the marginal cost of market data is probably less than zero. Public orders are used for price discovery, executions and quote montages. Specialists and market makers rely on public orders to set quotes. Public investors then might well argue for their own share of tape revenue, especially as more investors or their brokers input orders online, and those orders are automatically displayed, saving trading centers from any direct cost on collecting and displaying the orders.
Market data should in fact be treated as a public good. Specialists and market makers can arguably provide a veneer of proprietary data, but ultimately it is the public's orders that create the tape. Protecting this public good from externalities such as fraud is the proper role of regulators, but this protection should be funded by taxes or SRO regulatory fees. The public already pays for regulation through brokerage and advisory costs; regulators should not charge for the public good itself. Charging the public to see its own data is an affront to the '34 Act's requirement for fair and non-discriminatory treatment.
The release seems to presume that collection and dissemination of market data is a "natural monopoly," and therefore needs a cost-based approach to ratemaking. Such an economic assumption is not quite accurate, however. As noted above, market data is not generated by a monopoly but by diverse market participants via ever-growing and transparent alternative trading systems. Furthermore, with the Internet, there are no impediments to distribution of this market data. While the actual collection and dissemination of data is done by monopoly markets, there is no "natural monopoly" here. Monopolized collection and dissemination exists partly because of impediments traditional market centers have placed in the way of full transparency and market access. With market data, consumers essentially "generate their own electricity" but are forced to send it through a monopoly collection system and then buy it back at unjustified prices. The Commission should not be fooled by any the "natural monopoly" arguments used by established market centers to continue their control over market data.
As the release says, Congress articulated general findings and objectives for the national market system and allowed the Commission to adopt a flexible approach other than ratemaking of market data fees. An economic-analysis approach to data-fee issues is appropriate and fully legal under the flexibility granted to the Commission by the Act.
Current Fee Levels Cannot Be Justified
As the release notes, "the total amount of market information revenues should remain reasonably related to the cost of market information." Unfortunately, the Commission has let the market centers get away with profiteering from data fees.
The release says "After deduction of operating expenses, each Network's revenues generally are distributed to its participants in accordance with their proportional share of the total transaction volume for the Network." (Emphasis added.) Apparently, according to the SEC numbers, these market-data revenues are not revenues at all--but profits-clear indication that fees are too high.
The existence of rebates is additional evidence that market information revenues exceed collection costs, and are not needed for regulating the integrity of the data.
The release says market data revenue amounts to 35% of Nasdaq's budget. Surely the simple act of collecting existing data (much of the dissemination work is done by vendors) does not eat anywhere near 35% of the total costs of running Nasdaq. Indeed, the release shows Nasdaq's market data revenues of $152.3 million are almost three times the $57.3 million paid to NASDR for regulatory costs!
If data fees are used for overall regulation-not simply for the collection, dissemination and regulatory oversight of data-the level of data fees are discriminatory under the Act. Data revenue used for regulation must by definition be in excess of the actual cost of collection and dissemination. A substantial source of data fee revenue comes from consumers and participants who do not share in tape revenue. Without excess data fees, member firms would presumably have to pay more for their self-regulatory functions. Therefore, through market data fees, "self" regulation has been partly financed by market participants outside of the brokerage industry through their overpayments for market data. A substantial portion of these overpayments are unrelated to doing business with a broker or adviser. Therefore, using data fees for overall regulation is arguably discriminatory and in violation of the Act.
As noted above, the marginal cost of collecting and disseminating data is probably zero. Yet the release notes that market centers have been able to grow quote fees by 51% between 1994 and 1998. Despite the larger increases in transaction reports and quotation traffic, this burden on all participants cannot be justified by a cost argument.
The release claims that the legislative history of the Act indicates Congress' intent that the fees collected from all persons using an SRO's facilities could appropriately be directed to funding the "costs associated with the development and operation of a national market system." But this legislative history was made in the early 1970s prior to the PC and the Internet, let alone the ITS and CTS. The structure of a national market system is here. There is no need to nick consumers for the costs of a system or technology that exists today.
The Amendments did not authorize control of this data, derived from the flow of customer orders, to be sold and turned into a major profit center.1 Nor can unjustly rich data fees be charged to fund self-regulation. The Commission correctly notes in the release that costs should be strictly allocated to the actual operation of a stock market, without overflowing into industry regulation overall. Congress did not authorize the funding or subsidization, via market data fees, of the industry's system of self-regulation.
The Proposed "Consensus/Cost Accounting" Approach Would Be Discriminatory and Flawed
The release says:
"The Commission's preferred choice for resolving market information issues will be to rely whenever possible on consensus among the SROs, the securities industry, and information users. ..."
The Commission is well aware that public investors have no organized, focused lobby. While the release mentions a laudable goal of "broadening participation in the fee-setting process," it is silent on exactly how this broadened participation will occur. The Commission then asks for input on this issue. Even a well-intentioned "consensus" process will result in undue influence by powerful market centers.2 Using consensus to set strategic policy has not served investors well. 3
The proposal's cost accounting regime would create a never-ending negotiation between market-center and SEC cost accountants. This accounting debate will be effective in market centers' predictable efforts at stalling any cutback or elimination of data fees--and cut into SEC staff time that would be better spent on regulation, not cost accounting.
Revenue and cost information for the market centers, which the release provides, helps in estimating how much market data revenue is needed for regulation. But even here the Commission shockingly admits that "It ... has not been possible to make precise calculations of how [SROs] have funded their market operation and market regulation costs." Under the proposal, the Commission may demand more cost information, but this too will provide little useful data as cost accounting is always imprecise. In fact, the Commission has full authority right now to gather this budget data, but has apparently been unwilling or unable to demand it. The public cannot be assured that the Commission will be able and willing to obtain the needed data for its cost-accounting negotiations to ensure a fair bargain for investors.
Finally, the Commission admits that the cost-accounting process has serious shortcomings. This is further reason why the regulatory cost-accounting approach is not the correct approach and would violate the '34 Act.
Market Data Fees Frustrate the'34 Act
Current data fees frustrate the Act in each of the following ways:
--Inhibiting formation of a true "national market system." The Commission rightly notes that "proprietary interests in this information are subordinated to the Exchange Act's objectives for a national market system." Free, or very low cost market data will be a prime mover in the formation of a national market system, which is mandated under the '34 Act. This will especially be the case as markets move to decimals and the free market sets lower trading increments for some securities.
--Creating discriminatory treatment. Offering flat-rate pricing for unlimited data only to professional investors is against the Act's anti-discriminatory language. Further, offering declining flat-rate fees to larger professional users discriminates against smaller brokerages and advisers. How do market centers justify higher unit costs to professionals with fewer terminals?
--Increasing unduly the costs of dissemination. The Commission rightly recognizes the overly high administrative costs and burdens of tracking end-users for purposes of paying the market-data cartel. Such burdens harm development of a national market system and are anti-competitive.
--Making fraud harder to spot. Investors themselves, by having readily available market data, will be better able to help police the market-and be in a position to document alleged fraud--an invaluable aid in carrying out the Act. The Commission wisely notes that investors must be able to assess the quality of execution of their transactions by broker-dealers. No-cost or very low-cost market data is crucial if investors are to play this key role in surveilling for best execution.
--Inhibiting sound investment decisions. Having real-time market data without restrictive cost structures is crucial for making sound investment decisions. Surely, few investors buy a stock without checking a real-time quote. Yet under the current pricing arrangement, investors generally cannot view online their entire portfolios with real time valuations and current asset allocations--and make decisions accordingly.4 This is another example of how data fees frustrate the Act's goal of protecting investors and guaranteeing fairness.
If the Commission pursues its "consensus" approach to data fees, it must require a heavy burden of proof for the continuance of anything other than free data, or data fees that decline in real terms at a far sharper rate than the public and participants have seen to date. Market centers must overcome each and every point above as to how continued levels of data fees better fulfill the Act's requirements than would zero-cost or lower-cost data fees.
The Commission should immediately commence an economic, not cost-accounting, study on the costs of market data. If done competently and objectively, such a study will show that data costs are relatively low and probably zero at the margin. The agency will then be in a position to promulgate a rule that will forbid market centers from charging per-quote fees, and push for lower flat-rate pricing especially as volume and scale economies grow. Per-quote fees should be ended immediately or offered only with flat-rate pricing options. The recent imposition of these per-quote fees, and the clear impact these fees have on retail investors, show that not only are the fees unnecessary for regulation but that they are discriminatory as well.
Market centers will predictably want to keep the revenues from data fees, cloaking their arguments in investor protection language. Yet the current level of fees run well beyond what the Act allows-reasonable costs for collection and dissemination. Such fees should not spill over into funding or subsidizing regulation, nor be used as a fast-growing profit center as they have been.
The Commission must show leadership in countering the industry's lobbying to keep high levels of data fees, keeping in mind that investors do not, and never have had, any representative organization to counter the political power of the market centers and Wall Street dealers. The Commission must in all cases error on the side of the investor, as opposed to Wall Street and the market centers. The Commission's threshold is clear: Unless objective evidence suggests free or low-cost market data is contrary to the '34 Act, the Commission must eliminate market data fees or severely reduce them. At a minimum, the SEC's policy should be to ensure that retail consumers are offered flat-rate pricing for unlimited use, and that overall the cost to all participants of market data significantly declines in real terms, as well as SRO's reliance on market data revenue.
Setting up a costly and cumbersome system for estimating (probably badly) costs of collecting and disseminating market data is unwise. It will be far easier to encourage fair and vigorous competition and negotiation between all participants to lower or eliminate data fees, keeping in mind the economic fundamentals discussed above. This is an approach the Commission has taken successfully in the past, and should vigorously pursue in the future, keeping in mind also the unlevel playing field that benefits entrenched market centers.
The '34 Act gives clear direction. Under Section 11A, the Commission must ensure that fees are not "unreasonably discriminatory," it must ensure the "availability to brokers, dealers, and investors of [trading] information" and it must facilitate the "economically efficient execution of securities transactions." Clearly the Commission must aggressively pursue a policy of nominal fees for market data, or free access, and demand a high threshold of proof to support justification for any market-data pricing scheme.
"For example, does a monthly fee of $0.50 or $1 per Network deter a significant number of retail investors from using real-time market information or preclude broker-dealers from providing enhanced information services to their retail customers? Thus far, per-query fees have generated much greater revenues than the monthly fees that allow unlimited use of information. The fees allowing unlimited use, however, would appear to provide a greater opportunity for broker-dealers to provide retail investors with a much improved quality of service, including potentially the opportunity to obtain dynamically-updated displays of quotations and transaction reports in a security. Compared to receiving information based on a single query at a time, a real-time stream of dynamically-updated information could offer retail investors a greater ability to control their securities transactions, including possibly the ability to execute transactions in the market of their choice (for example, by directing a limit order to a specific market) or monitoring the quality of execution by their broker-dealers. Comment is requested on whether the current fee schedules could inappropriately restrict the information services that broker-dealers provide to their retail customers."-Per-quote pricing charges do inappropriately restrict services. Per quote pricing should be done away with. Even the markets themselves will benefit. Schwab's lawyer is right in saying per quote fees are like Wall Mart charging for a price list.
"It bears noting that no comments were submitted to the Commission in 1995 when the NASD proposed to establish a per-query fee of one cent as an alternative to its monthly fee for nonprofessional subscribers, which was then $4 per month. Similarly, no comments were submitted to the Commission in 1996 when OPRA proposed to establish a similar per-query fee of two cents." --Past lack of comments does NOT bear noting--the pre-Internet age is irrelevant to today. The SEC must not duck its responsibility to defend the interests of unorganized investors despite any success or failure of a "public outreach" program or similar idea. Public outreach is a cop-out from doing economic analysis and making tough decision in the face of opposition from entrenched, organized interests.
"Comment is requested on whether the SROs should be required to provide greater disclosure of their financial condition, including disclosure of the costs associated with the performance of their various SRO functions."-One of the most striking disclosures in this release is the SEC's lack of good data on regulatory costs and resources. Not only should the SEC know intimately what SROs spend on regulation, but the public and the press have a right to know the resources behind industry regulation. Such information, even if it existed, is now largely closed to public view due to the private status of the SRO system .These regulatory budgets should be public records.
Comment on whether "the creation of an industry advisory committee on market information arrangements would constitute a more efficient and flexible vehicle to convey a broad range of views to the Plans and to the Commission."-No. Use economic analysis, not committees that are sure to be dominated by entrenched market centers. Who, for example, would be picked for the committee as forceful representatives for investors?
" ... it appears that the degree of use and the quality of the service provided to customers of an on-line broker-dealer (particularly under a monthly fee structure providing instant access to unlimited information) may be superior to the service provided to customers of a traditional broker-dealer (who must initiate a separate telephone call and speak personally with an employee of their broker-dealer each time they want to update their information). Comment is requested on whether fees for on-line access to market information by retail investors are warranted by the degree of use and the quality of service provided." -Is the Commission making a comparison of online self-directed investors versus investors who use an individual registered rep or adviser? If so, the distinction is hopelessly out of date. Full-service clients are online right now, both for executions as well as for online account access and collaboration with advisers. Discount customers use online quotes in a number of different ways as well. Surely the SEC is not looking to go down the "slippery slope" of evaluating which firm offers "superior" quote services and therefore deserves higher or lower pricing(?!).
1 The release shows market data being the top source of revenue at the NASD, and second only to listing fees at the NYSE.
2 Relating to the market data and other related issues, Charles Schwab & Co., not an insignificant industry player, had to petition the SEC for rule making in June 1999 to get relief from hidebound cartel-like data pricing, even though the Commission claims to have had concerns about retail fees since at least October 1997. An economic analysis could have been initiated then and completed by the end of 1998 for policy decisions last year.
3 See, generally, "The Transformation of Wall Street," Joel Seligman, Northeastern University Press, 1995. See specifically the chapters "The MidLife Crisis of the SEC," (Pages 349-438), and "An Unfinished Agenda," (Pages 439-568), for discussions of various unsuccessful consensus-building efforts to deregulate commissions and mutual fund sales charges, and eliminate anti-competitive off-board trading restrictions. Any "consensus-building" process will be framed and dominated by SROs and market centers who benefit from their regulatory power, expertise and lobbying abilities, and who have a history of successfully protecting their financial self-interests. For example, off-board trading restrictions, partly removed in the `70s, still remain. Mutual fund commissions also still remain fixed under Section 22(d) of the '40 Act.
4 "Jazzy Tech Tools," Registered Representative, February 2000. The story's "Stale Quotes" sidebar on Page 70 notes that most firms use delayed quotes for portfolio updates as they struggle to renegotiate quote-fee contracts.