October 21, 2003
Via e-mail: email@example.com
Attention: Mr. Jonathan G. Katz, Secretary
Re: Commission File No. SR-NASD-2003-128
Ladies and Gentlemen:
Bloomberg Tradebook LLC ("Bloomberg Tradebook") wishes to comment on the proposed rule changes filed by the National Association of Securities Dealers, Inc. (the "NASD"), through its wholly controlled subsidiary, The Nasdaq Stock Market, Inc. ("Nasdaq"), to the Securities and Exchange Commission (the "Commission") that would establish a maximum level of quote/order access fees for Electronic Communications Networks ("ECNs") (the "Nasdaq Proposal"). The Commission published the Nasdaq Proposal for public comment in Securities Exchange Act Release No. 48501 (Sept. 17, 2003), 68 Fed. Reg. 56358 (Sept. 30, 2003).
Introduction. In our view, Nasdaq has correctly identified access fees as a barrier to an efficient market. We agree access fees should be regulated, and we applaud Nasdaq's efforts to eliminate from the SuperMontage trading algorithm any discrimination of orders based on access fees. Nasdaq's proposal, however, does not go far enough and is not applied broadly enough. We believe Nasdaq cannot address these issues on its own. Access fees should be abolished for all securities and all markets, and we recommend that the issue be taken up directly by the Commission to achieve this end. Accordingly, we believe the Commission should not approve the Nasdaq Proposal. The Commission should address this matter itself. We believe Nasdaq cannot properly, or as we discuss below lawfully, be the forum where access fees are addressed. In the first place, Nasdaq has adopted such fees itself on SuperMontage, extending the application of access fees to the simple act of responding electronically to a market maker's quotation. One cannot expect Nasdaq to take the lead in setting access fees. Indeed, the $0.003 access fee cap Nasdaq has arbitrarily proposed happens to be equal to the rate Nasdaq already charges.
Fundamentally, Nasdaq today is not the impartial observer of the issue that it was in November 1996 when the Commission created access fees and granted the SROs the power to set them. Indeed, today, the problem of access fees extends beyond any particular SRO, and for that reason alone cannot fairly be addressed by any one SRO. Just as access fees cause adverse behavior among market participants, so too access fees are causing market distortions between Nasdaq and other exchanges that can only be resolved by the Commission.
Further, the issue of access fees has not arisen in a vacuum, but rather in the context of a much wider debate about the kind of market structure that is best for the U.S. equities markets. This context includes concerns about best execution, price/time priority, payment for order flow, sub-penny jumping, pinging, internalization, market data cross-subsidization, trade-around and trade-through rules, and market linkages, as well as the locked-and-crossed markets brought about by access fees. The Commission has been studying these issues for some time and has expressed an intention to weigh in on these important issues. We think the issue of access fees is best tackled by the Commission rather than any single SRO.
Policy considerations: access fees should be abolished. As a policy matter, we have long thought access fees should be abolished across the board and would welcome that development. There is no good reason why market participants entering limit orders should receive a subsidy from participants entering marketable limit or market orders, and plenty of good reasons why they should not. There is also, of course, no defensible argument for payment for flow of market orders, which used to be a common practice. The harm done by access fees to market structure occurs in two ways, in their impact on the behavior of those who would be charged the fees and in their impact on those who would receive them. First, by placing a tax upon market orders and marketable limit orders, access fees tend to distort and alter natural behavior and to discourage immediacy and to favor patience.
Second, access fees make it possible for rebates to be paid to limit order providers. The competition for rebates exacerbates the problem of locked and crossed markets, and also has encouraged sub-penny jumping, wherein a market participant improves a bid or an offer for an economically meaningless increment in order to receive a rebate. There is an economic swing in the cost incurred by a party that hits a bid or takes an offer and thereby foregoes the rebate payable for limit orders. The hit-or-take trader incurs an explicit cost, in the form of the access fee itself, and incurs an implicit cost in not receiving the rebate. That can be pretty significant as a percentage of the overall transaction cost, particularly for retail orders. In the case of a 1,000-share trade, a rebate of $0.002 cents per share amounts to $2 and the access fee, at $0.003 cents per share, amounts to $3, for a total swing of $5. If the typical retail ticket charge - even one by a "discount" broker or an on-line broker - is, say, between $10 and $25 per trade, the access fee swing would represent between 20% and 50% of that cost. Locked and crossed markets result from access fees because a broker, all other things being equal, would prefer to convert marketable orders into limit orders. If the market is $X.20 bid and $X.21 offered and the client is willing to buy securities at up to $X.21 or $X.22, his or her broker has an incentive to post a marketable limit bid at either $X.21 or $X.22 on another market center, locking the market, to capture the rebate rather than have its commission reduced by the access fee. This not only locks or crosses the market, but it also creates a conflict of interest for the broker, who would rather receive the rebate than have its customer pay a lower price or risk having the market move away and not have a trade occur at all. All of this, of course, is done without transparency. The customer is left in the dark. Principles of best execution are left behind.
Access fees replace competition for limit orders that might otherwise take place on the basis of service and innovation. In place of that competition and possible innovation is a payment taken from a third party. Sadly, we cannot know how much stronger the U.S. equity markets might be today were it not for access fees. In the final analysis access fees should not be lower - they should be abolished. There is no place for them in our National Market System. We believe the abolition of access fees would greatly reduce or resolve many of the market structure ills outlined above and provide for a better NMS. When access fees are abolished the incentive to pay for, and internalize, order flow would be mitigated. That would result in a more transparent and more liquid NMS. Investors would benefit from faster order handling and better executions at lower cost.
We reiterate our belief that access fees are harmful to the markets and should be abolished. If access fees nevertheless are to be capped rather than abolished, they should be capped by a neutral party and applied across all securities and markets. As a practical matter, as well as a matter of public policy, only the Commission can do this. Legal considerations. In addition to our belief that Nasdaq as a policy matter is not the proper party to control access fees, we believe as a legal matter that Nasdaq is not the right vehicle for controlling or eliminating access fees. The Nasdaq proposal, once Nasdaq becomes a national securities exchange, would directly contravene Exchange Act Section 6(e)(1), which prohibits a national securities exchange, with exceptions not relevant here, from "fixing rates of . . . fees charged by its members." The Nasdaq proposal to cap access fees charged by ECNs would do precisely that. While Section 6(e)(1) was adopted to deal specifically with the rules of national securities exchanges that, before May 1, 1975, had fixed minimum brokerage commission rates, the section cuts more broadly than that and also prohibits fixed maximum rates of commissions, allowances, discounts or other fees. The NASD has traditionally regulated "gouging" in the context of mark-ups under its mark-up policy, NASD Rule IM-2440, but that policy is stated to be a guide, not a firm rule and neither Nasdaq nor the Commission have ever suggested that prevailing rates charged by ECNs, if consistent with the policies in the Commission staff's no-action letters, involve gouging or other conduct the NASD can lawfully regulate. In addition, of course, the NASD is not itself a national securities exchange and therefore is not subject to Exchange Act Section 6(e), but the Nasdaq proposal, if approved by the Commission, will become subject to Exchange Act Section 6(e)(1) and will contravene that section if Nasdaq's currently pending registration as a national securities exchange becomes effective. As the Congress recognized in enacting Section 6(e), the history of fixed commission rates demonstrated the evils of imposing regulatory fiat on a market that is better served by competition and other market forces, given sufficient Commission and self-regulatory oversight to ensure that abuses do not develop. Conclusion. For the reasons set forth above, we respectfully recommend that the Commission not approve the Nasdaq Proposal, but that it consider taking its own action to abolish access fees, including those charged by SuperMontage.
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We hope that our letter is helpful to the Commission and the staff in its review of the Nasdaq Proposal. If members of the Commission or of the staff believe we may be of further assistance in these matters, please let us know.
By: Kim Bang by RDB