Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
Re: Release No. 34-42208; File No. S7-28-99
Dear Mr. Secretary:
This was a very interesting request for comments. As someone that has been involved with paying our quote costs for over 25 years, I know this is a subject that needs to be improved for all users. A group of regional firms tried to suggest changes to this process about 10 years ago without success. When I asked our people that have paid the bills, the uniform response was "make the process simpler. The subject is too mundane and often too detailed for most people to want to address. Many of these responses are repetitive, since the questions are similar.
Flexible, Cost-based approach to market information fees and revenues:
SRO's need to identify their costs. The costs that are directly identified, as market data should be reviewed by a third party, and an independent board for reasonableness. The simplest approach is to use the direct cost at the exchanges and at the "Plans" for distributing quotations. We have never understood the difference in monthly fees from the exchanges for the size of the broker organization. The cost of market operations and market regulation should be separated. Today, we do not know what the market data costs are, or whether they represent the true or actual costs of providing market data. Using an estimate is even more nebulous than what is done today. The release had revenue numbers, but nothing for expenses. It would help to have real expenses for a determination of what is reasonable. The only way to ensure fairness and reasonableness is to use actual costs. Indirect cost are subject to too many interpretations. Even using CPA's, you would never get a consensus of what cost would be appropriate to include in market data expenses. You only need direct costs. Otherwise, you will never know what is included in the total base. How could anyone ever audit the costs without staying with direct costs?
The number of executions should be used as the primary basis for compensation, and not quote traffic. Trades will show, if an execution point (specialists, market makers, or third markets') is actually executing trades for customers. Quotes only reflect traffic in the network. Price improvement from all markets will drive the executions. All exchanges, third markets, and ECN's should be linked together for transparency and price discovery. Routing orders to a specific market does not mean the order will be executed, since someone else may get there first, or the size is not available in that market. The option exchanges should also be linked, so customers do not see a trade through.
Quote expenses for professional end users could be billed through the quote vendors without a markup. Quote vendors currently bill the end users and the quote vendors supply data to the exchanges for billing by the exchanges. Using the quote vendors should simplify the process to a single point of billing. This should save money for the quote vendors and for the exchanges. Anyone wanting to supply quotes to retail customers should pay for connection into the Plans. The supplier of quotes would then pay the incremental cost of the infrastructure for both the telecommunications interface, and the internal computer systems to furnish quotes to retail customers. This retail supplier would price according to the market. This would be similar to the old (pre Internet) system, where a broker gave quotes over the telephone to customers, and the firms purchased the telephone systems to handle the calls and recordings devices for retail customers. All current contracts with NYSE, AMEX, and NASDAQ allow telephone quotes to customers.
The perception is that the Internet is free. Users pay a monthly fee to access the Internet, and then most of the content is free unless a user signs up for a fee service. Quotes in the Internet environment are perceived to be part of the free information to the public. Even the half-cent charge is viewed as trying to nickel and dime someone. Competition has created end user sites without a charge to retail customers.
Another consideration, that may have been researched in the past, would be for firms to pay a very small fee per month (such as $10 per 10,000 customer accounts with assets, based on quarterly statement mailings) as a self imposed fee to the exchanges for retail quotes, once a firm offers automated quotes to customers. The normal quote fee would be used for RR's, institutional customers, and day traders. Other market makers could have a separate fee as they do today, since this is used for their competing market making, and has a different value than for the other three types of professional users. The only rate the retail customer will understand is free. With direct cost being covered by all the professional users, the retail investor should be able to receive quotes at no cost from the exchanges. The cost would be to the provider of the quote service. The provider could be a broker that provides quotes with execution services, or some other site with other revenue sources, or a site that customers use for a fee that includes quotes, to cover infrastructure costs.
The professional user should be defined as the users (RR's) within brokerage firms, institutional users, other market makers, and day traders. All of these users make their living from this supply of information, which has a critical time value to them.
The Plans need to try to develop business plans that only require rate changes every 18-24 months. Technology changes will drive these cycles. Revenue should cover costs. Costs should include replacement and upgrades to systems.
With costs being covered, there is no reason for rebates. Rebates are like payment for order flow, someone is paying for the excess funds. Why should a small user subsidize a large user by letting the large user get a rebate and not the small user? The only way a rebate would make sense would be for a percentage rebate to all users at the end of a year based on total payments, if their were excess revenues available from the Plan's and exchanges. The size of firm should not be a factor in setting a minimum. The quote vendors have the same administrative cost for a one-page invoice or 100 page invoices. Vendors already send bills to users', use the current system to the best advantage.
With the for-profit models being considered by many trading locations, the trading entity and the SEC could pay for a separate division for market regulation. The regulatory division of a trading location should bill the trading portion of the entity for market regulation and support.
Distribution of Network Revenue and SRO funding:
Why not just cover the direct cost for the distribution of quotations? Let the SRO's use other direct fees to cover other expenses? The Plans could use the quote vendors to collect the fees. Both quote vendors and exchanges have a problem with collecting fees from users going out of business. Some end users currently have to pay deposits with quote vendors, and that deposit amount may need adjusting by the quote vendors. The Plans could capture their cost first, and then the exchanges and trading locations. If a vendor cannot collect from a firm, then by agreement everyone is out the revenue. Over time, users would factor a factor like shrinkage in retail sales into the cost for everyone to cover non-payments.
By only using the direct cost for the exchanges and Plans, there are no questions about the cost. Use other fee income, such as having the SEC pay the exchanges to regulate and operate their markets from the SEC fees paid to the SEC each month. Currently, the SEC is collecting (for the Treasury) more in SEC fees each month than is needed to fund the SEC. Use some of these excess fees to pay SRO's for their regulatory efforts. The SEC can determine how much they want to SRO's to do and how the SRO's should do their job. The SRO's should also bill the trading division of the exchanges for their expenses not covered by the SEC. The exchanges will determine fees for users to cover these regulatory costs. Only using the direct costs should keep the SRO's from increasing costs for non-market data projects.
Plan and SRO Disclosure:
The result may be another bureaucracy, but the Plans and SRO's need more disclosure. Instead of owners only, outside directors should be used by the plans. The exchanges have public and member directors. Quote vendors and the public should be represented. The Plans should be utilities of the exchanges and other trading locations. Rate filing will be driven by volume and changing technology. The Plans need to be prepared to use new technology.
Plan Governance, Administration, and Oversight:
The Plans should be open to membership from all users. The Plans should be funded from the sources of revenue from the quote streams to the quote vendors from professional users. The users are primarily professional users. RR's/IR's/AE's of firms, institutional customers, day traders, and market makers should be classified as professionals for billing purposes. Users of data for retail customers should pay for the infrastructure additions to support retail
Direct funding: If the SEC and SRO's pay the market regulation funding, this would not be a factor in the cost of quotes for users.
Proportional distribution: The income to the Plans should be based on executions by trading locations. Creating quotes for a 100 shares by a specialist or market maker away from the NBBO is clutter, and it would only create counter data for quotes into the system. If the SEC thinks quotes should be included, then decide on a low percentage to use for income distributions, but the weight should be for actual trading and not for quotes.
Rewards: Using trades as the criteria, or majority criteria will reward execution points for executing orders. Rewards should not be given for partial executions, such as 100 shares on a 2000 share order. Rebates, if used, should go to all users and not just to the execution points.
Reports: All Plans should file public reports with the SEC for public access. The reports should disclose the cost to the Plans along with the key budgets for the next year. The users (professional, public, day traders, institutional, competing specialist/MM) will know what is planned for the next year. This disclosure should also provide the opportunity for comments by users. If the Plans had an oversight committee composed of the Plans and all classes of users, the comments should go to that committee. For example, a simplistic Oversight Committee could have 3 Plan members, 3 professional members (maybe a RR, a trader, and an IS person), 3 SRO members, 3 public members, and 1 day trader, which would provide for an odd number for voting on issues. Provide two year terms per person, so new people are appointed over time. But the first time allow half the people to serve three two-year terms, so everyone does not leave at the same time. Let the committee pick the 4-year and six year members. Allow anyone to be nominated by sending nominations to the committee, so a pool of potential members are available in case anyone has to leave the committee, or when members have to be replaced after their term limits. The SEC and SRO's can determine the responsibilities and authority of this committee.
Plan fee structures: Plans should determine (with the help of the Oversight Committee) how they could simplify and define their quotation charges.
Pilots: Pilot programs should be encouraged, both for end users and within Plans. Once a pilot is considered, then the information on the pilot should be published with the SEC, so anyone and everyone can comment.
It is usually seems impossible, due to the complexity and number of components involved in collecting and disseminating quotation information, but the K.I.S.S. principal should be remembered at all times when implementing changes to this subject.
Robert B. Sloan