January 23, 2003
Ladies and Gentlemen:
Bloomberg L.P. ("Bloomberg")1 appreciates the opportunity to comment on the proposed rule changes filed by the NYSE relating to autoquoting price improvement on the NYSE and the dissemination of liquidity quotations (the "Liquidity Quote Proposal").
With the advent of decimalization, the NYSE quotation data currently made available to investors are inadequate and need to be expanded, particularly in view of the effects of decimalization on the market. For reasons discussed below, however, we believe the Commission cannot lawfully approve the Liquidity Quote Proposal without resolving problems that arise from the vendor agreements the NYSE proposes to use to restrict vendors in their dissemination of the liquidity quote data.
Decimalization has dramatically reduced the informational value of the best bid and offer and has made far more important to investors information about price depth above the best offer and below the best bid. The autoquote feature of the Liquidity Quote Proposal would significantly benefit investors because it would ensure the speed, accuracy and consistency with which price improvement is disclosed to investors. The fact that liquidity quotes will be "Xpressible", as described below, will reduce the specialist's ability to "penny" institutional order flow. All these effects will be beneficial and we believe the Commission should support the added disclosures the Liquidity Quote Proposal would bring to the market.
At the same time, however, the NYSE has built into its contracts with liquidity quote vendors restrictions on downstream use of the data that would significantly harm (i) other markets and trading facilities, (ii) market participants, particularly middle-market and smaller investors, and (iii) market-data vendors such as Bloomberg. These harms would be sufficiently serious that the Commission should not approve the Liquidity Quote Proposal until the NYSE has revised the purchaser contracts to eliminate these problems.
In a paper we delivered earlier to the Commission, a copy of which is attached,2 we outlined the anticompetitive effects of permitting monopoly market operators to integrate downstream and restrict access to the raw materials, i.e., essential market data. We pointed out also that the NYSE and other market operators should be able to enter the data-distribution market in competition with Bloomberg and others but should be allowed to do so only under conditions that prevent the market operator from taking improper advantage of its monopoly power and privileges as a market. While, as noted below, senior representatives of the NYSE have given us reason to believe that what we had been told earlier by the NYSE staff is not an accurate reflection of the policies the NYSE will in fact adopt in implementing the market data vendor contracts, we remain uncertain as to what the NYSE will in fact permit us to do with the liquidity quote data.
In light of what the NYSE had earlier given us to understand, we concluded that the Liquidity Quote Proposal is a glaring example of a government-protected monopoly with control over essential market data, using its monopoly to integrate downstream and compete with data vendors to the detriment of other market centers and investors. Those deleterious effects are anticompetitive, are not in the public interest, and are inconsistent with the statutory standards applicable to NYSE rulemaking. We are particularly troubled by the likelihood that the Liquidity Quote Proposal is but one of several initiatives it has in store for the market and that all will contain the same vendor restrictions.
The NYSE claims on its website that liquidity quotes are its proprietary informational product. In the Commission's open hearing on market structure held on November 12, 2002 in New York City, Chairman Pitt posed a key question to the panel participants regarding ownership of market data. He asked why the public should pay for market data when the public is not required to pay for the financial data provided by public companies in the Form 10-Ks they file with the Commission each year. The responses to Chairman Pitt's question are less important than the fact that the question itself was asked and is being considered by the Commission. The Commission, we believe, should have the widest latitude in addressing questions of the ownership of market data because answers to those questions will bear on other market structure issues.
The Commission should not accept the NYSE's assertions of ownership as a basis for allowing the NYSE to impose restrictions that do not serve the public interest and indeed contravene several policy choices the Congress built into the Securities Acts Amendments of 1975 (the "1975 Amendments"). As the Commission itself stated in its 1999 Concept Release on Regulation of Market Information Fees and Revenues, the Exchange Act trumps whatever property interests the NYSE may have under state law for market data:
Whether because of its misconception of its property rights, or for purely anticompetitive commercial reasons, the NYSE has concluded it should embed illegal, largely regulatory conditions in its market data vendor agreements. In our earlier comment letter to the Commission on the Liquidity Quote Proposal,4 we pointed out that the NYSE has embedded into its purchaser contracts provisions that should have been treated as proposed changes themselves for purposes of Commission review under Section 19(b) of the Securities Exchange Act of 1934 (the "Exchange Act"). We recommend that the Commission either require the NYSE to amend its filing to include the contracts as proposed rule changes or that, in any event, it consider the contractual limitations and their effects as relevant to the question whether the proposed rule changes are or are not consistent with the Exchange Act. We believe that the Commission cannot conclude that the Liquidity Quote Proposal, viewed in the context of these harmful contractual limits, is consistent with the Exchange Act. We respectfully submit that a Commission order approving the Liquidity Quote Proposal without requiring the NYSE to delete these harmful contractual provisions would be reversible as a matter of law.
We point out, however, that the NYSE very recently has given us some more encouraging indications. On Tuesday, January 21, 2003, we had a productive meeting with Robert G. Britz, the NYSE's president, co-chief operating officer and executive vice chairman, Catherine R. Kinney, president, co-chief operating officer and executive vice chairman, and Ronald Jordan, vice president, market-data products, to discuss our concerns about the restrictions imposed on us by the vendor agreement. This meeting followed earlier, less encouraging meetings with the NYSE technical staff. It was clear from our January 21 discussions that a major concern of the NYSE is that its data be "branded" and, if commingled or integrated, the NYSE liquidity quotes be explicitly displayed and branded. We discussed ways in which those concerns might be addressed and agreed to meet again to consider specific proposals. While no promises were made, the NYSE indicated that it would be willing to consider clarifications to its contract to address some of our concerns.
We will continue to discuss those matters with the NYSE, but given the comment deadline on the Liquidity Quote Proposal and a wide divergence between what we were told on January 21 and what we had been told earlier by the NYSE technical staff, we have drafted this letter without having a full understanding of what the NYSE will in fact permit and prohibit. We believe the Commission needs to assume that the application of the NYSE vendor contracts could be as deleterious as NYSE staff representatives had earlier led us to believe since, in the absence of a definitive determination to the contrary, the NYSE retains the power to allow its technical staff's position to stand. Should we reach a business agreement with the NYSE, moreover, this would certainly lessen, but would necessarily eliminate, the statutory concerns mentioned later in this letter, concerns that go to the heart of investor protection and the congressional goals for a national market system.
II. DESCRIPTION OF THE LIQUIDITY QUOTE PROPOSAL
As set forth in the Release, the NYSE proposes to display quotations, referred to as "liquidity quotes", that would reflect all trading interest represented in the highest bid and lowest offer (the "BBO"), as well as trading interest executable at prices down to (in the case of a liquidity bid) the liquidity bid price, or up to (in the case of a liquidity offer) the liquidity offer price. Liquidity quotes would aggregate size from orders on the specialist's book, from members in the crowd and from the specialist as dealer together with size at the BBO.
Under NYSE rules as amended, the specialist would not have to display a liquidity quote nor would there be a minimum or maximum depth a specialist might display in a liquidity quote. Both the price interval and the size of the liquidity quote would be at the specialist's discretion. Liquidity quotes could equal the BBO, but whether or not they did, they would be firm, real-time quotes and they would be eligible as XPress orders after 15 seconds of display.
III. COMMERCIAL IMPLICATIONS AND EXCHANGE ACT OBJECTIVES
As noted above, the Liquidity Quote Proposal is largely a response to decimalization. As described in the Release, the NYSE proposes to display and use quotations in stocks traded on the NYSE to show additional depth in the market for those stocks, thereby providing data essential for investors in a decimalized market. The fact that there now are 100 price points per dollar instead of the former eight (or sixteen) means that the data concerning trading interest above and below the national best bid and offer (the "NBBO") take on special significance. There is substantially less liquidity at the NBBO than there once was, given decimalization, and market information concerning trading interest at slightly inferior prices is at least as important, if not more important, than the NBBO itself. In a decimalized environment, the reported NBBO is effectively the tip of an iceberg that, when trading increments were at one-eighth, would have been more fully displayed. We believe the NYSE has correctly identified the problem, but its Liquidity Quote Proposal places the interests of the NYSE ahead of the interests of investors.
As noted above, we are uncertain as to just what the NYSE would permit and we are concerned that the Commission's approval of the Liquidity Quote Proposal would give the NYSE carte blanche to decide that issue on its own. In our meeting with representatives of the NYSE on January 21, 2003, we proposed to the NYSE various ways we and other data vendors might integrate and commingle NYSE liquidity quotes without diluting the NYSE "brand" and, at the same time, providing continuing attribution for its data. While our January 21 meeting was decidedly positive in many respects, and we remain hopeful that a useful accommodation can be developed, earlier meetings we had with the NYSE staff showed us a much different and more troublesome prospect.
In discussions held with technical staff of the NYSE before our meeting of January 21, 2003, we explored how the Liquidity Quote Proposal would work, in conjunction with the vendor contract, to prevent Bloomberg from combining the liquidity quote data with data from other markets and effectively prevent Bloomberg clients from employing Bloomberg analytics that would enable them to commingle NYSE liquidity quotes with data from other markets. These preliminary discussions largely confirmed our fears. We understood that the NYSE believes it essential to protect and preserve its "brand", a point made with equal force in our January 21 meeting. The NYSE staff notified us that the NYSE interprets its vendor agreements to permit data purchasers to use the data in whatever way they wish at their own sites and on their own computer facilities, but not to distribute the data to others in any format that would commingle the data with data from other markets, or with analytics that use the data. Bloomberg would be permitted to sell a package of analytics that would work on a user's own computer, but could not permit the user to tie into Bloomberg's own computer servers to manipulate the data or combine it with other data. The NYSE's technical staff has taken the position, in these discussions and in its Liquidity Quote Proposal, that it has the right to prohibit or condition commingling or integration of its data with data from other market centers.
On their face, the contractual restrictions cut against investor needs and the public interest and would, for example, prohibit Bloomberg from adding value to the liquidity quote data and would require a user to have sufficient computer capacity to store data that Bloomberg currently stores for the benefit of all its 170,000 terminal users. The economies of scale Bloomberg puts to work for its users would be defeated since each user would have to replicate at its own site, or not at all, the extensive computer resources Bloomberg today makes available at the click of a mouse.
We specifically asked the NYSE technical staff, in the meetings held before our January 21 meeting, whether we could make the following Bloomberg functionalities available to Bloomberg terminal users and were told that we could not:
The NYSE agreed at our January 21, 2003 meeting to give further thought to our proposals for commingling and integrating the liquidity quote data, but it would still be in their power to decide to revert to the positions taken by their technical staff. The current uncertainty as to just what would be allowed and not allowed, which is by no means elucidated in the NYSE's rule filing, is itself a cause for concern, particularly since it is highly relevant to the competitive impacts of the proposed rules on market participants and has a direct bearing on whether the Liquidity Quote Proposal is or is not consistent with the requirements of the Exchange Act.
If applied in accordance with what the NYSE staff had earlier told us, the vendor contracts would harm Bloomberg and other vendors that seek to add value in the form of analytics or data from other market centers. Bloomberg offers to its users the scale economies that derive from the extensive computer facilities we maintain and make available via the Bloomberg terminals. If a user had to establish and maintain its own facilities to replicate what Bloomberg itself does for its clients, or even to run on its own local computers programs purchased from Bloomberg or other vendors to achieve that result, the cost would likely be prohibitive. The NYSE agreements would force users to take that route, however, since Bloomberg would not be permitted to make its extensive computer facilities available to users to run analytics and prepare spreadsheets incorporating other market data, or historical data. As set forth in the Release, and coupled with the current contract that will govern dissemination and display of the data, the Liquidity Quote Proposal stands for the proposition that the NYSE reserves the right to prohibit commingling or integration of its data with data of other market centers. We respectfully submit to the Commission that this position is not supported by law and should not be adopted or approved by the Commission.
If the NYSE's primary concern is its "brand" and attribution of its data, its filing and its contract can and should be amended to address those issues in ways consistent with the goals of the 1975 Amendments and the national market system. To the extent the NYSE adheres to the position that it can prohibit commingling and integration of its data as a right, then properly understood, the Liquidity Quote Proposal is part of a strategy for using the NYSE's monopoly power to establish dominance in the downstream market for market data and analytics and to disadvantage, if not crush, its competitors. It is also a device for diverting the flow of orders in NYSE-listed securities away from other market facilities and restricting that order flow to the NYSE.
IV. THE NYSE'S COMMERCIAL INTERESTS AND THE PUBLIC INTEREST: CONGRESSIONAL POLICY IN THE 1975 AMENDMENTS
It is, of course, in the NYSE's commercial interest to maximize the value of its "brand". With that in mind, the NYSE seeks to avoid having its market information put next to market information from other trading venues that compete with the NYSE. If the NYSE were a private company that did not have a dominant market position secured by a government-protected monopoly, that commercial objective might be fair and appropriate. Under the Exchange Act, however, the NYSE is not permitted to pursue its private commercial interests in a way that harms the public interest and the interests of investors.
In addition to the harm the Liquidity Quote Proposal would do to Bloomberg and other similarly situated market-data vendors, it would directly harm investors. In the legislative history of the 1975 Amendments, the Congress underscored that its purpose in amending the Exchange Act was to put the public interest ahead of private interests and to prevent anticompetitive barriers from being put in the way of investors' access to information:
In the securities markets, as in most other active markets, it is critical for those who trade to have access to accurate, up-to-the-second information as to the prices at which transactions in particular securities are taking place (i.e., last sale reports) and the prices at which other traders have expressed their willingness to buy or sell (i.e., quotations). For this reason, communications systems designed to provide automated dissemination of last sale and quotation information with respect to securities will form the heart of the national market system. . . . The goals of [the SEC's] pervasive regulatory authority would be to insure the availability of prompt and accurate trading information, to assure that the communications networks are not controlled or dominated by any particular market center, to guarantee fair access to such systems by all brokers, dealers and investors, and to prevent any competitive restriction on their operation not justified by the purposes of the Exchange Act.5
The NYSE did not like what the Congress did to it in 1975. It continues to try to frustrate achievement of the congressional goals underlying the 1975 Amendments. In this current NYSE scheme, display of liquidity quotations would be governed by a contract with the same terms and restrictions as currently govern display of the NYSE's OpenBook data. In its order approving OpenBook, the Commission itself characterized such restrictions on vendor re-dissemination of OpenBook data as discriminatory on their face and noted that the restrictions also may raise fair access issues under the Exchange Act.6 We believe these restrictions undermine the effectiveness of the Commission's Quote Rule and Vendor Display Rule and are both anticompetitive and unfairly discriminatory, as we discuss below.
V. THE LIQUIDITY QUOTE PROPOSAL FRUSTRATES THE PURPOSES OF THE EXCHANGE ACT, THE QUOTE RULE AND THE VENDOR DISPLAY RULE AND IS INCONSISTENT WITH THE GOALS OF THE 1975 AMENDMENTS.
The Liquidity Quote Proposal, in the context of the vendor agreements, would harm other markets and market facilities. It would frustrate the purposes of the Exchange Act, as reflected in the Quote Rule and the Vendor Display Rule. The Quote Rule was designed to foster public disclosure and competition between and among markets. It requires a market such as the NYSE to disseminate to vendors its BBO, together with aggregated quotation sizes, but it does not reach bids and offers away from the BBO. The NYSE proposes to amend its Rule 60 to require that liquidity quotes be firm in compliance with the Quote Rule, but unless a liquidity quote is identical to the BBO, the NYSE will not have to disseminate it to vendors, as the Quote Rule requires for the BBO. In effect, the NYSE's proposal would give the Commission half of the Quote Rule by electing to post liquidity quotes as firm while relinquishing any obligation to disseminate them in a manner that is consistent with the Commission's clear intent. It would do so to further the NYSE's private, commercial objectives.
As the Commission knows, the Quote Rule works jointly with the Vendor Display Rule to ensure consolidation and dissemination of quotation data. The Vendor Display Rule was designed to ensure against discriminatory quotation and last-sale dissemination at a time when the market had been accustomed to having a separate NYSE ticker that did not include quotations and last-sale data from other markets. The Vendor Display Rule therefore requires market-data vendors that provide market data from a single market in a security to provide a consolidated display of information from all reporting market centers in that security, with an indicator showing the markets whose data are displayed, with at least equal ease of access on the desktop (e.g., same number of key strokes). Specifically, if a vendor provides quotation information for any stock traded on an exchange or Nasdaq, it must also provide either (a) the NBBO for the stock, or (b) a quotation montage for the stock from all reporting market centers. If a vendor provides transaction reports or last-sale data for any exchange-traded or Nasdaq stock, it must also provide the price and volume of the most recent transaction in that stock from any reporting market center, as well as an identification of that market center.
While the Vendor Display Rule requires consolidated information only with respect to the NBBO, it was adopted in an eighth-point environment, one in which there were eight price points to the dollar. As noted above, in today's decimalized market where there are 100 price points per dollar, the NBBO is much less important than it was and the quotations priced at several cents up and down are as important to traders as the NBBO once was. The importance of displaying liquidity quotes, as proposed by the NYSE, is augmented by the fact that, after 15 seconds of display, the liquidity quote will become "Expressible", that is, NYSE members will be able to execute directly against the liquidity quotes without going through the usual NYSE "auction market" mechanism. In so doing, the members will by-pass the specialist and avoid being "pennied" or broken up by the specialist. That advantage will make immediate access to liquidity quotes essential for the professional trader.
The Liquidity Quote Proposal, in conjunction with the NYSE's vendor agreement, not only weakens the Quote Rule but also undermines the effectiveness of the Vendor Display Rule. As noted above, the contract governing the display of liquidity quotes prohibits quotation vendors and their customers that use their analytics from commingling the NYSE data with the data from other markets in a single consolidated display. That prohibition cuts against the purposes of the Vendor Display Rule and improperly puts the NYSE's objective of protecting its "brand" ahead of the investors' interests in seeing arrayed against one another trading opportunities presented by different market centers. The SEC staff has made the point forcefully in a letter to Nasdaq concerning Nasdaq's SuperMontage and the proposed Alternative Display Facility (the "ADF") that such juxtaposition is an essential goal of the Vendor Display Rule:
Although Market Regulation's interpretive letter applies specifically to Nasdaq, it provides a clear statement of the policy the Vendor Display Rule is intended to effect, that is, the dissemination of consolidated market data. The Liquidity Quote Proposal, however, would reduce the dissemination of essential market data by uncoupling the Quote Rule from the Vendor Display Rule. Furthermore, the contract governing the display of NYSE liquidity quotes expressly prohibits vendors and their customers using their analytics from constructing a consolidated display of quotation data above and below the BBO and, if approved, would frustrate essential policies and goals of the 1975 Amendments.
The Commission adopted both the Quote Rule and the Vendor Display Rule in response to the direction from the Congress in Exchange Act Section 11A, added by the 1975 Amendments, "to use its authority under this title to facilitate the establishment of a national market system for securities."8 Central to the goal of establishing a national market system is "the availability to brokers, dealers, and investors of information with respect to quotations for and transactions in securities."9 In the decades since the enactment of the 1975 Amendments, fundamental changes in market structure have altered the landscape: the advent of decimalization, the technological advances that have led to the rise of alternative trading systems, the proposed privatization of exchanges and the development of Nasdaq Inc.'s Alternative Display Facility (the "ADF"). The recent open meetings on market structure issues conducted by the Commission clearly underscored the need to address these developments in the Commission's regulation of the markets.
The Quote Rule and the Vendor Display Rule probably should be revised in light of decimalization.10 The Commission need not await those updates, however, to evaluate NYSE rulemaking in light of the congressional objectives the Quote Rule and the Vendor Display Rule were intended to serve. Indeed, the Commission has a duty to do so in light of the requirement in Exchange Act Section 6(b)(5) to ensure that Exchange Act rules promote and not frustrate the objectives of free and open markets and a national market system, as further explained in Exchange Act Section 11A.
These issues can and should be addressed in assessing the Liquidity Quote Proposal. When coupled with the NYSE's restrictive vendor agreement, we believe the Liquidity Quote Proposal would be a significant step backward, undoing the fundamental policy goals of the 1975 Amendments by permitting dissemination of essential market data in a display format governed not by the clear mandate of the 1975 Amendments but by the terms of an unduly restrictive and discriminatory contract. We respectfully suggest the congressional directive in Exchange Act Section 11A requires that the Commission not approve the Liquidity Quote Proposal unless the restrictive provisions of the vendor agreement are stricken.
VI. THE LIQUIDITY QUOTE PROPOSAL IS ANTICOMPETITIVE AND UNFAIRLY DISCRIMINATORY.
The Liquidity Quote Proposal is anticompetitive and unfairly discriminatory. While it purports to address the needs of investors for greater depth of market data in a decimalized market, it advances the interests of a single market at the expense of other markets and a national market system and restricts the dissemination and display of essential trading data in ways that favor certain groups of market participants over others. Quite simply, the Liquidity Quote Proposal fails to conform to elementary requirements of the Exchange Act.
Exchange Act Section 11A(c)(1)(C) sets forth the congressional policy that all securities information processors should be able to obtain information with respect to quotations and transactions for purposes of distribution and publication on fair and reasonable terms. The terms the NYSE proposes to impose on vendors restricting the use and redistribution of NYSE liquidity quotes are neither fair nor reasonable. They provide that recipients of the data feed that externally redistribute liquidity quotes must do so only in the window format prescribed by the NYSE. In addition, they expressly prohibit vendors, broker-dealers and their customers using the vendors' systems' analytics from making any enhancements to the content or format of the liquidity quote display, including data from other markets, to create a more useful product. In effect, the NYSE's terms and conditions for NYSE's liquidity quotes would turn vendors and broker-dealers into captive distributors.
Exchange Act Section 11A(c)(1)(B) establishes the policy that a self-regulatory organization should distribute information with respect to quotations in such a manner as to assure the prompt, accurate, reliable and fair collection, processing, distribution and publication of information with respect to quotations for and transactions in such securities. Self-regulatory organizations must also assure the fairness and usefulness of the form and content of such information. Exchange Act Section 11A(c)(1)(D) in turn shows that exchange members, brokers, dealers, and securities information processors should be able to obtain information with respect to quotations for and transactions in securities on terms that are not unreasonably discriminatory.
The Liquidity Quote Proposal, in conjunction with the vendor contracts, would discriminate between and among users of the data, permitting data enhancement by those who have the in-house facilities to do so for their own use, but prohibiting vendors such as Bloomberg from conducting the data enhancements in a central facility. That fundamental discrimination would permit certain subscribers to enhance and adapt liquidity quotes by consolidating NYSE liquidity quotes with information available from other market centers for internal distribution. At the same time, the NYSE OpenBook and Liquidity Quote contract would expressly prohibit comparable adaptations and uses for other classes of subscribers.
There is no reasonable basis for depriving one class of investors of a level and quality of market data needed by all investors to make fully informed investment decisions. The difference in treatment of the classes of subscribers under the Liquidity Quote Proposal contravenes the policy in Section 11A(c)(1)(B) in that it impairs both the usefulness and fairness of the form and content of the NYSE's liquidity quote data for users and is inconsistent with Section 11A(c)(1)(D) in that it is unreasonably discriminatory.
The NYSE's contractual limitations on vendors not only would impose burdens on competition between the NYSE and other markets that trade or would trade in the same securities (e.g., Nasdaq), but also would result in a competitive disadvantage to the middle-market and small trading firms and individual investors as well.11 As noted above, the NYSE contract prohibits data vendors such as Bloomberg from integrating data from other market centers, as well as data analytics, into the NYSE data stream, but does not prevent certain end-users from doing so. As a result, large end-users (e.g., Fidelity, Merrill Lynch) may well be able to develop or buy for their own use programs to do what Bloomberg and other information vendors are prohibited from doing. As a result, the large market participant will have a competitive edge over the small to medium-sized participant, which lacks the resources to replicate those programs, and instead relies on Bloomberg and others, with their economies of scale, to put them on an equal or mostly equal plane with the "big boys". In addition, to the extent vendors cannot provide commingling of data to their large end users, vendors risk losing their business. In effect, this prohibition places the NYSE in direct competition with data vendors on an unequal playing field.
The NYSE's liquidity quotes constitute a facility of an exchange as defined in Exchange Act Section 3(a)(2)12 and therefore a review of the Liquidity Quote Proposal by the Commission is subject to the standards of Exchange Act Section 6(b). The Liquidity Quote Proposal is unjustifiably anticompetitive, in contravention of Exchange Act Section 6(b)(8). Exhibit C of the NYSE agreement states, in relevant part, that vendors:
Perhaps the NYSE's unstated concern in imposing such restrictions is that other exchanges, dealers, or market venues might find the NYSE liquidity quotes a useful tool for making markets in NYSE-listed stocks. The NYSE might also fear that these potential competitors would prepare a quotation montage that would diminish the time-and-place advantages NYSE floor members enjoy and would provide for comparison shopping of NYSE prices against the prices available elsewhere. These possibilities suggest that one purpose to the contractual restrictions on the integration and display of liquidity quotes is to limit the potential diversion of order flow in NYSE-listed securities to any market venue other than the NYSE.
Efforts by the NYSE to prevent "leakage" of order flow are by no means a new phenomenon. Almost 60 years ago, in the Multiple Trading Case, the Commission held that the public policy under the Exchange Act voided a rule of the NYSE that purported to prohibit NYSE members from routing orders in NYSE-listed securities to the regional exchanges.13 Later, when the NYSE tried to impose a "Public Limit Order Protection Rule" (the "PLOPR") that would have required its members to clear limit orders on the NYSE specialists' books before taking orders to regional exchanges, the Commission once again objected and entered disapproval proceedings under the Exchange Act.14 In the latter case, the Commission was unpersuaded by the favorable market impacts the NYSE argued would arise from its proposed rule. In the order commencing proceedings to consider disapproval of the PLOPR, the Commission stated that the fact that an NYSE proposed rule change would limit the ability of member organizations to effect transactions on other market centers within the United States was, per se, a ground for disapproval of the proposed rule change.15 As in the Multiple Trading Case, the NYSE's arguments about the need to have the PLOPR to promote market integrity and customer protection were irrelevant to that basic statutory issue.
More recently, in connection with its consideration of proposed amendments to NYSE Rule 92, the Commission determined that the NYSE should not be allowed to apply its rule to other marketplaces, which the NYSE had sought to do to prevent other markets from adopting more liberal trading standards than the NYSE was prepared to allow.16 Finally, it was only very recently that the NYSE rescinded its longstanding, anticompetitive Rule 390, which sought to stem the erosion of order flow to the third market.17
If the Commission were to approve the Liquidity Quote Proposal, it would permit the NYSE to put ECNs, the regional exchanges and other market venues at a competitive disadvantage for establishing markets in NYSE-listed securities. Putting roadblocks in the path of competing market centers would restrict their ability to attract order flow and would have anticompetitive market effects similar to those the Commission previously condemned in the cases referred to above. In today's trading environment, the SEC should strive for market consolidation on the desktop, that is, the bringing together on the trader's desktop of information from all market venues. The NYSE has continually tried to exclude other market centers, particularly the over-the-counter market. The SEC made the NYSE get rid of off-board trading rules, but the NYSE is once again trying to leverage its monopoly position to preclude the possibility that Nasdaq, the ADF and the regional exchanges will offer meaningful competition to the specialists on the NYSE floor. The Liquidity Quote Proposal is, effectively, the successor to Rule 390. The SEC should prevent the NYSE from achieving that anticompetitive objective and should strive to promote an environment in which traders and other investors can see in a usable format as much information as can be gathered together concerning trading opportunities.
As the Commission knows, Exchange Act Section 6(b)(5) provides that NYSE rules must "remove impediments to and perfect the mechanism of a free and open market and a national market system . . . and [must] not [be] designed to permit unfair discrimination between customers, issuers, brokers, or dealers . . . ." Section 6(b)(8) provides that an NYSE rule must "not impose any burden on competition not necessary or appropriate in furtherance of the purposes of [the Exchange Act]." In the NYSE Liquidity Quote Proposal, the NYSE states that "[t]he Exchange does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act."18 That rote incantation of the statutory standard in Sections 6(b)(5) and (8) is unsupported by any discussion and indeed is contradicted by the facts. The NYSE's formulaic response does not satisfy the requirements of the Commission's Form 19b-4 that such burdens be explained and justified in detail.19 As the Commission is aware, moreover, the courts have applied strict scrutiny to rule filings that do not meet statutory standards. The scope of this obligation is explained in Timpinaro v. SEC,20 in which the U.S. Court of Appeals for the District of Columbia Circuit remanded an SEC-approved rule to the Commission for failure to substantiate its belief that the rule would achieve the desired objective.21
In a context where the competitive impacts of an NYSE rule proposal are certain to be trivial, an elaborate discussion is not warranted. That is not the case here, however. The NYSE's statements do not elucidate the issue and, as a result, the NYSE's filing does not provide a sufficient basis for the Commission or the public to evaluate the rule change.22 In this case, the NYSE has submitted a proposal that would have substantial impacts on the ability of market-data vendors to compete with the NYSE in the provision of market data and the development of market-data applications. It would confer an unfair information advantage on one group of investors over another. It would also adversely affect the ability of brokers, ECNs and other market venues to compete with the NYSE for order flow in NYSE-listed securities. Given the significance of the issues raised by the NYSE's Liquidity Quote proposal, it is vital that there be a meaningful opportunity for public comment to guide the Commission in determining whether to allow these rule changes. The NYSE Liquidity Quote Proposal enhances the monopoly power of the NYSE over the dissemination of market data by imposing significant restraints on the ability of market-data vendors with whom it contracts to modify or redistribute the NYSE's market-depth data in useful and innovative formats.
The anticompetitive aspects of the NYSE Liquidity Quote Proposal are of particular public importance in light of the market power the NYSE has as a de facto exclusive processor of securities information with respect to its limit-order data. In evaluating the NYSE's proposed rule, including the governing contracts, and the burdens they would place on access to facilities of the NYSE the Commission should apply the standards of Section 6(b) with the same rigor as it would evaluate proposed fees by exclusive securities information processors regulated as such. 23 The Congress, in enacting the 1975 Amendments, warned particularly against possible abuses of market power by exclusive processors:
The Committee believes that if economics and sound regulation dictate the establishment of an exclusive central processor for the composite tape or any other element of the national market system, provision must be made to insure that this central processor is not under the control or domination of any particular market center. Any exclusive processor is, in effect, a public utility, and thus it must function in a manner which is absolutely neutral with respect to all market centers, all market makers, and all private firms. Although the existence of a monopolistic processing facility does not necessarily raise antitrust problems, serious antitrust questions would be posed if access to this facility and its services were not available on reasonable and nondiscriminatory terms to all in the trade or if its charges were not reasonable. Therefore, in order to foster efficient market development and operation and to provide a first line of defense against anti-competitive practices, Sections 11A(b) and (c)(1) would grant the SEC broad powers over any exclusive processor and impose on that agency a responsibility to assure the processor's neutrality and the reasonableness of its charges in practice as well as in concept [emphasis added].24
VIl. THE LIQUIDITY QUOTE PROPOSAL MUST BE EVALUATED IN LIGHT OF ALL RELEVANT FACTS AND CIRCUMSTANCES, INCLUDING THE VENDOR CONTRACTS.
For the reasons set forth in our December 16, 2002 comment letter, we believe the Commission should not allow the NYSE to embed improper limitations into contracts, rather than treat them as part of the rulemaking process, and thereby to evade the scrutiny and regulatory jurisdiction the Congress intended the Commission to exercise.25 We believe, however, that the Commission could vindicate the Exchange Act objectives in an alternative fashion if it wished to avoid characterizing the vendor contracts as rules.
The Commission could instead conclude that it cannot review and approve the Liquidity Quote Proposal in a vacuum, that is, without considering the context in which these rules will operate. The Commission has previously said that it must review a proposed rule change not only in light of the rule itself but also in light of its interplay with other practices of an exchange or other self-regulatory organization. In other words, the Commission need not confine itself to the words on the page in reviewing a rule, but may and should instead make a searching inquiry of the facts and circumstances and make a predictive judgment about the burdens on competition and other effects that would likely ensue if the rule were put into effect.26 The Commission need not approve a rule change that, in conjunction with other stated practices, interpretations, contracts, or other aspects of a self-regulatory organization's operations, contravenes important Exchange Act purposes, as the Liquidity Quote Proposal, viewed in conjunction with the vendor contracts, surely does in this instance.
We note that the fees the NYSE proposes to charge for access to Liquidity Quote data on a real-time basis are approximately equal to the fees the NYSE currently charges for access to all other NYSE market data on a real-time basis, about $50 a month per user. Particularly given what we expect would be the severe disadvantage an investor would suffer if these data were available to others but not to him or her, we expect the NYSE would collect large amounts of tribute from investors, member firms and others if these fees went into effect. For example, we believe these fees, which would equal $50 per month and $600 per year for each internal computer terminal (and would not apparently depend on whether the data were received on a delayed or real-time basis) would effectively double the average fees investors pay today for NYSE real-time data (they do not pay anything for delayed NYSE data) if the investors subscribe for liquidity quotes. Since decimalization has reduced the value of the existing BBO data, the investors would effectively be paying twice to receive information equivalent in economic value to what they used to receive before decimalization. Also, the $5,000 monthly per-site fee ($60,000 per site per year) will add up to large sums from the several thousand subscribers we anticipate will have to pay this fee. In its comment letter on Open Book, Charles Schwab & Co., Inc. observed that they "would be required to pay the NYSE an annual fee of $300 million just to make OpenBook information available to half a million of our online customers, a small percentage of our total online accounts."27
We believe Liquidity Quote will likewise result in substantially increased costs to the market. We recommend that the Commission evaluate whether these fees have any justification at all on the basis of cost or other factors since they will be exceedingly burdensome on our clients and investors generally.
The Liquidity Quote Proposal, in the context of the vendor contracts, represents a step backward. It participates in the tradition of NYSE Rule 390 and other efforts by the NYSE to stifle trading in NYSE-listed securities on other markets and market facilities. It would harm those markets and market facilities, middle-market and small trading firms and individual investors and would harm data vendors such as Bloomberg. The NYSE would use its powers as a government-protected monopoly to damage potential competitors in the provision of market facilities and investors themselves. It is inconsistent with the policies enunciated by the Congress in the 1975 Amendments and contravenes Exchange Act Sections 6(b)(5) and 6(b)(8) by imposing obstacles to a free and open market and a national market system and by imposing unnecessary and inappropriate burdens on competition.
Through the governing contracts, the NYSE asserts an ownership right to real-time data necessary for trading in a decimalized environment and would impose rules governing access to an essential facility of an exchange. The contracts limit access to essential market data by dictating the format of display of the data and by prohibiting integration of NYSE data with data from other markets. There is no public policy justification for allowing the NYSE to limit the downstream use of these data or to limit the technology that can be brought to bear to make these data useful to investors.
The limitations the NYSE would impose on these data would affect the public in deleterious ways. They would diminish competition between the NYSE and other market centers. They would impose costs on the downstream user that would discriminate unfairly against the middle-market and smaller investor or other market participant, who would be denied the advantages of economies of scale that Bloomberg and other vendors today bring to these market participants.
The Liquidity Quote Proposal, together with OpenBook, advances the private commercial objectives of the NYSE, but does not advance the public interest or the protection of investors. The proposal would rely on governmental approval to permit the NYSE to leverage its position as a government-protected monopoly to integrate downstream of the NYSE into the market for financial data. The proposal runs counter to the interpretive guidance on the Vendor Display Rule that the Division of Market Regulation issued to Nasdaq. Finally, the proposal undermines the goals of the 1975 Amendments. The fees the NYSE proposes to charge, moreover, bear no relation to the cost of providing the Liquidity Quote data and are oppressive. As noted above, we believe a Commission order approving the Liquidity Quote Proposal without curing these problems would be reversible as a matter of law.
We believe the Commission has the authority to require the NYSE to amend its Liquidity Quote Proposal to include in its filing copies of the OpenBook contracts and proposed Liquidity Quote contracts that will govern and limit access to the NYSE's liquidity quotation data. At a minimum, we respectfully suggest that the Commission should not now shut its eyes to what well may be the effects of those contracts, but should decline to approve the proposed rule changes until the objectionable provisions are removed. To that end, we recommend that the Commission seek clarification from the NYSE as to exactly what its vendor contracts permit and prohibit.
We believe the Commission should insist that the NYSE now publish those clarifications, as well as a cost-based justification for the fees it proposes to charge, in an amendment to its filing before the Commission acts on the Liquidity Quote Proposal.28 We believe the Commission should then afford the public an opportunity to make further comment.
cc(w/att): The Hon. Harvey L. Pitt