Comments of Charles Schwab & Co., Inc. on SR-NYSE-2002-55

Charles Schwab & Co., Inc.

Electronically-filed version. Also sending hard copy by overnight mail.

January 22, 2003

Re: Release No. 34-47091; File No. SR-NYSE-2002-55

Dear Secretary Katz:

Charles Schwab & Co., Inc. ("Schwab") appreciates this opportunity to comment on the New York Stock Exchange's ("NYSE") proposed rule to establish and disseminate Liquidity Quotations. Schwab could not agree more with the NYSE that "the advent of decimal trading has resulted in many more price intervals which can be the best quote, with the result that the highest bid and lowest offer may not reflect the true depth of the market at prices reasonably related to the last sale." We applaud the NYSE's development of the Liquidity Quotation product, which, if readily and fairly available to all market participants, could represent a great advance in market transparency and efficiency. However, Schwab is concerned that this product will not be readily available to individual investors, and the NYSE has not made vital information about the terms on which this product will be available.¹ For these reasons, Schwab urges the SEC to withhold approval of the NYSE's rule proposal until both the SEC and the public have had sufficient time to consider its impact on transparency in our National Market System.

In particular, the NYSE's failure to provide a means to grant individual investors access to this critical data on reasonable and non-discriminatory terms is not consistent with the applicable standards mandated by the Securities Exchange Act of 1934. Similarly, the NYSE's decision not to include the Liquidity Quotations in, or allow its integration with, the consolidated quote (national best bid and offer or "NBBO"), and the NYSE's contractual restrictions on the display and redistribution of the data, also are inconsistent with the standards for a National Market System set forth in the 1975 Amendments to the Exchange Act.

A. NYSE Has Not Shown How the Liquidity Quotations Meets Exchange Act Requirements.

Schwab applauds the development of Liquidity Quotations, which could be the most significant development in listed market transparency in two decades. Under the proposal, NYSE specialists would show in their quotes additional depth (price and size) beyond the best bid and offer.² As the SEC's own data has demonstrated, in the post-decimal environment, quote depth at the NBBO has declined dramatically in the exchange-listed (as well as Nasdaq) market. As a result, in a post-decimal world, depth of book market data is necessary for all investors to gauge interest in the market before trading, and then to monitor whether they are receiving best execution.

Because the NYSE's proposal involves market data and therefore has implications for transparency, the NYSE is correct that implementation of the Liquidity Quotations must be consistent with Section 6(b)(5) as well as National Market System principles under Section 11A of the Exchange Act.³ However, market participants need analysis and support, however, for the NYSE's belief - stated in the release - that its proposal furthers those principles. The NYSE needs to show how it will make the Liquidity Quotations available to individual investors at a reasonable price. We are concerned that, by restricting through contract terms how the Liquidity Quotations may be distributed and displayed, the NYSE's proposal fails to meet the following standards under the Exchange Act:

"Fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets."
"The availability to brokers, dealers, and investors of information with respect to quotations for and transactions in securities."
"The linking of all markets for qualified securities through communications and data processing facilities [to] foster efficiency, enhance competition, increase the information available to brokers, dealers, and investors, facilitate the offsetting of investors' orders, and contribute to best execution of such orders."⁴

Any SRO rule proposal bearing upon quotations must be consistent with the purposes of the Commission's own National Market System rules, including the "Quote Rule"⁵ and the "Display Rule."⁶ The NYSE's proposal recognizes that it would alter the interpretation and application of those rules as applied to NYSE quotations. For example, the Liquidity Quotations would be a "firm" quote so that specialists and broker-dealers would not be able to back-away from them. Congress set forth the purposes of these National Market System rules in 1975, including:

"Assure the prompt, accurate, reliable, and fair collection, processing, distribution, and publication of information with respect to quotations for and transactions in such securities and the fairness and usefulness of the form and content of such information."
"Assure that all securities information processors may, for purposes of distribution, and publication, obtain on fair and reasonable terms such information with respect to quotations for and transactions in such securities as is collected, processed, or prepared for distribution or publication by any exclusive processor of such information acting in such capacity."
"Assure that all exchange members, brokers, dealers, securities information processors and, subject to such limitations as the Commission, by rule, may impose as necessary or appropriate for the protection of investors or maintenance of fair and orderly markets, all other persons may obtain on terms which are not unreasonably discriminatory such information with respect to quotations for and transactions in such securities as is published or distributed by any self-regulatory organization or securities information processor."⁷

The Liquidity Quotations could represent a significant advance in market transparency. Nevertheless, the NYSE's rule filing needs to cover the issues which have the most effect on the above National Market System principles and statutory requirements: how this data will be distributed, to whom it will be distributed, and what price NYSE will charge vendors, broker-dealers, and investors for the data. If as a result of this proposal, some market participants will receive the data but not others, then instead of enhancing transparency, the Liquidity Quotations will result in unfair advantage of some market participants over others. Such a result would violate the above Exchange Act standards. The SEC needs to assure itself that this is not the case. The SEC should require the NYSE to submit and justify its fee schedule and data contracts that pertain to the Liquidity Quotations for public notice and comment. Only then will the SEC have the basis for determining whether implementation of the Liquidity Quotations and their impact on individual investors and other market participants is fair, reasonable, and non-discriminatory.

B. The Commission Should Review the Overall Impact of NYSE and Other Recent SRO Market Data Proposals To Assure that the Public Interest Is Served.

In response to an advance comment letter filed by Bloomberg L.P. dated December 16, 2002 on the Liquidity Quotations proposal, the SEC reiterated its view that the contracts under which the NYSE distributes OpenBook, and will be distributing the Liquidity Quotations, includes "restrictions on vendor [and broker-dealer] redissemination and enhancement, integration or consolidation [which] are on their face discriminatory, and may raise fair access issues under the Act."⁸ It would seem that any restrictions imposed by the exchange affecting market transparency and the operation of the Quote and Display Rules that are facially discriminatory and result in the lack of fair access are matters of fundamental importance for the SEC to consider, if not resolve, before approving the exchange's proposal. It is therefore puzzling why the SEC's public notice for Liquidity Quotations goes on to state:

We do not believe that it is necessary to resolve the issue of whether the contracts need to be filed under 19(b) prior to publishing this proposed rule change for comment because the NYSE's proposal on liquidity quotations, like its previous proposal on the OpenBook service, does not include, and therefore does not seek approval of, the agreements to which the commenter objects.⁹

The SEC thus appears to be saying that, although the Commission's approval order for Liquidity Quotations may enable the NYSE to discriminate and deny fair access, because the NYSE has refused to submit for Commission review the very terms of its contracts that could have these discriminatory effects, the Commission need not consider them. This is contrary to the Commission's authority and responsibilities under Section 19(b) of the Exchange Act.¹⁰ As Bloomberg L.P. articulates in its December 16 letter, the terms under which the NYSE distributes and restricts Liquidity Quotations meet the definition of an SRO "rule." The Commission is the final arbiter of what is an SRO rule and what should be subject to public notice and comment and SEC review and approval.

The Liquidity Quotations proposal is only the latest example of how, through the piecemeal SRO rule filing and approval order process, the Commission may be inadvertently and fundamentally changing the National Market System without reviewing the overall impact of SRO actions.¹¹ The net effects of the NYSE's and other recent SRO actions is the creation of a two-tier market for data and transparency that includes a bifurcated quote and enables the exchanges to control and profit from market data products to subsidize their competitive activities¹²:

An "exclusive tier" that provides depth of book and quote information that everyone agrees is necessary to make our markets transparent today. NYSE (similar to Nasdaq with its QuoteView data products) by dint of monopoly position granted by SRO status, claims ownership over that quality data, although it is comprised of facts generated by broker-dealers and their customers. NYSE wants to control the price and methods of distribution of these facts and has withheld from Commission review the means that it will use to control the data: its vendor contracts (which broker-dealers like Schwab which distribute data to their customers must also sign) and fee schedule. The result will be that only large broker-dealers with the ability to reformat internally the exclusive top tier data will be able to take full advantage of the Liquidity Quote.
A "second tier" that will continue to consist of the NBBO without any depth of book information and without the ability to see where real interest in the decimalized market is beyond a few hundred shares. The NBBO will continue to exclude the data necessary to make informed trading decisions and monitor best execution. Despite the comparative lack of value of this information, broker-dealers and vendors, due to the Display Rule' requirements, will continue to have to purchase and distribute the NBBO to individual investors at arbitrary high prices.

* * * * *

The NYSE's failure to include a non-professional fee to enable individual investor access, and its restrictions on market data distribution appear discriminatory, anti-competitive, and contrary to National Market System principles. To assure that the Liquidity Quotations proposal meets the requirements of the Exchange Act, the SEC must first review the fee structure and the distribution restrictions, which are SRO "rules" within the meaning of the Act. The Commission should allow full public consideration of the impact of NYSE's proposal on market transparency and the Commissions Quote and Display Rules, especially the creation of a bifurcated quote for listed securities outside of the consolidated quote and National Market System Plans.

Accordingly, the Commission should postpone any approval and extend the notice and comment period after the NYSE supplements its filing to explain how this data will be distributed, to whom it will be distributed, and what price it will charge vendors, broker-dealers, and investors for the data.

Very truly yours,
W. Hardy Callcott

cc: Chairman Pitt
Commissioner Glassman
Commissioner Goldschmid
Commissioner Atkins
Commissioner Campos
Director Annette Nazareth
Deputy Director Robert L. D. Colby
Associate Director Alden Atkins
Chief Economist Lawrence E. Harris

____________________________

¹ Notice of Filing of a Proposed Rule Change by the New York Stock Exchange, Inc. Relating to the Dissemination of Liquidity Quotations, Release No. 34-4709, 68 Fed. Reg. 133 (Jan. 2, 2003) (Exchange's statement of purpose for rule change).
² NYSE's OpenBook makes some of the limit order information on the specialist's book available to institutions or others willing to pay a professional rate for the data feed, but does not affect the actual quote.
³ Id. (Exchange's statement of statutory purpose).
⁴ Exchange Act Sections 11A(a)(1)(C)(ii) & (iii), and (D) (emphasis added).
⁵ Exchange Act Rule 11Ac1-1.
⁶ Exchange Act Rule 11Ac1-2.
⁷ Id. at Section 11A(c)(1)(B), (C), and (D) (emphasis added).
⁸ Liquidity Quotations Notice, supra note 1, at footnote 4.
⁹ Id.
¹⁰ Moreover, the Commission in the past published such contracts for notice and comment and reviewed them as rules. See, e.g., Release Nos. 34-22851 and 34-28407.
¹¹ NYSE's OpenBook Service, as well as Nasdaq's QuoteView depth of market data products that are part of SuperMontage, have similar impacts.
¹² See comment letter dated December 20, 2002 from Charles Schwab & Co., Inc. regarding Release No. 34-46805, SR-PCX-2002-62 (observing that the exchanges' market data rebate programs subsidize exchange competitive activities and reflect excess monopoly rents, and requesting that the Commission analyze and regulate market data fees under Section 11A of the Exchange Act).