March 14, 2001
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Attention: Mr. Jonathan G. Katz
Re: SEC File No. SR-NASD-99-65
Ladies and Gentlemen:
Bloomberg L.P. ("Bloomberg") 1 appreciates the opportunity to submit its comments on Amendment No. 4 to TRACE in response to the request by the Securities and Exchange Commission (the "Commission" or the "SEC") in Securities Exchange Act Release No. 43873 (January 23, 2001), in which the Commission has approved the TRACE proposal (the "Approval and Amending Release"). The TRACE proposal was originally submitted by the National Association of Securities Dealers, Inc. (the "NASD") through its wholly owned subsidiary, The Nasdaq Stock Market, Inc. ("Nasdaq"), in Securities Exchange Act Release No. 42201 (December 3, 1999). The NASD filed Amendment Nos. 2, 3 and 4 to its proposed rule change relating to the elimination of Nasdaq's Fixed Income Pricing System and the creation of a corporate bond Trade Reporting and Comparison Entry Service (referred to herein as "the TRACE proposal") in Release No. 43616 (November 24, 2000). Under both the original TRACE proposal and the TRACE proposal as amended by Amendment Nos. 2 , 3 and 4 and approved by the Commission, the NASD would establish a mandatory trade reporting and dissemination facility for corporate bonds. In a letter to the Commission commenting on the original TRACE proposal, Bloomberg opposed TRACE because it represented a bid by a market competitor for an exclusive franchise over trade reporting in corporate debt securities.2 In a subsequent letter to the Commission commenting on Amendment Nos. 2 and 3, Bloomberg continued to oppose the TRACE proposal and concluded that the amendments offered by the NASD did not change the fundamental character of the original TRACE proposal.3
Both the NASD, in its letter filed with the Commission in response to comments critical of Amendment Nos. 2 and 3 to the original TRACE proposal (the "Response Letter"),4 and the Commission, in the Approval and Amending Release, attempt to address the criticism that TRACE, as proposed, would be a monopoly collector and disseminator of bond trade data that would impose unnecessary burdens on competition. It is evident that both the NASD and the Commission agree with us that these have been and remain the principal concerns with TRACE and we acknowledge the effort they have made to discuss and justify the burdens that TRACE will impose on competition. While it is clear in the Response Letter and in the Approval and Amending Release that both the NASD and the Commission believe that TRACE, as amended and approved, is the least anti-competitive means for gathering and disseminating bond trade data and that TRACE will foster rather than hinder competition, it is not clear to us on what bases the NASD or the Commission has drawn its conclusions.
The Key Elements of TRACE as Approved and Amended. As the TRACE system is described in the Approval and Amending Release and the Response Letter, its key elements appear to be as follows:
Will TRACE Foster Competition? Both the Commission and the NASD state that TRACE, as approved and amended, will not be a monopoly and will foster rather than stifle competition. Given the description of TRACE in the Approval and Amending Release, it is not clear how the Commission and the NASD have arrived at their conclusions. The following are the principal arguments advanced by the Commission in the Approval and Amending Release in support of its position and what we respectfully suggest are unresolved issues with respect to those arguments:
Argument 1. The Commission argues that giving control over TRACE to the NASD, in lieu of Nasdaq, addresses the criticism that it would have been anti-competitive for Nasdaq to have the exclusive right to market bond trade data.
Concerns. The fact that TRACE is owned and operated by the NASD instead of Nasdaq does not make TRACE any less a monopoly. In addition, there is no indication in the Approval and Amending Release that the NASD will solicit open bidding for the technology service provider for TRACE. Instead, the NASD has stated that it will award what is apparently an exclusive contract to Nasdaq to act as its vendor of information-processing services for TRACE. As a result, having the NASD rather than Nasdaq control TRACE will not resolve the anti-competitive concerns previously raised by Bloomberg and other commenters.
Argument 2. The Commission states that the TRACE rules do not prevent intermediaries from collecting bond trade data from NASD members for transmission to the NASD.
Concerns. It is not clear that NASD members would have any incentive for submitting the required data through intermediaries rather than submitting the data directly to the NASD. Even if NASD members were to provide required data indirectly to the NASD, via intermediaries, it is not clear how this act of transmission by an intermediary would foster competition, since the NASD ultimately will be the final and sole repository of the bond trade data that members are required to report. Neither the Commission nor the NASD provides a basis for concluding that TRACE will foster any competition in the collection of bond trade data.
Argument 3. The Commission states that information vendors that receive bond trade data from NASD members will be free to offer unconsolidated information products in direct competition with the NASD. In addition, the Commission suggests that some of the data to be made available to other data collectors will include data unavailable to the NASD, thereby making the unconsolidated data collected by these intermediaries competitive with, or more valuable than, the NASD's unconsolidated data.5
Concerns. The Commission does not make clear in the Approval and Amending Release on what basis it foresees a competitive market in unconsolidated data. It is not clear why NASD members would have an incentive to make such additional data available to vendors, and, if they do, how this, in and of itself, would lessen the economic impact of the NASD's monopoly in collecting data and in distributing consolidated data. The Commission does not explain why anyone would prefer to buy unconsolidated data instead of consolidated data.
Argument 4. The NASD says that it will not sell unconsolidated data and the Commission appears to say that the NASD will distribute its unconsolidated data, evidently free of charge.
Concerns. Neither the Response Letter nor the Approval or Amending Release defines "unconsolidated data"; it is unclear how much of the data collected by TRACE is included in the term "unconsolidated data". The NASD does not explicitly state that it will distribute unconsolidated data for free, nor does it state that it will not enhance unconsolidated data with analytics and compete directly with data vendors if there is a market for such data. That leaves open the possibility that the NASD could dominate any potential market in unconsolidated data.
Argument 5. The NASD states that it will limit sale of consolidated data to broker-dealers and data vendors, and that it will not sell consolidated data to end users other than broker-dealers.
Concerns. The points made, while apparently true, do not resolve the monopoly issue. As the sole distributor of consolidated data to broker-dealers and vendors, the NASD would be a monopolist. The broker-dealers are themselves the principal market for the consolidated data and it may be expected that, having bought the data from the NASD, the broker-dealers will redistribute the data to their institutional customers. Withdrawing from the end-user trade would not create competition with the NASD, which would remain a monopolist in the most important segment of the data distribution market. The NASD does not state, moreover, that it will not provide consolidated data for free on its own website. In effect, since it receives its data from its members for free, the NASD can afford to make consolidated data available free of charge on its website to nourish the competitive posture of the website and to compete in the end-user market with data vendors that have paid for the consolidated feed they receive from the NASD.
The NASD Does Not Justify Burdens on Competition Imposed by TRACE. In its Response Letter, the NASD states that the TRACE proposal, as amended by Amendment No. 4, imposes no burden on competition not necessary and appropriate in furtherance of the purposes of the Act. The NASD has not provided an adequate basis for its conclusion. The following are the statements that the NASD makes in the Response Letter in support of its conclusion:
Point 1. The NASD states that the amended TRACE proposal allows for competition in the collection of trade reports.
Response. As noted above, NASD members are required to report bond trade data to the NASD except that the rules would exempt from the mandatory reporting requirement trades where: (i) the security involved in the trade is listed on a national securities exchange; (ii) the trade is executed on that exchange or another exchange; and (iii) the trade is reported to a national securities exchange. The reason for the exclusion of exchange trades, which in effect might appear to be an anticompetitive agreement to divide the bond trade data markets, is not apparent and has not been explained in the Approval and Amending Release or any other Commission release concerning TRACE. There is no basis, in any event, for concluding with respect to over-the-counter trades that members would have any reason to report the required data to the NASD through intermediaries and, even if they did, how that would create competition. As a result, it can only be wondered whether the possibility for competition in the collection of trade reports is anything but illusory.
Point 2. The NASD states that its role under TRACE is limited to consolidating trade reports for regulatory purposes.
Response. In fact, the evidence indicates that the NASD will be the sole consolidator of bond trade data and will consolidate the data for commercial purposes as a source of monopoly rents.
Point 3. The NASD states that it will sell the consolidated data only to broker-dealers and data vendors and that it will not sell consolidated data to end users other than broker-dealers.
Response. As noted above, the market sector the NASD would monopolize would appear to be the most important market for consolidated data. The NASD provides no data or other information that would suggest that the revenue it would forego by not competing with its members in data distribution to end users would be significant. In the equity markets, many brokerage firms supply real-time data to their customers for free. The lack of any substantial foundation for its position leaves open a number of possibilities, among them that the NASD has decided to abandon the market for distribution to end users because it anticipates the market will not be large or that it can only be serviced at a loss or, as noted above, that the NASD plans to make its monopoly consolidated data available for free on its website to nourish the competitive posture of the website and to compete in the end-user market with data vendors that have paid for the consolidated feed they receive from the NASD. In addition, the NASD has not indicated whether it will add analytics to the consolidated data, thereby further diminishing competitive opportunities for any other business enterprise to compete with it.
The Record to Date Does Not Give the SEC a Legally Sufficient Basis for Approving TRACE. The NASD has failed to provide a legally sufficient basis on which to find that the burdens on competition imposed by new rules are permissible. We note that in addition to its customary incantation, that the NASD does not believe the TRACE proposal would impose any burdens on competition that are not necessary or appropriate in furtherance of the purposes of the Exchange Act, the NASD has now added a further ipse dixit statement to the effect that it believes the TRACE proposal is the least anti-competitive means to achieve the objectives of the TRACE proposal.6 Meeting the standard imposed by Section 15A(b)(9) and the Commission's Form 19b-4 (Item 4), however, is not a matter of making unsubstantiated assertions. As the Commission notes in its Form 19b-4, a self-regulatory organization's statement concerning burdens on competition "should be sufficiently detailed and specific to support a Commission finding that the proposed rule change does not impose any unnecessary or inappropriate burden on competition."7 The NASD has not complied with that requirement in this rule filing.
As a matter of law, the NASD's failure to provide adequate information concerning the competitive burdens TRACE would impose has deprived the public of an adequate basis to comment on TRACE and Amendment No. 4 and deprived the Commission of a legally sufficient basis for approving TRACE or Amendment No. 4. For a fuller discussion and analysis of the applicable law with regard to the Commission's rulemaking, please see Bloomberg's letter to the Commission, dated September 12, 2000, commenting on the SuperMontage proposal at pages 15 through 21, which is incorporated herein by reference.8
In addition, the Approval and Amending Release is marked by other procedural deficiencies. The Approval and Amending Release does not include a publication of the complete TRACE rules, nor does it contain a clear statement and explanation of the operation of TRACE, including the specifications or system requirements for TRACE. Such deficiencies deprive NASD members and other commenters of the kind of description of the TRACE facility that is necessary to an informed assessment of the NASD's proposal and a meaningful comparison with the alternatives.
In view of these several deficiencies, we believe the Commission lacks a legally sufficient basis to approve the proposed rule change and that an order approving it would be reversible as a matter of law.
Fees: Good Costs versus Bad Costs. We gather that it is not intended that the NASD will charge fees to those who provide data to the NASD for its TRACE system. Fees will be charged only for consolidated data emerging from TRACE. The fees for that data will of course be derived from the NASD's consolidation monopoly and the SEC should strictly regulate them as such.
In the Response Letter, the NASD states that it expects to partially recover its costs of regulating the bond market through TRACE fees. We urge the Commission to adopt a cost-based approach to setting TRACE fees that is based solely upon the true and necessarily incurred costs of consolidating the market data it receives in its capacity as a data consolidator, and not any other costs. As part of its rate-setting function, we urge the Commission to apply standards customarily applied by state public utility commissions in evaluating whether rates monopoly utilities charge are fair and reasonable (or "just and reasonable" as some state statutes describe). To that end, we recommend that the SEC require the NASD to file annually with the Commission and make available to the public financial statements related to TRACE, audited on the basis of regulatory accounting principles established by the Commission.
We note that the NASD continues to propose loading onto its monopoly data fees its costs of regulating the bond market and we urge that those costs not be part of the permitted rate base. There is no indication in the available financial data for the NASD that indicates that the NASD's current profits, independent of market data fees, are insufficient to fund its regulatory obligations. In addition, permitting the NASD to factor its regulatory costs into TRACE fees will increase the cross subsidization the NASD already enjoys with the fees it collects for equity market data. The regulatory costs the NASD incurs should be funded separately from other revenue sources, such as membership assessments, which may be subject to at least some competitive and other limits.
Finally, we note the Commission's statement in the Approval and Amending Release that the NASD will establish charges and fees for TRACE by submitting a rule filing with the Commission pursuant to section 19(b)(1) of the Act. The Commission further states that broker-dealers and vendors, as purchasers of consolidated TRACE data, will be considered users of the TRACE facility for purposes of considering whether a section 19(b) rule filing establishing fees and charges for TRACE is consistent with the Act. It is, however, unclear whether the NASD plans to submit its proposed rule filing under section 19(b)(3)(A), which allows rule filings establishing or changing a fee to be effective automatically upon filing with the Commission and without a public comment period.
TRACE and the Advisory Committee on Market Information. In the Response Letter, the NASD represents that it will cease functioning as a consolidated information disseminator if the SEC's Advisory Committee on Market Information (the "Advisory Committee") "develop(s) a market driven approach to equities market data that can be applied to bond market data." Neither the Response Letter nor the Approval and Amending Release explain how TRACE would be dismantled to make way for a market-driven approach developed by the Advisory Committee. In the Approving and Amending Release, the Commission states that if the Advisory Committee concludes that an approach substantially different from TRACE provides a superior way of assuring price transparency in the corporate bond market, the Commission would consider such a conclusion in evaluating any NASD amendments to TRACE. The question is, would the Commission independently reconsider TRACE on the basis of the Advisory Committee's work, or is an NASD amendment a condition to applying the Advisory Committee's findings to TRACE? If the latter, then the Commission, intentionally or not, has provided the NASD with an disincentive to propose amendments to TRACE. Taken together and at face value, the NASD and Commission statements acknowledge the importance of the work of the Advisory Committee and anticipate significant guidance from its findings, including a market-driven alternative to TRACE. In light of the ongoing work of the Advisory Committee and the apparent importance of that work to both the NASD and the Commission, neither the Response Letter nor the Approval and Amending Release explain what factors led the Commission to approve TRACE before the Advisory Committee completed its work and submitted its findings and its recommendations.
Conclusion. In approving the TRACE proposal the Commission has granted the NASD an exclusive franchise by mandating, with only limited exceptions, that all NASD members report their corporate bond transactions to the NASD. While both the NASD and the Commission have recognized that TRACE represents a significant burden on competition, neither have met the statutory requirement of adequately justifying the burdens that TRACE would impose on competition. The NASD has not provided the public with an adequate basis for assessing TRACE nor has it provided the Commission with an adequate basis for approving TRACE or Amendment No. 4.
We respectfully urge that the Commission reexamine its approval of TRACE, particularly in light of the ongoing work of the Advisory Committee, and that the Commission consider postponing implementation of TRACE until after the Advisory Committee has submitted its findings and recommendations. While it is too soon to tell whether the Advisory Committee's work will provide any useful resolution to the issues discussed above, the Commission should not assume that its Advisory Committee's work will be not worth waiting for.
Should the Commission choose to implement TRACE before the Advisory Committee has completed its work, we respectfully urge the Commission to take steps to guarantee that the TRACE fees are based on the true and necessary costs of data consolidation and not other costs. The Commission should take steps to minimize the market distortion caused by monopolies. By mandating that fees be cost-based and that they be set based upon accurate and publicly available financial data, the Commission can provide at least some assurance of a fair price for TRACE data, greater dissemination of those data and increased transparency in the corporate debt markets.
* * *
We appreciate the opportunity to make our views known to the Commission and the staff and we hope that our letter is helpful. If members of the Commission or of the staff believe we may be of further assistance in these matters, please let us know.
Very truly yours,
ByKevin M. Foley by RDB
Kevin M. Foley
|cc (w/att.):|| The Hon. Laura S. Unger, Acting Chairman
The Hon. Isaac C. Hunt, Jr., Commissioner
The Hon. Paul R. Carey, Commissioner
Annette L. Nazareth, Esq., Director, Division of Market Regulation
Robert L. D. Colby, Esq., Deputy Director, Division of Market Regulation
Belinda Blaine, Esq., Associate Director, Division of Market Regulation
David M. Becker, Esq. General Counsel
Mr. Richard G. Ketchum
National Association of Securities Dealers, Inc.
|1||Bloomberg is engaged in the business of providing its customers with financial market information, news and analytics via its worldwide electronic network (the "BLOOMBERG PROFESSIONALTM service"). Bloomberg also serves its broker-dealer and institutional customers' communications needs and facilitates their transaction of business by offering various additional services, including electronic messaging, non-anonymous offerings, bids wanted and equity order-routing and indications of interest, and linkages to certain exchanges within and outside the United States. Approximately two million text messages and transaction messages involving billions of dollars of securities are sent and received by Bloomberg customers across the BLOOMBERG PROFESSIONAL service every business day. In addition, Bloomberg expects in the future to provide access to additional points of liquidity as customer demand dictates.|
|2||See comment letter by Bloomberg and the Philadelphia Stock Exchange, Inc., dated February 15, 2000 in SEC File No. SR-NASD-99-65; see also comment letter by Bloomberg dated February 15, 2000 in SEC File No. SR-NASD-99-65.|
|3||See comment letter by Bloomberg to the Commission, dated December 22, 2000 in SEC File No. SR-NASD-99-65.|
|4||See letter dated January 5, 2001 from Joan C. Conley, Senior Vice President and Corporate Secretary, NASD, to Katherine A. England, Assistant Director, Division of Market Regulation, Securities and Exchange Commission, re: File No. SR-NASD-99-65 - Amendment No. 4.|
|5||Approval and Amending Release in text accompanying nn. 66-69.|
|6||See the Response Letter at n. 6.|
|7||Form 19b-4, Item 4.|
|8||Comment letter by Bloomberg Tradebook dated September 12, 2000 in SEC File No. SR-NASD-99-53.|