SEC Quashes Nasdaq Plan

Terry Flanagan

SEC Nixes Nasdaq OMX Plan To Draw Orders with Market-Data Carrot.

Nasdaq OMX’s proposal to discount fees for members acquiring reams of market data and executing high volumes of trades was put to rest Sept. 20 when regulators said the fee strategy could shift attention away from the quality of transaction services and may be discriminatory.

The exchange company initially filed Jan. 20 for the fee schema to be immediately effective, and eight days later the Securities and Exchange Commission suspended the filing. It voiced concerns that the approach could be inconsistent with the Securities Exchange Act of 1934.

The exchange companies with the largest market share, including Nasdaq OMX and NYSE Euronext, charge for their market data, which has created a significant revenue stream. Market data fees at Nasdaq OMX, for example, represented 13% of the firm’s revenue in the second quarter, and at NYSE Euronext they provided a similar portion. On the other hand, BATS Global Markets, a smaller exchange company, has never charged for market data.

The SEC’s decision erects a roadblock for exchange companies to use market data—an essential trading tool—to draw orders, at least in terms of conditioning discounts on reaching specified targets. Nasdaq OMX aimed the discounts at broker-dealers catering to retail investors, which provide the most prized type of orders because they typically take the form of market orders that generate rebates for professional traders posting limit orders. Nasdaq couched the fee strategy as beneficial not only to retail broker-dealers but to their retail clients.

“This is an attempt by Nasdaq to compete to attract retail investors’ orders and to improve the experience of investors on Nasdaq’s public market,” the exchange company said in its initial filing. “The more Nasdaq data a firm provides to retail investors, and the more that firm trades on Nasdaq, the lower its fees will be.”

Nasdaq noted that it believed the fee discounts could be passed onto investors.

The proposal’s fee discounts, in fact, were significant. Broker-dealers in “tier 3,” with the biggest discounts, were required to execute an average of at least 65 million shares daily and to incur $500,000 of monthly market data fees, and they would have seen that market data fee sliced in half. Tiers 1 and 2 required lower volumes but provided smaller discounts.

Nasdaq also proposed increasing current rebates to liquidity providers in the first tier, executing at least 12 million shares daily on average and incurring $150,000 in market data fees. Rebates in tiers 2 and 3, however, remained unchanged.

Such discounts would appear to benefit the largest online broker-dealers catering to retail investors. TD Ameritrade, however, filed a comment letter in late January applauding the filing’s suspension by the SEC and saying proposal failed to comply with a recent decision by the United States Court of Appeals for the District of Columbia,  NetCoalition v. Securities and Exchange Commission.

Christopher Nagy, managing director of order strategy at TD Ameritrade who penned the firm’s comment letter, said the decision says exchanges must assess market data fees that are fair and reasonable based on “a substantive justification of costs of producing such data. Nasdaq’s filing fails to meet these requirements and, therefore, disapproving it is in the public interest.”

Nagy also noted the online brokerage’s recently submitted petition for rulemaking that requested a regulatory review of the collection, distribution and costs of exchange data products. “As a result, TD Ameritrade also strongly encourages the Commission to seek commentary and adopt proposals to modernize the long outdated market data regime,” Nagy wrote in the comment letter.

The comment letter submitted jointly by the Securities Industry and Financial Markets Association (Sifma) and the NetCoalition, leveled several criticisms against Nasdaq OMX’s proposal, including what it asserted to be the proposal’s discriminatory nature.

“These discounts are unavailable to firms that service professional investors or those entities that serve retail investors and purchase depth-of-book data but do not provide order-execution services,” the letter said.

The SEC, in its filing last week to pull the filing, said Nasdaq OMX failed to show its approach was not discriminatory. The regulator said that contrary to Nasdaq OMX’s argument that other exchanges could provide similar discounts to compete, exchanges that either do not provide market data or do not charge for their data “would not be able to respond to Nasdaq’s proposal with a similar pricing scheme.”

In addition, said the SEC, Nasdaq’s approach could important market priorities. “Nasdaq’s proposal would allow it to use significant discounts on fees for its market data products as an inducement to attract order flow rather than relying on the quality of its transaction services and the level of its transaction fees to compete for orders,” noted the SEC.

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