U.S. stock markets must prove that competition limits the fees they charge brokers and other firms for real-time quotation data, after a court rejected the Securities and Exchange Commission’s approval of charges proposed in 2006, a lawyer for Nasdaq OMX Group Inc. said.
Competition among U.S. equity exchanges is enough to keep any one firm from setting prices too high for their feeds, which are sold to individual and professional investors and data providers, said Jeffrey Davis, Nasdaq’s deputy general counsel. A group of companies including Google Inc. and Yahoo! Inc. sued to block the SEC’s reliance on “market-based” pricing when it approved fees in 2008, arguing that the agency should consider the cost of producing the information.
Charging for data on U.S. share transactions, bid and ask prices and trading volume for public and private feeds accounts for as much as 17 percent of net revenue at companies such as Nasdaq OMX and NYSE Euronext, SEC filings show. A U.S. federal appeals court overturned the SEC’s clearance of a 2006 fee application from NYSE Arca on Aug. 6, saying the agency didn’t have enough evidence that competition would hold down prices.
The issue is “whether or not competition between the exchanges, and in particular order flow competition, constrains pricing,” said Edward Ferraro, a securities regulation attorney and expert on market data in New York. He spoke yesterday at a panel discussion with exchange executives in New York arranged by Capital Markets Consortium.
The case was brought by NetCoalition, a policy group representing about 20 companies including Mountain View, California-based Google and Yahoo of Sunnyvale, California, as well as the Securities Industry and Financial Markets Association, the largest trade group for U.S. broker-dealers. Its aim was to get the SEC to use cost-based considerations in evaluating whether exchange fees are “fair and reasonable” instead of relying on market forces to limit the charges.
Bloomberg LP, the parent company of Bloomberg News, is a member of NetCoalition and had independently asked the SEC to set fee standards for market data in 2006.
“Cost may be a relevant factor to determine if there are market forces at play,” Davis said. “It’s just one. It’s not the first or last indicator.” He added that the court “flatly rejected” the notion that cost is the only relevant factor for determining whether data fees are fair and reasonable.
In its August decision, the court said the SEC could use a “market-based” argument to justify exchange fees, and rejected two arguments from NetCoalition that favored a cost-based approach. Arca’s proposed fees were lower than those charged by Nasdaq when it asked the SEC to approve them.
NYSE Arca, owned by NYSE Euronext, asked the court on Sept. 17 to reconsider its withdrawal of the SEC’s fee approval. The exchange said the court’s decision “risks placing NYSE Arca in the position of being the only market unable to charge for its proprietary depth-of-book data product.” While the SEC hadn’t adequately justified its decision, the court didn’t disagree with the SEC’s approach to fees, Arca said.
Depth-of-book data from exchanges is information about bids and offers inferior to the best prices that exist in equity exchanges. Brokers and investors use the data to determine supply and demand for a security and where to route larger buy and sell requests.
At issue is the private, or non-core, data that exchanges can choose to sell to brokers, vendors, high-frequency traders and investors. It’s separate from the core, or public, data they must provide to so-called securities information processors, which aggregate the information and sell it to companies such as New York-based Thomson Reuters Corp. and Bloomberg LP.
The public information, also called consolidated data, includes the last sale price for a security, each market’s best bid and offer, and the national best bid and offer. The data also comprises the number of shares traded and quoted at the best prices. U.S. exchanges and the Financial Industry Regulatory Authority generated $464 million in revenue in 2008 for core market data sold to vendors and investors, according to the SEC.
NYSE Euronext got $244 million in sales from offering public and private data in the U.S. last year. Nasdaq OMX had $214 million in U.S. market data revenue.
“The court didn’t say if the SEC was right or wrong and didn’t say what it would take to justify the fee,” said James Angel, a finance professor at Georgetown University in Washington, in an interview. Angel expects the SEC will ask exchanges for some “cost-based information” to justify future approvals of fees.
Nasdaq told the SEC on Sept. 14 that the market for data products is competitive. It also said the cost of producing the information includes distributing it, operating the exchange’s trading systems and regulating the market. These are “joint products with joint costs,” the company said.
“If the cost of the product exceeds its expected value, the broker-dealer will choose not to buy it,” Nasdaq said in a statement about the market data it sells investors and firms. “Moreover, as a broker-dealer chooses to direct fewer orders to a particular exchange, the value of the product to that broker-dealer decreases.”
Bats Global Markets, which operates an exchange in Kansas City, Missouri, provides its depth-of-book market data for free. Eric Swanson, general counsel at Bats Exchange, said that while the venue could “absolutely” charge for that data and is considering fees on certain non-core products, giving it away is currently part of the company’s “growth strategy.”
“What the court is saying is a cost analysis is clearly relevant,” Swanson said. The court didn’t suggest that analyzing cost was the only way to evaluate whether the fees are fair, he added. Factors such as competition between exchanges for orders and trades could help prove that limitations exist on the level of market data fees they can charge.
“We’d never do anything in the market data arena that would have a negative impact on our transaction revenue,” said Michael Simon, general counsel and chief regulatory officer at the International Securities Exchange. Two-thirds of New York-based ISE’s revenue comes from fees for trading options, he said. “We want to induce people to come to ISE” by making quotes available, he said. ISE is owned by Eurex in Frankfurt.
While the equities marketplace is competitive, “exchanges have gone from membership organizations to for-profit companies,” Angel said. “They’re doing what a good company tries to do for shareholders, which is to make money.” Arca had given the data away to attract buy and sell orders before it was acquired by NYSE in 2006 and decided to charge for it, he said.
“NetCoalition hasn’t won the case but they won the battle,” Angel said. “The SEC will have to go back and justify that the fee is reasonable.”