Justice Department Saw Multiple Monopolies in NYSE-Nasdaq Deal

For the U.S. Justice Department, antitrust concerns in Nasdaq OMX Group Inc.’s proposed takeover of NYSE Euronext went beyond a monopoly in stock listings.

Nasdaq OMX and IntercontinentalExchange Inc. withdrew their joint $11.3 billion bid for NYSE Euronext on May 16 after the Justice Department threatened a lawsuit. An acquisition “would have substantially eliminated competition for corporate stock listing services, opening and closing stock auction services, off-exchange stock trade reporting services and real-time proprietary equity data products,” the department said.

While keeping one exchange operator from controlling where U.S. companies raise money may have been reason enough to block the proposal, the other objections are debatable, said Jamie Selway, managing director at Investment Technology Group Inc. in New York. Selway said the auction issue isn’t separate from the listing concern, trade reporting is a minor business, and the logic underlying the assertion about data is questionable.

“The corporate listings concern makes sense,” Selway said. “The other three are throwaways.”

The Justice Department had no comment beyond its previous public statements, said Gina Talamona, a spokeswoman.

Taking over NYSE Euronext would have given New York-based Nasdaq OMX the company’s cash equities, options and technology businesses, while Atlanta-based ICE would have received the Liffe derivatives unit in Europe and the U.S. They made their unsolicited bid on April 1 in an attempt to block the planned union of NYSE Euronext and Frankfurt-based Deutsche Boerse AG.

Speedy Review

The Justice Department’s decision clears the way for Deutsche Boerse to complete its acquisition of the New York Stock Exchange owner, announced in February. It left Nasdaq OMX without a merger partner and securities professionals such as Andrew M. Klein, a partner at Schiff Hardin LLP in Washington who advises exchanges, brokers and investment managers, stunned by its speed.

“NYSE was an exchange that existed quite happily under antitrust laws when it had 80 percent of stock trading and total control over its quotation and last-sale data,” said Klein, who was director of the Securities and Exchange Commission’s division of market regulation in the 1970s. “Saying the deal with Nasdaq was anticompetitive threw a monkey wrench into a transaction that, as a hostile offer, had already generated considerable consternation.”

Beyond creating a listings monopoly, a combined Nasdaq-NYSE would have the “incentive and capability to increase the price of trading during the opening and closing auctions,” Christine Varney, head of the Justice Department’s antitrust division, said on a May 16 conference call.

Raising Fees

The concern about a merged Nasdaq and NYSE raising fees for investors who trade in the daily opening and closing auctions is related to the worry about a listings monopoly, Selway said. The exchange that lists a stock attracts virtually all the volume at those times, he said.

The open and closing auctions, conducted by listing markets at 9:30 a.m. and 4 p.m. New York time, aggregate investors’ buy and sell orders to determine a single price that reflects the trading interest sent into those processes. The auctions are trading events that set stock prices at times of the day when a lot of retail and institutional customers execute orders.

“If exchanges structure their open and closes differently, you have competition between alternative methods and investors can decide what works better,” said Robert Schwartz, a finance professor at Baruch College at the City University of New York who has studied markets and trading rules since the late 1970s. That can prompt exchanges facing the threat of competition to improve their auctions and limit fees.

Trading Demand

The opening and closing auctions should reflect as much trading demand as possible to yield the best prices, said Schwartz, who was on an advisory committee that helped Nasdaq Stock Market design its auctions almost a decade ago.

“For any given stock, you want consolidation in where orders are sent at the open or close, not fragmentation,” he said. Having exchanges with different methods of calculating opening and closing prices allows for potential competition.

Justin Schack, managing director for market structure analysis at New York-based Rosenblatt Securities Inc., said that rivalries among exchanges have forced venues including Nasdaq to improve their auctions to attract traders.

The auctions “are inextricably bound to listings,” Schack said. “Their power to exert control and pricing power could have been significant,” he said of a Nasdaq-NYSE union.

Off-Exchange Trades

A merged company could also have raised fees on systems for reporting off-exchange transactions that the Financial Industry Regulatory Authority runs with Nasdaq and NYSE, known as trade reporting facilities, Varney said. About 30 percent of U.S. equities trading occurs away from public markets.

The trade reporting facility Nasdaq operates with Finra already handles 93 percent of transactions reported from off-exchange, with NYSE getting the rest, according to data compiled by Bats Global Markets Inc. Nasdaq used to have all the volume. Two other TRFs developed in the last five years shut down. They’re not “high-value” offerings by exchanges, Selway said.

Varney said the combination of NYSE and Nasdaq could also increase charges for proprietary market data and curtail the introduction of products the exchanges sell to investors and brokers. They include real-time quotation and trade information and are separate from the industry’s public market data.

Bats, Direct Edge

Two exchange firms, Bats in Lenexa, Kansas, and Direct Edge Holdings LLC in Jersey City, New Jersey, which together account for a fifth of U.S. equities volume, offer real-time market data that competes with NYSE’s and Nasdaq’s. The companies are owned by groups that include units of Morgan Stanley, Credit Suisse Group AG, Citigroup Inc., Bank of America Corp., Goldman Sachs Group Inc. and Knight Capital Group Inc. and were formed as a hedge against NYSE and Nasdaq gaining too much sway over U.S. equities trading and related services.

Still, Christopher Nagy, managing director for order routing sales at TD Ameritrade Holding Corp. in Omaha, Nebraska, said the Justice Department’s focus on market-data costs is important to brokers that must acquire that information. While antitrust officials discussed only proprietary data from exchanges, he said the public trade information retail brokers buy from NYSE Euronext and Nasdaq-run units is too expensive.

“If you combine the two exchanges and that becomes the dominant purveyor of data products for the displayed markets, that would have been monopolistic,” said Tim Quast, founder and managing director at ModernNetworks IR LLC in Denver. “The DOJ’s decision makes sense.”

Antitrust Remedies

Nasdaq OMX Chief Executive Officer Robert Greifeld said in a statement on May 16 that the company had offered to sell the NYSE self-regulatory organization, or entity that controls the Big Board exchange, along with related businesses to allay competition concerns.

“Nasdaq seemed willing to sell the NYSE SRO as a fairly substantial remedy,” Selway said. “It’s a real surprise that DOJ would respond so quickly and forcefully.”

Matthew Cantor, a New York-based partner at antitrust law firm Constantine Cannon LLP, said it was unclear who could buy NYSE and preserve its value without owning the rest of the company. Issuers might “jump ship,” he said.

Varney said on the May 16 call that no remedy offered by Nasdaq OMX would have met DOJ’s approval. She said her group conducted a “thorough investigation” of the deal that they saw as creating a monopoly.

Business Rationale

When a company offers to sell assets at “the heart of the merger, one wonders what it is they’re going to divest and how it will compete and what is the business rationale for the transaction,” she said.

That the review took just six weeks is unusual, Cantor said. Most take months as economists analyze the likely impact on prices and competition, consider potential solutions to address competitive concerns and figure out whether they can build a case to prevent a transaction they think will result in harm to consumers, he said.

The Nasdaq case signals that “transactions that on their face look like they’re going to substantially lessen competition aren’t going to pass muster,” he said. “They’re going to pull the trigger.”

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