Next month the industry will see the culmination of a legal battle between the largest exchange groups—the New York Stock Exchange (Nyse), Cboe, and Nasdaq (the petitioners in the case)—and the Securities and Exchange Commission (SEC). The exchanges want the US Court of Appeals for the District of Columbia to void two initiatives by the SEC aimed at modernizing the way National Market System (NMS) data is disseminated to subscribers.

On March 18, the court will hear oral arguments in the case against the Market Data Infrastructure Rule (MDI Rule), and on March 24, it will hear oral arguments in the case against the Consolidated Tape Plan (CT Plan). It’s possible that by the end of March, the court will give the petitioners what they want and vacate one or even both initiatives, bringing a fruitless end to the SEC’s two-year intensive regulatory process.

In 2020, the SEC moved to realize its long-held intention to modernize the way US equities market data is disseminated. These efforts took the form of proposals that ultimately became formalized as the MDI Rule and the CT Plan. They were designed to work independently—possibly the SEC anticipated that the large exchanges, also known as the self-regulatory organizations (SROs), would be successful in getting one voided—but also be complementary.

Currently, subscribers can get market data from the exchanges in the form of proprietary data feeds, or public feeds from the Securities Information Processors (called the exclusive Sips, as they each consolidate data exclusively from Nyse or Nasdaq). In contrast to the prop feeds, which can include top-of-book with granular detail, the “core data” available from the exclusive Sips is more limited but very important, as it includes top-of-book quotes and the National Best Bid and Offer (NBBO), calculated by the Sips.  

The MDI Rule and the CT Plan would together “modernize” this system. The MDI Rule widened the definition of the “core data” that Sips provide, from top-of-book to depth-of-book, odd lots, and auctions. It also sought to create the conditions for a world where a new kind of Sip called a competing consolidator would emerge, bringing competition and product differentiation to the public feeds, driving down the cost of market data, and democratizing access to low-latency feeds. It also allows financial firms to become self-aggregators, essentially performing the consolidation of this data for their own internal use (as many do already).

The CT Plan will govern the new market data system. The operating committee sets fees for subscribers to Sips data, and contracts a new plan administrator. It is to be governed by an operating committee, and the SEC took care to dilute the power of the large exchanges in the makeup of the operating committee it mandated.

Firstly, the SEC stipulated that the CT Plan operating committee assign votes to the exchanges per SRO group, rather than per medallion, as is the case on the exclusive Sip plans. This erodes the power of the petitioners on these operating committees. For example, on the current equity data plans, Nyse, Nyse American, Nyse Arca, Nyse Chicago and Nyse National each get one vote on the plans’ operating committee—a total of five votes. Under the proposal, these five exchanges would be treated as one SRO group and get only two votes (based on their consolidated market share).  

Their power is also diluted in the CT Plan by the fact that market participants like broker-dealers are now given a vote on the operating committee. On the other plans, these individuals representing non-SROs can sit on the operating committees and go to their meetings, but don’t have any voting power.

Both the MDI Rule and the CT Plan represent threats to the petitioners’ businesses, and, they say, impede their roles as SROs with the legal responsibility to operate the NMS in the public interest. The petitioners want the court to completely vacate both. To do so, they must prove that the rule and the plan are “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law” under the Administrative Procedures Act.

This is what they have done in briefs filed to the DC Circuit Court of Appeals and seen by WatersTechnology, and what they will be arguing in oral hearings in March.

These aren’t the only important dates coming up, however. Confusingly, while the CT Plan is currently stayed by the court pending the outcome of the litigation, implementation is proceeding on the MDI Rule. Under this rule, the SROs last year filed a controversial fee schedule for what they would be charging competing consolidators for market data. The SEC must respond to this filing at the end of February.

So what exactly are the petitioners arguing in their briefs ahead of oral arguments?

The CT Plan

The petitioners want the court to vacate the CT Plan because, they say, the SEC doesn’t have the legal authority to give individuals representing non-SROs any voting power on the plan’s operating committee.

Also, they argue, the Commission’s group-based voting structure violates the Securities Exchange Act. These individuals will help push through proposals that are not agreed upon by the majority of individual SROs, impeding the SROs’ ability to act jointly in operating the NMS and make sure that the operations of the CT Plan meet the standards imposed by the Exchange Act, which is their legal role. The SEC isn’t allowed to dilute the petitioners’ voting power in the way that it has done—by treating each individual one as a separate regulated entity, they say.

The petitioners also argue in the briefs that the SEC treats these exchanges as separate entities when it suits its purposes. The Commission, for example, requires separate entities within exchange groups to maintain separate pools of liquidity. The argument is that it’s inconsistent for the SEC to treat these operators as consolidated groups now that it suits it to dilute their voting power.  

The SEC, on the other hand, contends that it can give individuals power to represent non-SROs on the operating committees: All is fair in its Congress-mandated objective of making sure that brokers, dealers, and investors have access to the NMS information they need. The Commission also says that nothing in the law actively precludes the involvement of non-SROs in the NMS, or that there is any law that mandates that each SRO gets a vote on the operating committee.

The exchanges also take issue with the SEC’s requirement that the CT Plan have an independent plan administrator—“independent” in this case meaning the administrator can’t be owned by a business that sells proprietary data feeds. The Commission believes that this would represent a conflict of interest.

The current Sips are administered by Nyse and Nasdaq; the petitioners say the SEC is depriving the CT Plan of expertise because the plan can’t leverage the experience of administrators who have been doing, they say, a great job for decades. It also requires participants to bear the costs of finding and training a new administrator.

Also, the SEC is inconsistent, the briefs state, because it did not forbid non-SRO data vendors from taking on the administrator role, even though they also sell market data and could also theoretically benefit from access to subscriber lists and audit data.

“Although the CT Plan does not require the administrator to be a non-SRO data vendor, it permits a data vendor, but not an exchange that sells proprietary data, to serve in that role. Such disparate treatment of similarly situated entities is prohibited by the Administrative Procedure Act,” the briefs say.

The MDI Rule

When it comes to vacating the MDI Rule, the petitioners will argue that it should be vacated partly because not only does the rule fail to address the issues it is intended to, it actively makes them worse.

The stated intention of the SEC in devising this rule was to address what it called informational asymmetries between market participants: Essentially, large and sophisticated market participants can afford the exchanges’ detailed and low-latency prop feeds, while the smaller or slower ones must make do with slower, more basic core data from the Sips.

The SEC wants to address this asymmetry by instating the competing consolidators and making low-latency depth-of-book feeds available to a wider range of subscribers.

But the petitioners argue that the Commission’s rule doesn’t address this issue at all—in fact, it only makes matters worse. Some competing consolidators will offer core data at slower speeds than the exclusive Sips do right now, they say. The more sophisticated market participants with the resources and the tech know-how to do so will obtain core data directly from the exchanges and consolidate it themselves as self-aggregators.

This will give those players even more of an advantage, the petitioners say: No matter how latency-efficient the competing consolidators are, submitting data to their subscribers inevitably involves one more “hop” than experienced by the self-aggregators.

The large exchanges also argue that competing consolidators won’t be subject to the same regulatory scrutiny as the exclusive Sips, creating a risk of service outage, especially if a consolidator neglects to invest in its infrastructure. This risk is at odds with the imperative to reduce informational asymmetries, the briefs say, because outages will cut off certain market participants from the data and not others.

Currently, the Sips calculate a “gold standard” NBBO, the briefs say. A small number of market participants calculate their own NBBO, but the vast majority can’t do this and rely on the Sips for theirs. In a world of competing consolidators, the playing field won’t be level because the accuracy of each market participant’s NBBO will depend on the capabilities of the consolidator to which it subscribes. Again, those market participants that choose to subscribe to the most reliable and lowest-latency (and thus most expensive) competing consolidators will have an advantage over all others—except, of course, the self-aggregators.

The incumbent exchanges also insist that the competing benefits the SEC say will arise from the competing consolidators are purely speculative—there’s no evidence that competition will emerge. In the MDI Rule proposal, the Commission says an ideal number of competing consolidators is perhaps 12, and seems assured that this competition is currently waiting in the wings.

But, the exchanges argue in their briefs, many of those market participant that can do so will become self-aggregators, and emerging competing consolidators would be competing for an uncertain revenue pool that is likely to have shrunk. According to the SEC’s own findings, they say, these self-aggregators are most likely to be the very broker-dealers and investment advisors that are the hungriest consumers of market data.

“Even if the Commission’s estimate of a total revenue pool were accurate and relied on by firms considering whether to become competing consolidators, those firms still would not know, at the time they were making their market-entry decision, what share of the revenue pool they were likely to capture,” the briefs say.

Competing consolidators will have to pay exchanges the same prices for data, constraining their ability to compete on price. Most likely, this will hamper the emergence of more than one consolidator, which would be entirely contrary to the Commission’s aims with this entire project.