SEC overstepping authority in NMS plan, Nasdaq claims in court

A lawyer for Nasdaq told a court of appeals on Monday that the US markets regulator is overstepping its authority in ordering the biggest exchanges to come up with a new governance plan for the public consolidated feeds of US equities market data, which would give more voting power to broker-dealers and other organizations that sit on the operating committees governing these feeds.

In February, Nasdaq, the New York Stock Exchange (NYSE) and Cboe Global Markets filed petitions in the Court of Appeals for the District of Columbia Circuit, seeking to vacate a plan by the Securities Exchange Commission (SEC) that would change the governance of the consolidated tapes currently operated under the National Market System (NMS)—the Consolidated Tape Association plan, administered by NYSE, and the Unlisted Trading Privileges (UTP) plan, operated by Nasdaq.

Thomas Hungar, a partner at Los Angeles-based law firm Gibson Dunn & Crutcher, said the SEC has no power to give voting rights to organizations that are not exchanges. He said that, via the Securities Exchange Act, Congress gave the SEC the authority to directly authorize only exchanges (referred to as self-regulatory organizations, or SROs) to act jointly in operating the NMS.

“The commission is essentially arrogating to itself the power to transfer authority to Congress via the SROs to non-SROs under the guide of a provision [in the act] that refers only to SROs. It makes no sense, and it violates the structure and purpose of the act,” Hungar said.

The SEC said in 2020 that Rule 608 of Regulation NMS authorizes two or more SROs, acting jointly, to file with the commission an NMS plan or proposed amendment to an effective NMS plan. And that is exactly what the SEC then ordered the SROs to do.

This order was part of wider effort by the commission to—as the SEC describes it—modernize how market data is disseminated to US consumers. The commission is concerned that the two feeds of top-of-book quotes, consolidated from trading venues and published by the Securities Information Processors (Sips), are no longer suitable for the needs of market participants in increasingly high-tech markets. So in December 2020, it finalized a rule that expands the definition of the data to be distributed by the Sips, and opens the door for the emergence of multiple, competing Sips.

At the same time, the SEC looked to modernize the three NMS plans that govern the two Sips. This was the context for the order being disputed in the appeals court: The commission told the SROs, which sit on the Sips’ operating committees, to file a new NMS governance plan. The SEC believes the SROs have a conflict of interest, and claims that the Sip feeds are often slower and contain less information than the proprietary market data feeds offered by the exchanges, which control much of the voting power for the NMS plans.

The SEC also believes the SROs have a disproportionate amount of voting power on the Sips’ operating committees, and the new plan would take some of that power away and give it to other bodies that sit on these committees.

Nasdaq said in a comment letter filed with the SEC last July that the radical revisions to the NMS are unsubstantiated, and that the new rules are tantamount to government appropriation of exchange proprietary data and intellectual property. Today in court, Hungar argued that Congress gave the SROs more authority over the NMS plan as a kind of quid pro quo, since they are subject to unique obligations, like investor protection and direct oversight by the SEC.

“None of this applies to the individual representatives that the SEC is trying to shoehorn into this body,” he said, referring to the Sips’ operating committees. “The gerrymandered vote dilution scheme that the commission has imposed on the SROs also violates the statute,” he said.

The commission’s rationale is also discriminatory, Hungar said: The SEC wants independent administrators to run the Sips, but it would allow data vendors to serve as those administrators, “even though they face precisely the same alleged conflict of interest that the commission attributes to the SROs,” he said, adding that the commission has failed to prove that harm has occurred as a result of the dominance of the exchanges on the Sip operating committees.  

Tracey Hardin, assistant general counsel at the SEC, told the court there is nothing in the Exchange Act that indicates that Congress intended to rest sole decision-making authority of the financial markets with the SROs. She argued that Nasdaq looked at the act “in a vacuum,” and said that the language used by Congress in the Act outside of the specific sections cited by Hungar showed that non-SROs—issuers, investors, broker-dealers, Sips, and really any other interested parties—were always intended to be involved.

Hardin also noted that Nasdaq did not deny the obvious conflicts of interest that occur when the administrator of the Sip is operating both the public datafeeds and selling its own proprietary data products. “They argue that there was not sufficient evidence of harm here, but the commission is entitled to act prophylactically, and it did that. Concerns have been expressed by a number of market participants across a broad spectrum of roles in the market, both at the roundtable held in 2018, and before the commission … to justify the reasonable step of ensuring that the administrator is not wearing two hats,” she said.