Recent Regulatory Developments
By: Ari Burstein, General Counsel and Chief Policy Officer, Imperative Execution

In a long-awaited decision impacting trading and market structure, on May 24, the US Court of Appeals for the District of Columbia Circuit denied a petition filed by several exchanges challenging the SEC’s “market data infrastructure rule” (“Rule”).

The exchanges claimed that the rule was arbitrary and capricious and contrary to the goals and policies of the Securities Exchange Act.  

The Court, however, found that the Rule “clearly represents a reasonable balancing of the objectives Congress directed the Commission to address in a complex and technical area based on the record before the Commission.”

Court Denial of Exchanges’ Petition on Market Data Infrastructure Rule

In a long-awaited decision impacting trading and market structure, on May 24, the US Court of Appeals for the District of Columbia Circuit denied a petition filed by several exchanges challenging the SEC’s “market data infrastructure rule” (“Rule”). The exchanges claimed that the Rule was arbitrary and capricious and contrary to the goals and policies of the Securities Exchange Act. The Court, however, found that the Rule “clearly represents a reasonable balancing of the objectives Congress directed the Commission to address in a complex and technical area based on the record before the Commission.”

Adoption of Rule was not Arbitrary and Capricious

The Court found that the Commission reasonably concluded that the Rule would promote its stated goal in two primary ways:

  1. The Rule adds new categories of data to the definition of “core data” so that investors who rely on core data will have information that more closely approximates what is available to proprietary data feed subscribers; this, in turn, is likely to reduce asymmetries between consumers who rely only on the consolidated data feed and other consumers by enhancing the information available to consolidated data feed subscribers; and
  2. The Rule introduces competition into the data market by allowing entities other than the exchanges to develop and sell data products based on data obtained from the exchanges; this change is likely to promote the availability of many different kinds of data products at different price points, making it more likely that consumers for whom proprietary data products are prohibitively expensive will find in the marketplace an affordable product appropriately tailored to their data needs.

The Court states that petitioners contend that the Commission’s adoption of the Rule was nevertheless arbitrary and capricious for two reasons:

  1. The Rule will exacerbate, not reduce, information asymmetries in the data market; and
  2. The Rule rests on speculation

The Court rejected petitioners’ claim that the Rule will exacerbate information asymmetries.  Specifically, the Court stated that this objection misconstrues the Commission’s goal in implementing the Rule given that the Commission aimed not to require that every market participant have access to the same data at the same speed, but rather to address a “dearth of options for consumers with widely divergent data needs in the existing marketplace.”  

The Court added that the Rule promotes the Commission’s purpose by assuring that consumers who cannot afford existing proprietary data products are no longer limited to the consolidated feed as their only option.

The Court also rejected petitioners’ claim that the Rule rests on “unfounded speculation” and states that a concern that too few competing consolidators would enter the market to achieve the anticipated benefits of competition is “misplaced.”  

Specifically, the Court noted that the Commission acknowledged that there was some uncertainty about the number of entrants to the market, but exhaustively explained why it predicted that the market would see a sufficient number of entrants to promote competition.  

Similarly, the Commission reasonably predicted that only a small number of market participants would become “self-aggregators,” leaving enough demand for the competing consolidators’ products to achieve the benefits of competition.

Rule is Consistent with Statutory Policies

The Court notes that the Exchange Act requires the Commission to act with “due regard for the public interest, the protection of investors, and the maintenance of fair and orderly markets,” and to assure the “fair collection” and “distribution” of market data.  The petitioners maintained that the Rule is inconsistent with these statutory policies because it will:

  1. Deprive investors of a single, uniform “national best bid and offer” quote;
  2. Stifle innovation in the data market;
  3. Drive order flow to off-exchange trading venues and impede exchanges’ ability to compete with such venues; and
  4. Deprive the exchanges themselves of a main source of revenue.

The Court found that the record demonstrates that the Commission considered each of petitioners’ concerns and reasonably determined, based on the information available to it, that the Rule was warranted.  

Specifically, the Court found that the Commission reasonably concluded that the Rule would not adversely affect the availability of a single, reliable “national best bid and offer” quote to the detriment of retail investors.  

The Court also noted that the petitioners have not explained how the NBBO would be appreciably more fragmented under the new Rule than it is under the current regime.

The Court also stated that the Commission could reasonably conclude that increased competition in the development and distribution of data products would enhance, not stifle, innovation.  

The Court noted the petitioners claim that the Rule undermines the exchanges’ incentive to invest in developing innovative data products but the Court stated that the petitioners’ “narrow focus on their own incentives ignores the broader context in which the Commission adopted the Rule,” i.e., by permitting other entities besides exchanges to offer data products, the Rule would promote innovation in the broader data market and is designed to encourage a proliferation of new data products.

In addition, the Court found that the Commission reasonably concluded that the Rule would promote competition notwithstanding the possibility that off-exchange “dark” trading venues could improve their competitive position under the new regime.  

The Court noted that the petitioners claimed the Rule’s anticipated impact on exchanges’ revenue from their proprietary data products will inhibit their ability to compete with off-exchange venues, contrary to the Exchange Act’s commitment to promoting competition, and that the increase in order flow to the less-regulated dark venues will reduce transparency in the marketplace as a whole.  The Court, however, stated that petitioners’ contention that the Commission “duck[ed] serious evaluation of the costs” the Rule would impose on competition “rests on a fallacy,” that petitioners “equate competition with their own competitive position,” and petitioners’ concern that the Rule will hurt exchanges’ bottom line is “speculative.” The Court adds that the Commission explained that any losses may be partially or fully offset by the fees paid to exchanges by competing consolidators for their data and by the opportunity for the exchanges to continue to sell some version of their existing proprietary data products.

Finally, the Court states that the Commission reasonably rejected petitioners’ concerns that their own lost profits would harm the marketplace as a whole.  The Court added that even if petitioners could somehow show that the net effect of the Rule on transparency would be negative, that would still not suffice, as transparency is not the only aim of Section 11A, that petitioners’ claim that reduced revenues will cripple their reinvestment in their own products, hurting their customers, “defies basic economic principles,” and that claims that any reduction in revenue would necessarily compromise the exchanges’ bottom line so severely as to affect their ability to comply with their regulatory responsibilities is “unsubstantiated.”

SEC Amendments to the Definition of Exchange; Alternative Trading Systems That Trade U.S. Government Securities, National Market System Stocks, and Other Securities

The SEC has reopened the comment period on proposed rulemaking to amend Regulation ATS for “Government Securities ATSs” and include significant Treasury markets platforms within Regulation ATS. The proposal has potentially wide implications for the markets beyond U.S. government securities as it would, among other things, expand the definition of “exchange” in several respects, including to require “communication protocol systems” to either register as exchanges or operate as alternative trading systems (“ATSs”).  The proposal also would amend Regulation ATS to require existing NMS Stock ATSs to file amendments to their existing disclosures in accordance with a revised Form ATS-N; require ATSs to report changes to fee disclosures on Form ATS-N no later than the date they make a fee change; and propose changes to the fair access requirements in Rule 301(b)(5) of Regulation ATS (“Fair Access Rule”).  The reopened comment period closes on June 13, 2022.

SEC Proposes Further Definition of "As a Part of a Regular Business" in the Definition of Dealer and Government Securities Dealer

The SEC has proposed new rules to further define the phrase “as a part of a regular business” as used in the statutory definitions of “dealer” and “government securities dealer.”   The proposed rules, among other things, would establish certain qualitative, activity-based standards that would require market participants meeting these standards in the equity and options markets to register as dealers with the SEC.  Significantly, the proposed rules raise questions regarding the application of the broker-dealer regulatory regime to proprietary/principal trading firms (“PTFs”) that would be required to registered under the rule.  Comments on the proposal are due on May 27, 2022.

Proposal of the CTA and UTP Operating Committees Regarding Odd Lots on the SIPs

The SIP Operating Committees of the CTA and UTP Plans have issued a proposal relating to the dissemination by the SIPs of certain odd lot quotation data as ancillary information on the SIP data feeds.  Under the proposal, the SIPs would disseminate: top-of-book odd lot quotes for each exchange, when that top-of-book quote is at or better than the BBO of such exchange, and an odd lot NBBO, when the best of the odd lot quotes is at or better than the protected NBBO.

SEC Proposal on Short Position and Short Activity Reporting by Institutional Investment Managers

The comment period has closed for the SEC proposal to provide greater transparency through the publication of short sale related data to investors and other market participants.  Under the proposed rule, institutional investment managers that meet or exceed a specified reporting threshold would be required to report, on a monthly basis using the proposed form, specified short position data and short activity data for equity securities.

CAT NMS Plan Fee Proposal

A proposed amendment to the CAT NMS Plan has been filed with the SEC to implement a revised funding model for the consolidated audit trail (“CAT”) and to establish a fee schedule for Participant CAT fees in accordance with the “Executed Share Model.”  The new CAT NMS Plan fee proposal has been posted on the CAT NMS Plan website.