This report is FISD's summary of the key issues contained within the SEC's Concept Release on the Regulation of Market Data Fees and Revenues. This is only a summary of the release and does not contain any analysis or staff recommendations. It focuses on US equities and options only. The tone of the release is neutral. It establishes the SEC's regulatory authority to regulate fees and sets out the relevant factual and legal context from which they will examine the issue. The SEC's objective is to collect feedback from the industry that will be used as raw material for the next steps.

Note: We have indicated page numbers that relate to the version of the release that we printed from the SEC's web site. Comments are due on or before March 31. Click here for a copy of the complete release and the accompanying tables:

SEC Concept Release on Regulation of Market Information Fees and Revenues

Introduction
The SEC postures on page 3 that changes in the way fees are charged and the role of revenue for real-time market information may be warranted. They make the point that public access to market data was not always available and was established with the creation of the National Market System (NMS) through the Securities Act Amendments of 1975. They state that the '75 Act is still relevant, but may need to be updated due to changes in technology and communications.

The Commission is focused on ensuring access to information for retail investors and is concerned that retail investor fees have not properly kept pace with changing technology and increased demand. The Commission intends to insure that market data fees applicable to retail investors do not restrict their access to quality market information .

The Commission makes references on Page 5 to the changing structure of securities industry, particularly the rise of Alternative Trading Systems (ATS) and for-profit exchanges. The movement to for-profit status is of concern particularly as it relates to ensuring the overall quality of the market's operation and regulation. The Commission sees a direct connection between the value of a market's information and the resources allocated to operating and regulating the market.

The Commission believes that the SROs will still have front-line responsibility for operating and regulating the primary US markets and need to use market data fees to fund that responsibility. They maintain that market data revenues have been steady (approximately 21%) over the last five years and have kept pace with growth of other SRO revenues. The Commission clearly believes that market data fees are an appropriate part of the funding process. The question on the table is whether the structure of the arrangements for setting fees and distributing revenue needs to be changed.

Section V of the release requests comment on a number of matters being considered by the Commission. These include:

1. a conceptual approach to evaluating the fairness and reasonableness of fees that, among other things, could establish a link between the cost of market information and the total amount of market information revenues,
   
   
2. a conceptual approach to distributing market information revenues to the SROs that could provide for more direct funding of SRO functions that enhance the integrity and reliability of market information,
   
   
3. greater public disclosure concerning fees, revenues, and the SROs' use of revenues, and
   
   
4. broader industry and public participation in the process of setting and administering fees.

After receiving the public's comments and completing its review, the Commission intends to take further action to assure that the arrangements for disseminating market information continue to reflect the objectives set forth in the Exchange Act.

Joint SRO Arrangements for Disseminating Market Data
The release states on page 6 that it is not dealing with the issues of data ownership, maintaining that state law concepts of ownership prevail in this arena. It focuses on consolidated market information and deals with the SROs right to charge fees as well as the distribution of revenue from those fees. The Commission's conclusion is that no single market fully owns the stream of consolidated information that is made available to the public, although the markets can assert a proprietary interest in the information that they contribute to the stream. The bottom line however is that proprietary interests are subordinated to the Exchange Act's objectives for a NMS.

If you are interested in the regulatory basis for this, the relevant Exchange Act Rules are as follows:

1. Rule 11Aa3-1 governs the dissemination of transaction reports and last sale information in national market system securities. In general, this rule requires a SRO to file a transaction reporting plan for such securities, and it requires a SRO's members to transmit the information required by the plans to the SRO.
   
   
2. Rule 11Ac1-1 governs the dissemination of quotations in national market system securities and additional Nasdaq System securities. In general, it requires a SRO to establish procedures for making available its members' quotations to information vendors, and it requires the SRO's members to communicate quotation information in compliance with the procedures.
   
   
3. Rule 11Ac1-2 governs the display of transaction reports and quotation information in national market system securities and additional Nasdaq System securities. In general, it requires all information vendors, if they provide broker-dealers with any market information for a security, to provide a consolidated display of information for the security from all reporting market centers.
   
   
4. Rule 11Aa3-2 sets forth the procedures for the filing and Commission approval of national market system plans and plan amendments.

National Market Structure
Pages 7- 9 give an overview of Network A, Network B, Nasdaq System, OPRA System, Governance and Fee Structures. It does establish that market data can be restricted to those that have been approved by the Network administrators and have entered into the various agreements. It sets out the two categories -- vendors (those that distribute information to others) and subscribers (those that use information for their own use) and acknowledges that there are two categories of fees -- monthly and per-query.

The release does acknowledge that administration of monthly and per-query structures require vendors and subscribers to disclose a lot of information about their business including the requirement to monitor and report the number of devices, customers and queries. It points out that the result is substantial administrative costs for vendors, subscribers and networks. Comments on how to reduce the cost of administering fee structures is specifically requested in Section V.

Page 10 sets out the process for commission oversight of fees, public comment, and the rights to establish pilot programs. The release acknowledges that some pilots have lasted for many years (not their objective) without being filed for Commission approval The Commission wants comments on ways to improve procedures that encourage innovation (the objective of pilots) without restricting the opportunity for the public to comment.

Exchange Act Standards Governing Market Data Fees and Revenues
The release establishes on page 11 that the 1975 Act says that Security Information Processors (SIPs) must be able to obtain market information on terms that are "fair, reasonable and not unreasonably discriminatory." They maintain that those terms need standards to guide their application in practice and that one commonly used standard (for monopolistic providers) is the costs to provide the service. In fact, the Commission likes cost-based formulas in that they preclude excessive profits as well as prevent against underfunding.

The release also establishes that the Commission can establish fixed rates for market information, but maintains that it won't do so as long as the rates are reasonable in relation to costs of providing the service for which the fees are charged. In essence, it makes the point that the Commission's preference is not to be in the rate setting business.

There are references to the so-called "ticker cases" from the Supreme Court in the Exchange Control of Market Information section on page 12. They note that the CBOT vs. Christie case held that CBOT could prevent grain companies from using market data and had the right to restrict the dissemination of quotations. The key point in the case was to give CBOT time (a few minutes) to protect its trade secret. In NY Cotton vs. Hunt, the Court reaffirmed the rulings in Christie and established that quotations are property and entitled to protection under the law. The release acknowledges that exchanges use these cases to assert proprietary rights and defend these rights vigorously. The key point is that the Commission believes that the findings in these cases don't apply to consolidated information -- and were, in fact, part of the reason why they established the NMS.

On page 13 of the release it is noted that the central market system was established to guarantee unrestricted public access and consolidated information. It also states that the Commission does not believe that NMS is incompatible with allowing the exchanges to charge for information.

Page 14 focuses on 1975 Amendments and makes it clear that the SEC is authorized to establish a NMS to maintain a stable and orderly market and to centralize buying and selling interest so that each investor will have the opportunity for the best possible execution of his order, regardless of where in the system it originates. The release does recognize that communication systems, (particularly those designed to provide automated dissemination of last sale and quotation information) form the heart of the national market system.

The release maintains on page 15, that Congress granted the Commission broad flexibility to determine whether the fees charged by an exclusive processor for market information are "fair and reasonable, not unreasonably discriminatory, and whether there was an "equitable allocation" of reasonable fees among persons who use an SRO's facilities. It points out that the most important objectives for the Commission to consider in evaluating fees are to assure (1) the wide availability of market information, (2) the neutrality of fees among markets, vendors, broker-dealers, and users, (3) the quality of market information – its integrity, reliability, and accuracy, and (4) fair competition and equal regulation among markets and broker-dealers.

Under the section on the Commission's Review of Market Information Fees (page 16) it's noted that the Commission has relied on SROs and Plans to negotiate fees that are acceptable to SRO members, vendors, investors and others. In essence, they have wanted the industry to resolve matters without intervention by the Commission. The point is made that there were no comments in 1995 when NASD established its per-query fee of 1 cent nor were there any comments when OPRA established a per-query of 2 cents.

The release provides a brief discussion on page 17 of the OPRA Order on allowing OPRA to charge an access fee on vendors indicating that costs are a relevant factor in determining the reasonableness of a fee for market information and on the Instinet Order maintaining that a proposed fee for quotation represented an unwarranted denial of access because NASD did not submit an adequate cost-based justification for the fee. The Commission repeatedly emphasizes that the scope of the Instinet decision was limited to the particular competitive situation presented in the proceedings. They clearly maintain that NASD was in the business of providing enhanced information products - not simply charging a fee for a stream of basic information.

Definitions of the cost allocation pools resulting from the Instinet order are outlined on page 18. The major categories of costs were summarized as: (1) operational costs, which were allocated to the six resource pools based on identifiable personnel, equipment, and physical facilities dedicated to those operations; (2) systems and product/service development costs, which were allocated to the six resource cost pools based on the historical or anticipated level of effort to be devoted to the respective resources; (3) overhead and general and administrative costs, which were allocated directly to resource and service cost pools to the extent that a causal relationship existed between those resources or services and the incurrence of the affected costs, and (4) residual overhead and general and administrative costs, which were allocated to resource and service cost pools based on the total cost input base.

SRO Financial Structure and the Cost of Market Information
The release establishes on page 19 that the Commission imposes a lot of regulatory and operational responsibilities on the SROs. It does this to spare the federal government much of the burden of securities regulation and was one of the primary reasons why Congress incorporated industry self-regulation into the Exchange Act.

The fees from market data are designed to enable the SROs to fulfill their self-regulatory functions and play an essential role in the Exchange Act regulatory scheme. That scheme includes four categories of functions: (1) Market Operation (designed to prevent fraud and promote just and equitable principles of trade); (2) Market Regulation (to prevent insider trading and other forms of manipulation); (3) Listing (to ensure minimum financial qualifications and reporting requirements for issuers); and (4) Member Regulation (to promulgate and enforce rules governing all aspects of their members securities business).

The Sources of Funding are set out on page 20 noting that SROs charge for four categories of services (1) regulatory fees and assessments, which are paid by an SRO's members, (2) transaction services fees, which are paid by anyone who uses an SRO's facilities for executing, reporting, and clearing transactions, (3) listing fees, which are paid by corporate issuers, and (4) market information fees, which are paid by all those who use or distribute the financial information disseminated by the SROs.

The release notes on page 21 that individual SROs vary widely in the extent to which they perform each of the four SRO functions and rely on the four sources of funding. As a cumulative matter, however, they received 21% ($410.6 million) of their funding from market information fees in 1998. The release notes that this percentage has remained remarkably consistent, despite the rapid growth in market data revenues in recent years.

Internal Cost Structures are discussed on page 22. The release notes that while SRO revenues are disclosed on financial statements, internal cost structures are much less transparent. The Commission acknowledges that standard accounting principles do not require internal break down of costs, but that financial statements do indicate that the majority of costs relate to personnel and technology systems. The Commission also notes that while SRO total expenses have grown, they have not kept pace with the growth in securities industry costs in general. In 1998, SRO market information revenues represented less than one quarter of one percent of securities industry's total expenses.

Nasdaq is the only SRO that separates costs into regulatory and operational functions. The financial statements of NASD reveal, on page 23, the following information about the costs associated with the NASD's SRO functions in 1998. (1) member regulation costs were approximately $236.6 million and were more than covered by $257.4 million in revenues primarily from regulatory fees; (2) costs associated with the other three SRO functions – market operation, market regulation, and listings – were approximately $361.3 million, of which at least $57.3 was associated with the market regulation function; (3) the combined cost of the three functions was more than covered by $426.5 million in revenues derived almost entirely from transaction services fees, listing fees, and market information fees; and (4) in percentage terms, the total costs associated with the market operation, market regulation, and listing functions of Nasdaq were funded 30% by transaction services revenues, 32% by listings revenues, 35% by market information revenues, and 3% by other revenues.

The release also points out that there is no strict cost-of-service standard in the Exchange Act. Instead, the Commission has flexibility in assessing the fairness and reasonableness of fees. That being said, the Commission clearly believes that some form of cost-based allocation is the right approach and is looking for comment on the nature of a flexible cost-based approach to market data fees and revenues to meet the objectives of the NMS.

The categories of cost that are incurred to generate and disseminate market information are defined on page 24. The Commission makes a clear distinction between "direct costs" and "common costs." Direct costs are incurred only to provide market information and can be allocated entirely to the cost of market information. Common costs are incurred for the provision of services in addition to market data and should be allocated among each of the various services they support.

In the Categories of Market Data Costs section, the release defines "Plan Costs" as the expenses incurred by the various processors and administrators of the Networks to disseminate consolidated information to the public. The Commission believes that Plan costs should be classified as a direct cost and that therefore the entire amount of Plan costs should be allocated to the cost of market information. Plan costs do not include any of the costs incurred by the individual SROs in generating market information and providing it to the plan processors. The Commission is considering including many of these costs (specifically the costs of operating and regulating their markets) as part of the cost of providing market information to the public.

The Commission also makes it clear on page 25 that the costs of member regulation should not be included as part of the cost of market information. Nor should the costs associated with advertising, marketing, or obtaining corporate listings be included in the cost of market information. In sum, the Commission preliminarily believes that the cost of market information should include, in addition to Plan costs, an appropriate percentage of the costs incurred by individual SROs in operating and regulating their markets.

The relevant funding issue is not whether investors ultimately will pay the costs of effective market operation and market regulation, but how these costs are funded in the first instance and whether the funding furthers the objectives of the Exchange Act. The Commission believes that market information fees remain an appropriate part of SRO funding. When used along with transaction services fees, listing fees, and regulatory fees, they provide a solid base of financial support for the SROs. Market information fees serve an important and unique role because they provide the broadest source of SRO funding. The fees are paid by all users of market information, including, for example, options and futures market participants that otherwise would not contribute (through transaction services fees or listing fees) to the funding of the particular markets on whose information they rely.

The release discusses allocation of common costs on pages 25 and 26. It states that while many of the costs incurred by the SROs in operating and regulating their markets could be included in the cost of market information, they also support other SRO services and therefore are common costs that must be allocated among these services. Consequently, the SROs' costs of market operation and market regulation must be allocated among the three relevant sources of revenue – listing fees, transaction services fees, and market information fees. The key challenge is how to determine the appropriate basis for allocating common costs.

Requests for Comment
Section V is the heart of the document and requests comment on:

1. the concept of a flexible, cost-based approach to evaluating the fairness and reasonableness of such fees and revenues.
   
   
2. a conceptual approach to distributing the Networks' revenues to the individual SROs that could reflect more fully the Exchange Act's national market system objectives. and
   
   
3. on a variety of issues relating to SRO and Plan disclosures and Plan governance, administration, and oversight including whether the Plans and SROs should provide greater public disclosure concerning their fees, revenues, and costs, and whether participation in the process of setting and administering fees should be broadened to include vendors, broker-dealers, and users of market information.
   

The Commission encourages comments to take into account the four principal objectives relating to market information -- availability of information, neutrality of fees, quality of information and fair competition/equal regulation. The Commission encourages commenters to also consider the extent to which proposals are capable of being implemented in an objective and reasonably efficient manner, particularly given the other uses to which the Commission's resources could be devoted.

The Commission's preferred choice for resolving market information issues is to rely, whenever possible, on consensus among the SROs, the securities industry, and information users. They want to enhance the potential for such a consensus by establishing more objective standards for setting fees and distributing revenues, by providing greater public disclosure of relevant information, and by broadening participation in the fee-setting process.

The Commission is considering the concept of a flexible, cost-based approach for evaluating market information fees and revenues. On page 27 the release notes that rather than require a strict mathematical calculation of costs in every case, this approach would rely on more flexible determinations of costs to determine whether fees are fair and reasonable.

The Commission is also interested in comments related to a cost-based limit on market information revenues: In the past the Commission had relied on consensus to resolve issues related to market data fees, but they believe that a revised approach is required due to changes in the securities market. In essence, the potential for a significant number of for-profit entities suggests that closer monitoring/oversight is required.

Comments are requested on whether a cost-based limit should be established. The Commission's plan would be a requirement for SROs to adjust their fees so that they don't generate revenues that would exceed the limit. This would require better financial disclosure by the exchanges. It would also require the SROs to file proposed fee changes with the Commission when necessary to maintain compliance with the limit. Comment is requested on whether there should be specific requirements relating to the frequency and timing of proposed fee changes.

The conceptual approach, outlined on pages 27 and 28 includes the following:

1. First, each SRO would calculate the amount of its direct market information costs. These would include, for example, the Plan costs incurred by processors and administrators of the Networks in performing their Plan responsibilities and any other costs incurred only and entirely for providing market information services.
   
   
2. Second, each SRO would calculate a gross common cost pool made up of the total amount of its costs that are appropriately classified as contributing substantially to the value of market information. Appropriate categories of costs would include the costs of market operation and market regulation, but would not include the costs of member regulation or other direct costs of services other than market information. Comment is requested on whether these categories are sufficiently distinct to provide the basis for a workable internal cost allocation. Comment also is requested on specific types of costs that should, and should not, be classified as substantially contributing to the value of market information.
   
   
3. Third, each SRO would apply a standard allocation percentage to its gross common cost pool to determine its net common cost pool. A percentage allocation is necessary to reflect the fact that these costs are incurred by the SROs not only to provide market information services, but also to provide listing and transaction services. The percentage would be the same for all SROs. It could be derived from the historical experience of the SROs (on average, the SROs appear to fund between 30% and 40% of their market operation and market regulation costs through market information revenues) or based on any other rationale that furthers the national market system objectives of the Exchange Act. Comment is requested on what would be an appropriate standard allocation percentage.
   
   
4. Finally, in the fourth step, it would be necessary for each SRO to allocate its total cost of market information (direct costs plus the net common cost pool) to the various Networks whose securities it trades. This allocation could be done directly (for those costs that can be associated with a particular Network), with the remainder allocated based on the proportion of the SRO's total trading volume represented by a Network's securities. The total amount of the costs allocated to each Network from the individual SROs would represent a limit on the amount of revenues that could be generated by each Network's fees.

Under this approach, separate rules would govern the distribution of Network revenues, and therefore an individual SRO would not necessarily recover the amount of its total cost of market information in distributions from the Networks.

The Commission requests comment on all aspects of the concept of setting a cost-based limit on market information revenues. It appears that the conceptual approach outlined above could have three principal benefits. First, it could provide a much closer and more objective link between SRO costs and market information revenues than has been required in the past. Second, it potentially could be implemented in a more efficient manner than a strict, cost-of-service approach that required each SRO to establish a basis for allocating its common costs down to the last dollar. Third, the conceptual approach outlined above could put all the Networks on a more equal footing in terms of the proportion of relevant costs funded by market information revenues, thereby possibly furthering the Exchange Act objective of fair competition. Comment is requested on the advisability and practicality of this approach, including whether a single approach is appropriate for each of the different Networks and for different types of securities. The Commission also would be interested in suggestions for any alternative approaches to setting a fair and reasonable limit on market information revenues.

The release addresses the concept of the fairness and reasonableness of specific fees on page 29. The key principle is that a network can't discriminate among markets, vendors, broker-dealers and users and must therefore justify all disparities in fees. Comments are requested on the fairness and reasonableness of professional subscriber fees. The key question is whether these fees, in practice, limit the availability of market information.

Comments are requested on page 30 on whether fees for the retail investor are low enough and structured in such a way that they do not significantly limit the availability of real-time information. The Commission suggests that lower prices could promote the development of more robust services by vendors and broker-dealers to retail customers.

Comments are requested on whether the fees for retail investors are unreasonably discriminatory compared to professional subscribers. The key point is that retail investors don't use the information in the same way as professionals and whether the difference in rates adequately reflects this difference in use.

Comments are requested on whether volume discounts are consistent with the Exchange Act objective of neutrality. The key question is whether the discounts should be strictly limited to differences in administrative costs.

There is a discussion associated with the distribution of revenues on page 31. Comment is requested on (1) whether certain individual SRO costs that most directly enhance the integrity of market information (principally, the cost of market regulation) should be funded as part of the Direct Distribution in addition to Plan costs, and (2) whether the formula for making the Proportional Distribution should be revised to compensate the SROs more in accordance with the value of the information they contribute to the stream of consolidated information. Finally, comment is requested on whether the SROs should be permitted to rebate market information revenues to their members

Comments are requested on the issue of direct funding of market regulation costs and whether a portion of market information revenues should be earmarked to fund Plan costs and costs related to enhancing the integrity and reliability of market information (i.e. market regulation). According to the release the potential benefits of such an allocation are two-fold. (1) it could help ensure that this vital SRO function is fully funded, thereby helping to prevent the publication of fraudulent, deceptive, or manipulative market information, and to assure the prompt, accurate, reliable, and fair publication of market information, and (2) the funding would be shared among all users of market information, rather than falling on the particular SRO that incurs the particular costs. To the extent that market regulation costs benefit the market for a security as a whole, the objectives of fair competition, equal regulation, and an equitable allocation of SRO costs might be furthered.

The issue of compensating SROs in accordance with the value of their market information is outlined on page 32: Comment is requested on whether the formula for making the Proportional Distribution should be revised to reflect more directly the value that each SRO's information contributes to the stream of consolidated information made available to the public. In particular, does the current practice of allocating revenues based solely on an SRO's proportion of transaction volume adequately further the Exchange Act objectives of maintaining the quality of market information and encouraging fair competition? In essence, is transaction volume the right criteria for determining value? Would it be possible to develop a formula that would reward markets that provide price discovery to which other markets look to set their own prices?

The question of rebates to members is described on page 33. Comments are requested on whether rebates are consistent with the Exchange Act objective of fair competition.

Comments are requested on plan and SRO disclosure including whether the Plans should be required to make annual filings that would be available to the public including: (1) a complete listing of all their fees; (2) the number of users participating in each of their different fee programs, and (3) audited financial statements setting forth their revenues (including an itemized listing of revenues attributable to their different fees), expenses, and distributions. Comment is requested on whether the SROs should be required to provide greater disclosure of their financial condition, including disclosure of the costs associated with the performance of their various SRO functions.

Comment is requested on plan governance, administration and oversight including whether the governance structures should be broadened to include such parties as vendors, broker-dealers, and investors.

Administration of fee structures is outlined on page 34. There appears to be considerable potential for making this process more efficient by standardizing and streamlining the agreements, policies, and reporting requirements that apply to vendors, broker-dealers, and subscribers. The existence of four Networks, each with its own fee structures and requirements, inherently limits the extent to which any Network, acting alone, could substantially reduce the cumulative administrative costs incurred by vendors, broker-dealers, and subscribers. Comment is requested on whether the Plans should establish industry-wide standards for administering their fee structures and, if so, the most appropriate means for the Plans to act jointly in developing such standards.

The Commission is concerned that the Plans have used their "pilot program" provisions to implement fee structures for periods of time beyond that which the provisions originally were intended to cover. Comment is requested on the advisability and usefulness of pilot programs. Should they be eliminated entirely or should the Plans have some flexibility to experiment with innovative services and fee structures without first going through the process of a Commission filing and public comment? If pilot programs should continue in some form, comment is requested on whether they should be limited to a specified time period (for example, one year), after which the program could not be continued unless it was filed with the Commission. Finally, comment is requested on whether the terms and conditions of all pilot programs should be made available to the public in some fashion prior to initiation of the program