SEC halts stock-data rebates by 3 markets

Fees are viewed as causing some extra transactions

July 04, 2002|By BLOOMBERG NEWS

WASHINGTON - The Securities and Exchange Commission said three stock markets must stop giving rebates of market data revenue to brokerages and electronic trading systems.

The Cincinnati Stock Exchange, the Pacific Exchange and the Nasdaq stock market give back to brokerages and trading firms some of the fees the exchanges earn from selling data on the price, time and size of Nasdaq trades.

Ending the rebates would mean higher costs for the electronic networks and brokers.

"The availability of large market data revenue rebates may be creating incentives for traders to engage in transactions with no economic purpose other than to receive market data fees," the SEC said in a statement.

The SEC's ruling follows a complaint last week by the National Association of Securities Dealers against Swift Trade Securities USA Inc. for so-called wash transactions - entering simultaneous buy and sell orders for the same amount of shares - that offset one another. Swift made the trades with trading network Island ECN Inc., which gives customers back part of its data revenue, to get market data fees without increasing or decreasing its holdings of the securities.

Financial information providers and brokers purchase the data from the exchanges.

The SEC said it "abrogated" proposals from the Cincinnati and Pacific exchanges and Nasdaq to extend existing pilot programs to offer rebates on Nasdaq stocks. Halting the rebates will allow the SEC to study the effects of market data revenue sharing, the agency said.

Exchanges that have in place permanent rebate plans approved by the SEC for stocks traded on the New York Stock Exchange and American Stock Exchange will be allowed to rebate half their data revenue, said Robert Colby, deputy director of market regulation at the SEC. The Cincinnati exchange has rebated as much as 90 percent.

"We repealed what we could," Colby said. "Some programs are past the period we could do that."

If the exchanges re-submit the plans, the public will be invited to comment on them before the commission approves the proposals, the agency said in a statement.

Trades on Island are reported by the electronic system to Nasdaq or Cincinnati. Nasdaq, to match the amount the Cincinnati exchange was rebating, filed with the SEC in recent months a proposal to give back 90 percent of the market data revenue, said Colby.

The problem is that "market data revenue has historically paid for a lot of regulatory costs," said Colby. "There is a question about whether rebating the revenue to participants undercuts regulation."

Exchanges such as Nasdaq, the NYSE and the American Stock Exchange are self-regulatory organizations. They scrutinize trading on their own markets to make sure transactions don't violate securities laws. Electronic trading networks, such as Island, pay the exchanges for regulatory services.

"We applaud Chairman [Harvey L.] Pitt and the commission for ensuring that the nation's equity markets will have proper funding for regulation," said Bill Harts, chief of corporate strategy at the Nasdaq, which is owned by the National Association of Securities Dealers.

Market data revenue sharing is based on the number of trades participants do, not the number of shares traded.

On Jan. 1, Island began returning a portion of the data fees it earned to customers on securities listed on the NYSE and Amex.

"A large part of this money belongs to investors," said Matthew Andresen, chief executive of Island. "We want to see it go to them. We are saddened to see tens of millions of dollars taken out of the hands of the American investor and bequeathed to the public monopolies that SEC is creating."

The network at the end of January yanked data on its trades from Nasdaq and gave it to the Cincinnati exchange, because Cincinnati was offering Island a larger cut of the money earned on the data.

A month later, Island raised with the SEC concerns about the incentive to "execute several small trades rather than one large trade for the same number of shares," according to a Feb. 11 letter from Island General Counsel Cameron Smith to Annette Nazareth, the SEC's director of market regulation.

"Rather than enter a 500-share order, a broker may be inclined to enter five 100-share orders to increase the number of transactions, and thus, its relative market share of" revenue, Smith wrote.

That may be happening in the Nasdaq 100 index tracking stock, the world's most actively traded security. On June 27, at 3:41 p.m., 44 trades of the Nasdaq 100 stock totaling 9,300 shares were executed on Island at the same price, $25.90. The average trade size was 211 shares. A few minutes earlier, at 3:39, 42 trades occurred totaling 5,500 shares. All were at the same price.

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