Securities Regulation Daily IEX defends NMS transaction fee pilot
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Tuesday, August 6, 2019

IEX defends NMS transaction fee pilot

By John M. Jascob, J.D., LL.M.

Investors Exchange has urged the D.C. Circuit to uphold an SEC program that temporarily restricts the fees and rebates that national securities exchanges may charge brokers for transactions in NMS securities.

In an amicus brief filed with the Court of Appeals for the D.C. Circuit, Investors Exchange LLC (IEX) has asked the court to reject a challenge to the controversial transaction fee pilot adopted by the SEC. In opposing the national exchanges that filed the petition challenging the Commission’s rule, IEX argued that the pilot will improve the U.S. equity markets because rebates distort market structure (New York Stock Exchange LLC v. SEC, August 1, 2019).

Transaction fee pilot. Adopted by the SEC in December 2018 under new Rule 610T of Regulation NMS, the transaction fee pilot is designed to study national market system (NMS) stocks and the effects that exchange transaction fee and rebate pricing models may have on order routing, execution quality, and general market quality. The pilot subjects exchange transaction fees, including "maker-taker" fee-and-rebate pricing models, to temporary pricing restrictions across three test groups. The pilot, which will last for a maximum of two years with a potential one-year sunset period, applies to all NMS stocks and includes all equities exchanges.

In response, three national exchanges, NYSE Group, Nasdaq, and Cboe Global Markets, filed petitions with the D.C. Circuit to challenge the SEC rule creating the pilot. In asking the court to vacate Rule 610T as being arbitrary and capricious and beyond the SEC’s authority, the NYSE Group argued that implementation of the rule would cause the exchanges to lose significant revenue to market competitors not subject to the rule. In addition, NYSE Group asserted that the rule would injure certain issuers of securities restricted by the rule because they would be limited in their ability to compete with issuers who were not so limited.

IEX’s defense. As the only national exchange filing an amicus brief in support of the pilot, IEX contends that rebates made by exchanges to broker-dealers to create incentives for different types of orders have fundamentally impaired the market structure. IEX noted that it does not offer rebates because rebates create harmful and expensive market complexities and are an unsustainable practice in the long run. In the view of IEX, the rebate system has resulted in unnecessarily complicated order types and market fragmentation while presenting traders with conflicts of interest and obscuring the true costs of trading. IEX argues that the use of rebates is not an essential component of a properly functioning market but rather a unique evolution in the U.S. that benefits only a few market participants like the petitioner exchanges at the expense of everyone else.

In IEX’s view, the SEC was justified in concluding that the evidence of rebates creating potential distortions in routing behavior, market structure, and execution quality was enough to justify a market-wide pilot to investigate these concerns. IEX dismissed fears that the pilot will harm the market, contending that any harms that may occur are more than likely to be overshadowed by the benefits to the overall market from reducing transaction fees and limiting rebates. Moreover, IEX believes that the pilot will improve market structure and benefit investors, both in the short term while the pilot is in effect, and in the long term when the SEC can take final action based on the results of the study.

IEX also contends that the pilot is the only way for the Commission to obtain the data required to make long-term decisions about reforming rebates. No natural experiment would produce this data, IEX asserted, given the competitive environment in which the exchanges operate. IEX also rejected the alternative proposed by the petitioners, stating that most of them would focus exclusively on conflicts of interest and not provide any data on market structure or quality, while others would impair the validity of the data. IEX also supports the SEC’s limiting the pilot to exchanges and excluding alternative trading systems (ATS), observing that exchanges and ATS operate under entirely different rules and have highly divergent fee practices.

Oral argument has been scheduled for October 11, 2019.

The consolidated cases are Nos. 19-1042(L), 19-1043, 19-1046, 19-1049, 19-1053, and 19-1054.

Attorneys: Paul Mishkin (Davis Polk & Wardwell LLP) for New York Stock Exchange LLC, NYSE Arca, Inc., NYSE American LLC and NYSE National, Inc. John Boles Capehart for the SEC. Hyland Hunt (Deutsch Hunt PLLC) and Sophia Lee, IEX Group, Inc., for Investors Exchange LLC.

Companies: New York Stock Exchange LLC; NYSE Arca, Inc.; NYSE American LLC; NYSE National, Inc.; Investors Exchange LLC

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