On March 14, 2018, the Securities and Exchange Commission (the “Commission”) proposed Rule 610T to create a pilot regarding transaction fees,1 creating three Test Groups designed to obtain data resulting from the lowering of the maximum access fee from its current $.003 per share2 to $.0015 per share for Test Group 1 and $.0005 per share for Test Group 2. For Test Group 3, the Commission is proposing to prohibit rebates in connection with an execution, not only with respect to top-of-book liquidity, but also with respect to depth-of-book interest. The Commission also eliminated a potential work-around to the prohibition on rebates in Test Group 3 by also prohibiting discounts on transaction fees linked to a broker-dealer’s posted volume on an exchange. However, an exchange could offer its market maker incentives for meeting market quality metrics adopted as part of new exchange rules.
The list of potential securities affected by the proposed pilot (the “Pilot Securities”) would consist of NMS stocks with a minimum initial share price of at least $2; if the share price of a Pilot Security dropped below $1 at the close, the Pilot Security would be removed from the pilot and no longer subject to the pricing restrictions applicable to the Test Groups. The Pilot Period is to last two years with an automatic sunset at the end of the first year, unless the Commission publishes notice that the pilot is to continue for another year.
Interestingly, the Commission has gone beyond the pilot framework proposed by the Equity Market Structure Advisory Committee (“EMSAC”).3 EMSAC proposed four groups, three test groups and a control group, where the only difference between each group was the access fee cap (.002, .001, and .0002). Unlike the Commission’s proposed pilot, there was no recommendation to incorporate a test group prohibiting rebates. In fact, EMSAC considered and rejected such a proposal. Additionally, while EMSAC proposed a random sample of 100 common stocks and ETFs within each test group, the Commission’s proposed pilot would impose the pilot on a larger set of stocks. Under proposed Rule 610T, each Test Group is to contain 1,000 NMS stocks, with the remainder included in the Control Group (which would be roughly the same size as the Test Groups).
It is unclear whether the Commission’s proposed pilot will withstand scrutiny as consistent with the Securities Exchange Act of 1934, especially given the D.C. Circuit’s views on reasoned decision-making. The Commission repeatedly states that the potential costs of the proposed pilot are difficult to determine because of a lack of data; however, the D.C. Circuit has previously struck down agency actions which fail to analyze costs simply due to the difficulty of doing so.4 Further, the Commission downplays the potential harm of the proposal on efficiency, competition, and capital formation, stating that any effects would be temporary and would only last for the duration of the proposed pilot. But the potential effects of a pilot lasting for two years affecting all NMS stocks cannot be downplayed. Importantly, the only actual data available regarding the potential effects of the proposed pilot are associated with Nasdaq’s experiment lowering access fees and liquidity rebates on a selected set of securities. Nasdaq’s analysis, as the Commission acknowledges, demonstrated that a reduction in access fees and liquidity rebates reduced Nasdaq’s market share and Nasdaq’s incidence of providing the NBBO. While the benefits of gathering information on the effect of access fees would be valuable in future regulatory efforts, the potential negative effects on the public price discovery process should give the Commission pause before implementing a pilot affecting all NMS stocks.
1 See Securities Exchange Act Release No. 82873 (Mar. 14, 2018), available at https://www.sec.gov/rules/proposed/2018/34-82873.pdf.
2 See 17 CFR 242.610(c).
3 See EMSAC’s Recommendation for an Access Fee Pilot (July 8, 2016), available at https://www.sec.gov/spotlight/emsac/recommendation-access-fee-pilot.pdf.
4 See Chamber of Commerce of U.S. v. SEC, 412 F.3d 133, 143 (D.C.Cir.2005) (difficulty in formulating cost estimate does not relieve SEC of “statutory obligation to determine as best it can the economic implications of the rule it has proposed” because even “in face of uncertainty, agency must exercise its expertise to make tough choices ... and to hazard a guess as to which is correct, even if ... the estimate will be imprecise”) (internal quotation and citation omitted).