Netcoal. v. Sec.

Decision Date06 August 2010
Docket NumberNos. 09-1042, 09-1045.,s. 09-1042, 09-1045.
Citation615 F.3d 525
PartiesNETCOALITION, Petitioner v. SECURITIES AND EXCHANGE COMMISSION, Respondent. NYSE Arca, Inc. and The NASDAQ Stock Market, LLC, Intervenors.
CourtU.S. Court of Appeals — District of Columbia Circuit

OPINION TEXT STARTS HERE

COPYRIGHT MATERIAL OMITTED.

On Petitions for Review of an Order of the Securities & Exchange Commission.

Carter G. Phillips argued the cause for the petitioners. Dennis C. Hensley, Kevin J. Campion, Richard D. Bernstein, and Roger D. Blanc were on brief.

Mark R. Pennington, Assistant General Counsel, Securities and Exchange Commission, argued the cause for the respondent. Michael A. Conley, Deputy Solicitor, and Luis de la Torre, Senior Litigation Counsel, were on brief.

Douglas W. Henkin argued the cause for intervenors NYSE Arca, Inc. et al. in support of the respondent. David S. Cohen, Eugene Scalia and Amir C. Tayrani were on brief.

Before: HENDERSON and GARLAND, Circuit Judges, and EDWARDS, Senior Circuit Judge.

Opinion for the Court filed by Circuit Judge HENDERSON.

KAREN LECRAFT HENDERSON, Circuit Judge.

In 2006, NYSE Arca, one of the largest securities exchanges in the United States, proposed to begin charging a fee to investors for access to its proprietary “depth-of-book” product, ArcaBook. ArcaBook lists pending orders placed on NYSE Arca-specifically, bids to buy at prices lower than, and offers to sell at prices higher than, the prevailing market price. The Securities and Exchange Commission (SEC or Commission) approved NYSE Arca's proposal, finding the proposed fees for ArcaBook were “fair and reasonable” and “not unreasonably discriminatory.” Petitioners NetCoalition, a public policy corporation representing approximately 20 internet companies (including Google and Yahoo!), and the Securities Industry and Financial Markets Association (SIFMA), a trade association representing more than 600 securities firms and banks, challenge the SEC order, arguing that it violates the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (Exchange Act), and the Administrative Procedure Act, 5 U.S.C. § 551 et seq. (APA). For the reasons set forth below, we conclude that the SEC did not adequately explain the basis of its approval nor, on this record, support its conclusion with substantial evidence and, accordingly, we remand to the SEC.

I. Background

The Exchange Act provides the framework by which the SEC regulates the transactions and the classes of participants in the major securities markets in the United States. See Bradford Nat'l Clearing Corp. v. SEC, 590 F.2d 1085, 1090 (D.C.Cir.1978). NYSE Arca is registered with the SEC as a national securities exchange, see 15 U.S.C. § 78f, and as such is a securities industry “self-regulatory organization,” or SRO, see id. § 78c(a)(26) (defining “self-regulatory organization”). Although self-regulatory, NYSE Arca remains subject to comprehensive SEC oversight and control. See Karsner v. Lothian, 532 F.3d 876, 880 (D.C.Cir.2008) (citing 15 U.S.C. § 78s(b)). For example, an exchange is required to file its governing rules with the SEC and comply with them. See 15 U.S.C. § 78 o-3(a)-(b). An exchange's rules must, among other things, “provide for the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities,” id. § 78f(b)(4); “promote just and equitable principles of trade” and not “permit unfair discrimination between customers, issuers, brokers, or dealers,” 1 id. § 78f(b)(5); and “not impose any burden on competition not necessary or appropriate in furtherance of the purposes of” the Exchange Act, id. § 78f(b)(8). As an SRO, an exchange must also file any proposed rule change (including a fee change) with the SEC for approval. See id. § 78s(b)(1)-(2). The SEC notices a rule change proposal for public comment and either approves it if it is consistent with the requirements of the Exchange Act or disapproves it. See id. The SEC has delegated the initial consideration of a rule change to its Division of Trading and Markets (which until 2007 was known as the Division of Market Regulation). See 17 C.F.R. § 200.30-3(a)(12).

In 1975, the Congress expanded the authority of the SEC through a major overhaul of the Exchange Act. See Bradford, 590 F.2d at 1091. Among other things, the 1975 Amendment directed the SEC to facilitate the establishment of a “national market system for securities,” or NMS, to link securities markets nation-wide in order to distribute market data economically and equally and to promote fair competition among all market participants. Id. at 1094 (citing 15 U.S.C. § 78k-1); see Regulation NMS, Release No. 51808, 70 Fed.Reg. 37,496 (June 29, 2005). The Congress specified five factors to guide the SEC in establishing the NMS: the Commission is to assure (1) efficiency, (2) fair competition, (3) availability of market data, (4) practicability of order execution in the best market and (5) the opportunity for an investor's order to be executed directly, that is, without the participation of a dealer. 15 U.S.C. § 78k-1(a)(1)(C). Under SEC oversight during the next three decades, the NMS grew to encompass the securities of over 5,000 companies with a collective U.S. market capitalization of more than $14 trillion. Today NMS stocks are traded simultaneously on one or more of the nine national exchanges that participate in the system, including the New York Stock Exchange (NYSE), the NASDAQ Stock Market (NASDAQ) and NYSE Arca, as well as at non-exchange trading sites like (1) alternative trading systems; (2) electronic communication networks (ECNs), including the BATS Exchange (BATS ECN); and (3) market-making securities dealers.

Because NMS stocks are traded so many places at once, one of the important innovations of the NMS system is to make available to investors a stream of “core” market data consolidated from all of the exchanges. Regulation NMS, 70 Fed.Reg. at 37,503 (consolidated data stream “form[s] the heart of the national market system” (quoting H.R.Rep. No. 94-229, at 93 (1975), as reprinted in 1975 U.S.C.C.A.N. 321, 324 (Conference Report))). Core data for each NMS security consists of three things: (1) last sale reports, which include the price at which the latest sale of the security occurred, the size of the sale and the exchange where it took place; (2) the current highest bid and lowest offer for the security, along with the number of shares available at those prices, at each exchange; and (3) the “national best bid and offer,” or NBBO, which are the highest bid and lowest offer currently available in the country and the exchange(s) where those prices are available.

To ensure that an investor can obtain core data for each NMS security, the SEC requires each exchange, including NYSE Arca, to report last sales ( i.e., the price and size of the most recent trade on NYSE Arca) and the current best bid and offer to one of several central data processors for consolidation. See 17 C.F.R. §§ 242.601, 242.602. Each central data processor then disseminates the consolidated information, including the NBBO, to broker-dealers and data vendors. See id. § 242.603(a)-(b). The SEC must approve the fees charged for core data, see 17 C.F.R. § 242.608(b)(1), and a broker-dealer is required to purchase the consolidated core data and make it available to an investor seeking to place a trade, 2 see id. § 242.603(c). In this way, today's core market data system

provides investors in the U.S. equity markets with real-time access to the best quotations and most recent trades in the thousands of NMS stocks throughout the trading day. For each stock, quotations and trades are continuously collected from many different trading centers and then disseminated to the public in a consolidated stream of data. As a result, investors of all types have access to a reliable source of information for the best prices in NMS stocks.

Regulation NMS, 70 Fed.Reg. at 37,503.

All other market data is “non-core” data. 3 This case involves non-core data referred to as “depth-of-book” data. Depth-of-book data consists of outstanding limit orders 4 to buy stock at prices lower than, or to sell stocks at prices higher than, the best prices on each exchange. 5 Because depth-of-book data is non-core data, the SEC does not require that it be included in the consolidated data stream or made available to an investor at the time of trade execution. 6

Depth-of-book data matters because of a concept called “depth,” which refers to the number of shares of a security available to trade at any given price point. If a trader wants to buy a certain number of shares that exceeds the depth (volume of shares available) at the best price, depth-of-book data will tell him the number of shares available at prices inferior to the best price. 7 In this way, depth-of-book data allows a trader to gain background information about the “liquidity” of a security on a particular exchange, i.e., the degree to which his total sale or purchase price will differ from what he would receive if the entire trade were made at the prevailing best prices. For instance, even a very large buy order for a security with high liquidity on a certain exchange will trade at or close to the best price while a similarly large order for a security with lower liquidity on that exchange will cost more in toto due to the fewer number of shares available at or near the best price.

A simplified example may help illustrate the concept of liquidity and the utility of depth-of-book data. Assume an investor wants to make an offer to sell 3,000 shares of company XYZ. The best bid price reflected in the core data at NYSE Arca for XYZ is 1,000 shares at $10. The investor knows he can sell up to 1,000 shares at $10 but he does not know at what price his remaining 2,000 shares will sell until after his order is placed. This is where depth-of-book data comes in. Assume further...

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