Domestic Securities, Inc. v. S.E.C.
| Decision Date | 01 July 2003 |
| Docket Number | No. 02-1308.,02-1308. |
| Citation | 333 F.3d 239 |
| Parties | DOMESTIC SECURITIES, INC., Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent. Nasdaq Stock Market, Inc., Intervenor. |
| Court | U.S. Court of Appeals — District of Columbia Circuit |
Warren L. Dennis argued the cause for petitioner. With him on the briefs was Linda Lerner.
Susan S. McDonald, Senior Litigation Counsel, Securities & Exchange Commission, argued the cause for respondent. With her on the brief were Meyer Eisenberg, Deputy General Counsel, Jacob H. Stillman, Solicitor, and John W. Avery, Special Counsel.
Peter E. Greene argued the cause and filed the brief for intervenor.
Before: SENTELLE, ROGERS and GARLAND, Circuit Judges.
Opinion for the Court filed by Circuit Judge SENTELLE.
Under the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (2000), the Securities and Exchange Commission (SEC or Commission) must approve any changes to the rules of the National Association of Securities Dealers, Inc. (NASD), the private organization responsible for self-regulation of the over-the-counter (OTC) securities market. In 2002, the SEC issued an order approving a NASD proposal to implement a new computerized quotation and trade execution system, known as SuperMontage, for the Nasdaq Stock Market, Inc. (Nasdaq). In its petition for review, Domestic Securities, Inc. (Domestic), an Electronic Communications Network, challenges a feature of the trade execution rules governing SuperMontage, arguing that it discriminates against ECNs and harms competition. Domestic also challenges the SEC's approval of an Alternative Display Facility, which was designed to provide a quotation display mechanism for traders who do not wish to use SuperMontage. We hold that we lack jurisdiction over Domestic's challenge to SuperMontage's trade execution rules because the rules were approved in an earlier SEC order, and Domestic failed to seek timely review of that order. We deny Domestic's petition for review of the ADF approval order because the SEC's order was supported by substantial evidence and was not arbitrary or capricious.
In 1975, Congress enacted amendments to the Securities Exchange Act of 1934, directing the SEC to "facilitate the establishment of a national market system." 15 U.S.C. § 78k-1(a)(2). Specifically, Congress charged the SEC "to use modern communication and data processing equipment to link all securities markets nationwide." Bradford Nat'l Clearing Corp. v. SEC, 590 F.2d 1085, 1094 (D.C.Cir.1978); see also 15 U.S.C. § 78k-1(a)(1)(D). In centralizing the market for securities, Congress sought, inter alia, to promote "economically efficient execution of securities transactions" while maintaining "fair competition" between securities brokers and dealers. Id. § 78k-1(a)(1)(C)(i)-(ii).
NASD has played an important role in the establishment of the national securities market. NASD is the only "national securities association" registered with the SEC pursuant to 15 U.S.C. § 78o-3. As a registered national securities association, NASD must maintain rules that, inter alia, "remove impediments to ... a free and open market and a national market system, and ... protect investors and the public interest," while permitting neither "unfair discrimination between customers, issuers, brokers, or dealers," id. § 78o-3(b)(6), nor the imposition of "any burden upon competition not necessary or appropriate in furtherance of the purposes" of the Act, id. § 78o-3(b)(9). See Timpinaro v. SEC, 2 F.3d 453, 456 (D.C.Cir.1993). In addition, NASD is a selfregulatory organization (SRO) responsible for regulation of the OTC securities market, 15 U.S.C. § 78s. As an SRO, NASD must file with the Commission any proposed change to its rules. Id. § 78s(b)(1); NASD, Inc. v. SEC, 801 F.2d 1415, 1416 (D.C.Cir.1986). After notice and comment, the Commission may approve the rule change if it finds that the change is consistent with the Act and regulations governing the SRO. 15 U.S.C. § 78s(b)(2)(B).
Since 1971, NASD has operated an electronic automated quotation system-the NASD Automated Quotation system, or "Nasdaq" that affords dealers the means to display and instantaneously update their "bid" and "ask" quotations for securities, for which they are registered with NASD as market makers. By 1984, the Nasdaq system had evolved from providing only price quotations to providing automatic execution of some trades.
Also in the mid-1980s, Instinet developed the first Electronic Communications Network (ECN or Network), which provided a private trade execution network for its subscribers. Subscribers, usually dealers or institutional investors, could post "limit orders"-orders to buy or sell a specific number of shares of a security at a specific price; the Instinet computer system matched those orders with the orders of other subscribers and automatically executed the trades via computer. Oftentimes, Instinet could provide a better price than Nasdaq in a given security because market makers were not required to post on Nasdaq customer limit orders that were priced better than the market makers' own best bid or offer quotations for the same securities. Thus, market makers could display one set of prices for retail customers on Nasdaq while offering more favorable prices through Instinet.
To address this discrepancy, in 1996 the SEC adopted the "order handling rules" (OHR or the Rules), which require a market maker, or an ECN on its behalf, to publish in the national market the market maker's best-priced customer limit orders and to provide trading access to those orders. See 61 Fed.Reg. 48,290 (Sept. 12, 1996). The Rules brought market makers' best-priced limit orders into the national market system and put ECNs in direct competition with market makers for the business of customer limit orders. Id. at 48,307. It also gave non-ECN subscribers access to the best-priced limit orders displayed on an ECN. Previously, the ECN had charged each side of a trade executed on its system-both of whom were subscribers-an execution fee. Recognizing this, the SEC allowed the network to continue to impose charges for access to its system, so long as the fee was "not structured to discourage access by non-subscriber broker-dealers." Id. at 48,314 n. 272.
After the adoption of the OHR, several companies began operating ECNs, including the petitioner, Domestic. In 1998, the Commission adopted Regulation ATS, which, inter alia, required each network to display all of its limit orders in the national market system and provide trading access to those orders. 63 Fed.Reg. 70,844, 70,865-73 (Dec. 22, 1998). Regulation ATS also expressed the Commission's view that exchanges, such as Nasdaq, could be operated as for-profit corporations. Id. at 70,849, 70,882-84. Nasdaq opted to become a for-profit entity. Although NASD remains the parent corporation of Nasdaq, the SEC has promulgated regulations designed to ensure that NASD does not use its regulatory authority to promote its pecuniary interest in Nasdaq.
By the late 1990s, Nasdaq had become a virtual trading floor for the national OTC securities market, offering sophisticated computerized trade execution capabilities. ECNs' limit orders were displayed alongside the quotations and limit orders of Nasdaq market makers. Nasdaq's trade execution system permitted market participants to enter only a single quotation on each side of the market for each security into the system at any one time. The quotations were arranged as a montage according to price and time. Two types of execution were available through Nasdaq: (1) SuperSOES, which allowed participants to execute small orders automatically against the quotation of a market maker; and (2) SelectNET, which allowed participants to route orders to a particular market maker or ECN for non-automatic execution. The automatic execution feature of SuperSOES created a risk of double liability for an ECN if its displayed quotation or limit order had been executed internally-e.g., on an ECN's internal network-shortly before the SuperSOES automatic execution occurred. To avoid this risk, the ECNs did not participate in SuperSOES, but participated only in SelectNet. Under SelectNet, ECNs received only order delivery, and could decline to execute the order if it had already been executed internally. Over time, some ECNs began declining to execute orders, not because of prior internal execution, but because the broker submitting the order had failed to pay the ECN's SEC-authorized access fees.
In 1999, Nasdaq proposed to implement SuperMontage, a new trade execution system, to consolidate SuperSOES and SelectNet and to completely integrate quote and limit order display with order execution. SuperMontage allows participants to enter multiple quotations and orders. Participants may choose either to direct an order to a specified market maker or ECN or to have an order matched generally with the best price available, with price ties broken by a queue based on the time the quotation was entered. ECNs that charge access fees are placed last in the queue at each price level. Market participants are not required to use SuperMontage to execute trades, but may choose to continue to use any other method, including ECNs' private networks.
Under SuperMontage, ECNs retain their ability to take order delivery rather than automatic execution. An order delivery ECN is electronically presented with an order and is given up to thirty seconds to indicate whether or not it will accept the order. If the ECN declines the trade, the system automatically re-routes the order to the next participant in the SuperMontage queue.
The feature of SuperMontage challenged by Domestic is known as "decrementation." Under the decrementation feature,...
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