National Ass'n of Securities Dealers, Inc. v. S.E.C.

• Decision Date: 30 September 1986
• Docket Number: No. 85-1012,85-1012
• Citation: 801 F.2d 1415
• Parties: , Fed. Sec. L. Rep. P 92,926 NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent, Institutional Networks Corporation, Intervenor.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 1415

801 F.2d 1415

255 U.S.App.D.C. 376, Fed. Sec. L. Rep. P 92,926

NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent Institutional Networks Corporation, Intervenor.

No. 85-1012.

United States Court of Appeals, District of Columbia Circuit.

Argued April 8, 1986.

Decided Sept. 30, 1986.

Francis J. Wilson, with whom Robert E. Aber, Washington, D.C., was on the brief, for petitioner.

Anne E. Chafer, Asst. General Counsel, S.E.C., with whom Daniel L. Goelzer, General Counsel, and Elisse B. Walter, Associate General Counsel, Washington, D.C., were on the brief, for respondent. Paul Gonson, Atty., S.E.C., Washington, D.C., also entered an appearance for respondent.

Daniel T. Brooks, a member of the bar of Supreme Court of Virginia, pro hac vice, by special leave of court, with whom Ronald D. Eastman and Barry S. Spector, Washington, D.C., were on the brief, for intervenor.

Before MIKVA, GINSBURG and BUCKLEY, Circuit Judges.

Opinion for the court filed by Circuit Judge BUCKLEY.

BUCKLEY, Circuit Judge:

The National Association of Securities Dealers ("NASD") petitions this court for review of orders of the Securities and Exchange Commission ("SEC" or "Commission") rejecting as excessive a fee that NASD proposed to charge for access to certain computerized securities information that it collects. Intervenor Institutional Networks Corp. ("Instinet") is engaged in the business of, among other things, selling computerized securities information collected by NASD. Instinet objected to NASD's proposed fee before the SEC and now asks this court to affirm the SEC's rejection of that fee. Because we conclude that the SEC's action was not arbitrary or capricious and was supported by substantial evidence, we affirm the orders of the Commission.

I. FACTUAL BACKGROUND

NASD is a national securities association registered with the SEC pursuant to section 15A of the Securities Exchange Act ("Act"), 15 U.S.C. Sec. 78o -3 (1982 & Supp.1986). NASD has over 6,700 broker-dealer members located throughout the United States. The purpose of the organization is to provide self-regulation of the over-the-counter ("OTC") securities market. To this end, it owns and operates the NASDAQ system, a computerized securities information service.

The NASDAQ system became operational in 1971 and was intended to rationalize the OTC market by providing buyers and sellers of OTC securities with up-to-the-minute information about market conditions. The NASDAQ system collects price quotation information concerning OTC securities from market makers (i.e., broker-dealers who hold themselves out as willing to buy and sell particular securities on a regular basis). This information is processed by the NASDAQ computers and made available to the public in four basic forms.

NASDAQ "Level 1" service provides the best bid and offer for securities listed on the NASDAQ system to over 100,000 subscribers. NASD does not sell this information directly to subscribers. Rather, it supplies the information to vendors such as Instinet, Quotron Systems, Inc., and Bunker Ramo Corporation, who further process it and sell it to subscribers. In addition to charges assessed by the vendors, Level 1 subscribers pay a monthly fee of $8.75 per computer terminal to NASD.

NASDAQ "Level 2" service provides more complete market information than Level 1. Subscribers receive a full listing of all market maker bids and offers for each NASDAQ security. Level 2 service is not available through vendors, but rather is sold directly to subscribers by NASD. There is a "query function" built into the NASDAQ computers that enables Level 2 subscribers to obtain the most current information concerning each OTC security directly from NASD. Subscribers pay $150 per terminal per month for this service. There are approximately 500 Level 2 subscribers.

"Level 3" service is identical to Level 2, except that, in addition to the query function, it has an "update function" that permits market makers to enter new quotations into the NASDAQ system for securities in which they make a market. Like Level 2 service, Level 3 is provided directly by NASD and costs $150 per terminal per month. There are approximately 2,000 Level 3 subscribers.

The fourth form in which NASDAQ information is made available to the public is "NQDS" service. This service provides subscribers with the same information that is available through NASDAQ Level 2 service. Unlike that service, however, NQDS service is not sold directly to subscribers by NASD. Rather, as in the case of Level 1 service, NQDS data is provided in raw form to vendors, who process the data and then sell it to subscribers. At the present time, Instinet is the only vendor engaged in the business of selling NQDS data to subscribers. This case concerns the fee that NASD may charge NQDS subscribers for the information that they receive through Instinet.

NQDS service is of relatively recent origin. It was initiated as a result of a 1981 SEC decision that required NASD to make available to securities information vendors full price quotation data for those NASDAQ securities designated by NASD as "national market system" ("NMS") securities. Instinet was the only vendor to express an interest in obtaining this data. Instinet and NASD entered negotiations aimed at reaching an agreement similar to that existing between the parties with respect to Level 1 service. Both parties understood, however, that, unlike Level 1 service, Instinet's new service would be in direct competition with NASDAQ Level 2 service.

Negotiations between the parties soon reached a deadlock over the question of fees, and in June 1983 NASD filed its proposed terms with the SEC. Under NASD's proposal, Instinet was to be charged a $3,200 per month "vendor fee," which would cover the cost of transmitting quotation data from NASD to Instinet. In addition, Instinet's customers were to pay NASD a "subscriber fee" based on the $150 per terminal per month fee paid by NASD's Level 2 and Level 3 ("Level 2/3") customers. The $150 fee was to be discounted to reflect the fact that Instinet subscribers would receive quotations for only NMS securities rather than all securities available through Level 2/3 service. The amount of the discount was to be in rough proportion to the percentage of total NASDAQ trading volume not consisting of NMS securities.

II. SEC PROCEEDINGS

In July 1983, Instinet filed a petition with the SEC pursuant to section 11A(b)(5) of the Act, 15 U.S.C. Sec. 78k-1(b)(5) (1982), alleging that NASD's proposed terms were an inappropriate prohibition or limitation of access to NASDAQ information. In particular, Instinet asserted that NASD's proposed fees were unreasonably high. Instinet also claimed that NASD's refusal to provide quotation information for NASDAQ securities not designated as NMS securities would render its service unmarketable.

In a preliminary ruling in August 1983, the SEC found that NASD's proposed fees constituted a prohibition or limitation of access to services. See 48 Fed.Reg. 38,124 (1983). The SEC announced the initiation of a proceeding to determine whether NASD's prohibition or limitation of access violated section 11A(b)(5) of the Act, and partial interim relief was granted to Instinet during the pendency of the proceeding. Specifically, NASD was ordered to begin providing full quotation data for NMS securities to Instinet, and Instinet was directed to pay into escrow an amount equal to the sum of NASD's proposed fees. Instinet began receiving NQDS service under the terms of this order in September 1983.

NASD subsequently offered to provide Instinet with quotation data for all NASDAQ securities, not just NMS securities. NASD insisted, however, that the subscriber fee for complete data should be the full $150 fee that it charges its own customers for Level 2/3 service. Thus, the principal issue in the SEC proceeding was the reasonableness of NASD's proposed fees. In essence, Instinet claimed that, because NASD's situation was analogous to that of a public utility, NASD's fees should be based on the costs incurred by it in collecting NQDS data. NASD argued, on the other hand, that its fees should be based on the value of the service provided to Instinet, which value was defined by the fees charged for its Level 2/3 service.

The SEC announced its findings in an order issued April 17, 1984 ("April order"). See 49 Fed.Reg. 17,640 (1984). The Commission agreed with Instinet that NASD's charges must be cost-based. The Commission accordingly approved the $3,200 per month vendor fee, but it ruled that the proposed $150 per month subscriber fee was inconsistent with section 11A(b)(5) of the Act. The Commission explained that NASD's value-of-service method of computing the subscriber fee effectively would require Instinet's subscribers to pay for services that they do not receive from NASD. In particular, the fee charged by NASD for its Level 2/3 service covers the cost of operating the Level 2/3 query function, which is not included in NQDS service and which Instinet must provide to its subscribers at its own expense. The cost to Instinet of operating its own query function is obviously reflected in the fees that Instinet charges its customers. Thus, if NASD were permitted to charge Instinet's subscribers the full $150 fee, those subscribers would be forced to pay twice for a query function that they only receive once.

In order to avoid this problem, the Commission ruled:

The NASD, in effect, should recover only those costs it would incur if it operated a pure "pass-through" system--a system that only collected information and passed it on to vendors. The NASD should not recover any costs related to its own competing vendor service.

Id. at 17,649. The Commission then determined that the best indication of the cost to NASD of collecting NQDS information is the $8.75 per month fee that NASD charges...