UNITED STATES SECURITIES AND EXCHANGE COMMISSION ADVISORY COMMITTEE ON MARKET INFORMATION Thursday, April 12, 2001 9:07 a.m. Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. Diversified Reporting Services, Inc. (202) 296-9626 2 PARTICIPANTS: MR. MICHAEL ATKIN Vice President, Financial Information Services Division, Software and Information Industry Association MR. ROBERT G. BRITZ Group Executive Vice President, New York Stock Exchange MR. ANDREW M. BROOKS Vice President, Head of Equity Trading, T. Rowe Price MR. ROBERT COLBY Deputy Director, Division of Market Regulation, SEC MR. THOMAS DAVIN Nasdaq MR. MICHAEL T. DORSEY Senior Vice President, General Counsel and Secretary Knight Trading Group MR. JAMES DOUGHAN Susquehanna Partners MS. CARRIE E. DWYER General Counsel and Executive Vice President, Charles Schwab MS. ADENA FRIEDMAN Senior Vice President Nasdaq MR. THOMAS HALEY New York Stock Exchange MR. DAVID A. HUNT Partner McKinsey & Company MR. GEORGE K. JENNISON Senior Managing Director, Retail Equity Group, First Union Securities Diversified Reporting Services, Inc. (202) 296-9626 3 PARTICIPANTS (CONTINUED): PROF. SIMON JOHNSON Sloan School of Management, Massachusetts Institute of Technology MR. DONALD C. LANGEVOORT Professor, Georgetown University Law Center MR. BERNARD L. MADOFF Bernard L. Madoff Investment Securities MR. BRIAN McNELIS Reuters America MR. MARK A. MINISTER President and CEO, Bridge Training MS. ANNETTE L. NAZARETH Director, Division of Market Regulation, SEC MR. EDWARD NICOLL Chairman and CEO Datek Online Holdings MR. PAUL O'KELLY Chief Operating Officer, Chicago Stock Exchange MR. GERALD D. PUTNAM Chief Executive Officer, Archipelago MR. PETER QUICK President American Stock Exchange MR. ERIC D. ROITER Senior Vice President and General Counsel, Fidelity Management & Research Company MR. JOEL SELIGMAN, Chair/Moderator Dean, Washington University School of Law Diversified Reporting Services, Inc. (202) 296-9626 4 C O N T E N T S AGENDA ITEM: PAGE I. Progress Report on Subcommittee 6 II. Presentation by CTA/CQ Plan Administrator 29 III. Presentation by Nasdaq/UTP Plan Administrator 64 IV. Presentation on FISD Market Data Policy Database 10 V. Discussion 116 VI. Public Comments 151 VII. Summary/Next Steps 154 Diversified Reporting Services, Inc. (202) 296-9626 5 P R O C E E D I N G S DEAN SELIGMAN: Let me call our fourth meeting to order. We have what will be, I suspect, a pretty full agenda. We're going to begin with four reports. And just by way of a couple of preliminary points, I'm going to ask people to hold their questions on each of the respective reports until the initial presentation is done. I am concerned that when we're complying with our charter and essentially limited to six public meetings, that I want to use the time efficiently today and cover all or at least as much of the agenda as possible. I'm concerned that if we have too many questions in the process it will slow it down too much. Second, in three of the four reports there are slides. Each of the various presenters is going to ultimately reproduce the slides and we'll circulate them to each member on the committee. Let me start with Don, who is chairing the subcommittee on alternative methods of consolidation, and just get a progress report. Don, as you all know, besides leading another subcommittee meeting before May 14th, our focus on that date will be how a multiple consolidator system ultimately could work. Diversified Reporting Services, Inc. (202) 296-9626 6 PROF. LANGEVOORT: Right. Thanks, Joel, and given all the work we have to do today, let me try to be very brief. As Joel mentioned, the subcommittee, which contains 11 members of this full advisory committee, met once on March 26th and will be meeting again this Monday. Our objective is to prepare an agenda for the May 14th meeting that will reflect the questions we think the full advisory committee needs to discuss and, hopefully, some sense of consensus -- to the extent there is any -- among the subcommittee as to ideas, conclusions or whatever that has come out of our deliberations. The first meeting was a very productive one. We divided our discussion into two parts: one, the technological feasibility of moving to a multiple consolidator model, secondly, the economics of moving to a competing consolidator model. On the first of these two questions we received very valuable reports from Tom Davin and Tom Haley on the existing SIAC system, how it works, what the technological challenges are of bringing various data feeds into a single consolidated stream and what that would mean to the process of having multiple consolidators facing that same task. Bottom line -- and I won't go through all the details, we'll certainly present that to you in advance of Diversified Reporting Services, Inc. (202) 296-9626 7 the May 14th meeting -- it was a fairly optimistic one. That is to say, technologically, the process of receiving the feeds, sequencing, validating from multiple sources using multiple consolidators involves something of a challenge and will require some degree of SEC oversight. But the subcommittee is optimistic that the self- interests of their various participants, the experience that we've had in other areas -- vendors under the current system, options, commodities, other areas -- suggests that those technological problems would be worked out with a relatively small degree of SEC supervision. Thus our conclusion, our consensus, I think, is that the system is technologically doable. The economics poses a more difficult problem, and was the substance of our discussion at the second half of the first meeting and will continue to be the subject of the discussion on Monday. To the extent that a display rule is kept in place -- and we took it as the consensus of the full advisory committee at the March meeting, there's a strong feeling the display rule should stay in some form -- questions of market power, who can control pricing, whether there will be exploitative pricing, were serious ones. Obviously, it's a matter that divides members of the advisory committee and the full committee. The New York Stock Exchange has articulated Diversified Reporting Services, Inc. (202) 296-9626 8 numerous times that there are restraints built into the governance structure of the SROs and other mechanisms that prevent exploitative pricing. Not all members of the subcommittee or the full committee agree and one of the things we are exploring is whether there are compromises, middle ground options, that might be mechanisms for limiting that pricing power to the extent that it exists. What we've discussed -- and, to some extent, this anticipates the discussion this committee will have this afternoon -- are possibilities such as most favored nation pricing, which I think really means trying to figure out who is comparable to whom, so that they should pay roughly comparable prices. Secondly, the possibility of advisory committees informing the individual SROs with respect to pricing decisions, a supplement to the current governance structures that we have in place now. Perhaps -- and this is something we are going to discuss more on Monday -- maybe relaxing the display rule, perhaps looking at ways in which the time at which the NBBO or other data needs to be displayed is limited to time of execution rather than a broader requirement, or perhaps -- and I emphasize perhaps -- the possibility of allowing synthetic NBBO, NBBO that is comparable to, but perhaps not exactly the same as what it is now. Finally -- and, again, repeating a discussion that Diversified Reporting Services, Inc. (202) 296-9626 9 we've had previously on the full committee -- the possibility that various market participants can sell their data separately: broker/dealers, perhaps specialists, the exchanges, so that there will be multiple data sources competing in the marketplace. Again, we will continue all this discussion. So let me just finish up by saying, I think the subcommittee process has been very valuable. The smaller group and the informality of the structure has, I think, led to a good quality of communication among members of the subcommittee, and we're happy, I think, that we've made some progress, even if we haven't solved all the problems. So we'll see what we bring to the full committee on May 14th. I'd be happy if other members of the subcommittee want to add anything to what I said, but I think that's my progress report. DEAN SELIGMAN: Okay. It sounds very much like a work in progress and we'll have, obviously, a full exploration of the issues on the 14th, and, as you suggested, preceded by certain documentation. Let me go a little bit out of order for the presentations this morning we met to prepare, and I'd like to start with Michael Atkin and I'd like to walk through this FISD market data policy database and certain questions that suggests. Diversified Reporting Services, Inc. (202) 296-9626 10 With each of the presenters, I asked, in effect, that their presentations be fewer than 30 minutes. In the most optimistic world, the questions also would be within 30 minutes. If we need to discuss them further, we will. We'll see that some of what Michael will discuss will be related to then what is picked up by Tom Haley and Tom Davin for New York and Nasdaq. Michael, let me turn the floor over to you. MR. ATKIN: All right. Thanks, Joel. And I have a time line down to 15 minutes for you, so -- At the conclusion of the meeting, March 1, there was seemingly a lot of uncertainty and a lot of lack of clarity, if you will, about market data management, how the process worked, what was it. So after that meeting, the Commission staff asked me if I would put together a small paper, which I did, circulated it to everybody on this advisory committee, and I'm going to briefly summarize what was in that paper. My intent was to give you a neutral assessment, without an undue amount of judgement or assessment on my part, and to give everybody a common starting point so that you could have a conversation on market data policy issues even if you weren't directly involved in the wonderful world of market data administration. All right. Throughout the paper that I sent, I Diversified Reporting Services, Inc. (202) 296-9626 11 used the term "market data management" to refer to a whole spectrum of issues associated with market data policy, contracts, billing and reporting, and administration. However, I will make an important distinction between the issues that are process-related versus those that are policy- related, and I think that's a very important distinction. First off, the entire global industry is in support of and is actively working on process efficiency. The goal is to promote electronic commerce to reduce the costs associated with market data administration. This is clearly a classic win/win for everyone. Still, there are lots of inefficiencies in the system that can be improved and the industry recognizes them and is cooperating to address them. Business policies of the exchanges are a different matter. There is no clear consensus on the right business model. There is no clear right answer. There are honest differences of opinion on what it takes to run the business of the exchange and there are many shades of gray. If you'll bear with me, I'm going to try to shed a little bit of light on why things are so gray. I think it's also important to recognize this is not a U.S. problem. There are over 85 fee liable exchanges around the world. There are dozens of third party services that all work together to make up the market data inventories of the vendors and the user firms. There are lots of Diversified Reporting Services, Inc. (202) 296-9626 12 policies, lots of variations of policies, and they all need to be understood and applied by organizations that are in the market data redistribution business. Unfortunately, administration is part of the job, and a confusing job it is, because not only do you have to comply with the multiple policies of hundreds of sources, but you've got to apply old contractual requirements to real world circumstances. You've got to do so for situations that were neither known nor anticipated when the policies and contracts were created, and if you really think about it, that's probably the best reason why all of you should go back to your organizations and dramatically increase the salaries of your market data managers. This being April and I'm Jewish, I had to do the Amonish Tonok slide. Underlying the entire discussion, I believe, are four core questions. The first is, who should determine the business practices and business models of the exchanges, particularly in this rapidly evolving industry environment. The second, I think picks up on Don's comment, is to recognize that the generation next, meaning the critical issues under debate within this committee, transparency and display rules and the like, are very different from the business issues and business structures that currently exist. The question I think that everyone is asking is, how do you Diversified Reporting Services, Inc. (202) 296-9626 13 maintain a level playing field and ensure that the business practices of the next generation of services don't have the unintentional consequence of impeding commerce. The third is what, if anything, outside of what the industry is doing cooperatively, can be done to streamline, simplify, standardize and automate business processes, in essence, to promote the straight through processing of market data administration. It's a shared goal amongst everyone and it's one that has real dollars associated with it and potentially will save the industry a lot of money. Then ultimately, and I think the reason we're -- or partially the reason why we're sitting in this room -- is what's the practical role for the Commission to help the industry manage those business challenges? To state the obvious, all market data management questions start with the contract. The market data contract is the principal document that governs what vendors, redistributors and subscribers can and can't do with market data, because once it's signed, all parties are obligated to comply with the terms and conditions. Not surprisingly, our members spend a lot of time dealing with contract issues. In fact, we develop, we publish, we continue to evolve something we call our Exchange Contract Guide to help support this delightful process of contract negotiation. Diversified Reporting Services, Inc. (202) 296-9626 14 I don't want to be too flippant about it. I think it's a very important document. It's freely available on our Web site to the entire industry. Its purpose is to dig deep into the bowels of the contract issues by an unbiased analysis of what the business considerations are for each of the segments of the contract, and then we illustrate that with real examples from market data contracts around the world. Every contract, in one way or the other, deals with these 12 core market data issues. What we did was to combine all of the model agreements from all of the vendors and all of the contracts that existed in the industry into one big document, get everybody discussing this document to define the points that are in it, and to make sure that we could do two things. Not only do you understand the objectives of each of these contract provisions, but you've got to look at the practical problems associated with implementation. The result is a sample contract. It's got lots of analysis. It's all used as a starting point for negotiation. This document is being used and has been used for well over a year in the industry. In fact, we're now getting pushed to add more to it, add redistribution issues associated with new things people are doing, index redistribution and stuff like that, re-derive data. So when you think about it, when you think about Diversified Reporting Services, Inc. (202) 296-9626 15 our policy database, it's all driven off of this contract structure. So what's the problem? Well, besides the point that there are some -- forgive me -- very draconian contracts out there. The rules related to market data are governed by this legal document. This is a legal document that's difficult to negotiate. It's also subject to interpretation. Understanding and translating the complex policies of multiple exchanges is anything but simple. Because they're legal documents, they don't necessarily spell out how the rules are to be implemented in the real world. Because they are complex and they're difficult to negotiate, they have a long life span, for years, many of them. As a result, they're out of date, they don't address the new technologies, they don't address special circumstances, they don't deal with new applications. Contracts are often vague, subject to interpretation, which, of course, leads to conflicts of interpretation. Compliance with the rules has also got to be communicated. You've got to deal with the various people who work with data all throughout the information chain. These rules are complex. They sometimes conflict with the internal objectives, the sales objectives of the people who are redistributing data, and it's the lack of knowledge and that breakdown of communication that I believe leads to the Diversified Reporting Services, Inc. (202) 296-9626 16 downstream errors, which sometimes result in significant financial liabilities. Then finally, as mentioned, the contracts vary around the world. Keeping track with all the obligations, particularly as it relates to redistribution, and especially with nontraditional vendors in the business, is a difficult and an error-prone process, which is why we built our market data policy database. Our objective is to document all of the obligations and requirements covered by exchange contracts and other policy documentation at a very granular level. In fact, we have taken our 12 contract segments and have now translated that into about 230 individual contract type of questions that you can ask. The database now includes agreed market data policy statements from 45 exchanges. We are going to completely cover the industry, and once we finish the exchanges, we're intending to do the third parties and vendors, and we've done fee schedules that have been normalized for 75 of those exchanges. The purpose of the database is fourfold. First, know thy rule and comply with the requirements. Ignorance of the rules should not be anybody's excuse for not following the rules. You might not like them, but you've got to understand them. Second, make sure that the vendors and their Diversified Reporting Services, Inc. (202) 296-9626 17 downstream clients have consistent, complete and uniform interpretations of all the administration requirements on a global basis. In essence, anything that's ambiguous from an exchange needs to be clarified because you're holding people accountable for following the procedures. Third, make sure the polices are rational. Lots of the contracts are outdated. New policies need to be created. In essence, we built this to allow the industry access to the collective experience of the global market data industry as either they had to update their contracts or develop new ones. So wondering about Internet redistribution policy? Go check the database and see how others are doing it. Trying to figure out how to deal with creating an index using proprietary exchange data? Go check the database and see how others are doing it. And hopefully, rationality wins out and you tend to move toward uniformity. In essence, any debate on policy starts with what's the current policy? Then, how does that policy compare to others so that you can have a rational conversation amongst the various parties on what makes sense in the long run? Finally, as more and more people get into the market data redistribution business, they need some place to reference their requirements. What are the requirements and costs to redistribute real time data from the New York Stock Diversified Reporting Services, Inc. (202) 296-9626 18 Exchange, EuroNext and Deutsche Borse via my Web site? What kind of agreements are needed if I want to take a snapshot of data, redistribute it via my Web site, using these eight European exchanges and Chicago Board of Trade? That kind of thing. We are now in beta tests. We are running the thing through its paces. Our purpose is to make sure that real people who work with market data can ask real plain language questions and get useful answers out of our database. All right. That's enough on the tools that we're trying to build. Let me turn to the business side of the equation, because this is really, I think, getting into the core of the question on who should determine the business practices of the exchange. The first, this prior approval versus vendor discretion, is really a debate about the business models that exist in the industry. These are the two primary models that currently exist. Vendor discretion, which is used by most of the exchanges around the world, gives the vendor a license to redistribute data without prior approval, but subject to the terms of the exchange contract. The prior approval model starts with the premise that no one is allowed to do anything with the data until it is approved in advance by the exchange. Vendors say the prior approval is administratively cumbersome. The North Diversified Reporting Services, Inc. (202) 296-9626 19 American equity exchanges say, this is necessary for us to effectively manage our business. I'm going to get into that in a second, but it's not clear, from my experience, that there is an easy answer to that dilemma, or actually to any of these dilemmas I'm going to paint for you. North American equity exchanges use various classification systems to determine the rights to use data and the fees associated with usage. For example, there's a distinction between professional and nonprofessional subscribers for fee determination. There are distinctions between vendors, subvendors and subscribers for assigning contractual and liability obligations. There are distinctions between internal redistributors, external redistributors and no redistribution for fee determination and for assignment of administrative requirements. Unit account: it's critical because this is, in essence, what you're required to track and what you're required to report on. Units can be device-based, user- based, location-based or I.D.-based. There are unit account policies for single users, for common areas, for shared terminals, for multiple terminals at a single desk. This is an area of huge debate. Do you count units, passwords or locations? If there are two data feeds supporting one user, is that one unit or two? What about if that application is serving both Diversified Reporting Services, Inc. (202) 296-9626 20 trading and analytics? Is that one unit or two? Each exchange sets its policy for how it both determines its unit and applies those policies. How about for enterprise licenses? What's the basis? What's the metric to use? Is it accesses? Terminals? Registered reps? Trading turnover? What's the metric? These are just not simple questions and there's more than one side of each of these issues and I wanted to make sure that as we were talking about them, they were characterized correctly. Billing and reporting is another huge area of debate. Billing and reporting right now is -- I would characterize it as a multiple system, costly, manually intensive, administrative nightmare. The good news, however, is that everybody agrees with that and everybody is on board with the objective of simplification and automation. But it's a huge task. It's complicated by differences in both reporting requirements and differences in billing approaches. Let me give you an example. For data feeds, the New York Stock Exchange, Nasdaq and OPRA maintain a direct contractual relationship with their subscribers. They have this prior approval process through the Exhibit A for New York and OPRA and Attachment A for Nasdaq. The vendors don't like it. They think it's cumbersome and unnecessary. They want the exchanges to adopt Diversified Reporting Services, Inc. (202) 296-9626 21 a model that says, authorize the use of data subject to your terms and conditions. The exchanges, on the other hand, have adopted this convention because they need to have it in place to support that direct contractual relationship with the subscriber, which begs the question, why are the exchanges in the billing business? And, in fact, a lot of vendors ask that. Why are the exchanges in the billing business? Vendors say, "Get out of the billing business." But not everybody agrees with that. The exchanges and the large user firms like direct reporting because it makes reconciliation easier and it makes billing more accurate. The redistributors are not necessarily the best in doing these administrative processes on behalf of the exchanges. Some vendors have said, "We don't want the burden and the cost and particularly the liabilities of being the billing agent for the exchange." Again, not a simple issue to resolve. And then there's also -- I don't mean to make them any less significant -- issues associated with intellectual property rights for delayed data and derived data. What's the extent to which vendors and subscribers can create their own intellectual property using exchange market data? I think this is important as we begin to look at the new world of exchange competition, or to the extent to which this data is subject to fees and reporting obligations. Diversified Reporting Services, Inc. (202) 296-9626 22 So what I wanted to do was just paint for you -- and what I tried to do in my paper -- what I thought were the seven core business issues that exist. The bottom line point of all of that is it's not a simple subject to figure out who sets those policies and how those policies are set. Let me talk a little bit about the good stuff. There is a lot of coordination and cooperation around the world on business process automation. While it's a massive undertaking, I think the payoff is potentially very significant. And I frankly want to give the exchanges their due on this, because they are not only active and willing participants in this discussion, they are often the lead in moving this activity forward. The system, you know, the evil, hideous Exhibit A process, is a great example. It started out with multiple agreements. Nasdaq had their own. New York had their own. OPRA had their own. Toronto had their own. Everybody said, "This is crazy. We've got all the same stuff." The exchanges agreed. They got together through our organization. We created a single document. That document is currently in use. But that's not all. The exchanges are now taking it a step further. Two weeks ago I spent a couple hours with the New York Stock Exchange, took a look at what they call Diversified Reporting Services, Inc. (202) 296-9626 23 their Automated Data Feed Reporting Process. It's a beautiful system. It is a Web-enabled Exhibit A, reduce that whole process to a series of click-throughs, automatic validation, checking reference available to the vendors. It's really sweet. I think it will significantly reduce the turnaround time for authorization and will allow faster response to marketplace needs. Now it begs the question, of course -- still open question -- is that process needed? But that aside, the process that exists is moving toward electronic commerce. Also on the docket -- I talked to Ron Jordan over at the exchange -- is click-through subscriber agreements for professional subscribers. This is something that Nasdaq led the way in. They now have it implemented. Nasdaq started it. The New York Stock Exchange is following suit. I think that's a good example of how this process works. The New York Stock Exchange was the first exchange to adopt the user definition of unit account. Users all got together, tried to come up with a standard contractual definition of unit account. NYSE said, "It makes sense to us. We will implement it." They eliminated double billing and are no longer -- if you get New York Stock Exchange delivered to you by two vendors to a single desk, you only pay once for that. That's their policy. And they've established procedures to make sure that firms get credit and Diversified Reporting Services, Inc. (202) 296-9626 24 can take advantage of that. The exchanges are also helping achieve and willing participants in the automation of reporting, the simplification of billing processes. I think this is a hugely important initiative, and will significantly reduce costs. So as you look at this equation, understand what's going on right now in the industry. There are legitimate business issues under debate and everybody is working together, in my opinion, to try to make the process more efficient. All right. Let me sum up. First point is, do not, please, underestimate the complexity of market data management or try to simplify these issues as we slog through this debate. I'd even go so far as to say, the problems that are being articulated by the industry are not about fee setting and they're not about SEC regulatory oversight. They are more about these market data challenges that I've tried to lay out that the industry is debating right now. Second, everyone seems to be in support of market data contract and fee policy transparency. Every query that we've looked at says, in order to fix these problems or to have a debate on these problems, you've got to find out what the current policy is, and everybody is willing to play this game. I don't think transparency is a question. Third, the entire industry recognizes the Diversified Reporting Services, Inc. (202) 296-9626 25 complexities associated with market data management and they are working cooperatively to try to simplify, rationalize and automate the market data business processes. Business process automation is a huge win. There are lots of opportunities for simplification, consistency and uniformity. I think we might be well served to try to figure out how we can support activity, because it has got a lot of inertia and it's a difficult thing for the industry to get its arms around. Last slide: I have been listening to the discussion on business models and on market data policy for a long time. The right orientation on these issues is still not completely evident. All sides make legitimate points. There is a productive dialog taking place on business policies. We're working to try to build some tools to allow the industry to have some empirical data so that they can make their case. At the end of the day, however, it seems to me that these are legitimate business issues that need to be managed on the basis of the business realities of the involved parties. The direct involvement of the Commission is likely only required if one group is being obstructionist or if there is an impediment to commerce. I personally don't think that's happening, but I'll leave that judgement to others on this advisory committee. Diversified Reporting Services, Inc. (202) 296-9626 26 As I indicated in my paper, the discussion concerning the level of information required for market transparency, including the concepts of information competition, the role of exchanges as value-added information providers, the notion of mandates on the factors of production, and the potential for changes to the display rule, I believe, in my conversations with the industry, are the most important points that we are debating and the ones that we would probably be well served to devote our time on having a full debate. So with that, Joel, I'll take any questions if there are some. DEAN SELIGMAN: Thank you, Michael. And let me just -- to be sure everybody appreciates what, in part, your database will achieve is increased transparency of contractual terms, including on a global basis, increased transparency of fee schedules. Individual exchange user contracts, including Exhibit A, would not be captured in the database, and who is subject to particular aspects of the fee schedules is not captured in the database. MR. ATKIN: Yeah, I would think that that's proprietary information that the firms don't want to have shared with their competitors. I talked to one firm, for example, that's doing a new transaction-based system and is trying to figure out what Diversified Reporting Services, Inc. (202) 296-9626 27 its market data policies are. They sent me a note and said, "Please don't share this with anybody because we're trying to get a jump on the market." So I don't think that's really an exchange issue, I think that's really a vendor and end-user issue. DEAN SELIGMAN: When do you think you'll be done with beta testing of the database? MR. ATKIN: It's hard to say, because the purpose of the beta testing is to make sure it's right and we're going to do it until it's right. DEAN SELIGMAN: Sure. MR. ATKIN: It will probably be finished by June or July of this year, enough that -- I mean right now I'm pretty confident that the data is accurate. What I'm a little bit unclear about is our retrieval interface in trying to -- because this is complex stuff and you've got to figure out how to do multiple queries on various policies. So we're working on our interface to make sure that the end user ultimately who's making the decision about, do we do something, can get the information they need. So my guess is mid-year. DEAN SELIGMAN: Okay. Are there other questions from the committee? Okay. Michael -- oh, I'm sorry. Bob? MR. COLBY: Can I just ask, within the U.S. Diversified Reporting Services, Inc. (202) 296-9626 28 context, do you have a view as to whether having multiple consolidators of the data as opposed to the consortium, how that would affect the data management issues? MR. ATKIN: I don't think it would affect it at all. I think the rules and policies are set by the data originators. The distributors have to follow the rules, but having multiple distributor points I don't think is going to change those rules at all. MR. COLBY: Right now I think the policies are set by the administrators on behalf of everyone in the plan and if they were being set individually by each of the members that currently participate in the plan as opposed to by one single consolidator, would that affect that? Is that -- MR. ATKIN: I might be wrong here, Bob, but I'm not sure if the first statement is 100 percent accurate. I think the policies are set by the exchanges. The plan administrators just administer the policies. I mean, Tom, you probably know a lot better -- MR. HALEY: That is correct. MR. ATKIN: Yes. DEAN SELIGMAN: And we will certainly amplify that point in presentations that are coming. Other questions for the group? All right. Well, Michael, thank you very much, and I have a feeling your thoughts on this will be interwoven Diversified Reporting Services, Inc. (202) 296-9626 29 throughout today and the sessions to come. Let me turn to Tom Haley now to focus on the CTA/CQ plan administration. There are a number of specific questions that were propounded, and I think you also have a PowerPoint presentation? MR. HALEY: I do. DEAN SELIGMAN: Okay. MR. HALEY: Thank you, and I believe that the way we're going to do this, this morning, is that I'm going to do the first half of the 30 minutes and Bob is going to do the second half of the 30 minutes. I've got some slides that will set the stage as to what we do as the network administrator and Bob is going to cover a number of the questions that have been raised. DEAN SELIGMAN: Fine. Why don't you proceed? MR. HALEY: Okay. Well, let me just start right out here with the things we're going to cover. I flipped through that slide and we don't have a backup on here, but we're going to cover -- basically this first slide, I just wanted to set some perspective. What we're talking about here for everybody, just to jog your memory for a second, we've got two plans. We've got a CTA plan and the CQ plan. CTA covers transactions. CQ covers quotations and the BBO. The SROs that are participants in those plans govern those plans. There are currently nine SROs that Diversified Reporting Services, Inc. (202) 296-9626 30 participate in the CTA plan and the CQ plan. Under those plans there are two networks: Network A and Network B. Network A refers to trades and quotations in respective NYSE listed equities. Network B refers to trades and quotations in respective AMEX and other regional-listed equity securities. We're going to be talking about the Network A administrator today. There is also the -- AMEX administers Network B. And I think, as you well know, there is one processor, SIAC, and there are two systems that SIAC operators, which are the consolidated tape and the consolidated quotation system. And I mention those two because that's really the starting point where the contract process begins, when we get back in here in this presentation to the contracts. NYSE is the Network A administrator, as you know. What does NYSE do? Well, basically, it carries out the duties and responsibilities pursuant to authority that's been delegated to it by the SRO participants. So we operate pursuant to delegated authority. That authority was delegated to us by the participants. NYSE, in terms of carrying out its Network A administrator responsibilities, is obligated to administer Network A agreements and rates as established by the participating SRO boards and approved by the SEC. So all of Diversified Reporting Services, Inc. (202) 296-9626 31 our contracts and rates are part of the plans. They've been approved by the SROs, filed with the Commission and approved by the Commission. What do we do on a day-to-day basis, to get into more in the way of specifics as to what our role entails? Basically, it's contract administration. We contract with vendors and other data recipients for access to Network A and Network B data. The data that comes out of the consolidated tape and consolidated quotation system comes out in a single stream containing both Network A and Network B data. We do the contracts with folks that want to interface with the consolidated tape and the consolidated quotation system and we do that on behalf of Network B as well. We also contract using standard form agreements with subscribers for Network A data and we create and oversee Network A pilot programs. The administrator bills and collects appropriate fees as per the Network A rate structure. One aspect of our duties used to be to arrange for leased lines to support the Network A ticker. That's pretty much phased out at this point. That's the low speed visual ticker. We also oversee SIAC's operation of the consolidated tape and consolidated quotation system on a daily basis. There's coordination between NYSE personnel and the SIAC personnel to the extent that it's necessary and appropriate, Diversified Reporting Services, Inc. (202) 296-9626 32 on a monthly basis. We pay SIAC's bills for their production and development. We also distribute the net revenues to the participants and provide an accounting to them. The next chart is a single page. This rate structure is the rate structure that is in place for display fees, that has been approved by the participant SROs, and which has been submitted and put through the regulatory review process, approved by the Commission. This rate structure is also readily available. This rate sheet is readily available on the NYSE'S NYSEData.com website, and the rates that you see up there generally generate and account for 90-percent of the network A revenues. Most of that comes from the top part of that sheet, which is the professional display fees for professional subscribers. As you can see, it's a tiered system. This was -- it's got 14 tiers. It was established in 1987. During the interim between 1987 and now, this -- there's been one 6-percent increase that took effective January 1, 1992. We maintain a database that has over 15,000 professional subscribers in it, professional subscriber accounts, 500,000 display devices on a global basis. And at the end of the day, on a monthly basis, this boils down to roughly an average unit cost of about $25 per month per terminal. These fees also entitle a recipient to Diversified Reporting Services, Inc. (202) 296-9626 33 receive and display last-sale prices, transaction reports, bid and ask report, bid and ask prices, ticker, all on the same screen, together with BBO and Montage. We do not have separate pricing for BBO and Montage, it's all-inclusive in the rates that are paid for network A display. The second part of that rate structure that you saw up there previously was display fees for nonprofessionals. The nonprofessional rates are, basically we have a monthly fee, and for data that's made available to nonprofessionals, these fees will apply to the vendor providing the data, whether that is a traditional form of vendor, such as a Reuters, or whether or not it is a broker-dealer such as a Schwab, or a Fidelity, or Soloman Smith Barney, or what have you. The fee for the first 250,000 subscribers is a dollar, and in excess -- over 250,000, it's 50 cents each. If you're serving your subscriber base, or your customer, your retail customer population on a pay-for-use basis, or on a usage base, rather than pay a monthly fee, we have established usage rates. Those usage rates are what you see there. The vendors meter the data. And for the first 20 million quotes, the fee is three quarters of a penny. The next 20 million, it drops to a half a penny, and for over 40 million, it drops down to a quarter of a cent. And these two are tied in. If a vendor Diversified Reporting Services, Inc. (202) 296-9626 34 that is using usage-based has a nonprofessional subscriber who is a heavy user, and he is taking down streaming data, that individual is capped for purposes of what the vendor pays, at the monthly dollar rate. You've heard a lot about nonprofessional fees over the course of your meetings here, but I just put up this slide to share with you some of the histories. That displays the monopoly power of the New York Stock Exchange and the Network A consortium. In 1984, a nonprofessional paid a hundred and sixty eight bucks for a display of Network A data. Today it's down to a dollar. Lastly, we recently put in place what we call an, "enterprise maximum," and that is for broker-dealers that are providing services to their customers, or broker-dealers with in-house devices. The maximum that they will pay on a monthly basis is $500,000 in respect of their in-house devices, or in respect of what they make available to their retail account holders. The two combined, their liability will not exceed $525,000 for the month. That was put in place in 1999. That, in effect, says that a firm, for instance, Carrie's -- Carrie knows the -- Schwab's got seven and a half million accounts, from what I read. All of those accounts could be serviced with streaming data on a monthly basis, and Schwab's bill would virtually not go up any significant Diversified Reporting Services, Inc. (202) 296-9626 35 amount, and certainly not go above five and a quarter. Let me turn now to agreements. The Network A agreements that the administrator has to administer are also agreements that have been put through the regulatory review process, that have been filed with the Commission, and that in turn have been approved for use by the Network A administrator. And again, to reiterate, the Network A administrator -- these are the only agreements that we have, these were approved by the SRO boards, by the Commission, and these are the agreements that we use. They're readily available to vendors, investors, via the NYSE website. They apply uniformly to all data users. And basically, we have two standard forms of agreement. One for -- which we call the, "vendor form" of agreement, and another called the, "subscriber form" of agreement. The vendor form is the standard form of agreement that all organizations that interface with the SIAC systems, or that interface with a vendor to get a data feed service must enter into with us. Now, Mike spent a second talking about preapproval. Part of that preapproval process is that if Reuters gives a data feed to one of its accounts without our preapproval, Reuters remains liable for the actions of that account and their use of the data. If they get our preapproval, they're off the hook. So therein lies part of Diversified Reporting Services, Inc. (202) 296-9626 36 the logic behind preapproval. The vendor form of agreement also incorporates exhibit A, which I'll talk a little bit more about in a second. The subscriber form of agreement. Basically, we only have, for professional subscribers, a standard written form of agreement. I was surprised, Mike, but I'll take your word for it. I didn't think we let Nasdaq ahead of us with a click-on for professionals, but apparently we have. In the nonprofessional arena, we have a standard form of written agreement for nonprofessionals, but over the years, we've also adopted, in addition to that -- substantively the same, but somewhat different in format, we allow vendors to take and add an addendum to their contract, rather than have to use ours today. But basically, the terms and conditions in that agreement are the same. And we also have developed a click-on agreement that the vendors can use with nonprofessional subscribers. Briefly now, on the exhibit A, as I said, the Exhibit A is an attachment to the vendor form of agreement. In the commercial context, I say this is somewhat analogous to a bill of lading or a packing list. This, the Exhibit A, is the understanding that we, as the Network A administrator, have with the customer, as to -- and it documents what the data is that they're getting, how they're going to be using it, what appropriate fees will be levied, what fees from the Diversified Reporting Services, Inc. (202) 296-9626 37 approved price list will apply, in this case. And I think, as was pointed out by Mike, and also I will add to it ,that we started out with Exhibit A, but subsequently AMEX, Nasdaq, OPRA, Board of Trade in Toronto, have adopted a similar concept. And that's it. That gives you the baseline for what the administrator does. DEAN SELIGMAN: All right. Let me -- before we address those separate issues, are there questions anyone would like to pose to Tom with respect to the role of the administrator? Yes, Mark? MR. MINISTER: Yeah, Tom, are there any current differences in data content or display restrictions between professional and nonprofessional? MR. HALEY: None. MR. MINISTER: There had been. I'm old enough to remember there used to be, but there are none now. MR. HALEY: I'm -- MR. MINISTER: You're not that old, I know. MR. HALEY: I -- well, I'm having a senior moment, I guess, because I don't remember. MR. MINISTER: So there are. So I guess the question -- and I don't know if you're the one to answer it -- why the average professional user pays $25, and the average nonprofessional user pays $1. So I'm trying to find the 25 to 1 difference, if there is no difference in content Diversified Reporting Services, Inc. (202) 296-9626 38 or display. MR. HALEY: Okay. I think if you go back to 1984, all there was, was one. There was no distinction made between pro and nonpro. One of the things that we've tried to do over the last 15 years is, promote real time for the nonprofessional, or the retail account holder. In turn, it's been, from our perspective -- and I believe the Commission has gone along with us -- reasonable and appropriate, and fair to offer this form of discrimination in our rate structure, in order to make more widespread real-time data to the individual segment of the investor community. DEAN SELIGMAN: I guess if I can just follow up Mark's question, are you running, in effect, a cross-subsidy? In effect, are the professional fees subsidizing the nonprofessional? MR. HALEY: Well, the professional fees continue to represent three-quarters of the total that is generated, in terms of Network A fees. I don't think the use of, "subsidy" would be the right word. We've got a pool of revenue that's being derived from different sources and uses of the data that we think are consistent with the objective of trying to promote more widespread dissemination of real-time to the benefit of investors. And, you know, you've still got the delayed issue sitting out there. And that's been something we've tried to overcome. Diversified Reporting Services, Inc. (202) 296-9626 39 MR. BRITZ: Joel, if I may, I think there are two answers. One answer is that, via consensus from the industry and, frankly, at the encouragement of the Securities and Exchange Commission, the notion of making a data product -- a real-time data product more widely available to, "individual investors" through favorable pricing, is something that the industry absolutely got behind and supported. So there's the whole consensus issue. But there's also a sort of more complex analysis of this, which you can make yourself crazy doing, but if you care to go down that path, a broker at average rate $25, sitting at a screen, can service a number of customers -- I haven't a clue what that number is -- via the telephone and via constantly calling up symbols. So what you need to do somehow, if you really want to get at to whether or not there are cross-subsidies here is, look at that number of customers that can be serviced by a single $25-dollar screen by a single, or perhaps multiple brokers, relative to the so-called nonprofessional click-on. MS. DWYER: Joel, could I just say, I think you're assuming that there is an issue of subsidy here, and yet -- DEAN SELIGMAN: I'm just posing a question. MS. DWYER: No, I'm saying, but I think that's the wrong question, because I don't think we've established basic cost of furnishing this. I think you should look at it as a Diversified Reporting Services, Inc. (202) 296-9626 40 pricing differential. And I would just say, for an average brokerage firm, it's not $20 a month, it's $20 to the New York Stock Exchange, $27.25 to the AMEX, $20 to the Nasdaq $50 if they get level II -- and $10 per terminal to OPRA, plus vendor fees on top of that. That's quite a pricing difference. DEAN SELIGMAN: Okay. Let me just pursue one other question. You alluded to pilot programs. How many pilot programs do you currently administer? And secondly, are there any pending? MR. HALEY: Bob was going to cover that, but I'll do it. We currently have one pilot program underway, and you've all seen it. It is the ticker display on CNBC and on Bloomberg. There are five TV networks that are participating in that pilot, and it's been going since 1996, and it's our intention to file that in the year 2001 with the Commission for permanent approval. There are none on the drawing board. DEAN SELIGMAN: Other questions from the committee? MR. JENNISON: I have one. DEAN SELIGMAN: Sure. MR. JENNISON: Tom, is that to say that there are no unique pricing scenarios out there with specific firms, other than the one you referred to? Other than that one pilot program, there are none out there? MR. HALEY: There is one Network A pilot program, Diversified Reporting Services, Inc. (202) 296-9626 41 and it's been that way for the last four or five years, four years at least. MR. COLBY: Tom, just for absolute clarity, do you have any ability to negotiate individual deals outside of the pilot program? MR. HALEY: Do not. DEAN SELIGMAN: So your fee structure is uniformly administered. MR. HALEY: We administer the fee structure that was presented there, and use the contracts. And some of you in the room perhaps have, from time to time, attempted to have your legal counsel make changes to those agreements, and we won't do it. They are the same agreement across the board for everybody, and NYSEdata.com has it all up there if anybody would like to see it. DEAN SELIGMAN: Eric? MR. ROITER: Thank you. I have sort of a reverse engineering question. The slide that you showed, that showed the dramatic decrease in pricing over the last 10 or 15 years or more, can you explain what factors accounted for the higher fees in the early years? MR. HALEY: Okay. Where we started out in the first year, in 1984, is that there was no distinction between professional and nonprofessional. We didn't make a distinction between subscribers, and we didn't have a Diversified Reporting Services, Inc. (202) 296-9626 42 separate category of subscribers. So everybody paid the same rate. That rate at that point would have been a hundred and sixty eight bucks. I think it was in the 1984 time frame, there was an outfit that was -- QuoTrek -- they were developing a hand-held device, and they came to us and asked for our help in setting up separate rates for nonprofessionals. They thought this was a technology that would take off, and bring real-time data to the individual investor. That resulted in the $13-dollar fee that you saw there, I think in 1984. In 1987, in conjunction with your organization and Carrie's organization, to combine last-sale bid/ask and ticker, which were nonprofessional -- which were separate rates for nonprofessional, into a single rate, we brought it down to $4. And there was kind of an understanding among OPRA, NYSE, AMEX, and Nasdaq, to see if we couldn't all somehow or another get nonprofessional into the area of the price of an eighth on a hundred shares, which would have been $12.50 a month. I think the actual thing came out to about $13.50. NYSE's piece of that was four bucks. It went up to 6 percent Jan. 1, '92. We had a modest increase in '97. And then, as a result of much dialogue with the broker/dealer community, in conjunction with the fact that the internet had come into play, there are a lot of customers out there now with PCs that wanted to get Diversified Reporting Services, Inc. (202) 296-9626 43 access to real-time data, we took, I think, some very aggressive action and reduced those rates substantially. And that's kind of the history of it. It was something that was a lot of dialogue back and forth between ourselves and the broker/dealer community, and to a certain extent, the vendors. If that answers your question, Eric. DEAN SELIGMAN: Other questions? Well, Tom, thank you very much. Let's turn things over to Bob, then. MR. BRITZ: I also apologize for the slides. I've got, really, just a bit of housekeeping to do up here. Annette asked us to address a handful of questions in our presentation that were originally contained in a March 20 memorandum from Carrie Dwyer, and while Tom, I think, has done a terrific job implicitly addressing some of those -- and I won't go over the territory he has covered -- Carrie has raised a number of very pointed questions, that I think are deserving of explicit answers, rather than implicit answers. So the words you see up there are Carrie's, the highlighting is mine. I'm just trying draw your attention, and I don't know how readable that is. I'm just trying to draw your attention to the -- trying to correlate the answers to the questions, if you will. The first question is, how exactly is market data information priced? What are the full extent of the cost Diversified Reporting Services, Inc. (202) 296-9626 44 burdens imposed on broker/dealers, market data vendors, taking into account exhibits and pilot programs? I won't spend a lot of time on this, because we have spoken and written extensively in terms of how market data is priced -- Tom has covered it, discussions with Mark and participants initially, to the extent that there is any traction, industry associations, consensus building, gauging the impact on SRO funding, balancing that against the objective of widespread data distribution. Vetting with the CTA, pre discussions with the SEC, approval by the boards, public filing, public notice, public comment. And the SEC does with it what it will at the end of the day. So that's essentially a snapshot of the first part. That dialogue has in recent years been a fairly easy dialogue, because pricing actions have all been of the south variety. It makes the conversations a little easier. That process I just very quickly described to you, it's exactly what happened in 1999. And maybe this gets to Eric's point as well. There have been two dramatic revenue cuts in the nonprofessional space;, 50 percent in 1997, and another 50 percent in 1999. I won't bore you with the 1997 ancient history. In 1999, we went through that process that I just described that led to that 50-percent reduction in the nonprofessional rates that Tom showed you earlier, and also Diversified Reporting Services, Inc. (202) 296-9626 45 created the enterprise arrangement, which has worked to the benefit of a number of broker/dealers. Picking up quickly on some of the highlights, there's a notion here that there are additional terms and conditions imposed, I guess, by the Exhibit A. I would suggest to you that Exhibit A is a printed form. It is a fill-in-the-blanks questionnaire form, the sole purpose of which is to elicit from the applicant what data they wish, how they'll use it, to what extent -- are there 15 display units? Are there 15,000 display units? -- from what source? Do they wish to drop a line directly into SIAC? And questions along those lines. They do not impose any additional terms and conditions. The irony here is that the notion that somehow what is contained in the Exhibit A injects variability into the application of our pricing, is truly an irony, because the sole purpose for the Exhibit A is to understand how the firm is using the data, and to what extent, and what data, and apply that to the published standard, uniform rate schedule, so that we know what fee A is appropriate for that particular firm, and to the extent that another firm comes in behind that firm, so that we can in fact produce a process that creates uniformity. Costs and burdens that vary from participant to participant. The answer to that is, sure they do, because if Diversified Reporting Services, Inc. (202) 296-9626 46 you want 15 units as opposed to 15,000 units, they're absolutely going to vary. But I think the term that is used repeatedly throughout this is, do similarly situated firms pay the same rates? The answer to that is yes. And that is in fact the purpose of the Exhibit A process. There's a comment down below, "nor can we understand or evaluate the full amount of revenues earned by the exchange." I'll just mention that. I won't respond to it now. It's mentioned several times. I'll respond to it in a moment. Question two, I think I largely answered, is, what do different classes of market participants pay? The answer is, with one exception, which we've already talked about, there's no such thing as different classes of market participants. If you are using the data in a certain way, it matters not to Network A that you are a broker, that you are a mutual fund, that you are a news organization. Network A does not distinguish by type of customer, it distinguishes by how, and to what extent, and what data will you be using, with one exception being the nonprofessional that we have just discussed. It's the only distinction as between so-called classes of market data users. And as I said a moment ago, certainly they have sliding scales. Tom showed them to you. Rates are not Diversified Reporting Services, Inc. (202) 296-9626 47 different, fees can differ, certainly, according to different uses and according to size. I actually may have skipped ahead for the moment. There's just more about market participants being treated differently for no specific reason. I simply would respond that it's all in the fee schedule, and the fees are applied uniformly, and the schedules are all standard. How are specific arrangements negotiated? What's the relationship to various exchange rebate programs? I think the operative word there is, "negotiated," and when you look down, it talks about the network administrator, what terms they negotiate, what discretion they have. Tom has largely covered this. The Exhibit A and the contracts are printed, standard forms. There are no terms to be negotiated. There is no discretion allowed vis-a-vis the network administrator. And probably the most -- an example I can point to -- and perhaps Bob Colby will remember this. It was the one pilot that exists today, the CTA pilot. About four years ago, we came down to the SEC, because one of the first things that, frankly, I decided, or wanted, to do when I inherited market data four years ago, was take real-time -- take delayed data off of television. I didn't much care at the moment whether we replaced it with real-time, but I knew we wanted to get Diversified Reporting Services, Inc. (202) 296-9626 48 delayed off the television. It turned out, after we thought about it, there was no good reason why we couldn't put real-time on television. As we thought about that, we came down to the SEC, and we said, "There are two networks doing this, CNN, CNBC. Do you think this is a good idea?" They were very enthusiastic about the idea. We said, "Okay," then we would expect that we'll simply march up to their offices and negotiate something with them. The Commission's ultimate view on that was that that would be unacceptable, that we had to create a rate, publish a rate card, and administer -- offer and administer that rate uniformly to users, now up to five users. We were a little surprised by that, but nonetheless, it is what it is. And I think it illustrates the point that, at least as regards to the Network A administrator, there's absolutely no discretion and no authority whatever, even in that sort of silly example, to negotiate. The rest of this is about market data rebate programs. The New York Stock Exchange does not have such a program, so I will have to defer, to answer this question, to other markets who do have such a program. All the way down below, again to the extent that you can't read that, it continues to talk about negotiation. Hopefully, I have put that to bed. Diversified Reporting Services, Inc. (202) 296-9626 49 But there's a new concern raised. Concerns by market participants that they must, again, negotiate for market information with their governing self-regulatory organizations. A, there's no negotiation. B, it's a purchase of services. And I would suggest to you that broker/dealers purchase an endless number of services from self-regulatory organizations without any heightened degree of difficulty. The next one, I think, is on pilots, and Tom has already covered that. And so I won't even bother with that one, except to the extent that at the very end of that, if I have the right one -- yes -- at the very end of that, again, the discussion is largely about pilots there. Obtaining this information, i.e., the scope and the revenues associated with pilots -- and Tom perhaps didn't say it earlier -- the revenue associated with the cable TV pilot is de minimus relative to the overall revenues of CTA. But again, at the very bottom, "obtaining this information will also reveal the full amount of market information revenues earned by the exchanges." The full amount of market information revenues earned by the New York Stock Exchange is on line three of our annually published income statement. There is no -- maybe I misunderstood the point here. If the point -- if this is an accusation of fraud, Diversified Reporting Services, Inc. (202) 296-9626 50 financial fraud on the part of the New York Stock Exchange, the CTA, and PricewaterhouseCoopers, then, you know, perhaps we can talk about that. I didn't think that that's what was meant. Short of that, all revenues -- there are no double secret market data revenues, or any other kind of revenues that do not find their way into NYSE annually audited financial statements. How exactly does market data cross-subsidize other self-regulatory functions? There's a comment in there. Some have suggested that market information fees should support self-regulatory functions. The New York Stock Exchange has never made that suggestion. The New York Stock Exchange -- as I have said to this committee before, market data revenues are at a loss, and it is in no position to cross-subsidize any other function at the New York Stock Exchange. On the contrary, it is subsidized by other fees at the stock exchange. Down below, obtaining this information will help the committee understand how the exchanges and Nasdaq account for market information costs and revenues. I can help you there. We account for market information costs and revenues on an accrual basis, in accordance with generally accepted accounting principles. The last question. Mercifully the last question. Systems maintenance costs, administrative costs exchanges Diversified Reporting Services, Inc. (202) 296-9626 51 incur for aggregating and disseminating market data. If it isn't obvious to most people around this table, we do not produce cost accounting for -- in our financial statements for market data or, frankly, any other business line at the stock exchange, for the simple reason that there is no generally accepted accounting principle framework in order that would enable us to do that. There is no great difficulty in producing a cost accounting P&L for -- well, there is a fair amount of difficulty, but it can be done for market data. That's not the issue. The issue is that you could produce a hundred P&Ls for NYSE market data, and no one would be better than the other, because there would be very substantial and, frankly, arcane assumptions as to the categories of fees that are appropriately used, and the percentage of allocation within those categories that -- I think I've said before, I think whatever debate exists on market data today would pale in comparison to the debate of producing a cost accounting P&L for market data. So I will draw this to a merciful close. The punch line to all of this is that all rates are established through consensus among the broker/dealer community, and indeed through a public process via the SEC. All rates contracts are public and standard, uniformly applied. Contract administration is designed to ensure uniformity. Diversified Reporting Services, Inc. (202) 296-9626 52 The NYSE, the CTA, and other participating markets, annually produce audited financial statements with their P&L. It's not clear what more we could do vis-a-vis transparency of the process but, frankly, we're open to suggestions. And I would suggest that none of that is surprising -- uniformity, standardization -- given the governance structure that the New York and the other markets live under. So I'll stop there, Joel. DEAN SELIGMAN: Okay. Are there questions? Let's start with George. Then I saw Eric. I wasn't looking at this side of the table. MR. JENNISON: Bob, I'm curious. In answer to the second to the last question, you said that -- you seemed very confident in saying that the market data operates, and the New York Stock Exchange operates at a loss, and is in fact subsidized by other areas. And then in answer to the last question, you said that, you know, talking about costs, and costing out the entire operation, it would be difficult to do, but could be done, and you hadn't really done -- MR. BRITZ: No, I didn't say we hadn't really done it. And if I said, "difficult to do," I only meant to the extent that it would require assumptions and allocations. Not difficult to do, George, difficult to agree upon the underlying allocations and assumptions that are in there. But I'll answer the first part of your question, if Diversified Reporting Services, Inc. (202) 296-9626 53 I may, which is that I am not smart enough to know, when a trade takes place, are we executing to investors' orders, or are we producing the price. And clearly, we're doing both. But if you're going to get into a cost-accounting exercise, which, as you all know, is more art than science, you have to say, "Well, a percentage of this box is dedicated to creating that price, and a percentage of this other box is dedicated to actually executing investors' orders." My own personal theory, which you've heard before, is that it's all about the price, because if we were in the order-execution business, we could e-mail the counter parties as to the details of their trade, and that would be perfectly okay with them. But there are probably millions of other people around the world who weren't party to that price, who have a very significant interest in that price, and more than a few sitting around the table. So the difficulty is in separating out those two, but I don't have to do that, frankly. I can look at transaction charges, I can look at market data fees, I can look at facilities. So that combining all of market operations, if you will, which includes all of that, it all operates at a significant loss. So I don't have to find angels on the head of pin in order to know that market data undoubtedly operates at a very -- tens of millions of dollars loss. Even my rusty cost accounting can deliver that Diversified Reporting Services, Inc. (202) 296-9626 54 conclusion very quickly. DEAN SELIGMAN: Eric? MR. ROITER: I think that was my question, as well. I thought I had heard you talk about two different types of accounting -- cost-based accounting and GAAP accounting -- but you're not making that distinction. I think you're saying that you can't really separate these closely interwoven threads, and that whatever set of assumptions you might apply in trying to quantify the costs associated with producing market data, those costs would exceed your revenues? MR. BRITZ: I actually made a broader statement, Eric, which is that the cost of executing investors' orders, and the cost of producing market data exceed the revenues from three revenue lines that contribute to that. So I guess what I have said is, there's no need, from my point of view, to drill down and try and divide the baby up. I know that all of market operations operates at a substantial loss. What I said as to the difference between cost and GAAP -- cost accounting is an internal management tool. There isn't an accounting firm in the world that will apply any certificate to a cost-accounting exercise, so it's not a surprise that we don't produce that in our annual financial reports. But certainly, we do look at cost accounting on an internal basis, as I suspect all of you do. Diversified Reporting Services, Inc. (202) 296-9626 55 DEAN SELIGMAN: Are there other questions? Carrie? MS. DWYER: I'm assuming -- maybe we ought to move on to the Nasdaq, because the comments that I have about all of this are more general and apply all of this. DEAN SELIGMAN: Before we do, let me just follow up with a couple of questions, and they're, in part, following up on George and Eric's point. If I understand what you're saying in response to, how is market data priced? You're describing a process. MR. BRITZ: Yes. DEAN SELIGMAN: To the extent one tries to understand the economic analysis, if you will, that goes to determining where fees should be, or how they should change over time, I don't have as clear a sense as to whether you do any economic analysis, and if so, what kind it is. MR. BRITZ: Well, I think you do, Joel. There are lots of variables that go into that. As I mentioned, in the last 10 years, they have all been on the rate-cut side, and probably amusing to this committee, but when I go to the finance committee of our board, and indeed the board as a whole, the biggest problem I have is explaining to them why this is a good idea to cut this particular fee by 50 percent, what the negative revenue implication is of that, and how we are either going to cut our own costs in order to offset that, or how we're going to recover that in some other fee. Diversified Reporting Services, Inc. (202) 296-9626 56 So the whole notion of how this proposal impacts non only New York, but I presume analyses are done in other marketplaces, as well, in terms of the ongoing funding and financing needs of the particular market is important. In terms of economic analysis, well, let's go back to the rate cut in 1997 by way of example. It was in the nonprofessional space. This was the per-quote usage-based fee. We had a program, and the over-the-counter NASD had a program, as well. We had 13 participants. All 13, to a firm, came to us and said that we had gotten it wrong. We did that -- by 1997, it was running about three years. We had gotten it wrong, and they much preferred the over-the-counter product. And we thought about that some, but at the end of the day, and a reasonable period of time, we said, "Fine, that's what they want, that's what we'll give them." It was a product that was in the marketplace, that was priced. We did nothing more than mirror the price and mirror the terms, because at the end of the day, that's what the customer said they wanted. The revenues were cut 50 percent in that example. That's not surprising that the customers wanted that. So you get to use benchmarks, sometimes, when you're lucky, that are out there in the marketplace. That's about the best way I know how to -- hopefully, I have given Diversified Reporting Services, Inc. (202) 296-9626 57 you some raw material for a reconciliations to that, Joel. DEAN SELIGMAN: All right. Now, to take it another level, there are differences between professional and nonprofessional fees. How do you determine where to set each? What's the economic analysis that you go through for that exercise? MR. BRITZ: Well, -- because economic analysis pretty much implies value pricing. And I can go back to that meeting on cable TV four or five years ago, but any number of other meetings, where it's been the SEC's point of view that, again, at least with regard to Network A -- that's all I know about -- that value pricing is not remotely part of the equation. Clearly, we don't all know what fair and reasonable means, and we have struggled with that over some period of time. And clearly, we're not in a cost-based metric. But the notion of applying economic value, of looking at a product that we will bring out, and saying that, "Well, McGraw Hill has a product similar to that, and they charge 50 bucks," is a license that the SEC has made very clear that we don't have. As regards the split between professional and nonprofessional, I would be candid to say I don't know. This was a little bit before my time, but I don't know that there was economic analysis. I know that there was an industry Diversified Reporting Services, Inc. (202) 296-9626 58 push to make real-time market data -- remember, at this time, the delayed product was pervasive in the nonprofessional space. That's a product that, for lots of obvious reasons, we didn't want to be associated with. It's an inferior product, it's not actionable, we didn't want our brand attached to it. It's very much behind why we wanted to take delayed off of cable TV. I don't know what viewers thought when they saw that billboard that said, "20 minutes delayed," but I know it couldn't have been anything very good. So the delayed product was pervasive, because at a hundred and sixty eight dollars, it was simply too expensive for most individual nonprofessional investors to have that. So when various vendors, and particularly broker/dealers, came to us, more in the late '80's, early '90's -- and frankly, Schwab was a pioneer in this category -- we sensed a consensus building that we needed to create a differential as between the professional price and the nonprofessional price, with the tradeoff being, or the benefit being, that we would make the data significantly more available. And that would inure to the benefit of the entire industry. DEAN SELIGMAN: Okay. I appreciate that. I think I've got a question from Andy. MR. BROOKS: So Bob, just to follow up on that, if Diversified Reporting Services, Inc. (202) 296-9626 59 in 1984 the rate -- there was one rate at a hundred and sixty four dollars, and now we have two rates -- a professional rate at $25, and a nonprofessional rate at $1 -- and there's virtually no difference between the data, because they're both real-time -- is that correct? MR. BRITZ: Real-time, yes, but there's a huge difference. MR. BROOKS: Well, I understand the point about how one professional could redistribute that data to their customer base, and call 50 clients and all that, and I appreciate that, but -- MR. BRITZ: No, there's even more of a difference in terms of the timing, the delivery system associated with that, whether it's inquiry-based versus streaming. There can be lots of differences. MR. BROOKS: Okay. MR. BRITZ: The similarity, Andy, is that they are both real-time. MR. BROOKS: Okay. Well, I guess I'd like to hear about this, maybe at some later point, but what I'm focusing on is the data that we're buying. The price has gone from a hundred and sixty five to twenty five, and the data that Charles Schwab or somebody else is getting has gone from a hundred and sixty five to a dollar. And I'm kind of thinking, I appreciate that we want to provide everything to Diversified Reporting Services, Inc. (202) 296-9626 60 everybody in America, and that's a wonderful thing, but again, have we -- are we being consistent in the application of these rates, and perhaps, are we disadvantaging the institutional/professional investor class, in order to cross-subsidize, or to benefit the individual investor? MR. BRITZ: Andy, your facts are slightly wrong. The data that goes from Schwab, or any other vendor, to a nonprofessional customer is a dollar a month, to be sure. The data that is displayed on Schwab's screen of a Schwab broker, a so-called professional, is -- we make no distinction. That's between broker/dealer and institutional. DEAN SELIGMAN: Bob, let me just follow up, though, on the response you made to Andy. It is worth clarifying. You suggested there are differences in the data, even though they're both real-time, that are going to professional and nonprofessionals. Could you particularize what those differences are? MR. BRITZ: Well, I'll give you one example. Professionals typically will have a market minder -- and some of the vendors can perhaps do a better job here than I can -- professionals typically have a market minder, which is a kind of a push technology. You don't need to constantly hit the enter key in order to get an update. Many nonprofessional products simply have a one shot, one bite at the apple every time you hit that key. That's just one example. Mark? Diversified Reporting Services, Inc. (202) 296-9626 61 MS. DWYER: But the exchange doesn't provide that. MR. MINISTER: Yeah, I was going to say. That is not exchange-differentiated, it's vendor-differentiated. We offer a streaming product of nonprofessionals also, so from an exchange standpoint, there isn't any difference, it's vendor-differentiated, I believe. MR. BRITZ: I think that's right. No, I think that's right. I guess what I was responding to was the product that the end customer receives can be very different than what you're looking at in terms of your professional -- trading desk, Andy. MR. BROOKS: Okay. Again, just to -- MR. BRITZ: But the point is a good one, everything that leaves SIAC on behalf of the CTA and the NYSE is real-time data. We are not in the delayed business. Everything that leaves us is uniform, that is true. DEAN SELIGMAN: So it's uniform to both professionals and nonprofessionals. They're getting -- MR. BRITZ: The pipe is the same pipe, the content is the same content. When it reaches professionals and nonprofessionals, Joel, it can look significantly different. DEAN SELIGMAN: But that's because of the intermediaries? The vendors, and so forth? MR. BRITZ: That is correct. DEAN SELIGMAN: Okay. Diversified Reporting Services, Inc. (202) 296-9626 62 MR. BROOKS: Just to follow up, if I can, if that's the case, our choice of vendors is our choice, and we're happy to use the vendor that's massaging this data in the way that we want it, but why should we be paying 25 times what the nonprofessional investor is paying to get the same raw data, if in fact it's the same data? MR. BRITZ: Well, I mean, the simple answer to that, Andy, I think, is what we have been saying thus far. That the pricing process that we have described to you, in terms of grass roots at the individual broker/dealer level, and vendor level, and all of the vetting that that has done, has built a consensus around the notion that it is a good idea to increase the pervasiveness of the data, to discount off the professional rate for a nonprofessional customer. All of the SRO boards have endorsed that. It was publicly filed with the Securities and Exchange Commission. There was a public comment period, and the SEC ultimately approved it. So it's consensus-based. MS. DWYER: So Joel, just -- so this goes back to the comment I made earlier. So we're not talking about economic analysis, we're not talking about cost base, we're not talking about subsidy, we're simply talking about a pricing decision, based on what the market will bear, whether or not it's validated by the SRO boards, you know, which it is. But that's essentially, I think, the point. Diversified Reporting Services, Inc. (202) 296-9626 63 DEAN SELIGMAN: However one characterizes it, I think we've got it on the table exactly what the issue is. Bob, thank you very much. MR. BRITZ: Certainly. DEAN SELIGMAN: I'm going to suggest that -- let's take a 10-minute break, and begin again at ten to 11:00. We'll pick up with the Nasdaq. There is coffee right outside, and we'll just keep rolling. (A brief recess was taken.) DEAN SELIGMAN: We're going to begin at this point with a presentation from Tom Davin and Nasdaq. MR. DAVIN: Great. Thank you. The Nasdaq stock market is pleased to be able to address the committee regarding our role as the administrator of the Nasdaq UTP tape plan. In response to Dean Seligman's letter that followed up on the March 1st meeting, we've put together a presentation that will address some questions that he raised in his letter regarding how we handle our role as the administrator. Basically, I've divided my presentation up into four main parts. The first is how market data fees are set. Next, the type of fee arrangements that exist, just the basic dollar figures. Third is contract administration -- how Nasdaq, as the UTP administrator, administers contracts with market data distributors. And then, lastly, just to touch on Diversified Reporting Services, Inc. (202) 296-9626 64 what the other responsibilities are of the administrator -- kind of a day in the life of the tape plan administrator, if you will. I think there's definitely some overlap in what I'm going to say and what's already been said by Bob and Tom. Wherever possible, I'll try to focus in on the areas where we're different, or where perhaps we're touching on some issues that weren't already touched upon, but there's obviously going to be some overlap here. Okay. To begin, I've got two slides regarding how fees are actually set. Basically, this is a sequence of events that we go through, as the tape plan administrator, and that the other members of our tape plan go through with us, as we change rates for existing fee structures, or as we create new fee structures for our market data. The first thing that we need to do -- or the first thing that happens is, we identify a business need or an opportunity. In theory, this could be something that sort of happens in a vacuum, just within Nasdaq. As the tape plan administrator, we could just come up with a great idea for a new fee structure, or a new level for an existing structure, and go ahead and push forward and try to implement it. In practice, it's been a lot different than that. I think, by and large, when we make changes or when we contemplate changes, it's at the behest, or as a result of Diversified Reporting Services, Inc. (202) 296-9626 65 requests made by the industry. It may be the online brokerage industry, it may be the market data vendors, it may be firms in the trading community. Typically, what we're looking for is proposals that are going to have application with more than one firm, that are going to have broad applicability, and they're going to benefit multiple firms. So once we've identified something that seems like a viable approach to go forward, we review it within the Nasdaq staff. We want to do some analysis on it, we want to compare it to our existing fee structures to make sure we've got consistency across the fee structures, that by implementing this new fee, we're not severely undercutting an existing fee structure unintentionally. Second, we want to take -- we do want to take a look and make sure there's broad applicability. We wouldn't want to respond to just one firm's concern, create a fee structure that would -- responded perfectly to their issues, but had no applicability to anybody else. We want something that is going to help the entire -- if not the entire industry, a broad spectrum of the industry, if we do make a change. And then finally, we look at the financial impact. We take a look at who the main customers might be of the -- or distributors might be under the pricing structure being contemplated, and we see what the impact would be on them. Diversified Reporting Services, Inc. (202) 296-9626 66 We take a look at existing distributors, and see what the financial impact would be on them. And then we look at our own revenues, and the tape plan revenues, and see what the impact would be of implementing the fee. As we're going through all these steps, we're talking to all of the potentially affected market data distributors, we're asking them, you know, what they think they might do, would they use a potential fee structure, how much usage might they have of it, and try to get a sense as to what the impact is going to be on our bottom line, and on the bottom lines of our customers. Next, if we feel as though we've got a viable fee structure, we take it to the Nasdaq committees and the boards that oversee our market data pricing. The board -- the Nasdaq board represents -- and Nasdaq members represent the general public, and also investors -- both individual investors and institutional investors -- but also represents Nasdaq issuers. All of these constituencies have a vested interest in Nasdaq market data pricing being reasonable and promoting broad distribution of the data. Obviously, as the users of the data who have to pay for it, the investors and the brokerage firms are very sensitive to the idea of a fee being higher than it needs to be. For Nasdaq issuers, they want their issues, the data on their issues, broadly distributed. Diversified Reporting Services, Inc. (202) 296-9626 67 They wouldn't want overly high Nasdaq pricing to retard that function. So the representation of our board would certainly keep in check any tendency we might have to overcharge for the data. The next step, if it's approved by the Nasdaq board, is we take it to the UTP operating committee. The UTP operating committee represents the various exchanges that trade Nasdaq-listed issues. At the UTP operating committee, Nasdaq, as the tape plan administrator, would present our proposal. We would provide them with all the analysis that we had done about the likely impact on individual investors and brokerage firms and tape plan revenues, and leave it to them to make -- basically, leave it to them to take it back to the respective organizations, to be approved or not approved. And that, in fact, is the next step. The UTP participant representatives go back to their respective boards, and they go through with their boards a process analogous to what Nasdaq has already done with its board, and basically vet the plan there. By and large, the exchange boards are comprised in a similar way. There's representation, certainly, from the brokerage industry. There's often individual investor representation. So again, this is another check on any tendency we might have to raise the fees unnecessarily. Diversified Reporting Services, Inc. (202) 296-9626 68 Next, if it's been approved by the UTP participant boards, we would take it to the SEC. We would file with the Securities and Exchange Commission, providing for them all the reasons that we thought it was a good idea to implement a new fee, or change an existing fee level. And we provide them also with a lot of the analysis that we had done for ourselves, and for the UTP plan participants. At that point, the SEC may well have questions for us. We obviously want to be sure that we're all clear on just what it is that we mean by a particular structure, and how it might be implemented. The fee structure is then put out for a public comment period. During that period, the general public, brokerage firms, investors, everyone is free to comment upon it. To the extent that there are any serious adverse comments, it's invariably true that the SEC asks us for a response on that, and asks us to address the issues that are raised by the comment letters. Then we would get SEC approval, hopefully, and we would put the pilot -- or not put the pilot -- put the fee into effect. We put announcements out to the general public, we put it out on the Nasdaqtrader website, so that market data vendors and market data subscribers were aware of the new fees. We would indicate what the time frame was for the introduction of the fee. At that point, the fee -- we would start billing it, and the fee would be fully operational. Diversified Reporting Services, Inc. (202) 296-9626 69 I'd like to emphasize, or just point out, that this process is pretty much the same, whether we're talking about a permanent fee filing, or a pilot fee filing. It would go through pretty much all these same steps before we would launch into either one of those things, because we feel it's important to vet these issues very fully. Okay, that's how fees are set. Now, getting very specific -- first of all, all current pricing structures that we have are available to all vendors and subscribers of Nasdaq data. There isn't any sort of a discrimination going on there, there is not restrictions not allowing particular vendors to distribute data under particular pricing structures. Next, with regard to transparency, all of our fee structures, both the pilots and the permanent structures, are posted publicly. Most prominently, it's on the Nasdaqtrader website. It's also in a variety of different marketing materials that we provide to a number of different constituencies. The Nasdaqtrader website has been in place for about five years. Prior to that, we had a -- we posted the pricing in marketing materials, and in what we call, "new vendor kits," that we provided to the distributors of our data. And that has always been something that's been publicly available. It isn't something that is restricted or kept from anyone. Diversified Reporting Services, Inc. (202) 296-9626 70 In describing our pricing structures, I want to first describe the two different levels of entitlement, or sort of the two different data sets that we sell. The first one is what we call level 1, and that's kind of akin to what we've been discussing in these meetings as the mandatory minimum data. It consists of the best bid offer, and the last sale data on all of the Nasdaq issues. In level 1, there is also some ancillary data related to mutual funds, and also related to Nasdaq indexes, and things like that, but the fundamental core of the data is best bid and offer, and last sale data. So that's level 1. The next level of data, the next level up, is often referred to as level 2, but technically, we refer to it as NQDS. And that entitlement, or that data set, includes all the data from level 1, and then it includes the individual market participant and UTP exchange quotes in each Nasdaq-traded issue. So it provides not just the highest bid, the lowest offer, it also provides the individual market participant quotes at all price levels. So this basically provides the depth kind of information that many people seek. These are the specific prices that we have for usage for usage-based fees. This probably accounts for, I would say, probably about 95-percent of our total market data revenue for the UTP plan. We call them usage-based fees, because people pay based on how much they use. Either the Diversified Reporting Services, Inc. (202) 296-9626 71 amount of data given out, or the number of subscribers that they service with their Nasdaq data feed. Basically, as you can see on the screen, the first row is there level 1 pricing as you read across to the right. The second row is the NQDS pricing as you read across to the right. We have professional and nonprofessional per-user pricing for both level 1 and NQDS. You can see the rates right there. And then for the level 1 data only, we also have a per-query fee, which is where you pay based on a single inquiry, getting a single piece of data on a single security. And we also have pricing for automated voice response systems, where you would call up on a touch tone telephone, and access quotes that way. So these are the fees that we have today. As you can tell, the asterisks -- a number of these are actually pilots right now. The two nonprofessional fees and the per-query fee, right now, operate under a fee pilot at the moment. Okay. Other fee structures that we have. There aren't really a whole lot of other ones. For distribution of real-time index data, we charge $500 per month. That is, in essence, a global license. It allows a vendor to provide real-time Nasdaq index data to all of its clients, regardless of whether they're paying standard user fees for those clients. This is used most prominently in the dot com world. Diversified Reporting Services, Inc. (202) 296-9626 72 There's a lot of web sites that offer delayed equities data, but do allow their subscribers to see the real-time index data. And then, we have an annual -- a relatively modest annual administration fee. That is charged just to market data distributors. So there's about a thousand market data distributors paying one of these fees. This basically just is sort of a baseline fee that we charge to the vendors, and to the other distributors to sort of maintain their account with Nasdaq, and reflect some of the other costs that we incur in servicing their account. Next, I'd like to discuss fee pilots in particular. When we undertake fee pilots, there's a number of criteria that we use before we would launch into a pilot, and that we operate any pilots under. First, it's typically going to be an experimental situation. It's going to be something that we don't have experience with before. Either it's going to be an all new structure using an all new metric, or perhaps it'll be a significantly different price level for an existing metric. But the point is, we don't do pilots of existing structures at existing rates for particular people, or anything like that. Typically, they're also -- well, not even typically -- they are of limited duration. We have currently committed Diversified Reporting Services, Inc. (202) 296-9626 73 that we will not run any pilot for longer than two years. When we get to the end of two-year period, we would look to either kill the pilot, change it radically because the business need is there, or file it as a permanent fee with the SEC. The SEC is informed of any new pilots. When we undertake a pilot, the first thing we do is, we will let the SEC know what the pilot is, why we're doing it, and what we anticipate the duration is going to be for that pilot. Actually, in point of fact, the most recent pilots we've actually had explicitly approved by the SEC. We've had them treated just like a permanent fee filing, in the sense that the SEC fully vetted it, put it out for public comment, and approved -- explicitly approved the fee structures. So we don't feel as though we necessarily would always have to do that, but given the sensitivity that's been expressed in recent years to pilots, we wanted to make sure that everybody was comfortable with what we were doing in the things that we called a pilot. And then finally, and perhaps most importantly, our pilot fee structures are available to all distributors and subscribers of market data. We don't limit them just to the people who ask for them, or for people in a particular industry or running a particular kind of system. They're broadly applicable, and they are also -- the transparency is Diversified Reporting Services, Inc. (202) 296-9626 74 also very high. All of our pilot fees are listed right alongside our permanent fees on our web site, and all of our other marketing material. So there shouldn't be any reason anyone who's aware of our fees in general, isn't just as well aware of our pilot fees. Okay. Now, the current pilot fees -- there's actually -- you've already seen some of this. As I mentioned, the first three bullets, the two nonprofessional fees, and the per-query fee, those are on the matrix that I showed a couple of slides back. Those are, today, pilots. The two level 1 pilots we are actually seeking, or will be seeking, to make them permanent fee filings. We think they've been out there for a while, we think they've been successful. They're battle tested, if you will. And we intend to file those as permanent fees once we get our board approval, and the UTP plan participant approval. The very first one, the NQDS nonprofessional per-user fee of $10 is a relatively new rate. We introduced that about six months ago. As a result, I think we'd say the jury's still out as to how successful it is, and whether it's really meeting people's needs. So that one is a pilot, and will be a pilot for probably at least the next year. Then I'd just mention, really, more in the context of the per-user and per-query fees, that we also allow the capping of per-query fees at the applicable professional or Diversified Reporting Services, Inc. (202) 296-9626 75 nonprofessional rate. I mentioned before, any fee we have is available to any vendor or any subscriber to our data. The capping of per-query fees means not only are all our fee structures available to people prospectively -- you know, can you pick? You go, "I want to use this fee structure next month." It's actually available on the fly on a dynamic basis, on a customer-by-customer basis. An online brokerage firm, or an online vendor, can make a choice in the middle of a service month as to how they want to pay for a customer. They can either pay per user at the rate of a dollar, or they can pay on a per-query basis. So if that particular customer doesn't use much data in a particular month, they can pay less than a dollar. If they use a tremendous amount of data in a month, they still only pay a dollar. And we allow that determination to be made, again, on the fly. There's no need for a decision to be made prior to a service month, as to whether a customer is a per-query customer or a per-subscription customer. And then the final pilot we have -- and I think this is very similar to what the New York Stock Exchange has -- is, we distribute real-time data through cable television networks. We charge on the basis of households, connected households who receive the broadcasting. And it's a tiered rate. The first 10 million pay at a certain rate, there's a reduced rate for the next 10 million, and a reduced rate for Diversified Reporting Services, Inc. (202) 296-9626 76 every household after that. Okay. That's pricing. Now, we're going to move on to contract administration. The administration of distributor agreements with the thousand or so Nasdaq market data vendors and internal distributors -- the substantial part of what we do is as the administrator of the Nasdaq UTP tape plan. We contract with each and every distributor of our data. So, as I said, that's about a thousand firms. We get agreements with each and every one of them, or at least we did when they first started using data. For a vendor like Reuters, who's been in business forever, we probably got the contracts with them 10 years ago. For a brand new dot com, we're getting those contracts today. The agreement is a basic document. It's a standard document across vendors and other distributors. And it basically spells out the relationship between Nasdaq and the UTP plan, and the individual distributor. It addresses things like pricing, usage reporting, indemnification. Limitations of liability, and methods for dispute resolution. With respect to negotiation of agreements, and the variability of the agreement that we have with individual market distributors, this is going to largely echo the New York Stock Exchange presentation, but we are under a stringent requirement to maintain a level playing field in Diversified Reporting Services, Inc. (202) 296-9626 77 the distribution of our data. We can't discriminate against one vendor vis-a-vis another vendor. That severely constrains our ability to really negotiate the text of that contract. In practice, we really cannot negotiate the contract, as far as making amendments for one vendor that we don't make to other people. Certainly, if one firm finds something in our contract that we decide is the right thing to change for everybody, we would make that available to everyone, but we can't negotiate the terms of the individual agreements. With respect to variability, the one area where I guess it is true that every distributor's contract is somewhat different, is with regard to their system description. Every distributor, as an attachment to their agreement -- it's attachment A -- provides us with a technical description of how they are going to control our data, and how they're going to be able to report to us the necessary usage numbers for us to collect the specified fees. Because every single firm is different, those descriptions are all going to be slightly different. We ask for the information in a standard template, so there is a lot of similarity, but the bottom line is, the attachment A is kind of the way we map, from a lot of very diverse organizations and diverse uses of data, to our standard fee structures, which are relatively limited in nature. So there Diversified Reporting Services, Inc. (202) 296-9626 78 is definitely variability there. As far as the distributor agreements, we've got two basic types of distributor agreement. The first is what we call a vendor agreement. That's for an organization like a Reuters or a Bridge, who is taking our data and redistributing it to third parties, and we would refer to those third parties as being subscribers. The other type of agreement we have is an internal distributor agreement. That would typically be a brokerage firm, or an institutional investor, who takes a data feed containing Nasdaq data and uses their own network, and their own systems to redistribute the data within their own organization, but without any external distribution. In terms of content, the difference between the agreements is, the internal distributor agreement, because it's of a more limited scope, has less pages. It's shorter, it's easier to fill out. In practice, we tend to have more applications from people wanting to do internal distribution than people who want to become vendors. As a result, we wanted to be able to streamline the process for those folks. And also, they tend to be a little bit less savvy technologically, and they have less staff dedicated to filling out these kind of forms. So it's basically a streamlined agreement. Certainly, anybody who was doing internal distribution, who wanted to sign a vendor agreement Diversified Reporting Services, Inc. (202) 296-9626 79 could, since they are -- strictly speaking, they would be considered a vendor, as well. Next, I want to just address very quickly subscriber agreements. As I mentioned, a subscriber, in our world, is someone whose access to data is controlled by an upstream vendor. It doesn't include firms that can do their own distribution of data. We do not have an agreement that we sign directly with subscribers. We do have a requirement, however, that market data vendors sign a standard agreement with each of their customers that consists of standard Nasdaq terms. And these terms protect Nasdaq, limit our liability in certain instances, and confirm our proprietary assertion -- our assertion of proprietary rights to the data. We have -- we do that in hard copy -- we allow vendors to do that in hard copy. We also have online administration procedures that vendors can avails themselves, as well. In terms of transparency, the agreements, the text of the agreements, are all on Nasdaqtrader.com. If somebody didn't have web access, they could call us, and we would mail them a copy of a blank agreement, as well. Because we don't negotiate the agreements, the blank agreement that someone would see on Nasdaqtrader is identical to the agreement that virtually every single vendor has today. Distributor system descriptions, however, are confidential. We don't make that transparent. We don't Diversified Reporting Services, Inc. (202) 296-9626 80 think it would be appropriate. We certainly think we would get a great deal of complaints from the firms who have filed attachment As if we started sharing their system descriptions with their competitors. So that information is proprietary and confidential, and we treat it that way. Not only do we treat it that way vis-a-vis competitors and putting it out to the general public, we're also very careful with it internal to Nasdaq that it's only used by the market data staff to evaluate market data applications, and it's not shared, for instance, with our trading services staff, or with any of our technology staff, because again, we don't want to compromise any proprietary information. Next, I'd just like to walk you through, very quickly, the process that your average distributor might go through in becoming a distributor of Nasdaq data. These are the basic steps. Typically, they'll contact us first. They'll give us a phone call. They may know where they want to get their data from. They may think they want to get the data directly from us, they may want to get it from a vendor like Bridge or Reuters, they may have no idea. They may just know that they want Nasdaq data. We'll talk to them, we'll give them a sense of how our pricing lines up for them, give them a sense of the technical and contractual requirements they're going to have Diversified Reporting Services, Inc. (202) 296-9626 81 to fulfill. And then, pretty quickly, we'll steer them to the Nasdaqtrader web site, because that is where all the contracts are, that's where our transmission specifications are, and it's where all of our policy-type statements are. So we want the people to take a look at all that as quickly as we can. So the distributor will go there, they'll access the contracts, and the forms, and the policies. They'll take those back. In filling out the forms, it's not unusual to get a call from an applicant prior to them sending it in, just because there's something they don't understand, or they're looking for clarification, but pretty quickly, we'll typically get the submission of the contracts and the system description. At that point -- and this is kind of where we get into the point that Mike Atkin mentioned about preapproval -- at this point, they're not authorized to receive the data, they have to wait for us to approve their usage of the data, and approve their contract. We'll get the contract from them, we'll get the system description. The contract is typically a pretty straightforward process, provided they haven't tried to make unauthorized modifications to it. We'll execute that, we'll review the system description. If they have adequately described how they're going to control the access to our data, so that they can Diversified Reporting Services, Inc. (202) 296-9626 82 report the usage to us, we'll go ahead and we'll approve it. Typically, it's probably about a two-week process from start to finish, from the time we get the form to the time that it's approved. To the extent that we go back to a firm, and we've got questions they need to resolve for us, obviously, the critical path item there is them getting back to us with the information that we need. Once we've gotten any clarification we need, and we've approved them, we'll kind of, at least figuratively, sit down with the firm and identify for them very explicitly, what we expect them to report, and what fee structures apply to them from the standard fee schedule, so that there's no misunderstanding as to what their revenue -- what their payments to us are going to be based on, and what the reporting requirements are to us. And then, finally, we'll authorize the data feed. If it's coming directly from Nasdaq, we'll authorize our network provider to turn on the data. If it's coming through another vendor, we'll send a letter out to that vendor, authorizing them to provide the data. And at that point, we have a new distributor. And as I said, we've got about a thousand of those. There's a fair amount of turnover, though, if for no other reason than the dot com -- because of dot coms. We probably bring on between 200 and 300 new firms as distributors of Diversified Reporting Services, Inc. (202) 296-9626 83 Nasdaq data each year. And then the final slide I have here, as I mentioned, in just kind of a day in the life of a plan administrator. Some of the things we do besides contract administration. And I think Tom Haley touched on a lot of these things in his own presentation. We collect usage reports. That's what we -- that's how we bill the client. That's what the billing is based on. We get monthly reports from each distributor that say how much data they distributed in that month. We do the billing and the collection on behalf of the UTP plan. We -- it's actually handled by the NASD finance department. We send out monthly bills. Sometimes people don't pay, and we have pretty garden variety collection efforts with that. Third, we have an auditing function. We get monthly reporting from market data vendors, but that's based exclusively on their systems, and it's all just under our contract. As a result, we do, on a periodic basis, go out and verify that what's been reported to us is in fact accurate, and reflects the true state at any particular vendor or distributor. We are responsible, as the administrator of the tape plan, to provide financial reporting to the plan participants regarding the revenue levels for a particular period. Then we also handle the distribution of the proceeds Diversified Reporting Services, Inc. (202) 296-9626 84 from the UTP tape plan to the various participants. We have kind of basic account management responsibilities. We get a lot of calls from market data distributors and subscribers with questions about our products, questions about fee schedules, questions about roll-out schedules for new products, and product changes. So we've got a group of three people who basically field those types of calls, and make outbound calls regarding new initiatives, and things like that. Then finally, we do mass communications. We alert the distributor community to things like pricing changes, policy changes, changes to the transmission specifications for the Nasdaq data feeds -- because we are also, at the moment, the processor for the Nasdaq data feeds -- and any other mass communications that need to go out to the distributor community. So that, in a nutshell, is the other functions that Nasdaq fulfills as the tape plan administrator. And with that, I'm pretty much done what I had to say, so I'll take any questions. DEAN SELIGMAN: Tom, let me follow up. I want to pose five questions, just to create a kind of comparable basis from you and the New York side. First, you alluded to one pilot program in your discussion. Do you currently have any others, and are you aware of any others that are pending Diversified Reporting Services, Inc. (202) 296-9626 85 at this point? MR. DAVIN: We have one pilot program analogous to what New York has with the cable TV distributors, for the real-time ticker data that goes across the bottom of the screen. So that -- in that sense, we've got that one. We also have three other pilots that we've actually had approved by the SEC, but they were approved as pilots, and two of the three we're looking to file as permanent fees. And those are the nonprofessional fees for NQDS and level 1, and the per-query fee for level 1. DEAN SELIGMAN: And do you have any pilots in the pipeline, if you will, that haven't reached the SEC? MR. DAVIN: We do not, except for the fact that we're going to take two of these things out of pilot, or we think we're going to take two of these things out of pilot and make them permanent. DEAN SELIGMAN: Okay. Second point, Bob made the point that the market data, in effect, is subsidized. That other parts of New York Stock Exchange revenues are used to deal with the provision of market data. Is that the reality at Nasdaq, as well? MR. DAVIN: I think the way we look at it is that market data is one piece, but it's an integrated piece with just about everything we do as a stock market. And there's a lot of different ways we could carve up the costs. And Diversified Reporting Services, Inc. (202) 296-9626 86 perhaps there is a way we could carve it up to make market data -- you know, we could throw a lot of costs at it, and we could probably come up with a good reason for that. But we don't have costs that I think everybody could agree were the right costs. I think the way you divide up -- you know, we could argue for years about what the right way is to divide up the costs. DEAN SELIGMAN: When you change your fees, or otherwise, do you go through an economic analysis to justify the change in fees? MR. DAVIN: We certainly look and see what the -- we do a financial impact analysis, to see -- it's been a while since we've raised a fee, but we certainly would look at who would be impacted by raising a fee. We would look at who would be impacted by reducing a fee, although that's typically not as controversial. And we look at what the revenue impact is going to be on, well, not so much Nasdaq, but the UTP plan participants, including Nasdaq. DEAN SELIGMAN: But just to follow up, that sounds a little bit like a more comprehensive economic analysis than Bob was describing? Or is it basically about the same? MR. DAVIN: It would be hard for me to say, because I'm not sure exactly what New York does for any particular thing. We don't get into -- I think our view has been that this isn't a science. It's not something where you can make Diversified Reporting Services, Inc. (202) 296-9626 87 a big spreadsheet, and a number will pop out at the end as, "and this is just the right price." Instead, we kind of road test these things. We talk to the people who would be impacted by a fee change, to get a sense of not only what would it do to them, but in the instance where we reduce a fee, how much more distribution would they be able to do, or would they do, as a result of the reduced fee. DEAN SELIGMAN: Let me put the question this way: Why do you change fees? MR. DAVIN: Well, I think it's going to vary, from time to time. I think in the instance -- the most recent one has been, we've reduced the nonprofessional fees and the per-query fees to nonprofessionals. And I think the situation there was really responding to the environment. The -- just the fact of the internet, and the broad distribution of the internet, made it much easier for the average person to get at market data. And as a result, we saw an opportunity on a number of levels, that by reducing the fee, we would obviously be able to just dramatically expand the amount access to the data, particularly by nonprofessionals, and then also, we'd also -- we were in a situation where there probably wasn't going to be a significant adverse revenue impact to the UTP plan participants, because we would have a classic case of Diversified Reporting Services, Inc. (202) 296-9626 88 reducing your fee, but raising your revenue, because you just broaden the market for your data. DEAN SELIGMAN: All right. And I'll take that another step in followup of a question I earlier posed to Bob. There are obviously differences between professional and nonprofessional fees, how do you decide where to set those levels? MR. DAVIN: Well, again, I don't think it's a science. I think the reason -- you know, we would look at the differences being related to the fact that, on average, the average professional user is going to get a lot more use out of their subscription to Nasdaq data in a given month than your average nonprofessional. So that -- and there's obviously going to be a lot of variation there. There could be a day trader paying a dollar a month, who's getting a lot of value out of the data, and there could be a professional who isn't getting nearly that much. But we're dealing kind of with averages. The average level-1 professional user, we would expect is going to use, or receive, about 20 times the value of the average nonprofessional user. DEAN SELIGMAN: All right. And the like question, just for comparability sake, there was a description of the enterprise fees on the New York side. MR. DAVIN: Right. Diversified Reporting Services, Inc. (202) 296-9626 89 DEAN SELIGMAN: Do you have enterprise fees, and if so, how do they work? MR. DAVIN: We do not. We don't have a cap. We don't have enterprise fees, period. We've done a lot of analysis over the last few years on the idea of a bit broader application of an enterprise license. Rather than just having a cap that would certainly benefit the very top tier firms, we've been looking at other metrics that might be used to price market data for brokerage firms, that would allow them to make even broader use of the data, while paying comparable fees to what they pay today. Quite frankly, it's turned out -- it's been a very difficult task to try to find a mathematical relationship that works, and keeps the revenue levels relatively consistent, while still making the data available to a broader spectrum of individuals and brokerage firms. DEAN SELIGMAN: Okay. Let me throw it open for questions from the committee. MS. NAZARETH: Could I just make a comment? DEAN SELIGMAN: Please. MS. NAZARETH: It seems to me that partly implicit in your questions on economic analysis is sort of how do we -- how did we get to these fee structures in general? I mean, where did this all start? I mean, I'm looking for your responses. Diversified Reporting Services, Inc. (202) 296-9626 90 It seems to me that the answers that we've gotten is, "Well, we basically start from historical precedent, where, you know, through -- over a period of time, there seemed to have been consensus around the structures under which these fee schedules were created. And then what we do is, we justify, through financial analysis or otherwise, incremental changes, obviously, making sure that they don't cause too much dislocation to the existing structure, and that they can be justified by policy reasons, or the general politics of the firms and what people" -- "what the market will bear." And that's sort of what I'm taking out of the answers, and I'd like to know what your response is. Have I discerned what your implicit responses are, or is there something additional that you would add to that? Bob, do you want to start? MR. BRITZ: Well, I would respond to the, "what the market will bear" comment by recollecting any number of meetings I have been with the SEC in, that absolutely took off the table any notion of pricing for the data against its market value. So if we are somehow pricing against what the market will bear -- I don't think anybody thinks we're pricing what the market will bear. I also think -- you know, we've been charging for market data for a hundred and thirty years, so there is some Diversified Reporting Services, Inc. (202) 296-9626 91 historical precedent, and I don't have any idea why the folks way back then came up with a particular price. Having said that, market data revenues are embedded in our budget on an annual basis, and anything we do goes to the finance committee and the board. So you get -- and the board gets a monthly look at our P&L, so you -- the consensus participants get a frequent look. I don't think they're tied to any historical schedule. The other thing I would say is, I don't know that there's a historical precedent for nonprofessional, or certainly for the internet. So -- and the real answer to your question, Annette, is it's very much a process of consensus. Joel talks about round robin drafting of a document. I recall what we did in April of '99 in terms of cutting the nonprofessional fees in half, and we were fortunate enough to get a consensus around an enterprise agreement. And I agree with Tom, this is not the one that we started out with. We had half a dozen that we tried on for size, with a very substantial number of broker/dealers and buy side customers before we ended up settling on this, so it is very much trial and error. Why do we create new prices? Because creating new prices is, in essence, a way of creating new product, Joel. We didn't have a nonprofessional product at a hundred and Diversified Reporting Services, Inc. (202) 296-9626 92 sixty eight bucks. And so the most compelling reason to create new prices is to fill a need. You need to gauge that need. Either we wake up and identify that, or more likely, firms and vendors come to us and say, "Have you thought about this?" We test that, in terms of whether or not, as Tom said, it's a one-off kind of need, or there is reasonably broad appeal against that need. We try and understand whether there is traction against that product. And then we bubble it up through this process that we have both talked about. And at the end of the day, you get -- you either get, or you do not get, consensus. Our -- price is a perfect example of that. We put out any number of metrics, and couldn't get consensus on those. We were able to get consensus on the one we finally embraced, which, I repeat, was not our first choice. DEAN SELIGMAN: Well, that's very illuminating. And what I'm hearing from both of you is, you're discovering a process, you're discovering a consensus-building process. It's not driven like a cost-based model, it's not like utility rate regulation. And I think the point has been made clearly. And if I was pushing you a little on questions, I just wanted to be clear that we all understood what we were dealing with. Are there other questions? And we should really do Diversified Reporting Services, Inc. (202) 296-9626 93 this for both Tom and Bob, and then the other Tom. Let's start with Eric. MR. ROITER: Thank you. I'd like you to both address whether the consensus model that you've described changes at all if a market center becomes a for profit market center. MR. DAVIN: I think it certainly could make a difference, but ultimately, we still have the same group of customers. We have the same data customers we have, whether we're a publicly traded company or whether we're not for profit. As I mentioned earlier, issuers want their data to be out there. If we are pricing this so high that the data -- that that's being inhibited, we're not -- we're going to lose issuers, at least on the margin. Similarly, you know, a big constituent for us is going to continue to be the trading community, and brokerage firms, and individual investors ultimately, and to the extent that we're not pricing our data fairly, or there's even a perception that we're not, that's going to impact on people's views of whether or not they want to do business with the Nasdaq stock market. MS. FRIEDMAN: I do think this supply and demand drives our decisionmaking, absolutely, and I think it would continue, even if we became a publicly held company. I think we have to look at how we're going to make our success as a Diversified Reporting Services, Inc. (202) 296-9626 94 market, and if the information is not in the public's hands, then we won't get order flow, and we won't get issuers. So I think it's important to note that, really, the model for creating pricing really doesn't change when we become a public company. MR. ROITER: I think one difference is, though, that you want to return something to your investors, and at some point, you have to identify what source of revenue is going to produce profit. And we've heard described this morning that, for both Nasdaq and New York, while it's perhaps extremely difficult to be precise about the expenses that are associated with a generation of market data, that the sense of both Nasdaq and New York -- the strong sense -- is that market data is provided at a loss. MS. FRIEDMAN: We actually haven't -- MR. ROITER: Now, if that's the case in a for profit business model, then I would ask the question, what are you looking to as the source of your profits? MS. FRIEDMAN: Well, first of all, we have not maintained that position. And I would say that throughout the history of Nasdaq, we've wanted to make sure that we have sufficient revenue to innovate, and to build capacity that's necessary, and to reinvest any funds into the company to grow it when necessary to handle customer demand, order flow, to handle demand for issuers. Diversified Reporting Services, Inc. (202) 296-9626 95 So I would say that we've always had that intention in mind, we've always kept that in the way that we do our accounting. So I don't think that would change either. MR. JENNISON: Can I just ask, at Nasdaq, do you consider market data distribution to be profitable or unprofitable? MS. FRIEDMAN: I would say -- I mean, Nasdaq is a profitable entity, so -- and I don't think we could sit there and say, "Well, one piece is profitable, and another piece is not." The fact is that Nasdaq is a profitable entity, and if you look at all the costs and all the revenue streams, we do have a profit that we take to innovate, we take to build capacity necessary for decimals, or we take to build new systems. DEAN SELIGMAN: All right. Are there other questions? Start with Andy. MR. BROOKS: Just one other observation, perhaps. It seems to me that the cost of distributing this data, aggregating it, and pushing it out to the end users, has to have come down just enormously in the last 20 years, with technology and innovation, and telecom innovation. So it just -- I think it's important to kind of -- as we talk about consensus pricing -- Eric sort of alluded to it, and Carrie has talked about, what will the market bear? I cannot do my job without this pricing. I will pay anything I have to, to Diversified Reporting Services, Inc. (202) 296-9626 96 get it, or to get that data. I have to have it. And arguably, there are lots of people like me, and arguably, the individual investor that gets the data pushed to him from CNBC, or through a Charles Schwab device or something, doesn't need that data to do their jobs, to exist. They would like to have that data, but there's a difference there. And it seems to me that we -- as we talk about this, we ought to try and keep in mind what's fair, and the consensus process that you all have employed to sort of put it out there and float balloons, and see how the public and the environment reacts, I think, is probably a good one. I just hope it gets as much -- you know, there's as much jabbing as needs to be done is happening. MS. FRIEDMAN: Can I -- I would like to respond to one part of your comment, which is that the cost of creating, and processing, and producing the market data has gone down in the last 20 years. And I would disagree strongly with that. The costs of our organization have gone up tremendously over the recent years, because of the tremendous volume we've seen in our market, and we've had to build capacity for that, and that then drives the data that we send out. And the more data that we have to deliver, the higher the cost that it is. Diversified Reporting Services, Inc. (202) 296-9626 97 Now, the data -- I think it's important to note that there's tremendously more data going out, and we do -- you know, we increase the bandwidth on our networks, we increase the size of our host machines, we do a lot to ensure that the data has integrity, that it's gone out real-time, that's it's completely reliable, that it doesn't go down. And all of that has a huge associated costs with it. MS. DWYER: Well, you know, I would say that's also a cost of being in business as an exchange. MS. FRIEDMAN: Absolutely. MS. DWYER: You can't attribute that cost, the cost of capacity, to market data. But I have a question. As long as we're on pricing. I was going to save this for this afternoon, but one thing that is intriguing to me is that when I look at the -- I had my staff give me a list of what we pay each market and each vendor, just so I could get a view of the overall costs. We pay a lot more for a professional feed for AMEX data than we do for any other market. DEAN SELIGMAN: AMEX? MS. DWYER: Right, AMEX. AMEX is much more expensive than any other market, so in terms of figuring out the economics of pricing, it's a much smaller market, it's data that's much less used by our customers than New York or Nasdaq data, and yet to put it on our terminal costs us more Diversified Reporting Services, Inc. (202) 296-9626 98 hard dollars. And we have to have it on every one of our 10,000 terminals. How do you -- where does that come from? Is that a historical artifact? Or is that a rational pricing decision? DEAN SELIGMAN: I wonder if we should let Peter address that. MR. QUICK: That probably goes back to the days when you were at the AMEX. DEAN SELIGMAN: Carrie, could I just ask, is that absolutely or relatively. Is it absolutely more expensive? MS. DWYER: Yes, it's $27.90 per terminal, as opposed to much less for the other two terminals. DEAN SELIGMAN: Peter, do you want to comment on that? MR. QUICK: I actually looked into whether -- when the last time the fees were changed, and actually, there was a proposal back in 1984 to drop the pricing, but it did not receive unanimous approval. I don't have any further details on that. DEAN SELIGMAN: Okay. Let's take -- I think, actually, we had Bob Colby? Okay, forgive me, Bob Britz. MR. BRITZ: I just want to respond to Andy's comment. I think they're both right, actually. The unit cost of, at least CTA network getting market data, had decreased to the user by 85 percent in the last 15 years, but Diversified Reporting Services, Inc. (202) 296-9626 99 the actual cost of producing and delivering the data continues to go up for the very argument that was made. Just by way of example, New York doubled its capacity at the switch, switching order-processing capacity in the year 2000 off of a double in year 1999, and we'll increase by 50 percent this year. And Carrie is absolutely right. That's a stake in the ground that the New York has put, that that's critical to conducting our business, but remember, if we cannot take in at the switch level, an order, you cannot create market data at the back end. So I think Andy and -- I'm sorry, the one with the -- I'm sorry, I apologize -- are both right. And the community has, in fact, gotten extremely more market data, and more valuable market data over the last 15 years, at a significantly reduced unit cost. So to the extent that's been invisible to you, I understand that on one level, but now you're enlightened, Andy. DEAN SELIGMAN: Are there other opportunities for enlightenment here? Eric. MR. ROITER: I think we heard from New York that it has not returned or rebated market data fees. Is that also true of Nasdaq? MS. FRIEDMAN: Yes. We don't rebate market data fees. DEAN SELIGMAN: And what about AMEX? Diversified Reporting Services, Inc. (202) 296-9626 100 MR. QUICK: The AMEX does not rebate market data fees. MR. NICOLL: It's not true. MS. FRIEDMAN: In what way? I'm sorry. MR. NICOLL: You rebate market data fees from your competitors, that you receive from your competitors. MS. FRIEDMAN: Oh, you're talking about intermarket, but that's Network A, that's not Nasdaq. MR. NICOLL: But I do think -- I mean, in all fairness, you ought to disclose the fact that you do have a program and that other -- regionals around here have a program where they rebate market data fees to various participants. MS. FRIEDMAN: Right. A lot of the UTP participants have that program, and we, as a third market player in Network A, which is New York listed securities, we do rebate our -- some portion of our fees to the people who submit the orders. DEAN SELIGMAN: I would be interested if either of you want to just illuminate us a little bit more how that works. You could do it now, or if you want to send a memo in, but I think that's worth getting on the table. MS. FRIEDMAN: Well, this is -- it's actually a pilot, I believe, but I think it's -- and it's one that we continually go and get resubmitted to the SEC for Diversified Reporting Services, Inc. (202) 296-9626 101 continuation, but we basically -- we call it the "intermarket," and it's a way that we are a smaller player in New York listed securities for member firms that are not members of New York, or choose not to trade through New York or another CTA participant. And we allow them to come in and submit quotes, submit orders, and submit trade reports through Nasdaq systems, and they then -- we, in turn, Nasdaq, receive some portion of the Network A revenue. And we then recently have started a program to supply some of that revenue back to the participants who are placing the orders with Nasdaq. MR. MADOFF: I think you should elaborate on that. I think in fairness to full disclosure on this issue, I guess that you would say that -- I think it would be safe to say that the industry feels that all the exchanges, in one form or another, are passing through CTA revenue, or market data revenue. Some are doing it in a more defined manner, but all of this was a competitive issue. In other words, there were people -- although the New York, I think, officially does not rebate part of the market data fee, I would say that there are a lot of people that would take the position that the specialist posts are subsidized by the exchange, in anything from free rent, to technology, to things of that sort. Then the Chicago started rebating fees directly Diversified Reporting Services, Inc. (202) 296-9626 102 back to their specialists on the floor. I'm not sure what some of the other regionals do. Cincinnati certainly does it. And Nasdaq felt compelled to do it as a competitive issue. So although everybody has different ways of doing it, different schedules, pretty much, but I think that -- my guess would be, as someone who trades on all of those exchanges, I could say that the opinion -- our opinion would be that every exchange is involved, in one form or another, of rebating part of its market data fees back to participants. DEAN SELIGMAN: Now, there's a difference in what you're describing on some exchanges and, I take it, what Adena was describing, which is, you file the pilot, the nature of the rebate is in a document, it's public. Is the nature of the type of rebate you're describing publicly knowable? MR. MADOFF: Probably not. I would say, certainly, the rebate that we get from Nasdaq on third market trades is because it was filed. What -- I'm not familiar with what filing, if any, Cincinnati has done on rebating part of their fees, and I don't -- I'm not familiar with -- I can't speak for the other exchanges. But some are, and some aren't. The bottom line is, the effect is the same. DEAN SELIGMAN: Paul? Diversified Reporting Services, Inc. (202) 296-9626 103 MR. O'KELLY: The Chicago stock exchange does have a rebate program. It's part of our rules, which are a public document. The rebate program is filed -- DEAN SELIGMAN: Paul, I think you need to turn on your -- MR. O'KELLY: Ours is a program that is part of our rules, it was filed with the SEC. Anyone who goes to our rulebook will see the rebate program. What you don't see in our rebate program -- or what you will see in our rebate program that based upon our specialist maintaining certain market share, and when they receive certain market share levels, they get a rebate of part of the market data fees. What they do with those fees are up to them, the specialists. It's up to them to do whatever they want with those fees. But I can tell you -- and we don't try to hide this fact, although we don't know the exact quantities of this -- those fees are, in many cases, returned to the order-sending firms that are sending those specialists the order flow that helped them gain their market share. And what you see happening here is that, in Chicago's case, we are getting market data fees that we see are more than we need to run the exchange, we're turning around and giving them to specialists, who are turning around and giving them to the people that are bringing us the order flow. We think that's a pretty good model, and we think Diversified Reporting Services, Inc. (202) 296-9626 104 it works, and it's something that we're neither ashamed of, nor are we reluctant to publish. DEAN SELIGMAN: Peter, is there anything like this on the American Stock Exchange you want to tell us about? MR. QUICK: No, there is no payment for -- no rebating back -- I'm sorry -- of the exchange fees. DEAN SELIGMAN: Bob, do you want to illuminate us as to whether the New York Stock Exchange has a practice here that would be of relevance to us? MR. BRITZ: That would be . . . DEAN SELIGMAN: Relevant to the discussion. That is, Bernie has characterized -- MR. BRITZ: We have no such practice. I -- with all due respect, I can't make any sense out of what Bernie was saying vis-a-vis the New York. I do understand what he said vis--vis Nasdaq and the other markets. MR. MADOFF: Would you like me to elaborate? DEAN SELIGMAN: I think it might be useful. MR. MADOFF: Again, I will -- I stated that this is my interpretation, but I would say that it probably is the interpretation of most markets in this sense. Depending on the way you slice it, I would say that, clearly, the ones that disclose it as part of their program, like Chicago and Cincinnati, and probably Nasdaq and maybe there are other regionals, I'm not sure -- you know, it's relatively easy to Diversified Reporting Services, Inc. (202) 296-9626 105 decipher. This started, I would say, that people felt that, although the New York does not -- and it started all with the payment for order flow issue, going back originally. And I will add that I agree that it is -- most people feel that it is passed on back, eventually, to the customer, although everybody could debate that one way or another. But it was -- I think it would -- I thought it would say -- it would be naive to think that the various exchanges, even before this started to happen in a formal practice, were not somehow or other using the market data fees, or revenues from the exchange. Again, it's very hard to sort of go through the veil of subsidizing the specialists, market makers, whatever you want to call them, in their trading operation. So yes, you probably do not have a formal fee. But I will tell you that technology, and all sorts of things, are made available to the specialist, and people would look at that as a way of the exchange using revenues that come in from market data fees to subsidize the specialists. Now, I'm not going to debate the issue, because I don't think it's important enough, other than the fact that I would say that that's probably the opinion out there. Maybe it's not correct in the New York or in the AMEX, but in my experience, and people I've spoken to, pretty much people Diversified Reporting Services, Inc. (202) 296-9626 106 seem to be of that opinion. DEAN SELIGMAN: All right. MR. MADOFF: And I don't think there's anything wrong with it, by the way, so to me, it's academic whether someone has a formal way of doing it or not, because I think nobody really cares about that. I think that's really public relations, more than anything else. The bottom line is the revenues -- and I think that's, quite frankly, why we're all here. I think that there's a whole issue of, people feel that the market data revenue is -- has to be restructured, the way the whole thing happens. And the issue is, whose revenue is this, and how should it be distributed. And I think what you saw, before this committee even formed, was the movement taking place, people putting pressure on the various market centers, and saying, "Listen, you have this revenue, it's being generated from trading that our customers, or your customers, are bringing to the table, and we want part of that back, or we want the accounting to be there." And I think that's really what this is all about. I think it's naive to think that it's not related. DEAN SELIGMAN: Okay. Bob, do you want to -- MR. JENNISON: I'd just like to echo that. You know, whether it's rebates, or whether it's fees or tariffs, they all lie on the same continuum, and as a person at a firm Diversified Reporting Services, Inc. (202) 296-9626 107 that executes on all these exchanges, I would say that the one universal fact that I see out there right now -- that we see -- is fees and charges on the exchanges right now tend to be soft, whether they're specialist fees, or something like that. They tend to be subject to heavy negotiation. I've seen that. And I guess I'd also just point out that I find this discussion a little bit curious, in that the two tape plan administrators told us that they can't really tell us whether it's profitable or unprofitable, but in the scheme of their entire enterprise, the entire enterprise is certainly profitable. And that's understandable, but -- and we also heard that the pricing mechanism is really just kind of consensus-based. It's curious that, you know, oddly enough, the nonprofessional fee is both a dollar. I mean, that kind of makes sense, it's all centered around the same number. And they're roughly both 20 to 1, or 25 to 1. But it's -- you know, I still get back to this point, where I think if we're going to push down, we may push down and talk down the price on market data. I fully expect the price of something else to pop up. It will appear somewhere, is my point. I feel like we have the two big plan administrators here, telling us that they don't look at this as a business unto its own, but they look at the entire enterprise, and Diversified Reporting Services, Inc. (202) 296-9626 108 that enterprise is profitable. I'm willing to bet that if we make this less profitable, by driving the price down to them, or to the plan, they'll restore their profits elsewhere, and it'll come to me on a different bill with a New York Stock Exchange, or Nasdaq, or AMEX, or Chicago stamp on the envelope. I mean, that's kind of how it works on the user end. DEAN SELIGMAN: Okay. Are there other questions? MS. DWYER: Joel, I don't have a question, but I have some comments, if it's appropriate to offer those at this point. DEAN SELIGMAN: Due course, and then I think Bob had his hand up. MS. DWYER: Bob, do you want to respond to that? MR. BRITZ: No, go ahead. MS. DWYER: Okay. People did a tremendous amount of work for this meeting. I think it's been really helpful. It was somewhat at my behest that we actually get into the facts of how it works, and I think it's been really useful. I enjoyed looked at the FISD's white paper. And I didn't get it ready for today, but in the next couple of days, we have some sort of specific additions to the data that have been offered here, based on our experience, that I'll circulate around to folks. But, you know, I was struck by all of these Diversified Reporting Services, Inc. (202) 296-9626 109 presentations, really. I would suggest we look at them a slightly different way. The question that Michael put forward right at the beginning was, who should determine the business practices of the exchange. And then that has kind of framed all of this, and our level of ability to affect how they run their business, and so forth, and how they do run their business. I don't think that's the question. I think this has been very useful to illustrate what is the question, which is, how should basic market data be distributed. The exchange is in this business because of a government mandate, but the objective is to treat -- I think, should be to treat market data as a shared resource that's essential to the functioning of the market. So whether it's cost-based utility regulation, or free market competition, I think we're struggling with all of that. But I think that is more the question than, "Gee, should we tell the exchange how to manage its internal affairs?" I think that what all of this illustrates is that market data for the past 25 years has been treated as a product to be licensed under a claimed proprietary interest. All these contracts we've been talking about are, essentially, license agreements that are designed to track, control, and price this proprietary interest. It goes all the way down to the individual user level. I was -- in my Diversified Reporting Services, Inc. (202) 296-9626 110 briefcase, coming out here, I had asked for a new RIM pager last week. Well, I have four -- DEAN SELIGMAN: A what? MS. DWYER: It's Blackberry. Gives you e-mail, lots of other things. You can get real-time quotes. So I have four brokerage accounts. I've signed to market data agreements with each of the markets for each of those. I use voice products, so at Schwab, I then have another agreement. Schwab then pays an additional fee for my access through that channel. I have web access on each of my four brokerage accounts, so I've done the infamous click-through agreements for all of those. And so here I have 15 pages of this -- I don't know if you can all see it, I can't even read it with my glasses -- from all the exchanges. I have to sign and execute. And as I did pour through them -- you know, it even restricts what I do with the pager. If I were to let my daughter use my pager, following the letter of this agreement, to check her e-mail, I would have lost control of the device and be in violation of the agreements. So this is the pervasiveness of this licensing of what is the most simple level of data in the market. I thought the FISD paper told us very clear -- a 50-page, four-column spreadsheet of all the essential terms in the markets contracts, 230, I think it was, individual policy Diversified Reporting Services, Inc. (202) 296-9626 111 considerations that the contracts deal with. I mean, the enormous complexity of this -- Schwab has a dedicated team of folks who do nothing else but administer the Schwab side contracts. And they do all of these things, billing, collection, auditing, reporting, as well as -- and I beg to differ with the markets -- negotiation. These -- every time we -- you know -- well, let me just go back through what the FISD listed. These are the conditions of the license. Prior approval. The assumption is that for any use you make of market data is prohibited unless you receive prior approval. User classification systems that change how you pay for market data, and what you can do with it, depending on who you are. Units of count, which they list as being by, "device, user, location, or identification based," and are fairly inconsistent throughout the industry. Subscriber agreements, which I've mentioned, are these product licenses. And then, you know, they're pretty onerous billing and reporting requirements, which are audited, and so forth. All of this to support control and pricing of this licensed data. And when we negotiate our Exhibit A, we're required, for prior approval, to disclose all kinds of interesting information about exactly what our business model Diversified Reporting Services, Inc. (202) 296-9626 112 is. Every time we change a facet of our business, we need to go back and amend these agreements, and make sure we have prior approval. And I will tell you that those are bilateral negotiations, with unilateral interpretation. And my people spend a great deal of time. They're engaged in negotiations right now with both the Nasdaq and the New York Stock Exchange about various things. We are never not negotiating one of these things. So to say that the contracts are up on the web, and they're -- they are not done that way. Because of the variability of business, and the difficulties of interpreting use, and counting, and so forth, they're very complicated. And this isn't to say there's bad faith from the exchanges, but it is a bilateral negotiation every single time. And that produces enormous discretion, and that produces the questions that asked about, are people really treated equally? Is -- you know, there is very little transparency around these negotiations. If I can cut a special deal, I have to assume somebody else can. Am I being treated the same? I don't know. Maybe I am. But the fact that I worry about it is something that bothers us. I will produce this white paper. I think we can give some concrete examples of some of these things, where we have really spent an inordinate amount of Diversified Reporting Services, Inc. (202) 296-9626 113 time and effort and pain, negotiating through these things. And I just didn't want to leave that unsaid. But I think what we have to deal with is the fact that -- should market data be a product that is licensed under these kinds of conditions. And that rather than meddling with the exchanges business model, which I think we don't want to do. They run a fine business, they're entitled to do that. But -- and I should say, the exchanges. I think that's really the issue we ought to focus on when we talk about these issues this afternoon. DEAN SELIGMAN: I do appreciate that Michael Atkin used the phrase, "business model," and it obviously does not bind the committee. It does describe, though, I think, perhaps the way his business looks at this. I appreciate your comments. I do think this afternoon I want to get back to the prior approval a little bit when we get to administration plans. I'm interested in, among other things, not only in the complexity, but the time it takes. Let me turn to Bob, who -- MR. BRITZ: No, I'll pass, Joel. Thank you. DEAN SELIGMAN: It is now noon. I think we've had a good morning, in terms of putting a lot of background on the table. What I'd like to suggest is, let's take a one-hour lunch, and get straight back to work at 1:00. I want to go straight to transparency issues. I've called it, Diversified Reporting Services, Inc. (202) 296-9626 114 "item E" on page 3 of the agenda that's been distributed. We'll proceed from there to what we should refer to as, "nondiscrimination," or most-favored-nation kinds of concepts. I want to go on to pilots. I want, as well, to take up the administrative and technological issues if we're able to today. I'll give you a brief overview when we come back, as to how this relates to fees, but by and large, I think we know where we're going, and I think there are now some tough issues we need to wrestle with. Let's pick up again exactly at 1 o'clock. For those who would like to join us for lunch, there's lunch in the same back room we had it last time. (Whereupon, at 1:00 p.m., a luncheon recess was taken.) * * * * * A F T E R N O O N S E S S I O N DEAN SELIGMAN: I think it's time to begin. Let's start with E, which deals with transparency. Obviously, both in the last meeting and in this one, there was a great deal of reference to the notion we need more sunshine in the process. Before the meeting, we posed five questions as to various ways in which more transparency might be achievable. I'd suggest Question 5 might not really be on the table, Diversified Reporting Services, Inc. (202) 296-9626 115 given the statements of the plan administrators this morning, but we can take it up. I would almost, I guess, like to go around the table and ask each of you I guess to focus on the five questions collectively and focus on the following issue, and you can take them up one by one. If we need more transparency, why? And what specific information should we focus on requiring in addition to what's already out there? Clearly, Michael Atkin began today by giving us a sense of a database that will be communicating contract types, fees schedules and so forth, not only for North American equity markets, but indeed for global ones. Clearly, the plan administrators made it reasonably clear that contract types, fee schedules, are very much available, and there's no reason why one would expect that there wouldn't be. But the real ball game here I think may be in Questions 2, 3, 4 and conceivably 5. I'd like to know specifically from each of you your sense, if we need more information, precisely what it is and why. Let me start, Michael, with you -- I know this is an area you've given some thought to -- then we'll go back to our normal alphabetical conventions. Give me your sense, focusing hard on Question E, if you will, 4(e), what your recommendations and thoughts would be for us, and we'll keep Diversified Reporting Services, Inc. (202) 296-9626 116 going around the table. MR. ATKIN: Well, all five questions, Joel, or are you just talking about -- DEAN SELIGMAN: Yes, it may be too ambitious to do all five. I'm trying to proceed in a way where we have an opportunity this afternoon to cover a lot of ground. Let's do it maybe -- I don't know. Is there a sense that we'd be better off segmenting this, doing them one by one? MR. BROOKS: I think they run together, these questions, Joel. DEAN SELIGMAN: All right. Let's almost think of this like a congressional committee. Does anyone want to segment these or shall we address all five collectively, each of you have a statement on it? We can follow up with more specific questions if we need to. Michael, you've got the floor. MR. ATKIN: I think everybody agrees that transparency is good. I think that for the fee schedules and contracts, they're available. I think it's just a question of aggregating them and making them easy to understand. So I think on Question 1, "Should the contracts and fees be made available?" I think yes and I think they are. I think there's a separate question of whether you make the costs available, which I assume is what Question 2 is trying to get at. Diversified Reporting Services, Inc. (202) 296-9626 117 Yes? DEAN SELIGMAN: Yes. MR. ATKIN: If you don't mind, I think we should separate out whether the contracts and fees are made available -- DEAN SELIGMAN: You know what? Let me step back. Let's start this again. Let's take them up one by one. We'll do crisper answers. The only real question on one is not so much, should this be available, it is available. It should be filed with the SEC. I'm not quite sure that that gets us a lot more than we already have. Anyone want to make the case it should be filed with the SEC or are you more or less comfortable where things are in terms of contract types and fee schedules? MR. ATKIN: Bob, aren't contracts currently filed with the SEC? I thought they were. MR. COLBY: I honestly don't know. We have them. We have the individual contract model. We certainly do not have the individual contracts with respect to particular parties. There isn't a filing requirement, but the model came in as an attachment to the plan. And I can't remember if it was filed or not, so -- MR. ATKIN: Joel, we found that it's not a question of having the contract available. It's a question of, what Diversified Reporting Services, Inc. (202) 296-9626 118 does that mean in the contract? What are the obligations required as part of this contract? The reason we built our database was not to make the specific contracts available. It was to try to explain what all the requirements and obligations were in terms of administration. DEAN SELIGMAN: Let me take it another step. This is not only contract types, but it goes to the specific contracts with users. That, I take it, is not filed with the SEC or available? MR. ATKIN: The specific Exhibit A and Attachment A or -- DEAN SELIGMAN: No, it includes Exhibit A, as well. MR. BRITZ: But, Joel, if I may? Exhibit A is a printed form, as I've said before, so certainly that's either filed or available. I won't argue the technical term. And the notion of making available to the SEC every broker/dealer and institutional investor's individual Exhibit A, frankly, would be okay with us as the administrator, but may or may not be okay with the firms. MR. ATKIN: I don't think you gain anything by making the Exhibit As available to anybody. DEAN SELIGMAN: Let's play it out around the table. Anyone want to make the case that the individual contracts, including the Exhibit As, should be available? (No response.) Diversified Reporting Services, Inc. (202) 296-9626 119 DEAN SELIGMAN: Okay. So what I'm basically hearing on Number 1 is more or less there's a comfort level that -- the basic structure of the contract, the basic forms are available one way or another, whether technically filed. With respect to individual firms providing, either through the SROs or otherwise, all of the individual contracts, including the Exhibit As, I hear nobody saying we should do that. I don't know if we need to go further with Question 1 unless anyone wants to address that? (No response.) Let's go on to Question 2. Question 2? MR. NICOLL: I'm sorry to interrupt you. DEAN SELIGMAN: Don't worry about it, Ed. MR. NICOLL: But you actually haven't formally asked whether we were all in favor of transparency, in this particular case, as a foundation. I mean I don't know whether that's on the table or not, but I'd like to call into question whether or not we understand what that means. We, for one, would actually dissent, in this particular case, the transparency if by "transparency," you mean that all rates should be publicly available, is necessarily the correct starting point. DEAN SELIGMAN: Okay. MR. NICOLL: And I would like to make an argument that, in fact, is not in the industry's best interest. Diversified Reporting Services, Inc. (202) 296-9626 120 DEAN SELIGMAN: Let me do this, Ed. Let's, rather than taking the generic, is transparency a good thing or a bad thing, let's relate it to specific types of information. MR. NICOLL: Right. DEAN SELIGMAN: We'll take up your point and your opportunity to articulate it at more length when we get to Question 3, which deals with revenues and would include rates. At the moment, though, I take it we really looked at Question 1 insofar as we want to. There doesn't seem to be any great difference of opinion. Let's go on to Question 2. This deals with the costs incurred by the plan processor, in essence, administering the plans. Who wants to make the case that this should be done? And maybe we don't need to go systematically around the table, but let's just see who wants to chime in. Bob? MR. BRITZ: Again, I think it is done, Joel, and Bob Colby may correct me, but I actually think this is technically filed if you're talking about the Consolidated Tape Association P&L audited -- I think that is technically filed with the SEC. MR. COLBY: I will have to check. MR. BRITZ: Okay. It's certainly given to the SEC, audited, in hard copy form. Diversified Reporting Services, Inc. (202) 296-9626 121 MR. JENNISON: But, Joel, is that the question or is the question the cost that the plan administrator, the New York Stock Exchange and Nasdaq, incur in distributing market data. DEAN SELIGMAN: Question 2 goes to the plan administrators. It's perfectly appropriate, though, to follow up that with the point that you're making, George. If you look not just narrowly at CTA/CQ, and obviously NASD and potentially OPRA, the related costs that let's say the New York Stock Exchange or the NASD have with respect to market information, I take it are not disaggregated and disclosed. And the question is, do we want to focus on that issue then? Does anyone want to make the case that those costs should be more carefully -- or more precisely, I'm not going to use the word "careful" -- more precisely disclosed than they are currently? MS. DWYER: Joel, I guess I would almost answer every one of the questions in this section by saying if you wanted to have a pervasive SEC-controlled scheme of regulation of this business as a public utility, then you would probably want all of this stuff on file, reviewed, disclosed and publicly available -- but only then. If you were moving to a more competitive model, then I would think none of these questions would be relevant. DEAN SELIGMAN: Well, in effect, we're probably Diversified Reporting Services, Inc. (202) 296-9626 122 going to have an analysis which is going to look at both different types of approaches. Clearly, if you go to a more competitive market model, that's a plausible outcome. For the moment, if you assume the SEC might have something like its current regulation in place at the end of the day -- I'm trying to understand exactly what transparency has meant. We've heard the phrase over and over again over the last few sessions. I'm not seeing a whole lot of hands basically saying that people are interested in more costs in terms of plan administration, more data there. There's obviously either not a sense of need or the sense of what's being provided already is adequate. MS. DWYER: Well, I guess one thing I would add is that sort of where we started this discussion, which was cost-based, if this is a public utility, and needs to be more highly regulated by the SEC, then you would want to know the answers to the questions we asked this morning. What does it cost to produce this? How does that match against the revenue? Is that a fair cost setting? "How do you set the fees?" the question you asked. How do you set the professional fees and the nonprofessional? That would be where I would say there would need to be much more transparency. DEAN SELIGMAN: That really goes to Question 3. It's okay. Let's focus on that one. Diversified Reporting Services, Inc. (202) 296-9626 123 MR. ATKIN: Joel, if I could just, on Question 1, just make one point? DEAN SELIGMAN: Sure. MR. ATKIN: If you want people to comply with the rules and understand what their obligations are, they need to be published and clear. In the current model of what the rules are, in order to have people comply with them, you need to know what they are. So I mean I think in that case everybody would probably support full transparency. DEAN SELIGMAN: Well, but we keep using the phrase "transparency," and I think it's real important now to pin down what we mean by it. In essence, what I'd like to focus on is people feel like they know what the contract types are, they know what the fee schedules are, they don't seem terribly excited about learning more about the cost of administration. Question 3, which may be the one that's nearest and dearest to certain hearts in the room, goes to more detailed information about the revenues generated by market data, fee arrangements such as the revenue produced by each type of fee, and the revenues distributed back to each SRO participant. Is that something that someone wants to make the case there should be greater disclosure of? Andy? Diversified Reporting Services, Inc. (202) 296-9626 124 MR. BROOKS: I mean I guess I'm not asking for a more intrusive process from a regulator standpoint, but I do think it's important for us to understand, and the public to understand, what drives pricing decisions and what drives routing and flows and what drives people's -- sort of their process and whether an order goes to the third market and gets printed here or it goes somewhere else, I think that that kind of information ought to be in the public domain so that people can understand perhaps the true cost of doing business, the true cost of trading, the true cost of executing that order. I think that would probably be a good thing. DEAN SELIGMAN: The statements we heard earlier today from the two Toms, in effect, were that, at the moment, there didn't seem to be that precise a level of accounting that was available. Clearly, one must assume that the various plans know what their revenues for market information are. But the true cost of providing various types of market data, I didn't get the sense that was disaggregated with great precision. Now, Bob, is that a fair statement? MR. BRITZ: You have to identify at what level in the aggregation process you're at. The participants clearly know what the revenues are. They clearly know what the direct processor costs are and they clearly know what the Diversified Reporting Services, Inc. (202) 296-9626 125 administrative costs are, all at the collection, consolidation, redistribution level. Only vertically within their own marketplaces, do they know what the production -- Chicago does not know what the production costs of market data are for New York, nor do I know Chicago. But there is a CTA P&L that starts at the revenue line and does, in fact, go through the costs associated with that collection and consolidation function. So they know it at that level, Joel. DEAN SELIGMAN: Andy, to go back to your comment, what you're talking about, though, is something different, correct? MR. BROOKS: I think it is. I mean the Commission, I believe, has asked for more transparency in terms of where orders are routed and what might be received by the broker/dealer for that routing. If you look on the back of a confirm, it will tell you that perhaps moneys have been -- you've received payment for order flow or it's gone to this exchange or somebody might have a proprietary or principle interest in something. I just wonder if it wouldn't be consistent in that end of the transparency spectrum to want to have in the public domain some filings or some full explanation of some of these revenues that are generated by market data fee arrangements and reciprocity and some other things. That's Diversified Reporting Services, Inc. (202) 296-9626 126 what I was trying to drive towards. Does that make sense? DEAN SELIGMAN: I think I understand what you're saying. But it's like on an order ticket basis? MR. BROOKS: Right now you have that on an order basis, I think. Don't you, Ed? I see you shaking your hand, but I don't want to be too intrusive about it, but I do think that for all classes of investors to truly understand the market data fees that are being charged, they've got to understand what the reciprocity is and what's sort of connected to it. I don't think you can talk about one without talking about the other or at least putting it in a filing or sort of somewhere. MR. NICOLL: I just find it ironic, Andrew. I mean you of all people know that there are times -- and you will argue -- that there are many times in the marketplace where transparency is not a good thing. It does not create efficient outcome. Institutional investors talk all the time about the fact that they need a certain amount of opacity in order to move in and out of the market without creating market impact. It's not clear to me that transparency does the industry, does the users, the good that they think that it does, nor that notions like most favored nation pricing schemes will do for Carrie want she wants it to do. In fact, Diversified Reporting Services, Inc. (202) 296-9626 127 I would argue that it's as likely do to the opposite and that, in fact, the level of transparency that we have mandated does the opposite. I mean we all know that this is a pricing discussion. It seems to me that sort of the 900 pound gorilla sitting in the corner is the fact that none of us are sure that market data is being priced correctly, whatever that means. Many in the industry suspect that it's being overpriced right now and I think that's much of at the core of the reason why we're here. And the issue is, why are we at this point? I think there's a very good argument to be made that even within the model that we're talking about here, which is the model of essentially a mandated BBO where, arguably, the providers of the quotes can exercise market power, that you would get a lower, more efficient price if large users were allowed to negotiate in the dark, then you get today where when a large user gets a big price discount, the producer of that product is required to disclose that to the world and thereby is disincented from doing the kind of volume pricing that it would normally do under normal market conditions. And it is not clear to me that this notion that if everything is published we'll be better off is, in fact, a good thing from a user's point of view or from the consumers' of the data's point of view even under these circumstances. Diversified Reporting Services, Inc. (202) 296-9626 128 MR. SELIGMAN: Peter. MR. QUICK: I have a question. We keep hearing the word "Most Favored Nation." Can't we all agree that there is no favored nation in terms of everything is either on the NASDAQ or the New York Stock Exchange web site or NASDAQ Trader.com web site in terms of what the contracts are, what the pricing schedule is? Is there an enterprise license that somebody can take advantage of? Yes. But there is no Most Favored Nation pricing? I mean, nobody gets -- you know, other than the published pricing schedule there is no such thing as Most Favored Nation. MR. NICOLL: Well, I'm just making an appeal to my counterpart over here. I actually think that there could very well be negotiations about what appear to be process which could, in effect, have real meaning in terms of what I pay versus what Schwab pays for quotes. And the devil is always in the details, and I, too, have a staff that does nothing but deal with these issues and spend a fair amount of time and resources about that. So I'm not sure that it is as cut and dry and made out to be, and I, too, have my suspicions that in the details of the data -- or the stuff that is not disclosed; that is, how I'm charged and how I collect data and then how I report that data versus how Schwab does is necessarily the same. Diversified Reporting Services, Inc. (202) 296-9626 129 MS. DWYER: Let me just -- MR. SELIGMAN: I'll be right back to you. MS. DWYER: Okay. MR. SELIGMAN: Let me just see if I can link this to where we are. I mean, what you're really saying is the details of what you provide, essentially, to the SROs through your Schedule A may create interpretation issues which could lead do different types of pricing structures for you, for Schwab versus whomever. But what I'm hearing at the same time is two things. Number one, as you put it, there is some suspicion that there's more money in the system than should be, that people are struggling, is there a way that you can address the allocation of fees; but number two, but nobody wants to go to full disclosure of Schedule A(s) and greater transparency on that point. MS. DWYER: Well, to respond to Ed, I think we're actually in the same place. What I was, apparently, inarticulately trying to say was all of this mandatory disclosure, rules, restrictions, and so forth, make sense if you're regulating a utility, and we see from California how difficult that actually turns out to be. It causes dysfunction. But if you are move to a purely competitive market, if I don't like the terms one market is offering me for the Diversified Reporting Services, Inc. (202) 296-9626 130 data, I can go somewhere else. And if one entity has a very complex, very onerous contractual regime, I'd like alternative to that to get the data, and I think that produces benefit for everybody. So I'm not sure we're very far apart. In a completely competitive world, I'd like to be able to negotiate whatever I can. MR. NICOLL: This will be the end. I want to make the point -- and I want to be specific about this -- that certainly I would prefer and I'm here to advocate for a much more competitive model on all levels. But even if we accept the predicate of this full committee, which is that generally we're going to be within the same regulatory regime that we are now, that we're going to have the display rule, for instance, that we're going to have -- and with all that comes, that follows from the display rule, all I want to put up for everybody's consideration is to think that even with that monopoly and market power on one side that it may be that you will get lower prices at the end of the day by allowing larger -- prices are set -- a long time we've known that prices are established at the margin. And it may be that we'll get better pricing if we allow large, sophisticated, knowledgeable negotiators to negotiate with the exchange in the dark to create lower Diversified Reporting Services, Inc. (202) 296-9626 131 prices for them than we have today. And if I were an exchange, I would love it -- if Schwab came to me and pounded me for a discount and I just said to Schwab, "I'm sorry. If I give you a discount, I've got to disclose it, and everybody's going to get the discount. Therefore, I can't." It may be that what we have is because of the regulatory regime the market is not operating as it should, and because of the mandate for the disclosure of every different pricing scheme that the exchange enters into that that prevents a more efficient outcome from occurring even under the present regulatory regime. MR. SELIGMAN: Thanks, Ed. Simon. MR. JOHNSON: I just don't want us to get bogged down on this issue because I'm not sure it's what you want us to do, but I'm not following the argument that says that we get lower rates either on average or particularly for small investors in a situation where every deal is secret. I mean, I can think of a number of instances where it would go the other way where I think the people that had the monopoly power would be delighted they can discriminate very carefully between different kinds of consumers according to their ability to pay. So that I can understand. But whether that's going to bring down prices on average and particularly prices for relatively small Diversified Reporting Services, Inc. (202) 296-9626 132 investors who I think of you, Ed, as actually advocating and trying to help those guys, I'm missing something here. So maybe we can talk about that separately. Maybe it's not central to the agenda. But if it is central to the agenda, I think we need a lot more debate about it because it's really not clear to me at this point. MR. SELIGMAN: Let me, I guess -- to try to adjust transparency, see if I can start this once more, I'll throw out the question in these terms: Is there a category of data that anyone at this table wants to recommend that is not currently disclosed that should be disclosed? If so, what is that category. If so, why? When we talk about transparency, that's what we're really talking about. Is it just, basically, when we use the phrase we're saying we like what we already have or we think in a general sense it's a good thing, or is there something specific that we want to take up? Eric. MR. ROITER: I think, perhaps, the reason people are struggling with this is that need to step back and ask what is promoted by transparency. I think of two basic objectives. One is to influence behavior. That might be to deter undesirable behavior. If you're a corporate director and you have to disclose in the company's proxy statement Diversified Reporting Services, Inc. (202) 296-9626 133 that you haven't showed up for at least 75 percent of your company's board meetings, that's going to influence your behavior. You're more likely to attend 75 percent or more of the meetings. I'm not sure that has much relevance to this particular context. Second is that transparency promotes pricing efficiency. I think pricing efficiency depends on a multiplicity of buyers and sellers. And perhaps the reason people aren't leaping forward to say that we need lots of transparency is that underlying this discussion is recognition that we don't have multiple buyers and multiple sellers of data. At least if you look all the way to the origination of that data, you've got one ultimate seller per market. And for the primary market, whether it's Nasdaq or the New York Stock Exchange, you've got that threshold bottleneck, I would say. Now, perhaps the consensus process that has been described here today ameliorates the difficulties that come from that bottleneck. I don't see really how transparency, if that's taken to mean filing Schedule A(s) as they are actually filled in by different subscribers, is going to alter the fact that you've got a single market center, at the end of the day, setting the price for its market data. It may be important for the SEC itself to have Diversified Reporting Services, Inc. (202) 296-9626 134 access to those Schedule A(s) and other arrangements, individual arrangements with subscribers so that the SEC can assure itself that the non-discrimination standards of the statute are met. But unless you move to a system where you actually can have multiple buyers and multiple sellers driving pricing efficiency, then making all of this information transparent doesn't really change things. MR. SELIGMAN: Okay. Bob. MR. COLBY: Eric, is there any value in the consensus fee-setting process of having more information in order to form the consensus? MR. ROITER: I suppose there's some marginal benefits, but I'm not sure where the balance is. If you have a comment process and require fees to be filed and you have an inspection program and you have the market centers representing that the fees that are explicitly set forth in their standard forms of agreement are, in fact, the fees that are charged, then I don't know, at least on the revenue side, what more you can get. And I listened intently to Carrie's description of what she called the negotiation process. I'm not quite sure that I would describe it as negotiation. When I go to a restaurant and I see many choices and I ultimately select from the menu, I don't see that I've negotiated anything with Diversified Reporting Services, Inc. (202) 296-9626 135 the restaurant. I've chosen from among a variety of options. On the cost side, I might turn the question back to the staff to ask whether, after all these years of overseeing the process of fee-setting by the exchanges whether the staff has felt that it has been in the position to make a good judgment about whether the fees that are filed are reasonable or not. And as I say, there may be some marginal benefit or making more information available. I don't know that it has to be out there for everyone so long as it's available to the SEC staff through inspections or otherwise. MR. COLBY: As to fee review, the question is what decision should be made? And I agree with Carrie. If you're going to do rate regulation, you need a great deal more cost information than we have, if you're doing, certainly, utility type regulation. I would just like to ask in a different way. If user is trying to look at the information -- look at the fees that are being set today and you want to make a judgment about whether this is the right balance in dealing directly with the boards of exchanges or trying to put input back into on a published fee that's out for comment, and the like, is the information that you really, sort of, need to start getting a feel even on the rough sense available readily now, Diversified Reporting Services, Inc. (202) 296-9626 136 or would more information be useful? MR. ROITER: Again, I apologize for repeating myself. I think there may be some incremental benefit. I do draw a distinction between for-profit and not-for-profit market centers. At the end of the day, the for-profit market center has to have a return for its shareholders. And yes, there will be an equilibrium that is arrived at for the for-profit market center. It may not be the same equilibrium that's arrived at in the not-for-profit market center. It may be more useful to get that kind of information when you were getting market data from a for- profit market center because then you can start dealing with the questions of whether that source of revenue is providing a reasonable rate of return to the market center, which I think is a different question than market centers that aren't operated for profit have to answer. MR. SELIGMAN: I think, given the response from the group on this question, it's worthwhile going on to the next one. Question IV-F really focuses on the SEC's rate review. There seemed to be a pretty clear consensus last meeting that this group did not recommend moving towards a more cost-based or utility type of rate regulation. There have been suggestions by some of the members of the group that the answer here is what was referred to as Most Favored Diversified Reporting Services, Inc. (202) 296-9626 137 Nation pricing. Let me just by way of putting us in statutory context, we all appreciate that the SEC review focusing on the concept of discrimination or what has sometimes been referred to as non-discrimination. The current statutory context, however, it's very important to appreciate precisely what the words are. The SEC has to ensure that all persons may obtain market information on terms that are "not unreasonably discriminatory." And among other things, the Commission, clearly within the context of that phrase has recognized that it is permissible, at least to date, to have separate fees for professional and non-professional subscribers. It has approved enterprise fees in one context. It has approved varying levels of rates based upon volume and usage. So that what we have is not the equivalent to, sort of, a one price fits all model, but we have a model where there has been a great deal of variation. Now, the suggestion has been made -- and maybe we'll start with Carrie, who propounded it, perhaps, most eloquent -- that the answer here, in part, turns on "Most Favored Nation" pricing as an alternative to what we now have. Maybe to get this part of the conversation going if Diversified Reporting Services, Inc. (202) 296-9626 138 you'll articulate again for us precisely what you mean by that and why that is different than what we now have. MS. DWYER: I'll try. If I've said it eloquently before, please refer to my former remarks. MR. SELIGMAN: Well, you wrote it eloquent before. MS. DWYER: Simple concept, again, is in moving out of the current highly regulated environment, which is where we think we ought to go. So it depends on what you're talking about. But it was an idea intended to counter the concern about market power of the Nasdaq or the New York Stock Exchange in a post-regulated market data environment. And the idea was that if there was still a regulatorily required piece of data, consolidated quote, that for that information there should be Most Favored Nation pricing. As I understand it, that's typically understood to mean that the price I charge to you must be as good as I charge anyone else and that that would be something SEC could oversee. For that regulatorily required piece of data, you would ensure that the continuing monopoly at least was administered fairly. MR. SELIGMAN: Now, when you say, "the price I charge to you," does this acknowledge that there can be different types of category of users of the data, or is it, basically, there's just one "you"? Diversified Reporting Services, Inc. (202) 296-9626 139 MS. DWYER: I assume you could stratify that. It would be up to the exchanges. They have professional and non-professional fees now. If those categories made sense going forward so that similarly situated people were treated equally, you could do that. Personally, we would be interested in moving to a world where a feed is supplied, and it doesn't matter how you use it or what kind of person you are, and the pricing would be uniform for that. That was what we intended. MR. SELIGMAN: Now, as I understand what was said earlier today, both the Nasdaq and the New York side basically represented with similarly situated users the fees were the same at this point. MS. DWYER: Okay. Well, that's definitional again, and I think Bernie described it pretty well. We have experience with this. Is that with or without rebates or other offsetting fee reductions? What's the price? Is it simply the stated price on the rate card, or is it the price all in for market data? There's quit a lot of variability about that either explicit or implicit in various markets. Bernie, sort of, nailed most of the forms it takes. MR. SELIGMAN: Okay. Now, Bernie referred to various implicit or explicit rebate as being responsible for variability. Is there any other concept you want to put on the table so we'll all be sure we're talking about the same - Diversified Reporting Services, Inc. (202) 296-9626 140 - MS. DWYER: Well, we have in the past talked about -- and this is where we came from on this issue -- the differential pricing for, you know, say, online users. It's not explicitly keyed to -- I don't think it was intended to discriminate against people, but it actually made for, at least a period of time, the access to the markets via a computer terminal more expensive than access through a broker. And we have always said that we think that access to market data should be channel neutral. You saw on the price scheme up here today there's a price for accessing a voice recognition product, a price for computer terminal, a price for broker. Probably, you'd want to level all those differential prices. MR. SELIGMAN: Michael. MR. ATKIN: We're talking strictly about U.S. equities? Because in the futures and options markets, there's first location fees and other pricing distinctions that are in play that I would think would be part of this conversation. MR. SELIGMAN: I think we really are limited ourselves to U.S. equities here. MR. McNELIS: Joel, could I add a comment? MR. SELIGMAN: Yeah. MR. McNELIS: One of the things that we, of course, Diversified Reporting Services, Inc. (202) 296-9626 141 have an interest in is selling data feeds, and there's differential pricing for data feeds even for the same type of user. There's an extra charge for one of our customers to receive a data feed and distribute data to professional brokers than there is for that person to take that same data on a proprietary terminal. So there are these discontinuities. Another thing that seems to us to be an issue, in the earlier discussion we were talking about transparency and should we make the documents public, and all of that. The documents are public. We all more or less came to the conclusion that, yes, the information is available. But Mike Atkin made a very important distinction. He said they had to be published and clear. One of the big problems is yes, they're published, but nobody knows what they mean. So every time you go on the margins to build a new type of business, a new outlet or a new market, you have to go back and negotiate either a new Exhibit A or some type of an agreement that classifies this new type of user so that you can get a price for how that user will be charged. And so yes, it's published, but it's not clear. The documentation is retrospective, but the business is prospective. So you never know what the cost is going to be. MR. SELIGMAN: Let me see if I understand this. Diversified Reporting Services, Inc. (202) 296-9626 142 What I'm hearing a little bit is the issue is more turning not so much on whether people who are "similarly situated" are treated the same, but the categorization of where you are among a series of categories the interpretation, perhaps, by the SROs as they analyze a Schedule A as to whether or not you're subject to this bucket or that bucket. MR. McNELIS: I mean, that is certainly part of it. And as Carrie says, there is significant negotiation that goes on about that. It's one thing to say, yeah, here's the schedule, but which part of the schedule applies? And that's where the negotiation gets pretty serious. MR. ATKIN: Joel, we documented over 37 different types of redistribution that existed as we were planning our database just as a test to see whether we could pull out the right information. I think what Brian is saying is every permutation of all of these applications have got to be evaluated against your contract and your pricing schedule, and it's not as clear where those things fit. MR. QUICK: Michael, would that be -- if I can ask you a question about that, pertaining to the U.S. equities markets, how many permutations would that be? MR. ATKIN: There's a lot of permutations. You've got vendor/sub-vendor redistribution to some application for some usage, and depending on who owns and controls the Diversified Reporting Services, Inc. (202) 296-9626 143 entitlements of the data you've got different pricing and different contractual terms. MR. QUICK: Well, certainly, I think the exchanges or the CTA can go ahead and make a pricing schedule up, but they can only deal with the facts at the time they deal with, and as the market changes, you know, whether it be individual investors being able to get it on their Blackberrys or whether it be getting it by voice recognition, you know, there are different situations that arise that call for interpretation. I'm not sure where we're going to be able to solve those questions. MR. SELIGMAN: Well, there is a different slant on this we could talk about, and that is maybe what I'm hearing is not so much anyone wants a different SEC role if we keep this model or wants a different statute, doesn't want more transparency, but maybe what you're focusing is on the administration, perhaps at the SRO/CTA level, standardization, more rapid review, fewer categories, simplification of a process as a way that particularly users would more quickly be able to negotiate and start data feeds and more effectively operate. MS. FRIEDMAN: If I could comment on that, first of all, in terms of trying to standardize the pricing across different types of delivery mechanisms, meaning voice port versus for query versus dynamic display, versus television, Diversified Reporting Services, Inc. (202) 296-9626 144 for that matter, I mean, I don't think that we could apply, you know a per query rate to a dynamic ticker on a television, and I don't think you could apply the same kind of rate on a voice port mechanism. You can't fit them all together into one single pricing scheme, and I think that once they are set, though, we do apply them equally. We apply them fairly across anyone who comes and asks for that specific type. Signing up of a vendor does not take a long time. I mean, it's not a lengthy negotiation. It takes about two to three weeks at most, and it's not a lengthy conversation. We have pretty cut and dry standards for which fees apply to them, and the Schedule A that people keep referring to we do have to look at system descriptions so we know that they will have the ability to pay us because we actually do vendor billing rather than direct billing. But I don't believe that there are a great deal of negotiations that go on between how that Schedule A is applied. They are individual, that's true. They go between Nasdaq and a specific vendor at the time, but I don't believe there's a great deal of negotiation within those schedules. I just wanted to respond to a couple comments I'd heard. MR. SELIGMAN: Trying to link the comments together, has it been your experience that you can, basically, when you change a process, be signed up within two Diversified Reporting Services, Inc. (202) 296-9626 145 or three weeks? Has it been more frustrating? MR. McNELIS: Well, certainly, Nasdaq has been very proactive in trying to smooth out the process, and CTA has not been quite as proactive in that regard. When you go to the markets with a whole new delivery scheme, there is negotiation there that has to be dealt with because it doesn't fall into any of the buckets. What would be nice is that it wouldn't matter. I can understand there's a difference between, obviously, television and working on a PC, but there are finer gradations, and things could be more closely linked, and there could be less worrying about the actual delivery vehicle than the fact that someone is going to use this data when they get it, and the pricing should be used on the fact that somebody is going to use the data when they get it, as opposed to how any vendor chooses to deliver it. MR. SELIGMAN: If you were czar of the universe, what would you do to change the process? MR. McNELIS: Probably set flat fees based on large numbers and forget about counting widgets, and all of those things. Probably. MR. SELIGMAN: Let's go around the room. Eric, if you were czar of the universe, what would you do to change the process? MR. ROITER: I don't have a ready answer for that, Diversified Reporting Services, Inc. (202) 296-9626 146 as you can tell. MR. SELIGMAN: You're only czar for a moment, Eric. MR. ROITER: I think we're working within the four corners of the statute, and if your question is working within that statute or recasting the statutory terms? MR. SELIGMAN: You're czar. You get to choose. MR. COLBY: Joel, are you asking about the contract administration process? MR. SELIGMAN: I am trying to tease out -- we're here because there seems to be a great deal of underlying conflict and controversy in the field, and I'm dealing with as quiet a group as I've dealt with in four meetings, and I feel like a dentist trying to get a tooth out. MS. NAZARETH: Could I raise this? I'm, sort of, wondering whether we've, sort of, come back a bit to the question I raised this morning, which was when we talked about, you know, the existing system and changes over time. And I said it seems like the descriptions were all that -- we started with a basic fee structure, complex though it is, and then we make incremental changes. I guess one of my questions is is part of what we're hearing or were you suggesting that maybe that's what's wrong, that we should not only be rethinking details of administration and details of contracts, contract language which is a decade old and hasn't kept pace with the technological changes? Diversified Reporting Services, Inc. (202) 296-9626 147 Are you, basically, suggesting that this whole not only administration but fee structure should be rethought in light of the fact that the technology and the way firms are using the data has changed so significantly that we should be starting from scratch in that regard? Because that does sort of relate to, I think, where I was this morning, which is I'm not quite sure whether there was ever consensus that everybody is happy with this and we should just, sort of, keeping building incrementally, or should we be thinking more broadly about changes to that? MR. McNELIS: Well, I don't think you can start from scratch. I mean, everybody has got Legacy systems that still operate under the old methods, and the pricing is probably settled and appropriate. People may or may not like the price levels. That's a different question. But certainly in terms of trying to advance a business you certainly want to have more flexibility when you're dealing with a supplier when you don't have any choice in suppliers just so that things could move more quickly, people would price products appropriately and get on with business and not be wrestling with these issues. MR. BRITZ: Maybe I can comment on that a little differently. This consensus thing cuts both ways. I mentioned earlier that we do have an Enterprise agreement. It was not our first choice by any means. Diversified Reporting Services, Inc. (202) 296-9626 148 Tom Haley earlier in the day showed you a 14-tier professional display unit schedule. If we had our druthers, we would not have a 14-tier display unit schedule. In fact, we have made quite a few proposals to industry groups to reduce that to two or three in favor of simplicity. The problem is that even if you do that on a revenue neutral basis, even if you do it on a revenue cut basis, individual firms within that you will provide winners and losers. And we have been trying for four or five years to get a consensus around a much contracted professional display device schedule without any success. So I'm reacting to your point that to some extent the schedule is a little bit of goulash. We started somewhere. Someone said, "Hey, we need this kind of a rate." We put it on. Someone said we need that kind. There's no question about that. I just want to emphasize the degree of difficulty of starting with a blank sheet of paper given that firms do pay what they pay today, and blank sheets of paper approach tend to produce winners and losers off of that. MR. SELIGMAN: Good point. Pete, let me -- MR. QUICK: Certainly, the tape A revenue is charged strictly on a terminal basis, and there is a schedule that the tape A actually deals with, and it is what it is, and it has been that way for quite a few years. But we do have the Enterprise fee, too, if somebody Diversified Reporting Services, Inc. (202) 296-9626 149 would like to take that, and there are a couple of firms that do take advantage of that. But it's single pricing, and that differs somewhat from the New York. MS. FRIEDMAN: Could you explain it further? MR. QUICK: Bid and offer I believe is 13 and change. Last sale is $13 also. And if you get both, it's $26 or $27. MS. FRIEDMAN: Actually, I meant the Enterprise license. Could you, kind of, go through how it works? MR. QUICK: It works similar to -- I don't know the details of it other than it's a flat fee similar to the New York. We do have two firms that use it and redistribute the data both to, I believe, the retail and the professional customers, and we've got a similar pricing scheme in terms of individual users, $1 a month. AUDIENCE: Do you -- MR. QUICK: No. It's just a flat fee. MR. SELIGMAN: Let me see if I can -- I'm sorry, Eric. MR. ROITER: I didn't want to take a complete pass on your question. When one gets to these knotty questions, perhaps it's more useful to try to eliminate the things that people can agree really aren't going to help much, at least to narrow the range of choices of things that actually could help. Diversified Reporting Services, Inc. (202) 296-9626 150 I started out thinking months ago that having a competitive bidding process for a single consolidator might be an improvement. I think at this point that doesn't seem to yield much benefit, because as we learned earlier the consolidator, SIAC, really doesn't operate for profit. It, basically, operates at cost, and you wouldn't really introduce any appreciable economic benefits by opening that up to competitive bidding. There are also high levels of barrier entries, perhaps, as well. Then we turn -- and I don't want to prejudge the outcome of the work of the subcommittee that Don is heading, but we've been considering the alternative model of multiple consolidators. I, at this point, have the preliminary view that at least from a pricing standpoint that is not -- I'm not yet convinced that's going to lead to any great pricing improvements. It may, perhaps, introduce more innovation and some different choices in terms of the data that's massaged, but from a pricing standpoint, so long as the market centers themselves ultimately retain the ability, at the end of the day and at the end of the process of consultation, if you will, and give and take, a multiple consolidator model doesn't seem to me to hold out much promise for introducing a great deal of pricing improvements. Once you eliminate those two, and these are Diversified Reporting Services, Inc. (202) 296-9626 151 preliminary views, you get back to a choice, a more narrow choice, among imperfect models. I think we are always going to have to choose among imperfect models. I'm uncomfortable with a model that enables a market center that is operated for profit to set a price unless you have an active role by a governmental agency to discipline that. At the end of the day, a for-profit market center if it's the primary market and has the benefit of a regulatory requirement that brokers display best bid and offer in that market is able to impose prices that aren't reflective necessarily of the real cost of the data or the cost plus a reasonable rate of return. I think that there may be a different outcome depending on whether the data is being originated in a market center that's operated for profit versus one that's not. Perhaps the existing model that we have for the non-profit market centers, imperfect as it is and susceptible to some marginal improvement, is, basically, the least imperfect model. With regard to the for-profit market center, perhaps there is a different model that would be less imperfect. I haven't really arrived at it yet. But I think there is some serious questions, because I think there are some fundamental differences. Diversified Reporting Services, Inc. (202) 296-9626 152 Once a market center that is an SRO and has the governmentally granted license to require market participants to pay for the data they generate, there is a different standard of fairness, I think, and reasonableness that attaches to their pricing. MR. SELIGMAN: Eric, if you focus on the model we currently have, it's essentially a process model. It's one in which, through various means, the actors in the industries get various types of inputs. There's this consensus-building process. The SEC, if you will, rate review is under standards that are different than a public utility. It hasn't played a particularly active role at a formal level. I suspect at an informal level it has raised lots of questions. It's sometimes poked a little bit. But the essence of what you've got right now in the not-for-profit SRO context is the notion of bringing various actors to the table. We talked some on March 1 about bringing more actors to the table one way or another, and that's one increment you can pursue. In terms of how the SEC might review this process model with either the current or somewhat expanded cast of characters at various tables, turning on profit versus for- profit, that's one that's harder for me to immediately fathom how you make that distinction meaningful under the current Diversified Reporting Services, Inc. (202) 296-9626 153 statutory framework. Do you any ideas or suggestions you'd want to pursue? MR. ROITER: I agree. I think it is hard within the current statutory agreement to really -- current statutory framework to make that much of a distinction, although I think the SEC has ways to find flexibility. It may be that the statutory standards should be revisited for for-profit market centers. I know it's out of -- it's not within the present debate to talk about the application of the antitrust laws, but certainly that's an alternative that could constrain any tendency of a market center that has real market power from extracting uneconomic prices, and that would relieve the SEC of having to set or review the setting of rates. How you'd reconcile the application of the antitrust laws within a regulatory environment where the market center is, for other purposes at least, subjected to SEC regulation, oversight, is something I hadn't thought through correctly, but it strikes me that that is an alternative. If you choose to operate for profit, which means you're choosing to produce returns for owners of the market center -- and that's the American way, thank goodness -- to me there is some inherent tension in that approach and when Diversified Reporting Services, Inc. (202) 296-9626 154 measured against the traditional premises that underlie the '34 Act and self-regulation. And perhaps an SRO or market center that chooses to operate for profit could be subject to SEC oversight regulation in certain respects but, in other respects, for example, the setting of market data fees and, perhaps, other fees that market center might be told, "You're on your own, and if you engage in pricing that is monopolistic or otherwise violative of the antitrust laws, you'll be susceptible to those laws." MR. SELIGMAN: Let me take a narrower question. We posed the question should SROs be permitted to distinguish among subscribers based upon whether the subscriber competes with the SRO for order flow, and that really would be a question whether or not you have for profit or not-for- profit. MR. QUICK: Can you repeat that? MR. SELIGMAN: I'm looking at Question 4. "Should SROs be permitted to distinguish among subscribers based on whether the subscriber competes with the SRO for order flow?" MR. QUICK: The SROs really don't set the -- I mean, the SROs, in conjunction with each other, are setting the prices. It's not one particular SRO. MR. SELIGMAN: That's a fair point. Let me try to start this again. Under the current structure, let see if we Diversified Reporting Services, Inc. (202) 296-9626 155 can see if there is general agreement on the following propositions: The "not unreasonably discriminatory" concept, in essence, focuses on similarly situated subscribers being subject to the same market data prices, and I take it that that concept is one that there's comfort in the room with? If you're similarly situated, the question is how you determine who is similarly situated, and the administration we'll put to one side for a second. MR. QUICK: I'll just note that the America Stock Exchange membership has its privilege, and there is a slight difference between a member and a non-member rate with the information. MR. SELIGMAN: But all members would have the same rate. All non-members would have the same rate. MR. QUICK: Yes. MR. SELIGMAN: Okay. Second, is there comfort at the table on the concept that under the current regime that, in effect, there can be distinctions based upon types of use, such as professional versus non-professional subscribers? And does anyone subject that there shouldn't be distinctions based upon that kind of distinction? MR. ATKIN: Joel, I have a question. MR. SELIGMAN: Sure. MR. ATKIN: The reason I feel kind of like a deer Diversified Reporting Services, Inc. (202) 296-9626 156 in a headlight in this is you keep saying "the current structure." And I believe there are at least three structures that are under consideration here that make it difficult. MR. SELIGMAN: Fair enough. MR. ATKIN: And the structures that I see are one dealing with the regulatory regime of NBBO versus display rules and information competition. That's a structure for debate. The second one is the business model structure. I think Brian was articulating the problem of time to market and clarity of rules and pre-authorizations, and that's a structure we have to deal with. And then there is the oversight and the fee-setting structure, you know, how it works with filing with the Commission and public comments, and I'm personally just having a little difficult time understanding which part of that -- MR. SELIGMAN: We've been focusing or at least I've attempted to focus us on the third, the fee-setting aspect of it, which is where the SEC currently has a role. We've heard references to non-discriminatory pricing, Most Favored Nation. I'm trying to determine whether or not this group wants to see if there should be different approaches the Commission should take if it doesn't go to a multiple consolidator system of some sort. Diversified Reporting Services, Inc. (202) 296-9626 157 MR. ATKIN: If everything else stayed the same, would we change the fee-setting structure? Is that the -- MR. SELIGMAN: I think that's a fair way to put it. MR. ATKIN: Okay. MR. SELIGMAN: Within the current fee-setting structure, in other words, there is this notion that "not unreasonably discriminatory" certainly permits different types of fees for different types of users. There is a presumption that within a category of user similarly situated users would be charged the same, and I think we've heard statements today that that's what the practice is. I'm trying to see if anyone would suggest that those aspects of what we currently have now are ones that people would propose we change if we keep the current type of structure and don't go to a multiple consolidator structure. MR. QUICK: I think what you're asking is is it reasonable, and you've used that term before. And I would suggest that it is reasonable for the distinctions. MR. SELIGMAN: Take it a second step, then. Is it reasonable, from the perspective of this room, to have Enterprise fees, which certain of the systems currently have and certain do not? An Enterprise fee is a type of discrimination. Is it one in which the people in this room would recommend should not exist or should exist? Diversified Reporting Services, Inc. (202) 296-9626 158 MR. JOHNSON: Joel, are we talking about the market centers remaining SROs or becoming for-profit -- sorry, being non-profit or for being for-profits? I think Eric put his finger on something really very critical in what he said, which is also the concept -- SEC concept release I think hits this directly, and we haven't talked a lot about it. If you have for-profit market centers, then I think -- unless we find a competing consolidator model, which we'll put to one side, but if we don't find that, if we're talking about within the existing system, then, I think if you have a for-profit organization which has substantial, apparently, monopoly-type power, then you would worry a lot about how they're exercising that power. I'm not sure that I would want to specify that we could write down exactly what would be reasonable or unreasonable, but if you are a for-profit monopoly, then you actually have a obligation to generate a profit. You would expect that to be a regulated monopoly. If it's non-profit, then it's a little bit different. So that's why I'm asking can you clarify? Are we talking purely non-profit world or for-profit? MR. SELIGMAN: We're about to have a world in which there will be NASD, which will be going to a for-profit model, and New York for the moment is not. So we assume we'll have both to wrestle with under the same statutory Diversified Reporting Services, Inc. (202) 296-9626 159 structure. Jim? MR. DOUGHAN: I'll make my first point of the day. I guess one thing -- when people talk about monopoly pricing power, one thing to realize, I guess to keep in mind, is that the relationship between the people providing the quotes and the people consuming them is a lot more complex and subtle. Usually, it's broker dealers paying for quotes from exchanges, and they have a very complicated relationship. It's not just merely someone who walks into a store and has to buy something. It's a lot more complex than that. So I'd just be very careful about assuming that there is necessarily a monopoly pricing power there immediately. It may be. It may not be. MR. JOHNSON: But if it's the case that some people who are dealing with this monopoly provider are the shareholders or other interests so you have a complicated relationship, and some people don't, and if we're worried about non-discriminatory access, so, you know, do small investors get charged reasonable prices, which, I guess, is one of the ultimate questions here -- I mean, your concern, your point is a legitimate one, a very important one. That makes a situation more complicated and makes us more cautious, if anything. MR. DOUGHAN: My simple point is it's extremely complex. Diversified Reporting Services, Inc. (202) 296-9626 160 MR. SELIGMAN: Simon, why don't you take it a step further. We soon will be dealing with at least one for- profit system. How would you suggest that would change how we should analyze it. MR. JOHNSON: Well, I think I'm in the minority of one on this issue, perhaps. And I came in late, so I was hesitant to speak up earlier on the previous questions. But I think if you have a for-profit monopoly with the potential of exercising market power, then I think it has to be regulated like a monopoly. If you're telling me that you have a non-profit -- if you'll make this work in a non- profit way, somehow put that between the for-profit guys in the market, maybe we can talk about that. But if it's a for-profit monopoly, I don't see how you avoid being a regulated monopoly. MS. FRIEDMAN: I would have to say that you're assuming we're going to be a monopoly when we're for-profits. We have to go through a lot of steps in order to become a for-profit company. We have to register as an exchange, which is a very complex and in-depth and lengthy process. There are others who are also registering as an exchange to trade the same securities that we trade and to receive market data revenue on the same securities that we trade. There are already exchanges out there who are Diversified Reporting Services, Inc. (202) 296-9626 161 trading the same securities we're trading. There are seven participants in the UTP plan. So you're assuming we're a monopoly and we're going to maintain our monopoly status forever despite the fact that we're a for-profit company. And once we become an exchange there are going to be other choices where people put their trade reports and where they put their quotes. And there already are, but I think that will proliferate quickly, and I would have to argue that you're maybe operating under the wrong assumptions. For-profit entity doesn't necessarily mean a for-profit monopoly. MR. COLBY: Joel, could I try to reprise a little bit the discussion? And tell me when I get this wrong. This group was pulled together to see if there's some better way to look at market data prices than the way we're doing it and whether a flexible cost base structure is the right way or whether the structure needs to be changed or whether there's other ways to go at it. And we've probed a lot of different respects, and Eric I think has summarized his views on a lot of the items that came up. And then it comes down to this question of whether there is market power or monopoly power, and where does it derive from? And one place people have pointed to it deriving from is the display rule, which, if everyone has to buy this Diversified Reporting Services, Inc. (202) 296-9626 162 information from everyone, then that gives this power to everyone. So there is talk about getting rid of the display rule, and we had a discussion about that, and most people thought it should be retained, and the subcommittees talked about narrowing it some. That certainly does spread. If there's market power to be had, it spreads it over the number of markets that exist because it means even the smallest one has some form of power. But let's say that wasn't there, not that I'm advocating that, but let's say that wasn't there. Then the question is do large dominant markets have market power? So maybe users can -- the smaller people either charge very low fees, or they give their data away, but do then the large dominant markets still have market power? Andy said he could not live without -- what was it? New York's data? MR. BROOKS: All the data. MR. COLBY: All the data. Let's say you could pick and choose. Then the question is, presumably, if there's a dominant market, can you live without the dominant market data? And if you can, then their market power is no so strong, and if you can't they have pretty strong market power. And if they do have market power, then the question is how can it best be addressed? Diversified Reporting Services, Inc. (202) 296-9626 163 MR. DOUGHAN: Well, I guess what I was getting at was that it's even more subtle and complex than that, because not only do have you to face the issue as to whether or not you can live without what it is they're selling, but the question is do you have any other -- is your relationship with person who is selling you something more complicated than that? Do you have other leverage on them other than the fact that you just have to buy this product? Do have you a decision as to where you can take your order flow? Do you have a decision as to where you can execute your trades? Do you have a decision as -- on many, many other items, and can you apply that leverage in return when they apply leverage to you? That's what I was really addressing. MR. COLBY: And that's a pretty -- I think we sort of need to know or take a guess at that. Then, if I can just continue on, there have been a number of proposals, I think, laid out to talk about how to reduce that market power. And at risk of doing injustice to any of them, is it all right if I can trot along? MR. SELIGMAN: Go ahead. MR. COLBY: Ed suggested in some context that the data could be replicated. Other markets might model it and sell it out-modeled. I don't know if -- I thought Carrie -- I don't know if you want to say this, but implicit in your Diversified Reporting Services, Inc. (202) 296-9626 164 remarks was that the data is licensed, and if there was no license, then it could be copied and re-disseminated, and that would certainly reduce market power data. There was another -- oh, another one that has sort of been floated is if the people that make up the market information can vend it out from under the market, then that would undermine market data -- market power, excuse me. I thought we started out this conversation trying to explore whether Most Favored Nation pricing would undermine. And I think the answer is the only way you could set a fee is to charge one fee. Whoever walks in the door everyone gets charged the same fee, I think that undermines market data because, presumably, the person with the largest economies of scale can walk in, pay that one fee and re- disseminate it. But it shifts the market power over to that person. Is that right? MR. JOHNSON: Mm-hum. MR. COLBY: So those are the notions I've period. So the we is -- and then New York Stock Exchange said, "Well, we really don't have market power because we're at least -- we're constituent driven and member governed, and so that constrains our market power. Is that a fair statement? I feel like where we are is that there has been these, sort of, four or five -- there's a question of how much market power there is absent the best bid and offer, Diversified Reporting Services, Inc. (202) 296-9626 165 display requirement, and there are these four or five notions of how to address it all of which have consequences. That's where we are, I think, and we're trying to think if there are any other alternatives other than rate regulation, if there is market power. MS. NAZARETH: I just want to make one other point also. I don't disagree that for-profit exchanges do raise additional issues, but I'd also be cautious not to make too much of that, because I don't think anybody in this room would say that the New York Stock Exchange is a charitable organization either. I mean, we've all talked about the different ways that profits get redistributed, and the fact that it's a mutual and that these costs, you know, offset other costs, we still have concerns about pricing, whether it's a mutual or a for-profit. So I'm not sure that -- preliminarily, my own thinking would be that I would not have vastly different ways of regulating this issue, whether it was for-profit or not. MR. SELIGMAN: Adena. MS. FRIEDMAN: Well, I would argue that there is another area to look at in terms of, kind of, diffusing market power, and that is just to build a competitive structure where people could compete for order flow, compete for listings, compete for other areas of the market. Diversified Reporting Services, Inc. (202) 296-9626 166 Because if we don't disseminate our information broadly, then our issuers are not going to get the, basically, advertising that they get through the dissemination of the market data related to their stock. And if they don't get that, then they're more likely to go somewhere else where they can get more broad access. So it's much more complex than just saying that one market has a certain dominance in its data, and therefore has market power. Data is just one interrelated piece of an entire market structure that works or doesn't work, and if it works well, then there is value there. And if it doesn't work well, then there's not, and people have a choice to go somewhere else. MR. DORSEY: I think you also have to look at it globally, because to pick up on what Adena was saying is that in New York were to shut down and not distribute its data, the flow isn't going to go into New York. We would put the prints up on, say, Nasdaq Europe. We would quote AOL and IBM over there, and Andy could trade with us in Nasdaq Europe. We could just expand the hours to cover the U.S. market. MR. COLBY: Well, but Mike, you already do, but the order flow is still going to New York. MR. DORSEY: No. I'm saying if he shuts down and does not distribute his data. Diversified Reporting Services, Inc. (202) 296-9626 167 MR. COLBY: Well, the question is probably, though I'm not absolutely sure, if they stopped redistributing data they would lose order flow. But that's not what they're going to do. The question is can they so constrain it without hurting their market, and that's a question. If they can't, then this is really a moot discussion because if just operating a market means that you need to distribute your data just as broadly as possible, then we don't need to bother with this committee anymore. Am I right? MR. DORSEY: I think it becomes optimal pricing. If you price it too low, you're giving it away. If you price it too high, you're cutting off flow and maybe directing it elsewhere. MR. BROOKS: I think, if you're running a market, you have to distribute your market data, and you've got to make it accessible to everybody because that's one of the premises of the national market system, connectivity, access and transparency in the context of seeing things. And to your point, Ed, that you made earlier, you're right. Institutions like it both ways, and we will always try and be speaking like it. MR. ATKIN: Asymmetry of transparency. MS. FRIEDMAN: But there's a competitive interest in doing just what Michael Dorsey said. There's competitive Diversified Reporting Services, Inc. (202) 296-9626 168 interest in getting it out to the broadest population. I mean, it's not just a mandate. It's the competitive interest in getting that out there because we want to make sure we drive back to our market rather than driving it to Chicago or somewhere else. MR. JOHNSON: Sorry to go on about this, but the way that competition usually works in this kind of market where you have intrinsic market power or potential market power -- not to say that you always exercise it and not to say you always exercise it to the fullest extent -- what usually happens is you have a period of intense competition followed by consolidation, and out of that consolidation come one or two dominant players who could be the existing consolidators now, or it could be a question, as Bob said, of transfer of market power. So the market power is not held where it is now, but it goes to somebody else who their hands on this data, and you have a natural monopoly and a natural tendency to -- you have a responsibility to your shareholders, if you're for-profit, to maximize your profit. You're going to have an opportunity, perhaps not tomorrow but in a year or in two years or whenever the situation settles down, and you're going to say here we can raise prices because we have the ability to do that because we have this market power that derives naturally from the way Diversified Reporting Services, Inc. (202) 296-9626 169 that information is -- MR. DORSEY: But people would generate information away from the marketplace. We generate about 10 percent of the Nasdaq information, and if they don't disseminate it to draw in order flow, we'll generate that data somewhere else in some other competing market. MS. FRIEDMAN: I think as long as there's a healthy competitive system in place there's going to be -- we're always going to be looking behind our shoulders. We're always going to be looking around at potential competitors. I understand -- whether you call it a natural monopoly or not, if it's free market and the economy is working properly to create proliferation, consolidation/proliferation based on whether we do a good job or not, isn't that what we're after? MR. JOHNSON: There are always constraints on your ability to exercise -- this is not a perfect analogy, but if you think about the development of railroads, for example, people would set up competing railroads, and there would be a period of very intense competition followed by one of consolidation. You could as then transport your goods through some other means. If you didn't like Commodore Vanderbilt's prices, you were welcome to carry them on your own -- in your own horse and cart, but Commodore Vanderbilt knew very well Diversified Reporting Services, Inc. (202) 296-9626 170 that once he had established control over certain routes he could charge higher prices than previously. This is a form of natural market power -- MR. DORSEY: And this is what killed the railroads is that they were slow to change as the interstates came in. MR. JOHNSON: It certainly hurt the railroads, and it certainly hurt the U.S. economy, too. MR. SELIGMAN: Okay. Stepping back, at the end of the day, we have to advise which direction we want to go. MR. DORSEY: Maybe the advice is to change the '75 Act amendments to make it more malleable or acceptable to a competing venue, trading venue type of model. MR. SELIGMAN: Now, what do you mean by that, Michael? MR. DORSEY: I thought that was kind of evident on its face, but the '75 Act amendments came in a period where we're looking at -- our markets are being affected with a national interest. The exchanges and the marketplace were, like, these national treasures. Now we're up to 2001, and while it's still affected with a national interest, we're moving to more of a competing market place type of paradigm, and I don't know if the '75 Act amendments where there was so much SEC government control oversight of data is the same type of thing that will work now in today's market structure or the changing market Diversified Reporting Services, Inc. (202) 296-9626 171 structure. You also have to look at this globally. Like I said earlier, we can generate our data here domestically, or we can generate it overseas with Nasdaq either in Europe or in Japan. MR. SELIGMAN: At the moment, I think where the committee has evolved after three and some fraction of a fourth meeting is a sense -- there seems to be a preference for retaining the NBBO and just unleashing everything else, allowing it to be through a more free enterprise system. There is a debate we have not resolved and will not try to resolve until May 14th as to whether or not we want a multiple consolidator system, we want to maintain the current kind of unitary consolidator system or we're going to propose some combination thereof. And we'll focus on that. If we go down the unitary consolidator, essentially, what we have now, there seems to be some suggestions at the margins, whether through advisory committees or otherwise, you want more voices at the table. There doesn't seem to be a lot of interest in using transparency as a mechanism to alter things. With respect to SEC pricing oversight, it's not in a multiple consolidator system, there was very little, if any, support for a cost- based system. In terms of how, under the current structure, you Diversified Reporting Services, Inc. (202) 296-9626 172 might alter the SEC's role using the "not unreasonable discrimination" or "fair and reasonableness" standards, what I've heard to this point today is, in effect, certain of the dimensions of what currently goes on no one has that great a problem with. This is, under the "not unreasonably discriminatory" standard, everyone accepts the fact that there will be categories, that you're trying to treat people within categories in a common way, that innovations such as enterprise fee pricing doesn't seem to trouble many people. But what we're getting pushed back towards is really not the details but the model. That is, we're really talking about so far two different types of possible models we can ultimately analyze and propound to the Commission. One is an incremental model. You play with what we currently have now. You, basically, focus on the NBBO in unleashing a few details of governance, maybe some suggestions that will ultimately address with respect to more efficient administration at least a heuristic about greater standardization of contracts, and so forth. That's one level, and it may be a recognition as we've looked into this it's more complicated than we thought it was. It is an imperfect model that has evolved because it's a complex and squishy kind of process, and by and large, to use Eric's almost Panglossian analysis, it may be the best Diversified Reporting Services, Inc. (202) 296-9626 173 we can do in an imperfect world. The other model is a much more radical one. The other model is, basically, to say '75 Act is over. We want a multiple consolidator system. We're going to move to a very difficult kind of world, and Don's subcommittee is focusing on that, and we'll have a real discussion on that May 14th. We'll try to focus on the dimensions of it. Let me pose this broad question right now since we've now had a lot of time to work through this: Is there any other model we should be looking at? I mean, are these really the two choices that we can contemplate given the realities of where we are now? MR. ATKIN: Just a question. MR. SELIGMAN: Sure. MR. ATKIN: Is there some combination model between this? I heard the alternative multiple consolidator as being one. Where would be modification of display rule? Could that exist in either model? MR. SELIGMAN: Potentially, I would think. MR. NICOLL: Could I just interrupt for a moment? I actually do think that we came to a bit of a consensus in our committee that to talk about multiple consolidators as a solution is just a complete chimera. The issue of consolidation is a $7 million a year savings that if there is market power it does not come from Diversified Reporting Services, Inc. (202) 296-9626 174 the consolidator; it comes from the markets themselves and that market power is either exercised as a result of the display rule -- I think there is strong evidence to suggest, with all due respect to my good friend, Mr. Quick, that it's happening here because it is interesting that the smallest markets here actually charges the highest rates of the three that are represented here. But it either comes from the display rule or it comes from -- without a display rule, it will come from the traditional notions of imposing monopoly rents and that either we have to introduce competition at that level and solve the problem that way and that -- and there are some of us that want to introduce that competition. But I think there is a consensus that just introducing competition at the consolidator level solves virtually nothing. MR. ATKIN: But Ed, how about the concept of consolidation every market has to be included in the best bid and offer? That's not a means of consolidation. That's a idea of consolidation. MR. NICOLL: Well, I would just put that under the notion of the display rule, that once you mandate that consolidation then you get into all kinds of issues of market power ironically of the smallest player rather than the largest. Diversified Reporting Services, Inc. (202) 296-9626 175 Once you do away with that consolidation, then you have the issue of the market power exercised by the largest players rather than the smallest. And in a way, the SEC is, sort of, caught in-between these two things, and overlaid on all that is its own mandate and, arguably, the mandate of Congress, to disseminate widely data to investors in a non- discriminatory way. MR. JOHNSON: I agree with Ed exactly on the point that if you're going -- and I think this is what Michael was saying as well, which is if you really think of introducing or going through this competing consolidators route you're led naturally to the display rule. I completely agree with the -- I'm not sure how widely it's circulated, Ed -- summary proposing the competing data consolidators. I think it's exactly right. I think that if you follow this logic through you have to abolish the display rule. I think I disagree with you completely that that's a good thing to do because I think you and I have different views about the market power consequences of this. I think you would initially have a period of very intense competition, and I think you would then have consolidation. You mights have fragmentation, of course, back to the pre-'75 situation, which I don't like, and I think you would also have market power held by different people, Diversified Reporting Services, Inc. (202) 296-9626 176 perhaps, than hold it now, so a change in market power, a reallocation or transfer of market power, as Bob was saying. And I think that would actually be a rather bad outcome. But I agree with you completely on the logic of your argument. MR. NICOLL: Well, the fact that neither one of us actually knows what's going to happen is not going to stop either one of us from arguing the point, unfortunately. MR. QUICK: Certainly, Ed, when you describe the AMEX's plan, it really depends upon what perspective you come to it from. As you heard I think the New York Stock Exchange, if you had one device on a machine or one device, it will actually cost you $128, as opposed to the AMEX, whether you want the bid or ask only, it would cost you $13 or the maximum of $27. So certainly, depending upon who you are sitting at this table and how many devices you have really depends upon how you look at the fee schedule. MR. ATKIN: So Joel, the two models are either fix the current system or amend the display rule? Is that -- MR. SELIGMAN: No. I think it's really what we've got is -- MR. NICOLL: -- Talking about that's a notion that our subcommittee is talking about, multiple consolidators really being a solution to this problem. I think we have a general consensus that it's, you know, marginal. It's Diversified Reporting Services, Inc. (202) 296-9626 177 probably not worth -- it's certainly not worth the time of all the people sitting around this a table to talk about multiple consolidators, in and of itself. MR. SELIGMAN: So, basically, what you're dealing with is, on the one hand, fix the current system. On the other hand, the subcommittee is going to come forward. We will see how it ultimately is framed, but will probably either be multiple consolidators or multiple consolidators plus, conceivably, recision of the display rule. MR. ATKIN: I think the point is, and I've talked to a lot of people about this, is 100 percent agreement that who does consolidation is of little consequence, but that the display rule issue is only question that should be talked about in terms of an alternative model. So I'm trying to reconcile -- MR. COLBY: See, Mike, I don't understand that. The display rule, arguably, spreads power to small markets, but it doesn't change whatsoever the power of the dominant markets. So before there was a display rule there was a dominant market that had pricing power over its data. And after there is a display rule, presumably, there will be dominant markets, maybe not the same one, but -- and then the question is -- it would appear to be there would be. It would be constrained to some degree, but the question is how much by other forces of competition, and I Diversified Reporting Services, Inc. (202) 296-9626 178 think that we just can't waste a lot of time focusing on the display rule unless you're absolutely confident that there is not a market power issue underlying it that has to be addressed, because then you've just moved the problem. You've just shifted it, and the same problem exists. MR. DORSEY: You're presuming, though, that somebody could hang onto their market by not displaying their information or doing it in such way as to, you know, just do it sporadically. MR. SELIGMAN: Well, there's a different argument that has been made. If you have a best execution rule, which you, presumably, would also have, if you rescind the display rule, if you, second, go to a multiple consolidator system, then you have a situation where it's not so much the dominant market but also the fringe markets anybody in the position where unless their data were reviewed in some sense by broker dealers before execution there would be potential fiduciary duty violations, and that would give the fringe markets the kind of market power they don't currently have. MS. DWYER: But Joel, how realistic is that? A fringe market wants to disseminate its data and be as useful as it possibly can be in order to attract liquidity and -- MR. DORSEY: Flow is king in this business. MS. DWYER: I would just flip the question around and say is anybody convinced that the current single-source Diversified Reporting Services, Inc. (202) 296-9626 179 monopoly system that was created before current technology and before the current kinds of diverse uses of market data we have today is really necessary? Does anybody think market data would degrade, that there wouldn't be consolidation, that there wouldn't be useful new products created? We had market power before the '75 Act. I will tell you there is market power now in terms of dealing with the single-source monopolies for market data, and we're on record, you know, with a petition and quite a few other written comments to the SEC about the discriminatory effect of the current pricing structure. We don't believe it complies with the statute. So what is the risk going forward to say do we need in this day and age a government mandated structure for the display of certain minimum data and investing market power in a couple of historically large markets? MR. SELIGMAN: Okay. MR. ATKIN: And that would be keeping the best execution rules, right? MS. DWYER: Yeah. MR. SELIGMAN: I understand the question. It has been posed, and -- MR. QUICK: I'd certainly argue from a market integrity aspect and investor confidence that you would want to display the consolidated best bid or offer and continue to Diversified Reporting Services, Inc. (202) 296-9626 180 do that. MR. SELIGMAN: What I'm hearing is, basically, in effect, on the equity side, the punch line of the story is May 14th, when Don's subcommittee comes back. What I'm hearing from Ed, and he tells me that the subcommittee has reached at least a tentative consensus, is multiple consolidators alone isn't the issue. The issue is the display rule. I think those who feel that way should have the right to the most eloquent articulation of that, and it would be useful to do it in writing as well as orally. I think the subcommittee really needs to focus on that. My impression is there will be a division. My impression is we started with somewhat of a majority in favor of retention of the display rule, and we'll see if once you've talked through why you feel this way, if there's new information that will change some minds. MR. ATKIN: Joel, I heard everybody in favor of keeping some form of NBBO, but I'm not sure if I heard that everybody was in favor of keeping some form of display -- keeping the display rule. Maybe I missed that. MR. SELIGMAN: That's fair. We posed it in terms of NBBO, and maybe that's a distinction we should draw out. MR. JOHNSON: Could I just respond to Carrie's question? I'd like to turn it around. Given that the exist Diversified Reporting Services, Inc. (202) 296-9626 181 system works pretty well -- I understand it's not perfect. I understand not everybody is equally happy with it -- who really believes that we should take this, basically, tremendous gamble of abandoning the basis of the national market system for possibly some gains for perhaps some individual firms, maybe some collective gains -- perhaps the system could work better, if you believe Ed -- but it's very risky. You have a system that, basically, works. And we have an opportunity to make some proposals. I thought actually, Joel, from your list, the one thing that we agreed on last time, at least it was in the minutes, was changing or some sort of advisory committee structure within the plans as a way to try and tinker with the -- and see if that makes people a little bit more happy. MR. SELIGMAN: I think I alluded to that. MR. JOHNSON: I'm sorry. I missed that. So I think the alternative is not something that works and could, perhaps, be made a little bit better and something about which we know very little and which would be extremely risky. And if you damage the integrity of the markets, you undermine investor confidence. That's not going to be easily undone. MR. ATKIN: Wasn't the issue that the NBBO was not the most useful piece of data any longer and that your comments that the markets work great now is somewhat in can Diversified Reporting Services, Inc. (202) 296-9626 182 he because maybe they -- you know, if you continue with this one piece of data and you don't allow for more enhanced data and some competition on transparency, if you will, that's when the markets work better. And that's what I thought -- MR. SELIGMAN: I thought where we were, at least when we focused on the NBBO, was two separate conclusions. On the one hand, there seemed to be a majority which favored retention of the NBBO. On the other hand, there was always tremendous sentiment in favor of allowing the exchanges and others to compete on everything else. So that, in effect, there would be this "mandatory minimum" was the phrase we used, and then there would be kind of a free market for the rest -- MR. ATKIN: NBBO to do your best execution obligations is what I heard. So everybody is going to have to calculate -- they're going to have to have an NBBO, but as a piece of data, as the piece of data that's mandated to be displayed, as opposed to mandated to be offered, I thought that was the question. MS. NAZARETH: I thought where we came out, I have to check the minutes, is that there was a majority that said mandated to be displayed only as that, sort of, minimum, and then the rest would be not mandatory, optional and that individual market centers however defined -- I'm not sure we -- would be able to sell the additional data or package Diversified Reporting Services, Inc. (202) 296-9626 183 however they chose. MR. JOHNSON: Some of us advocated mandating more data, the point you're alluding to. MR. McNELIS: Could I just comment on that last point, though? One of the things that we find is that there are a number of users who are not immediately going to invest and that they don't need a BBO because they're not immediately going to invest. And we would advocate that we should have flexibility to sell to that type of user data that is below, if you will, the minimum standard because they don't have a requirement for it. MR. COLBY: Not to front run, one of the things that's being talked about in the subcommittee is whether, if you retain a display rule, whether it should be focused on the portion of the execution process where it's most needed, which would be making sure that customers, if they're supplied data at the time of entering an order, gets data that reflects the best price across markets. But at the other point in the spectrum, like when you're not going to trade, that you wouldn't be required to use the BBO. MR. SELIGMAN: Adena, let me recognize -- MR. BRITZ: If I may, I'll be my usually diplomatic self and suggest that, in our view, that borders on, frankly, fraudulent. Diversified Reporting Services, Inc. (202) 296-9626 184 MR. COLBY: I'm sorry. What borders on -- MR. BRITZ: The notion of flashing a brand X quote and a brand Y quote up until you fill out the order template and then giving you the real quote. We have seen this movie before. It's a variation on the theme that says I'll give you 20-minute delayed. I'll give you 20-minute delayed. Fill out the template, hit the "send" key, and if you request, I will now give you a real-time quote. This is an idea that substitutes giving you delayed for giving you inferior. I took a look just for the sake of argument at Citigroup the other day in a quote montage, totally arbitrary on my part. Any of you can look at a quote montage. I promise you this is what you will find. I chose Citigroup because I thought it would be the most meaningful in terms of finding meaningful away quotes. The market in New York is bid $43.58, offered at $43.59, 6,600 shares bid for 3,300 shares offered. The market in Boston, which is on Auto Quote, is 10 cents away from the bid, 10 cents away from the offer, 100 shares by 100 shares. Chicago is exactly the same. The market in Cincinnati is 14 cents away from the primary bid, and I can't even do the math in terms of how far they're away from the offer, one by one. The market in Nasdaq is about 50 cents away on the bid and another 40 cents Diversified Reporting Services, Inc. (202) 296-9626 185 away on the offer, 5 by 10, and so on. Won't talk about Philadelphia and Pacific, but it's similar. I don't mean to be making any market quality, market structure or competitive order flow kind of comment here, just a market data comment and whether or not there's value to a consolidated display and offer. The most diplomatic thing I can say about these away quotations is that they're silly. They're of no value whatsoever. My friend Andy is not here. I have no doubt Andy is going to get the New York quote in this example. The question is where is Nasdaq's 50-cent quote away from New York going to go? Where is Boston's quote going to go? I have no horse in this race one way or the other. We're not strongly in favor of the display rule or against it. We're in favor of this group doing something with full knowledge. So I'm trying to hold the mirror up and say, here's what it looks like, and be sure you like what you see before you take some action. MR. NICOLL: Joel, I just need to respond to that. Almost throughout this debate I have agreed with almost everything the New York Stock Exchange has said, but that's unfair. That's very unfair because I would submit that those quotes are there simply because of both of explicit and the implicit agreements that are going on now in the marketplace in response to the regulatory regime. Diversified Reporting Services, Inc. (202) 296-9626 186 The mean, the fact of the matter is we all know that the regionals -- or that it is put forth almost as a fact that if the regionals didn't get their share of the market data that they go out the business. Many people have said that, and it hasn't gone -- it has not really been challenged. And one of the reasons that they Auto Quote is because they have to have a two-sided market, and because the way that we share revenue now is not by who is competing for quotes but who is competing for orders, because the way you distribute and share your market data fees is by the number of transactions that cross the tape. So as an exchange, I have incentive to auto execute without auto quoting. That is to say, to get the volume without taking any of the risks, to be parasitic to your marketplace, get the volume, and at the end of the month we divvy up all of the market data revenues based upon how many trades I put across the tape versus how many trades you put across the tape. That directly incentivizes me to be as far away from the market as possible to get my trades by not competing for them through putting my capital at risk but rather through doing deals with the providers of order flow so that I derive my prices off of yours and without actually being up on the box. Diversified Reporting Services, Inc. (202) 296-9626 187 And then I get the print, and then I get my share of the market data. That's the way that the system works now, so I have an incentive to be away on the quote and to get the trade because not only do I benefit from the trading profits that can be derived from that arrangement, but I benefit from the peculiar arrangement that we have for sharing market data revenue. MR. BRITZ: One wonders how you get the trade without being competitive on the quote. The market that did the -- MR. NICOLL: Because I auto execute against your quote. You know that as well as I do. If I'm out of Chicago, I auto execute against your quote rather than auto quote against it. MR. BRITZ: I do understand that. MR. NICOLL: And you know that because you've been complaining about it for 20 years. And you've described competing markets as being parasitic, and many people have, against the quote that you're putting up there. MR. BRITZ: I raise this, Ed, in the context of what has now come up, this motion of vending the away market's quotations up until the very last moment. I suggest it's a variation on a movie we have seen before -- MR. NICOLL: It didn't come from me, and I don't know what I think about it, but I do think it's just Diversified Reporting Services, Inc. (202) 296-9626 188 disingenuous to take the facts as they exist today simply because -- I would argue because of the regulatory regime that we're under and because of the implicit agreements that exist now between the various parties and to propound that that is what it's going to be like tomorrow when the regulatory regime changes. I agree with -- Simon has a point of view as to what's going to happen tomorrow when that regime changes. I have a different point of view. I think I understand what -- I think the SEC is trying to tell us that they're not going to assume that you're not going to be able to exercise market power, and I think that we have to -- if we really want the SEC to think strongly about making a significant change, we have to address that issue, and I'm not sure that we can. But I do think it's disingenuous to take what exists today and argue that this is good evidence for what the markets are going to look like tomorrow. I said submit and I've submitted before that you could argue that the exact flip is going to happen, that what you're going to incentivize is exchanges to auto quote rather than to auto execute. And so all of a sudden now you're going to have Boston with a very tight against yours, and the only problem they're going to have is that they're actually going to have to compete against you in the marketplace for people to hit Diversified Reporting Services, Inc. (202) 296-9626 189 their bids and offers which they may not want. MR. BRITZ: Not for 100 shares. Not much of a problem. You have a clarity of vision vis-a-vis the future of markets that mine is not quite so clear. MR. NICOLL: I just offer it as a possible alternative. I do not take lightly the notion of changing the regulatory regime, and part of this process -- and I agree that it wouldn't make sense for us to take monumental risks for incremental benefits. I don't disagree with that, but that is a different position. That's a risk analysis position rather than a position based upon who can exercise market power. It's sort of a different argument. MR. SELIGMAN: But I think the risk analysis have to be part of what we focus on. MR. NICOLL: Absolutely. I absolutely agree with that. MR. COLBY: I just can't resist. The interesting thing, as you look at Nasdaq and the market makers there, there is no -- there is a two-sided quote requirement. There's a prohibition on auto quoting. There is no requirement that you put up a quote from any regulatory standpoint. There's no requirement that you be a Nasdaq market maker. And what do you see? You often see a lot of ECNs -- I have to say this - Diversified Reporting Services, Inc. (202) 296-9626 190 - a lot of ECNs up at the top vibrating in and out of the best quote. At the bottom, there are some astounding things. There are market makers that have hundred-point spreads, and that's not being driven by any of the things that you said. There's some other reason why people will put quotes up. Presumably, they're not trading at those hundred- point spreads unless some order comes out of an ECN and -- MR. QUICK: You also have short sale exemption for dealers who post quotes. Whether or not they're real quotes or -- MR. COLBY: Yeah, but those things all prevail on the listed -- and margin all prevail in the listed market, too. So I don't know if this is driven by the quote rule, the best bid and offer or the two-sided quote requirement. MR. McNELIS: Could I just make one further comment? MR. SELIGMAN: Sure. MR. McNELIS: I'm sorry I stirred up this hornets' nest of discussion of whether people are putting up -- quotes or not. My point was not to people who are ever going to trade but people who are working in departments of firms that are not involved in trading and that don't need that information because they're not involved in trading, had nothing to do with the quality of markets that the people are putting up. Diversified Reporting Services, Inc. (202) 296-9626 191 Perhaps there are people in other countries who you know, have an interest in the markets but don't really need the full extent of high quality information that is needed for domestic traders. MR. SELIGMAN: What I'm hearing, basically, consolidating a series of discussions to this point is we're probably dealing with a bi-modal choice. The other shoe will be dropped, if you will, May 14th. We'll see if the subcommittee comes back with analyze seriously multiple consolidator system with or without recision of the NBBO, but that's seems to be the parameters of what the discussion will be. What I want to complete today is if we're, basically, dealing with increments, dealing with the current system, some of the increments we've discussed so far would be, in effect, if we keep the NBBO, making it very clear we've unleashed everyone for everything else, dealing a little bit with governance. I haven't heard anything on transparency that there seems to be much interest in in this group. We've heard references to Most Favored Nation, but I haven't seen so far today any sense as to how that would play out in any different type of SEC rate regulation. It may be that what we're, basically, saying is we're realizing our choice is either really very small Diversified Reporting Services, Inc. (202) 296-9626 192 changes in the current system versus a very radical type of proposal. And we'll tee them both up. We'll analyze both of them. Well present them to the Commission. We'll explain risks and benefits. Let me, though, before we let today go focus on three subsidiary issues and be sure we don't want to add these to the mix. I want to focus on pilots. I want to focus a little bit more on plan administration, and I want to focus a little bit on technology. I'm going to suggest that unless people feel strongly let's just keep rolling. Let's not take a break. We'll probably finish before 5:00. We'll probably finish maybe about 4:30 if we go through this, and some of you can catch planes earlier, and all the rest. Let me take a few minutes and let us focus on pilots. We've heard today, I think somewhat contrary to concerns or suspicions that there appear to be fewer pilots. The NASD side has, basically, said they've recently filed the pilots -- MS. FRIEDMAN: Well, actually, we do file all our pilots, and we are looking -- we are getting board approval to, and we'll have to go to the operating committee, too, but to get permanent approval for two of our pilots. MR. SELIGMAN: The New York Stock Exchange CTA/CQ side, basically, said they have one pilot at the moment, none Diversified Reporting Services, Inc. (202) 296-9626 193 in the pipeline. Let me propose the following: Would a constructive suggestion or recommendation to make to the Commission be simply that there be a mandate that pilots be filed; that they be -- certainly, the possible of pursuing them be retained. Within the filing would be the duration of them and other dimensions, but they would be publicly disclosed and that, in effect, that would be an appropriate to dealing with some of the concerns that have been expressed about this. The Nasdaq seems to have already, kind of, gone that direction. Could you live with, basically, a requirement that in the future you'd have to take what your, if you will, best practice is and formalize it? MS. FRIEDMAN: Well, I would have to argue that it depends on the structure we end up with. And I don't mean to go back to this mandatory minimum versus enhanced data, but under the mandatory minimum, if there is one and is there is a vendor display rule that governs that mandatory minimum, I think it would make logical sense that these type of pilot programs be filed and that the SEC maintain some oversight. On information that's no longer mandatory minimum or enhanced information, voluntary information, I do not believe those pilots should be filed. MR. SELIGMAN: That's a good point. Bob, suppose there was a requirement that within the framework of the Diversified Reporting Services, Inc. (202) 296-9626 194 mandatory minimum, if you will, there be filing of pilots, what would the take of the New York Stock Exchange be on that? MR. BRITZ: I guess within the framework of the mandatory minimum that would probably be okay. I will tell you that in the past more pilots have been brought to us by firms than we have cooked up and gone out to firms with. And there has been great concern among those firms, again, once within a small group that we'd identified that, yes, there was need here or an opportunity, there has been great concern among those firms vis-a-vis speed to market vis-a-vis competitive advantage. To the extent that you go to -- and maybe this is solved by the mandatory minimum. I'm thinking out loud here. But to the extent that you go to pilots being filed and disclosed, and so on, for innovative products, then you've done a disservice, perhaps, to the smart and the nimble because the less smart and the less nimble can throw sand in the gears via the regulatory process and, basically, hold up the folks who have been creative enough to come up with it. I just raise that as a -- I know that's what we've heard in the past. Ironically, the progenitor of the most pilots is the sharp firm, and that has been a great -- this all predates Carrie, or most of it predates Carrie. It has been a great concern of theirs and other Diversified Reporting Services, Inc. (202) 296-9626 195 firms, to be fair that having thought of a new distribution channel or a new idea the notion of having it fully exposed and delaying the time to market and giving the competitors a chance, and so on, has been problematic. But it's, frankly, you know, an SRO issue I think than it is the sponsor of the particular pilot. MR. QUICK: I would certainly say on behalf of the AMEX the AMEX would not have a problem with regard to filing pilot programs. We only have one existing right now with regard to broadcast that was not filed, but certainly, in the interest of a level playing field and total disclosure, we would not be opposed to that. MR. BRITZ: There was a point, Joel, where you talked about not necessarily dealing with filing but notification of the existence of the pilots. Clearly, you'd have to do that under the fairness and uniformity notion that we discussed earlier. There are no pilots that fit just one firm. They have to be made available to all firms. But there may be a speed to market reward for the particular firm or firms that have crafted the pilot in the first place and brought it to the marketplace. MR. SELIGMAN: Let me go back to Adena for a second. Actually, maybe I should start with Bob on this. If we're outside of a mandatory minimum, what kind of pilots Diversified Reporting Services, Inc. (202) 296-9626 196 would we be talking about? Would there still be any filing requirements in that context in any event? MS. FRIEDMAN: There are filing requirements with anything that we were charging a non-member, so yes. Anything where we charge a non-member we have to file. Therefore, it allows any competitor to come in and comment and try to squash anything that we do. So it really does cause a great deal of -- basically, a lack of incentive to innovate in terms of the data world. So if it's -- and our position is that if it's a voluntary data product and it's not impacting the mandatory minimum or it's not related to the mandatory minimum information that the SROs should be able to compete on a level playing field with any other provider of voluntary non- mandatory information and be able to create a pilot without SEC oversight. MR. SELIGMAN: The question I was focusing on, would you have to file that in any event? MS. FRIEDMAN: Yes. We do have to file it today because as long as we charge for something we have to file. MR. SELIGMAN: Okay. The other concept that received a fair amount of attention with respect to pilots is that while you could initiate them or can initiate them, rather, at the moment, under some circumstances under the plans, a question was posed whether there should have to be a Diversified Reporting Services, Inc. (202) 296-9626 197 filing of some sort within a period of time after initiation. That is, with the ones outside of the mandatory minimum, should there be a requirement that you can start them and within, fill in the blank, six months, one year, there would have to be a filing? MS. FRIEDMAN: Well, one thing you can look at is the trading system pilot program that the SEC has put in place in terms of they have a volume parameter that you have -- as long as you're under a certain amount of volume then you're not required to file. So you could look at something like that or a time parameter, but you want to make sure that you give the SRO, the innovator, essentially, a chance to be able to go out and try it out and make sure that they've priced it correctly, make sure that they have a chance to build a customer base and give them some level of time-to-market advantage if they have some innovative product. MR. SELIGMAN: How much of a time would they need? MS. FRIEDMAN: Generally, our pilots run two years today. MR. SELIGMAN: Okay. That sounds like a long time. Does that trouble anyone? If, basically, you moved towards a system where outside of a mandatory minimum, if you had pilots, there would have to be filing with the SEC? MS. FRIEDMAN: It doesn't mean a competitor can't Diversified Reporting Services, Inc. (202) 296-9626 198 come in and immediately create a comparable product. It just means that -- MR. SELIGMAN: I understand that. MS. FRIEDMAN: -- the SEC doesn't have regulatory oversight. MR. COLBY: There's, sort of, two questions on filing, if you will, pilots. The first is the process of getting something that's filed through the Commission. The second is the fact of telling people there is a pilot running. Should those things be split? What really gripes me when I go to the phone companies finding out that there was a better rate that I had no idea I failed to ask for, and so I'm the fool on the block because I should have asked for this better rate, but they never told me about it, and I wasn't smart enough to ask. MS. FRIEDMAN: Well, first of all, I would argue that -- well, I would agree. Disclosure of fees and what the pilot is and who it's available to I think is important, and certainly, if we were to create a data product we'd want to get that disclosure out there to try to bring customers in. But filing it is quite a different matter, a very different matter. You could actually have a negative comment and, you know, things that really could prevent you from even to move forward. So being able to get it out there and build customers and show that it's equitable and make sure we work Diversified Reporting Services, Inc. (202) 296-9626 199 out pricing issues and make sure that it's out there and, of course, disclosed, I think that's a very appropriate way for an SRO to act in a competitive environment. MS. DWYER: Doesn't the filing requirement adhere to the SRO so as Nasdaq becomes more of a pure market, pure vendor separated from the SRO functions you'd have less of a concern about the fees that they charge for this, sort of, off-market product? You could think about not overseeing fees for market data products other than the mandatory minimum. And if did you oversee it, on what basis would you oversee it. MR. COLBY: I'm sorry. I'm going to be maybe repeating myself now. Do have you to notify publicly that there is this pilot being run? Another is do you have to file it? The third is the level of review. The statute doesn't -- it just talks about these standards for information with respect to quotations and transactions in securities. It doesn't differentiate between this and that and this and that. But the pilots right now, they run -- as I understand them, they run privately -- not discriminatorily, but you have to know that there's a pilot going on in order to know that there might be a rate that you might be entitled to if you were to ask for it. MR. QUICK: This is something that was -- I think Diversified Reporting Services, Inc. (202) 296-9626 200 DTTC was very mindful when they recently announced their deal with Nasdaq Europe in terms of, you know, while they had worked on something with Nasdaq specifically to facilitate the clearing of transactions that will take place on Nasdaq Europe that there were other members of DTTC, New York, AMEX and everyone else that they certainly wanted to let them know that they would help them in any way they want on any overseas project. So likewise, with this, I'm not sure it should necessarily be filed for an approval process but more filed for a public notification that it's, in fact, out there with some kind of time limit on how long that pilot can be out there for, let's say, a year before it needs to go for, you know, a permanency. MS. FRIEDMAN: Can I ask why -- why would it ever need to be filed for approval? MR. QUICK: Because it would be a fee. MS. FRIEDMAN: It could be a new product. It could be a fee structure. SROs have a general obligation to provide fair and equivalent access to their information, so the fee -- if there's a pilot, it's applied to all. Maybe there is a disclosure requirement through notice to members or through a public document, but why would it ever need to be approved -- I'm talking enhanced state, not mandatory minimum. Why would it ever need SEC approval? Diversified Reporting Services, Inc. (202) 296-9626 201 MR. QUICK: I'm just looking at the pilot that we're running now for the broadcast, and that is something that we envisioned -- MS. FRIEDMAN: Is that for the mandatory minimum information? Because I would agree that the pilot for the non-professional level one fee that we currently have running eventually should be filed and approved. But that's mandatory minimum information. MR. COLBY: I'm sorry. Everyone is getting tired, so I -- if there's market power, there's market power not just for the mandatory minimum but for the enhanced data. So if that's a concern and it's not addressed any other way, then the point of filing is so the people can comment on the rates that are set for information that -- where the SRO operates market power. MS. FRIEDMAN: But wouldn't you argue that in a totally voluntary data product, meaning that they can choose to take or not, they can choose to -- it's not mandatory for best execution or to comply with any rules. Then, it's voluntary. Wouldn't supply and demand determine the proper pricing? MR. JOHNSON: Supply and demand will determine the pricing, but I think you're illustrating perfectly how market power can work in a situation. Now, this may be more market power than we're comfortable with, and that's okay. I'm not Diversified Reporting Services, Inc. (202) 296-9626 202 saying necessarily has to regulate it. But I think that what you're illustrating, certainly over this time period two years seems like a long time, but let's say over the two-year time period you're able to price discriminate across customers. So you would offer different deals to different people. MS. FRIEDMAN: That's not what I would -- MR. COLBY: Let's take an example. Once an -- becomes an exchange, the mandatory minimum is the best bid and offer of the single best dealer quote -- MS. FRIEDMAN: NBBO. MR. COLBY: The NBBO of Nasdaq. So Level 2, as we know it, would then be all enhanced data, right? MS. FRIEDMAN: Right. MR. COLBY: So we're talking about whether that sort of Level 2 enhanced data is the sort of information that shouldn't be filed and approved. Right? That's what we're talking about. MS. FRIEDMAN: That's one of many examples. That's one of many. MR. SELIGMAN: Bob, let's take a second step, not so much filed and approved but filed for notification. Should there be a requirement with respect to the non- mandatory data that when you start a pilot or whether we call it a pilot or not, there be notification of a new product, if Diversified Reporting Services, Inc. (202) 296-9626 203 you will? MS. DWYER: Why would it be different for any vendor or broker dealer who wanted to offer enhanced data? I mean, they wouldn't have a filing obligation today, and yet the exchanges, in competing with them, presumably, would retain these vestiges of the regulatory structure. You'd have to make that decision somehow. MR. SELIGMAN: I'm posing the question is this a direction we should go? I recognize there are different obligations for SROs, broker dealers, and so forth. In other words, within the mandatory data, what I'm hearing, although there has not been a lot of discussion, is that there seems to be some sentiment that to have filing and conceivably seeking approval of pilots seems to have some support or at least doesn't seem to have any opposition. Within the enhanced data framework, the question that Bob posed when he talked about the telephone service was, in effect, how are competitors who could use this going to know about it? Do you need a notification mechanism of some sort to ensure it? MS. FRIEDMAN: I don't think that we would be opposed to a notification mechanism as long as it's not saying that the -- if I were the SEC, I'd be concerned that by notifying people through the Federal Register that they're somehow endorsing or giving some level of -- I don't know. Diversified Reporting Services, Inc. (202) 296-9626 204 Obviously not. Just general notification we would not be opposed to -- MR. COLBY: -- We pay for the Federal Register. I'm not advocating anything, but -- MS. FRIEDMAN: But we have other -- MR. COLBY: -- notification can be done in a lot of ways. MS. FRIEDMAN: Right. We have certain notification mechanisms, too. But in any event, we have no problem with notifying people. We have an obligation as an SRO to supply data on a fair and equivalent basis, so I don't think there would be concern that we would do any sort of discriminatory pricing for particular participants. It's more innovative products or innovative pricing. MR. SELIGMAN: Peter, I take it from the AMEX point of view there wouldn't be any problem with a notification process of some sort? MR. QUICK: That's correct. MR. SELIGMAN: Bob? MR. BRITZ: No. MR. SELIGMAN: Okay. Let's move on. With respect to administration, there have been a fair number of comments about the complexity of having particular fee arrangements approved, and it's focused on a kind of prior approval framework, the time for it, the number of buckets, and so Diversified Reporting Services, Inc. (202) 296-9626 205 forth. One level of analysis may be picking up where Michael began this morning is to say that's really the business of the SROs or the business of the exchanges. We shouldn't go there. Another level of analysis is to say some of the discomfort with the system, if there is discomfort with the system, has focused on the slowness of approval on the sense that there's a complexity which frustrates people. Giving an illustration, I know Enterprise fees are approved. There are still some firms seeking Enterprise fees that haven't been able to secure it yet. The review process seems to take a while. The question I want to pose with respect to this is what should we recommend with respect to administration? Is it a question of greater standardization? Is it a question of focusing on the time for approval? Is it a question of just recognizing these are business realities; it's a complex world? What's the approach we should take with respect to the administrative issues here? MR. QUICK: I'm not sure what has been done in terms of -- I'm sympathetic with Carrie. She may not be the average trader with four different devices, but certainly with the volume of paper that any subscriber would have to fill out to get access I'm not sure that the Nasdaq -- the Diversified Reporting Services, Inc. (202) 296-9626 206 three different networks might not be able to speak to each other with permission of the SEC, of course, and if it needs to standardize some kind of forms and to look at how different the language is in the three different agreements to make it easier to subscribe to the different data. MR. SELIGMAN: Michael, to what extent are there variations in the contracts among the three networks we're talking about today? MR. ATKIN: I don't think there's a whole lot of variation, actually, in a lot of the things. Like, there's not a whole lot of variation in subscriber agreements. There's not a whole lot of variation, I think, in the terms and conditions of their business policies. I guess I come at it this way, Joel: It seems to me that everybody agrees that we should standardize, automate, simplify and do everything we can to make the business processes smoother. I'm just not sure what we would ask the Commission to do about that. I would love to have it happen faster. I think the whole industry would. But I'm not quite sure we would be asking for except for it's a good idea, get on with it. MR. SELIGMAN: Well, sometimes when firms in competition talk to each other there are anti-trust questions, so you need, in effect, the shelter, if you will, of the Commission for those discussions to take place. Diversified Reporting Services, Inc. (202) 296-9626 207 That's one possible issue. If what you're saying, Michael, is this is one where the SEC shouldn't have a particularly proactive control but should just, basically, encourage, perhaps, the three networks to talk to each other to see if there is capacity for greater harmonization or standardization and nothing else, I can understand that point of view. MR. ATKIN: Sit around and listen to a lot of people get really frustrated with the pace of innovation in terms of development and business process activities, but at the end of the day I'm not sure anybody is asking for the Commission to do anything about that. I don't know. Brian, do you disagree with that? MR. McNELIS: No. I wouldn't disagree with it, and I'm not sure either what the Commission itself would do on it. But we certainly would welcome more harmony and standardization of the process. One of the things, for example, Nasdaq does not require prior approval, but CTA/CQ does. I mean, maybe, you know, we could -- maybe it would just help to even get an explanation as to why that difference exists. We're not sure, you know, why it's okay in one and not in the other, you know, and those kinds of things. And there is just all these little things which they're probably Legacy things, and maybe they just haven't been picked up and Diversified Reporting Services, Inc. (202) 296-9626 208 addressed. But again, whether or not the regulators need to do anything I'm not clear, but certainly moving -- urging everyone to try to work together to smooth the process I think would certainly be a help. MR. SELIGMAN: Is there anything more we should be focusing about with respect to administration, or is it, basically, we'd like to encourage greater standardization but, by and large, the Commission should stay out of the way and leave it to the various plans? Let me pick up, I guess, on Brian's point. There's a variance between prior approval and discretion. That's strikes me as pretty fundamental. Should we be focusing on whether there should be a recommendation that there not be a approval prior -- MS. FRIEDMAN: I actually thought that years ago the FISD had an effort to try to standardize the contracts across exchanges, and it never came to a conclusion. MR. ATKIN: That's true. MS. FRIEDMAN: And I believe, and I don't know why because I wasn't here then -- MR. ATKIN: The lawyers got involved. MS. FRIEDMAN: Yeah. Right. And that will happen again. And actually, I was going to say that you get the lawyers in the room, they each have their own risk profile, Diversified Reporting Services, Inc. (202) 296-9626 209 their own willingness to withstand certain liabilities, and you're just -- I mean, I don't necessarily think it's a bad idea from a private enterprise basis through the FISD or some other might be organization to try to do this again. But do I believe that you're going to find that -- I don't think having SEC mandating any sort of standardization is going to help. I think you have to determine whether each of the exchanges are willing to withstand certain changes to their risk profiles or to their liability and see if there is standardization that way. In terms of the prior approval, that's something we could probably talk about in the context of the FISD or some other private -- that's what I would suggest. We're not averse to looking at that, absolutely not. But I don't know whether an SEC mandate -- MR. ATKIN: Nobody wants to volunteer for regulation. It might be conceivable that, you know, if these issues get to be very frustrating and intractable, you might want to be able to appeal to a higher authority, if you will, to move things off the dime. And that threat is a pretty useful tool to have. "Gee, we'd better do something because we don't want to be sitting in this room having Bob yell at us." That might be the extent that we might want to consider any kind of government involvement, in essence, a message saying, Diversified Reporting Services, Inc. (202) 296-9626 210 "Good idea. Get on with it. Don't make us call you back here" type of thing. MS. DWYER: Just so you don't think there's consensus, I'll just go back to my earlier comments that the entire property right licensing process is one that I would hope we could consider, the SEC could consider or legislatures could consider as imposing huge costs on the industry as well as our customers. MR. SELIGMAN: I think that would be one the legislature would have to consider, given the current framework. But other than that, I think we are in a situation where at least under the '75 Act amendments the SEC has pretty broad authority to deal with market data information. I'm not sure either the Securities Act amendments or the legislation itself focus precisely on property rights, but they did focus on the power to regulate. MS. DWYER: I know they did not focus on property rights. MR. SELIGMAN: I'm not hearing, unless someone wants to add anything, that there's a sense that through the question of administration of a system that people at this table want to make recommendations beyond the kind of Michael's cheerleading that we'd like to see greater standardization. Diversified Reporting Services, Inc. (202) 296-9626 211 We think the industry can do it. Perhaps we could even go further and say there has been some new databases with respect to contract policies, and so forth. The SEC, regardless of what we say always retains a residual authority given the current statute. But I don't get the sense that people think that's one that's going to make a significant practical difference. MR. ATKIN: Actually, Carrie, if you don't get -- if intellectual property rights doesn't get addressed correctly, would there be anything else that you could think of that we'd want to use this process for? MS. DWYER: To use this committee's process for? MR. ATKIN: Well, the authority of the SEC, I guess is the process we're talking about here. MS. DWYER: Well, I mean, we filed a petition a couple of years ago talking about the administration of the process as imposing -- as being unreasonably discriminatory, and for the reasons we talked about this morning, reason to get into how the contract process is administered was to illustrate the incredible amount of discretion in terms of use, users, technology, and so forth, that the markets have, which puts them in a very difficult position when they were competing against their members, in some cases, and wielding sole-source monopoly power. I mean, to me, that's the issue. It has been the Diversified Reporting Services, Inc. (202) 296-9626 212 issue for several years now. We don't appear to be moving forward to resolve that issue here, but I think that the way the structure is set up, the way it's administered is discriminatory, and we just keep making that point. MR. SELIGMAN: In the May 14th meeting, we will have a shot at a very different approach, and we will see if, in effect, the proponents of the different approach can sell it to the committee. At the very least, in one form or another, it's clearly going to be articulated in a final report. Let's just deal with one more, then. I know in Don's subcommittee there was a fair amount of discussion of the way in which market information is validated, and so forth. Clearly, when we get to our last meeting and focus on options there will be a fair amount of concern with respect to capacity issues which have been much on the mind of the options markets. We've talked here from time to time about competitive bidding. Eric is skeptical at this point it will make a practical difference. It will clearly be an issue we'll discuss in an ultimate report. There were several proponents of it. Indeed, I think there were a majority, if we retain the current system, who favored it. Above and beyond competitive bidding as one approach within the structure, the question could be posed if Diversified Reporting Services, Inc. (202) 296-9626 213 we need minimum technological and data quality standards, who should set them? Is this a role where we, basically, defer to either the current CTA/CQ, Nasdaq UTP and just, basically, take a cheerleader role? Is this one where the SEC should have a more active role? What's the sense of this group? MS. FRIEDMAN: We were talking a little bit about that in the multiple consolidator model, and we've been talking about who, kind of, setting the standard for these consolidators. I would argue that in a single consolidator world where you have a plan of SROs that they should have the ability to set the standard as a collective group because they're the ones who have to make sure the data gets out there. It's their revenue at stake. It's their integrity at stake, and it's their, kind of, image as a market as stake. So I believe that it really should be a collective decision among the SROs in terms of technological capabilities of a processor. I do think there are a lot of flaws in that, and I would like to hear Paul O'Kelly's view because I think he sits on the other side of the table at a lot of these various meetings. But I don't see a better approach. I don't think it's perfect. MR. O'KELLY: Well, I don't see a better approach either, but I could also address this question from the CTA side of things which has a little bit more history to it than Diversified Reporting Services, Inc. (202) 296-9626 214 our what amounts to a partnership that we have had rather than, kind of, a robust OTC/UTP program. The CTA plan setting the standards for SIAC to meet seems to have worked well over these 25 years. I've heard lots and lots of criticism of lots and lots of things. This is one area where I've heard no criticism. It has worked well, and so I don't see a need at this point for the SEC or anybody else to get involved in setting the standards that SIAC is supposed to meet. It seems to have worked well. It's one of the things that we easily agree on within CTA. Everyone has, as Adena is saying, kind of a very common interest in making sure that this data is collected and put out in a quality, timely fashion. With respect to the OTC/UTP plan, this could -- this issue of setting the standards will probably be looked at in a slightly different fashion once Nasdaq no longer is the SIP for the program. Because as it's one of the competitors of the other participants in the OTC/UTP program, you'll have concerns about where Nasdaq is spending its resources. And if it's spending them on a joint effort rather than a singular -- if the choices are spending them on a joint effort rather than a singular effort, you will always have some concern over that. That's not a criticism. That's Diversified Reporting Services, Inc. (202) 296-9626 215 just a natural human reaction to things. As we move to independence, I think that will ameliorate a lot of those concerns, and the process I expect will work just as well as it does in the CTA today where everyone has the same common interest in making sure that the quality of the data and the capacity of the system works well. MR. SELIGMAN: My sense is where this really becomes an issue would be in a multiple consolidator system, and that's one I take it Don's group is going to take a look at. But as long as we're dealing with what we've referred to as an exclusive consolidator issue, there just doesn't seem to be one. All right. So where are we? We've now met for four meetings. We, basically, have evolved towards two approaches. The approach we've, in effect, exhausted today has been if we make incremental changes in the current system what we seem to have agreed with so far has been at least a tentative conclusion would keep an NBBO but have, in effect, a more free market approach with respect to all other data. A least a tentative conclusion that there seems to be, I believe, a majority -- and I can't remember precisely how large -- would favor a more competitive bidding approach towards selection of the processor. There seemed to be in the governance area some Diversified Reporting Services, Inc. (202) 296-9626 216 sense of the wisdom of increasing participation by those who are not at the table through some sort of advisory committee. And by and large, when we look at other issues that have been on the table, while there has been a fair amount of discussion there hasn't been, I think, a consensus that has evolved for any of them. That is, if we were just taking the current system and going forward with it, we've got a low-risk kind of approach. It's one where we may have learned a good deal about the complexity of the arrangements and more sense of the history. Our other approach we'll get to on May 14th, and the other approach is what's called the brave new world approach. It will, at a minimum, be an analysis of multiple consolidators. It will undoubtedly have discussion if not a recommendation that there be recision of the NBBO or a different framing of the NBBO. And I think when we get to that alternative the point that Simon emphasized today needs particular attention. And Don, in preparing for it, you may want to focus on this. The incremental approach seems relatively low risk, recognition that technology -- some question about fee levels, but by and large the ways to address it were proposing don't sound as if they're going to threaten the operation of the system in any systematic way. Diversified Reporting Services, Inc. (202) 296-9626 217 In contrast, the alternative proposal I think there has to be a very careful analysis of what the risks are. I think there has to be a very careful analysis of how the proponents would address them, and I think that will be part of our meeting on the 14th. My anticipation is that the final report is, obviously, going to include discussion of both. I think, in effect, we are going to be teeing up to the Commission a menu with at least two items, two very different types of dinner, if you will, that they can savor. In July, we'll take a look at what we have just totally put to one side to date which is the options market. By then, we will have circulated perhaps several times drafts of a report on the equity side, and we'll begin to be receiving your input on that. And you'll find that there will be amplifications that you're going to want to make to certain points. I think it's safe to say we don't all agree on every point that we've discussed in the four meetings, and there will be obvious recognition of when there are dissenting or contrasting views in the document. We'll capture it one way or another. That's where we are at this point. The only question before I turn to the public and ask if there's any comment is do any of you want to comment further? Are there any other thoughts that the members of the committee would Diversified Reporting Services, Inc. (202) 296-9626 218 like to offer? Mike. MR. ATKIN: Just one quick question. You said kind of a free market approach to other data in the incremental approach. Have we given any consideration to what the fee oversight process is for non-mandatory minimum data? Just to give you an example, if the New York Stock Exchange decided to come up with a volume-weighted average price, an official exchange -- and they wanted to disseminate that, would that be -- how would the access to that kind of stuff work, and how would the fee oversight process to that kind of stuff work? Would that be completely free market? I mean -- MR. COLBY: From a statutory standpoint, the production by an exclusive processor of information with respect to transaction and quotations is subject to the standards of fair and reasonable charges and not unreasonably discriminatory. So it's the exact same fee standard. MR. ATKIN: It's the same process that would file with the Commission -- MR. COLBY: Yes. Yes, it is. That's right. MR. SELIGMAN: There would be no delineation, however, by the Commission of how these new structures would work. The Commission clearly, in its interpretations of "fair and reasonable" and "not unreasonably discriminatory" is given an awful lot of scope under the current system and, Diversified Reporting Services, Inc. (202) 296-9626 219 presumably, there would be even greater flexibility in how it could be charged. I will add one point, and it's worth not losing track of, if at the end of the day the Commission decides it wants the more incremental approach but you have a lot of new products developed on the free market side, you may find this a halfway house towards a new system that will evolve over time. You may find that fears about market power will not seem as significant if you don't see the fees dramatically change, if you see them appear competitive or similar, if you will, to where the mandatory minimum side of it is. That said -- Mark? MR. MINISTER: Yeah. I did want to go on record -- I think we passed by it -- stating that I do feel that this discrimination between professional and non-professional users is very great. I personally do think it is a subsidy paid by the professional users, but I think that the single consolidators and the vendors represented here take great comfort in Andy Brooks' comment that he couldn't live without the data and would pay any amount for it. So even though I object to the difference, I don't think it's going to matter in the long run because the professionals aren't objecting. MR. SELIGMAN: This is a public process. If anyone Diversified Reporting Services, Inc. (202) 296-9626 220 in the room would like to pose questions, make a comment, this is a good time to do it. I don't see the public clamoring to speak today. That said, we're adjourned until May 14th. (Whereupon, at 3:49 p.m., the proceedings were adjourned.) * * * * * Diversified Reporting Services, Inc. (202) 296-9626