In an unprecedented legal confrontation, the three largest US stock exchanges are taking their own regulator to block an initiative aimed at limiting the fees they can pay for trading.
Nasdaq Inc. and Cboe Global Markets Inc. On Friday, the Securities and Exchange Commission sued in a federal appeal court to stop the governor from carrying out the program one day after the New York Stock Exchange filed a similar challenge.
At stake, the Transaction Fee Pilot, which the SEC approved unanimously in December.
The pilot, who is expected to start towards the end of this year, has riled large US stock operators because it would undermine a key part of their businesses: a widely used system of fees and discounts called "maker taker," in which exchanges pay discounts to brokers and traders for some orders while they charge for others.
"It is a very difficult decision to decide to take your primary regulator to court," said Michael Blaugrund, journalist's transaction manager. "It's a very serious decision to cross Rubicon."
A SEC spokesman refused to comment.
Critics say that the maker-taker system damages investors by encouraging brokers to send customers' orders to the exchange that pays the most discount, rather than the one that gives customers the best results.
The pilot, which can last up to two years, will cut the fees that exchanges can charge for trading in hundreds of stocks, effectively forcing them to cut discounts on their stock as well. Other stocks would be untouched, and the SEC would monitor trading activity to see how the experiment played out.
Supporters of the pilot, including some ventures such as the Vanguard Group and
T. Rowe Price Group
Nasdaq, NYSE and CBOE say it would harm investors and listed companies by extending "bidding issues" ̵
The exchanges have also expressed concern that it will cause trade to shift to "dark pools" exchanges, private trading platforms often run by banks. This would reduce the transparency of stock prices, say the exchanges, while hurting the bottom line.
Almost 40% of the trading volume in US shares takes place outside of exchange, according to data from the CBOE.
"Do not harm" is obviously a mandate for the exchanges and the SEC, and this can certainly hurt. "Nelson Griggs, executive vice president for corporate services on Nasdaq, said in an interview Friday.
Mr Griggs added that hundreds of companies were drafted to the pilot without their approval and with little knowledge of how the experiment would affect trading in their shares. "You have companies that have no choice," he said.
"This action was not taken lightly," Cboe said, announcing his legal challenge. "However, the pilot is so intrusive, unimaginable and likely to damage stock markets, no choice. "
Some called the lawsuits a desperate move to protect the stock market's profits." If they don't have discounts, the business model falls apart, "said Joe Saluzzi, a partner of broker Themis Trading and frequent critic of the three major stock exchanges. "It is sad that exchanges went down to this level."
Nasdaq's filing on Friday was a dubious petition requesting the US District Court of Columbia Circu it to review the SEC rule that governs the pilot program. It was signed by Eugene Scalia, son of Central Supreme Court Justice Antonin Scalia and a lawyer at Gibson, Dunn & Crutcher LLP, who previously led to the success of the industry's regulatory challenges.
NYSE's filing called the pilot "arbitrary and capricious" And said it "exceeded the commission's authority." It asked the court for an injunction to block the SEC from conducting pilot.
Moved to sue The SEC is an extraordinary step by companies operating all the time through scrutiny of the commission, said Adam Pritchard, a professor of law at the University of Michigan who previously worked at the SEC.
"They will usually crack down and do what the SEC says," Pritchard said. "This can be a great success for their business model and that's why they resort to a lawsuit."
The DC Circuit Court has previously abandoned the SEC regulations after finding the agency not adequately assessed their impact on capital increase or competition.
The SEC has in recent years improved the appeal court, which has many legal challenges to federal regulations. For example, the D.C. circuit was equally shared over a matter that challenged the constitutionality of SEC's internal judges. The US Supreme Court later asserted against the SEC, and found the judge's deal was unconstitutional.
The SEC probably has a stronger argument in this case over stock exchange fees, Pritchard said because it approved a pilot program instead of ordering fees being changed permanently.
"Here's an attempt to look at government costs before imposing a final rule, which seems sensible," Pritchard said. "I see why the exchanges are willing to go to this extraordinary step, but it's not like they have a collision-proof argument."
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