Subject: Fee Filings

Dated: May 21, 2019

I. Overview[1]

The Division has prepared this guidance to assist the national securities exchanges and FINRA (hereafter, “SROs”) in preparing Fee Filings that meet their burden to demonstrate that proposed fees are consistent with the requirements of the Securities Exchange Act of 1934 (“Exchange Act”), and rules thereunder.[2] The Exchange Act provides that a proposed rule change may not take effect unless it is approved by the Commission pursuant to Exchange Act Section 19(b)(2),[3] or it becomes immediately effective upon filing pursuant to Exchange Act Section 19(b)(3)(A).[4] Rule 19b-4(f) under the Exchange Act specifies the types of proposed rule changes that may become immediately effective upon filing with the Commission, and includes those properly designated by the SROs as “establishing or changing a due, fee, or other charge imposed by the self-regulatory organization.”[5] Whether filed for Commission approval or immediate effectiveness, all proposed rule changes, including proposed fee changes, are required to be consistent with the Exchange Act.

This guidance discusses several aspects of Fee Filings, with a focus on how SROs can ensure that they have clearly described their proposed fees and addressed how they satisfy Exchange Act requirements that, among other things, fees be (i) reasonable, (ii) equitably allocated, (iii) not unfairly discriminatory, and (iv) not an undue burden on competition.[6]

II. Procedural Framework

Self-regulatory organizations are required by Exchange Act Section 19(b) and Rule 19b-4 thereunder[7] to file proposed rule changes with the Commission on Form19b-4.[8] The instructions to Form 19b-4 state that the form “is intended to elicit information necessary for the public to provide meaningful comment on the proposed rule change . . . and for the Commission to determine whether the proposed rule change . . . is consistent with the requirements of the Act and the rules and regulations thereunder . . . as applicable to the self- regulatory organization and in accordance with the requirements for each type of filing.” Accordingly, a Fee Filing proposal should fully and fairly describe the operation of the applicable fee (including its effect on market participants) and do so in sufficient detail so that the public can understand the Fee Filing proposal sufficiently to provide meaningful comment and the Commission can determine whether the proposal is consistent with the Exchange Act.

In reviewing a Fee Filing, the staff evaluates whether the filing complies with the requirements of Section 19(b)(3)(A)(ii), i.e., whether the filing “establish[es] or chang[es] a due, fee, or other charge imposed by the self-regulatory organization on any person,” and whether the filing contains changes that fall outside the scope of that provision.[9] A Fee Filing must also address all relevant statutory requirements, including the requirements that the fees (including rebates) are reasonable, that they are equitably allocated, that they are not unfairly discriminatory, and that they do not unduly burden competition.[10]

Among other things, if the staff believes a Fee Filing raises questions as to whether an SRO has met its burden to demonstrate that the proposed fee is consistent with the Exchange Act, the Commission may temporarily suspend it and issue an order instituting proceedings (“OIP”) to determine whether to approve or disapprove the proposal.[11] Under Rule 700(b)(3) of the Commission’s Rules of Practice, the “burden to demonstrate that a proposed rule change is consistent with the Exchange Act and the rules and regulations issued thereunder . . . is on the self-regulatory organization that proposed the rule change.” [12]

When reviewing rule filing proposals the staff is mindful of recent opinions by the D.C. Circuit and the Commission, respectively: (i) Susquehanna Int’l Grp., LLC v. SEC (“Susquehanna Decision”),[13] and (ii) In the Matter of the Application of Securities Industry and Financial Markets Ass’n for Review of Action taken by NYSE Arca, Inc. and Nasdaq Stock Market, LLC (“SIFMA Decision”).[14] In addition, requests by an SRO for confidential treatment of information provided in connection with a Fee Filing would be governed by existing Commission rules.

The Division has prepared this guidance for the purpose of providing the SROs, as well as market participants, with additional information concerning issues frequently encountered by Commission staff in its review of Fee Filings. The list of issues and considerations below is neither comprehensive nor exhaustive. Moreover, analysis of proposed fees for consistency with the Exchange Act may evolve over time as legal precedent and market structure also evolve.[15]

III. Considerations in the Preparation of Fee Filings Pursuant to Section 19(b), Rule 19b-4 and Form 19b-4 under the Exchange Act

In the preparation of a Fee Filing, an SRO is required to, among other things, provide a statement of the purpose and statutory basis of the proposed rule change, as well as the text of the proposed rule change. In short, the SRO must provide all information required and present it in a clear and comprehensible manner.

A. Purpose Section on Form 19b-4 for a Fee Filing[16]

• The purpose section of a Fee Filing on Form 19b-4 should be sufficiently detailed and specific to support a finding that the proposed rule change is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to the SRO.
  • SROs should include a plain English description of the product or service associated with the proposed fee, or any changes to the product or service associated with a proposed fee change, as well as a discussion of the benefits to investors and market participants of the new product or service or any changes thereto.
    • For example, if a proposed new product or service is faster, an SRO should describe the expected change in speed or latency (in microseconds or the finest applicable measure) and explain how the new product compares to other similar products or services offered by the SRO. If a proposed new product offers the potential for more orders to be processed in the same amount of time (i.e., greater throughput), the filing should describe the expected maximum throughput, and the improvement offered, including in a clear description the potential improved speed or latency (i.e., in microseconds or the finest applicable measure) during peak periods, and how the new product compares to other similar products or services offered by the SRO.
    • When a Fee Filing changes an existing fee, the SRO should clearly identify and discuss in its filing the existing precedent fee in order to make clear the difference between the current fee and the proposed new fee. The SRO should also explain, when relevant, the expected difference between current and proposed fees for different types of market participants, e.g., those with several users or connections as compared to those with few users or connections.
  • If there is no new product or service accompanying the fee change (e.g., if it is simply a fee increase, a new use case, or a recategorization), this should be made clear.
    • For example, if an SRO proposes a fee change to assess fees on a per login basis instead of a per connection basis, or if an SRO proposes to change the way it calculates professional use or non-display use, the SRO should make that clear in its filing.
  • The purpose section also should discuss:
    1. whether the relevant product or service, including the corresponding proposed fee or fee change, is targeted at – or expected to be limited in its applicability to – a specific segment(s) of market participants (and if so, the related details);[17]
    2. the projected number of purchasers[18] (including members, as well as non-members) of any new or modified product or service and the expected number of purchasers likely to be subject to a new fee or pricing tier, including members and non-members; [19] and
    3. how the fee may apply differently (e.g., additional cost vs. additional discount) to different types of market participants (e.g., market makers, institutional brokers, retail brokers, vendors, etc.) and different sizes of market participants (e.g., large, medium or small entity, as measured by order flow (including liquidity providing and/or liquidity taking flow), annual revenue, or other relevant metrics), including any differences based on other characteristics (e.g., volume for providing and/or taking liquidity) and any exceptions to the applicability of such fees.
  • The purpose section also should provide numerical examples, which could be provided in chart form, of the application and expected cost of the proposed fees, including, when applicable, the variable effect of the fee to different firms or subscribers based upon, for example, their (i) total number of ports; (ii) total number of mnemonics; and (iii) total or proportional share of market volume. These examples should include a clear illustration of the difference between the highest and lowest fee paid (or rebate received) among the persons subject to the fee, including, when applicable, a typical or expected effective rate for different types of firms or subscribers.
• When a Fee Filing changes an existing fee, the purpose section also should compare the projected number of purchasers likely to be subject to the proposed fee following the proposed fee change and the expected cost of the proposed fee for different types of firms or subscribers with the same metrics in the baseline period (i.e., with the same metrics before the proposed fee change).
• The filing must state when the fee will become effective (if it is to be effective on a date other than the filing date).

B. Statutory Basis Section on Form 19b-4 for a Fee Filing [20]

1. Governing Provisions

• A Fee Filing must address all of the relevant Exchange Act and regulatory requirements and explain how the proposed fee is consistent with them. The following is a non-exhaustive list of Exchange Act and regulatory requirements that must be addressed:
  • Section 6(b)(4) requires that the rules of an exchange “provide for the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities.”
  • Section 15A(b)(5) (applicable to FINRA filings) requires that “[t]he rules of the association provide for the equitable allocation of reasonable dues, fees, and other charges among members and issuers and other persons using any facility or system which the association operates or controls.”
  • Section 6(b)(5) requires, among other things, that the rules of an exchange “are not designed to permit unfair discrimination between customers, issuers, brokers or dealers.”
  • Section 15A(b)(6) (for FINRA filings) requires, in part, that the rules of an association are “not designed to permit unfair discrimination between customers, issuers, brokers, or dealers.”
  • Section 6(b)(8) requires that the rules of the exchange not “impose any burden on competition not necessary or appropriate in furtherance of the purposes” of the Exchange Act.
  • Section 15A(b)(9) (for FINRA filings) requires, in part, that the rules of an association “not impose any burden on competition not necessary or appropriate in furtherance of the purposes of this title.”
  • Section 11A, which facilitates the establishment of the national market system for securities, provides, among other things, that “[i]t is in the public interest and appropriate for the protection of investors and the maintenance of fair and orderly markets to assure (i) economically efficient execution of securities transactions; (ii) fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets; (iii) the availability to brokers, dealers, and investors of information with respect to quotations for and transactions in securities; [and] (iv) the practicability of brokers executing investors’ orders in the best market.”
  • Rule 603 of Regulation NMS requires that entities (exclusive processors, any national securities exchange, national securities association, broker, or dealer) that distribute information with respect to quotations for or transactions in an NMS stock to a securities information processor (or brokers, dealers, or other persons) do so on terms that are not unreasonably discriminatory.

2. Reasonableness of Proposed Fee (Section 6(b)(4); 15A(b)(5))

For Fee Filings, the staff’s analysis of reasonableness under Sections 6(b)(4) and 15A(b)(5) includes a review of the Fee Filing based on the Commission’s market-based approach.

• The Commission has traditionally taken a market-based approach to evaluating whether certain fees are consistent with the Exchange Act. [21] The Commission’s market-based approach incorporates two parts: First, the Commission examines whether the SRO making the proposal was subject to significant competitive forces in setting the terms of its proposal, including the level of any fees.[22] Second, if the SRO was subject to significant competitive forces in setting the terms of a fee proposal, the Commission will consider whether there is any substantial countervailing basis to suggest that the fee’s terms nevertheless fail to meet an applicable requirement of the Exchange Act or the rules thereunder.[23] Underpinning this approach is the belief that the operation of competitive forces “will work powerfully to constrain unreasonable or unfair pricing behavior,” including the level of any fees.[24]
• As an initial step in assessing the reasonableness of a fee, staff considers whether the fee is constrained by significant competitive forces. As discussed further below, consistent with the SIFMA Decision and Susquehanna Decision, to determine whether a proposed fee is constrained by significant competitive forces, staff considers whether the evidence provided by an SRO in a Fee Filing proposal demonstrates (i) that there are reasonable substitutes for the product or service that is the subject of a proposed fee; (ii) that “platform” competition constrains the fee;[25] and/or (iii) that the revenue and cost[26] analysis provided by the SRO otherwise demonstrates that the proposed fee would not result in the SRO taking supracompetitive profits.[27]
• If a Fee Filing proposal lacks persuasive evidence that the proposed fee is constrained by significant competitive forces, the SRO must provide a substantial basis, other than competitive forces, demonstrating that the fee is consistent with the Exchange Act. One such basis may be the production of related revenue and cost data, as discussed further below.[28]

Competitive Forces

• A statement by an SRO in a filing that a proposed fee is subject to competitive forces must be supported by evidence, including data and analysis. The statement should be accompanied by a definition of the relevant market for the product/fee in question and a description of the competitive environment of that market.[29]

i. Availability of Substitutes

• A statement that substitute products or services are available to market participants in the relevant market (e.g., equities or options) can demonstrate competitive forces if supported by evidence that substitute products or services exist. The Commission, for example, stated in the SIFMA Decision that products need to be substantially similar but not identical to be substitutable,[30] and that elasticity of demand may be evidence that market data products are subject to competitive forces.[31]
  • As an example in the proprietary depth of book market data context, an SRO should provide evidence to demonstrate how one depth of book product might be substitutable for another, taking into consideration the difference in content among proprietary data feeds.
• Along these lines, and in the context of market data, connectivity and access fees generally, any discussion of alternatives should include a discussion of how regulatory requirements, particularly best execution obligations, Regulation NMS Rule 611 (the Order Protection Rule), and/or the Options Order Protection and Locked/Crossed Market Plan (Options Linkage Plan), as applicable, affect the competitive analysis.
• An assertion that market participants can shift order flow, or discontinue or reduce use of a certain category of product(s) in response to a fee increase, must be supported with evidence that market participants are in fact able to do so in light of applicable factors, including legal obligations and costs of making a change.[32]
• More generally, SROs can estimate demand elasticity for the product in question by assessing the effects of historical fee changes for the same or related products.
  • When appropriate (i.e., where a market is not well defined), the “small but significant nontransitory increase in price,” or “SSNIP,” technique developed by the Department of Justice and the Federal Trade Commission can be used to analyze reasonable substitutability and define the relevant market for the fee in question.[33]
• Elasticity of demand, even if shown, does not by itself demonstrate the operation of significant competitive forces. Evidence that a fee increase will not result in both reduced demand and increased profit may also be necessary. The relevance of cost data in this context is discussed further below.[34]

ii. Applicability of Platform Theory[35]

• The platform theory of competition (“total platform theory”) also provides a potential pathway to demonstrating a competitive environment. Total platform theory generally asserts that when a business offers facilities that bring together two or more distinct types of customers, it is the overall return of the platform, rather than the return of any particular fees charged to a type of customer, that should be used to assess the competitiveness of the platform’s market.[36]
• Under the total platform theory, some products are “‘joint products’ with ‘joint costs’ at each trading ‘platform,’ or exchange.”[37] If the theory were to apply to market data and trade executions for example, then an exchange pricing its trade execution fees higher and its market data fees lower (or vice versa), would—because of ‘platform’ competition— nonetheless receive the same overall aggregate return from the two joint products.[38]
• An assertion based on “total platform theory” that an SRO’s aggregate return across multiple product lines, such as transactions, market data, connectivity, and access, is constrained by competition at the platform level is insufficient unless substantiated with evidence demonstrating that the theory applies in fact to the fee at issue.[39]
• An SRO asserting total platform theory should explain what the two (or multiple) sides or aspects of the platform are, and which of the platform’s products are related (e.g., via indirect network effects[40]). Additionally, if an SRO argues that platform products cross-subsidize each other, then the SRO should provide a clear explanation of the nature of the cross-subsidization and identify which products subsidize what other products.
• An SRO that wishes to rely on total platform theory must provide evidence demonstrating that competitive forces are sufficient to constrain the SRO’s aggregate return across the platform. In this context, at a minimum an SRO must present data and analysis demonstrating that its aggregate return is constrained by competition at the platform level.
  • Examples of relevant data would include evidence of the SRO’s sources and amounts of revenues, costs, and gross return of the entire platform.[41] More specifically, an analysis of baseline revenues, costs, and profitability (before the proposed fee change) and the expected revenues, costs, and profitability (following the proposed fee change) would provide helpful data and analysis to support a finding that competitive forces are operating on the entire platform.[42] Requests by an SRO for confidential treatment in this area would be governed by existing Commission rules.
• Moreover, the total platform theory, even if applicable to an SRO, does not necessarily demonstrate the absence of a countervailing basis to find that a proposed fee fails to meet an applicable requirement of the Exchange Act.[43]

Relevance of Cost Data

• As noted above, even when determining whether significant competitive forces constrain the fee at issue, courts and the Commission have acknowledged that costs may be relevant to that assessment.[44]
• In addition, even where an SRO cannot demonstrate, or does not assert, that significant competitive forces constrain the fee at issue, a cost-based discussion may be an alternative basis upon which to show consistency with the Exchange Act.
• If an SRO seeks to support its claims that a proposed fee is fair and reasonable because it will permit recovery of the SRO’s costs, or will not result in excessive pricing or supracompetitive profit, specific information, including quantitative information, should be provided to support that argument.[45]
  • A qualitative and general description of the categories of costs “offset” by the proposed fee is not sufficient, nor is an unsupported representation that increased fees are “revenue neutral.”
    • Rather, the SRO should provide an analysis of the SRO’s baseline revenues, costs, and profitability (before the proposed fee change) and the SRO’s expected revenues, costs, and profitability (following the proposed fee change) for the product or service in question.[46] As part of its analysis, the SRO should describe, among other things, its methodology for determining the baseline costs and revenues for the product or service, as well as its methodology for estimating the expected costs and revenues for the product or service.
  • Requests by an SRO for confidential treatment in this area would be governed by existing Commission rules.
• In addition, the SRO should address whether there is a consistent relationship between the SRO’s costs and fees for similar products or services.
  • For example, if an SRO proposes to assess a fee for a 10 Gb connection to the SRO that is five times greater than the fee for a non-10 Gb connection, but the cost for the 10 Gb connection is less than five times greater, the SRO should explain the rationale for the discrepancy.

3. Equitable Allocation of Reasonable Dues, Fees, and Other Charges (Exchange Act Sections 6(b)(4) and 15A(b)(5))

• In general, when assessing whether a proposed fee or fee change constitutes an equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities, the staff considers whether the costs of operating the SRO or, as applicable, the rebates, discounts, and waivers offered by the SRO, are allocated fairly among the various categories of persons using the SRO’s facilities and whether any fee differences among categories of persons are justified.
  • To the extent that the proposed fee or rebate does not affect or apply to all market participants equally, the SRO must explain how this disparate treatment nevertheless complies with the concept of equitable allocation. This explanation should reference the information and data provided in the purpose section, as noted above.[47]
    • For example, to the extent the proposed fee or rebate does any of the following:
      1. applies differently to various types of market participants;
      2. results in substantially different effective per share or per unit rates among different types or sizes of market participants, including by different activity levels (e.g., volume for providing and/or taking liquidity); or
      3. affects a specific market participant or small number of market participants, then the SRO must explain why this disparate treatment (with respect to each of the foregoing) is equitable.
  • If a proposed fee includes volume-based tiers or other tiered pricing (including volume-based tiers or tiered pricing that covers multiple types of securities (e.g., both equities and options) on a particular SRO), the SRO should explain why it chose the specific tier levels and the rationale for distinguishing among them, and must explain why that structure represents an equitable allocation of fees.

4. Not Unfairly Discriminatory (Exchange Act Sections 6(b)(5); 15A(b)(6), Rule 603 of Regulation NMS)

• In general, when assessing whether a proposed fee or fee change may be unfairly discriminatory, the staff considers whether any differences in the application of a fee or rebate are based on meaningful distinctions between customers, issuers, brokers or dealers and whether those meaningful distinctions are unfairly discriminatory between customers, issuers, brokers or dealers. Among other things:
  • To the extent that the proposed fee applies differently to various types or sizes of market participants, advantages or disadvantages a specific type of market participant, or targets a specific market participant or small number of market participants, the SRO must explain why the fee is not unfairly discriminatory.
  • Because the statutory provisions prohibit unfairly discriminatory fees, general statements that the product or service is optional, or that the proposed fees apply equally to all similarly situated customers are insufficient. The Fee Filing must address whether a proposal permits unfair discrimination between market participants.
• As with the discussion of equitable allocation, if a fee includes volume-based tiers or other tiered pricing (including volume-based tiers or tiered pricing that covers multiple types of securities (e.g., both equities and options) on a particular SRO), the SRO should explain why it chose the specific tier levels, the rationale for distinguishing among them, and why that structure is not unfairly discriminatory.

5. No Burden on Competition that is not Necessary or Appropriate (Section 6(b)(8); 15A(b)(9))

• In general, when assessing whether a proposed fee or fee change imposes a burden on competition that is not necessary or appropriate in furtherance of the purposes of the Exchange Act, the staff considers the competitive effect of the proposal and the purpose and basis for the proposal as articulated by the SRO in its filing. Among other things:
  • The SRO must address the effect of the proposed fee on competition. The SRO should address both intramarket and intermarket competition.
    • Concerning intramarket competition, as discussed further below, this means addressing whether the proposed fee could place certain market participants at a relative disadvantage compared to other market participants, and whether the SRO believes that this disadvantage could affect the ability of such market participants to compete.
    • Concerning intermarket competition, as discussed further below, this means addressing whether the proposed fee could impose a burden on competition on other SROs that is not necessary or appropriate.
  • Even where competitive forces may exist, an SRO must address why a proposed fee or fee structure does not favor one or more categories of market participants in a manner that would impose an undue burden on competition.
    • Concerning intramarket competition, for example, if for some broker-dealers transaction fees (per share) are relatively low (e.g., because they have large transaction volume and can benefit from volume discounts or because they disproportionately trade using liquidity-providing orders that receive rebates), while for other broker-dealers transaction fees are relatively high, the SRO should demonstrate why the fee structure does not unduly disadvantage the latter group of broker-dealers.
    • In addition, if market data, connectivity, and access fees (fixed costs) are high, and transaction fees (variable costs) are low, the SRO should explain how this fee structure does not unduly disadvantage smaller broker-dealers that have less transaction volume with which they are able to offset fixed costs, as compared to larger firms.
  • As with the discussion of equitable allocation and unfair discrimination, to the extent that the proposed fee or fee change applies differently to different categories of market participants, advantages or disadvantages a specific type of market participant, or affects a specific market participant or a small number of market participants, the SRO must explain why and how the fee would not impose an undue burden on competition.
    • For example, for the highest-priced product offerings for data, connectivity and access, SROs should address the following scenario:
      • If (i) a certain connectivity or access product offering is priced at a significant premium to other connectivity or access products; (ii) the higher priced offering enables faster access to an SRO’s matching engine or some other competitive advantage within the SRO’s infrastructure; and, (iii) only larger firms of significant size and scale are able to reasonably afford the product offering at the significant premium; then, the SRO must address why the proposed fee or fee structure does not favor certain categories of market participants in a manner that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.
  • SROs should also address potential burdens on intermarket competition with the use of tiered pricing structures that require minimum volume levels to realize significant economic pricing benefits.
    • For example, to the extent that a proposed fee structure creates significant incentives for certain market participants to realize significant pricing benefits by maintaining minimum volume levels with an SRO having significant market share, the SRO should address whether that structure permits the SRO to leverage its market share in a manner that would impose an undue burden on competition on smaller SROs attempting to gain market share.

SROs should be prepared to address potential burdens on competition particularly where there may be: (a) fee structures where, based upon the characteristics or order flow of a firm, there are significant differences in variable costs for firms (e.g., effective rate differences due to differentiated tiering schedules); and/or (b) fee structures where, based upon the significant premiums required to purchase certain high performance products and services for access and connectivity, there are potentially significant barriers to entry for smaller firms unable to reasonably afford such products.

C. Exhibit 5[48]

• The SRO must mark the proposed text against the text that was in effect immediately prior to the proposed fee change to correctly show the change.
• The SRO must clearly describe the proposed fee in the proposed rule text itself.

Please direct any questions concerning this staff guidance to the Division of Trading and Markets.