FINRA Proposal Riles OTC Market

Traders Magazine Online News, January 25, 2010

Peter Chapman

A proposal by FINRA to expand its business of collecting and disseminating quotes in over-the-counter equities by creating a "quotation consolidation facility" is under fire from OTC dealers and the largest OTC quote service.

Cromwell Coulson, Pink OTC Markets

Pink OTC Markets, the dominant collector and distributor of OTC quotes, previously known as Pink Sheets, is charging the Financial Industry Regulatory Authority of trying to "steal its quotes." The vendor maintains that the proposal is an abuse of FINRA's regulatory power, as well as an illegal seizure of private property. Pink OTC is getting support from the New York chapter of the Security Traders Association and others.

"Their plan is to steal Pink Quote data and sell it in their data feed," Cromwell Coulson, Pink OTC's president and chief executive officer, said. "The QCF is anti-competitive and a clear land grab by FINRA."

The QCF would be operated by FINRA and collect from dealers or their agents all top-of-book OTC quotes. It would then disseminate the data in real time over the Nasdaq Level One feed. The proposal requires Securities and Exchange Commission approval.

FINRA already collects some quotes from dealers for distribution over the feed, but it does not get all of them. The bids and offers it disseminates represent only a fraction of those available and may not reflect the best prices at any given moment. That is why FINRA believes it needs to consolidate and disseminate all the quotes. A "widely available NBBO" is necessary to ensure best execution and to forestall fragmentation in over-the-counter stocks, FINRA told the SEC. FINRA also said the data can be used as part of its surveillance efforts.

Those quotes FINRA does collect come off of its OTC Bulletin Board interdealer quotation system, a quoting service used by dealers to attract trades from other dealers. At one time, OTCBB had 100 percent of the business, but Pink Quote, introduced by Pink OTC in 2000, has come to dominate.

In December, Pink Quote boasted about 83,000 quote positions, versus 23,500 for OTCBB. The FINRA service has lost half of its quote positions in the last two years as dealers abandon the system for Pink Quote. Recent defectors have been E*Trade, Citi and StockCross.

The situation has become so dire that FINRA has put OTCBB up for sale. An announcement of the sale of the system was expected in January or February. Pink OTC is considered a leading contender to buy the system.

The decline in FINRA's OTCBB business is behind the regulator's decision to require dealers to deliver to it their quotes. The proposal also includes a $4 per security per month fee to be levied on dealers. FINRA will earn revenues from its dissemination of the quotes via its participation in the industry's market data revenue-sharing plan.

Pink OTC, which distributes NBBO data to third parties in competition with FINRA, is crying foul. It claims it will lose revenues if the FINRA proposal is approved. In the first half of last year, Pink OTC took in $3.7 million, or about one-third of its revenues from its licensing of market data. Coulson would not disclose the percentage of that figure that comes from sales of NBBO data, but says it is significant. "It's like losing an eye," Coulson said.

The deals Pink OTC has struck with parties such as Bloomberg, Thomson/Reuters and others for its data "would be repudiated," Coulson told the SEC in a letter. "The QCF proposal would amount to a 'taking' of Pink OTC's lawful property rights without compensation, which is a violation of the U.S. Constitution."

Although it is the dealers and the ECNs FINRA is requiring to provide it with the data, Coulson maintains that the data is the intellectual property of Pink OTC. "Dealers post on our system," he explained. "But the QCF proposal requires we provide all our Pink Quote data to FINRA. If we did not, FINRA would require the dealers and ECNs to immediately remove all quotes from our system."

For Pink OTC, the market data dissemination business has been a bright spot in a mostly dreary picture. In the first six months of 2009, market data licensing fee revenues grew by 15 percent. Revenues from Pink OTC's largest business, the provision of trading services, including Pink Quote and its Pink Link trading system, declined by 5 percent. That's mostly because dealers have exited the business while those firms that remain are employing fewer traders.

Coulson charges that FINRA wants to create the QCF solely for the revenues it will bring. "Rather than competing on the basis of product, service or price, FINRA now seeks through its QCF proposal to overturn the market's judgment by seizing market data for commercial use from a private competitor," Coulson told the SEC.

Indeed, FINRA's commercial division has seen a decline in revenues in recent years. It reported "transparency service fees" of $45 million in 2008, down from $56 million in 2007. It blamed the decline partly on a decrease in OTC market data revenues. According to a recently released SEC "concept release," FINRA received $20.7 million in revenue from the Nasdaq UTP plan (Network C) in 2008. Coulson estimates over $8 million of that is from OTC equity data.

Coulson and STANY both argue there is no need for the QCF. Pink OTC notes that brokers can get a feed from Pink OTC that consolidates quotes from Pink Quote and those securities dually-quoted on Pink Quote and OTCBB. That feed represents quotes on all OTC securities--approximately 9,300--except the 75 or so quoted exclusively on OTCBB. Pink also notes that brokers can purchase a feed from data vendors such as Bloomberg that consolidate all OTC quotes.

Pink OTC reports that it distributes about 800,000 top-of-book quotes per day, while FINRA distributes about 100,000. Still, Nasdaq's Level One feed is more widely distributed.

STANY told the SEC that the QCF was unnecessary because FINRA was abandoning OTCBB, leaving just one interdealer service run by Pink OTC. Therefore Pink OTC would be able to offer a consolidated NBBO feed.

STANY and others maintain the QCF will act to discourage any competition for Pink OTC's interdealer quote service. That would give Pink OTC a monopoly, which could lead to higher costs for market makers. "The QCF can be viewed as anti-competitive and a disincentive to innovation and improvement in the OTC equity market," STANY told the SEC.

Nick DeMaria, managing director of equities trading at discount brokerage StockCross Financial Services, agrees. "It will stymie any and all competition from even attempting to enter the marketplace," he said. "If this is approved and FINRA is allowed to overstep its bounds, no one will enter the marketplace and try to compete with them." DeMaria does not believe FINRA has the authority to create the QCF.

Dealers are also upset over the $4 per security per month fee they will have to pay. "Why, as a dealer, should I pay an inflated price to a regulatory body to do something that is already being done?" DeMaria asked. "The smaller firms forced to pay these fees are going to suffer."

FINRA would not comment for this article.