More Observations on the Supplemental Liquidity Provider Program

Previously Zero Hedge observed the rather curious integration of Goldman Sachs within the fabric of the NYSE’s program trading environment, which, by their own admission, has everything to do with Goldman being the (monopoly) actor in the NYSE’s Supplemental Liquidity Provider program. I highlighted that the program was set to expire on April 30.

Today, unsurprisingly, the NYSE posted a notice of a proposed rule change extending the SLP program another six months, until October 1, 2009 (this does not change my commitment to providing weekly NYSE program data). I appreciate our readers’ existing and future feedback in this matter.

“The Exchange proposes to extend until October 1, 2009, the six-month pilot program (“Pilot” or “program”) for “Supplemental Liquidity Providers” (“SLPs”) under Rule 107B. The SLP pilot program commenced operation on or about the date the SEC approved the NYSE “New Market Model” pilot which is scheduled to be in operation until October 1, 2009. The Exchange proposes to extend the SLP pilot until October 1, 2009, the termination date of the New Market Model pilot, as the SLP program was designed to operate in the New Market Model and was established to supplement the liquidity provided by Designated Market Makers (“DMMs”) in the New Market Model.

The Exchange believes that the SLP program has added meaningful liquidity to the marketplace and improved both NYSE and overall market quality. The Exchange will continue to monitor the efficacy of the program during the proposed extended pilot period. In the future, the Exchange may propose certain changes to Rule 107B, which will be the subject of a 19(b)-4 rule filing and filed with the Commission. Until such time that the Exchange proposes changes to Rule 107B, the Exchange is requesting to extend the operation of Rule 107B until October 1, 2009.”

The SEC published a notice of the NYSE proposal. Though both notices use the term “proposal,” it appears that the NYSE may be using a streamlined procedure that puts the proposal into effect immediately, without the ordinary notice and comment period. (Notice and Comment period would be required for the SEC, a federal agency, unless circumstances justify rule-making now and comment later; I think that the NYSE itself–as a self-regulated organization–is bound only by its own SEC-approved regulations).

Here is what the NYSE had to say about the expedited procedure:

“The Exchange believes that good cause, consistent with the provisions of Rule 19b-4(f)(6), exists to justify making the rule change immediately effective. Rule 107B was immediately effective when filed as SR-NYSE-2008-1087 as it is similar to several other market maker rules and rebate programs of other market centers. The Exchange relied on the Commission’s “Rule Streamlining Guidance” to obtain immediate effectiveness of Rule 107B. This request for extension of Rule 107B extending the SLP pilot to October 1, 2009, should also receive immediate effectiveness treatment by the Commission.”

“The Exchange believes that the proposed rule is non-controversial as it is a rule that has been in operation for approximately six (6) months and, as stated above, is similar to existing market maker and rebate rules of other market centers. Moreover, the NYSE believes that the rule has provided significant benefits to NYSE customers in the New Market Model. Such benefits include price discovery, liquidity, competitive quotes and price improvement. The Exchange contends that the benefits produced by the SLP program further justify filing the rule for immediate effectiveness.”

However, the exchange is not really willing to corroborate this observation through a traditional comment seeking approach, lest it receive commentary not alligned with its steamrolling intent: “Written comments on the proposed rule change were neither solicited nor received.”

Lastly, the following paragraph implies that the SLP has been extended effective immediately, and it is feasible that the SEC does not even get a chance to chime in here, essentially providing the NYSE prima facie authority over the Federal regulator in the SLP matter. But fear not investors, increasingly cautious of Goldman Sachs’ 60% dominance in NYSE principal program trading: the NYSE claims all SLP actions are merely for the “protection of investors and the public interest.”

“The NYSE also requests that the Commission waive the five-day period for notice of intent to file this proposed rule change, and the 30 day period before the rule becomes operative, both of which are prescribed by Rule 19b-4(f)(6), but which may be waived pursuant to Rule 19b-4(f)(6)(iii) if such action is consistent with the protection of investors and public interest. Because the SLP pilot will expire on April 30, 2009, the Exchange requests waiver of these time periods so that no interruption of the pilot will occur. The Exchange’s request for a waiver of these time periods so that the rule may be immediately operative is consistent with the protection of investors and the public interest for the reasons described above.”

The NYSE apparently intended some time ago to request this extension to the SLP program. The Federal Register, in Vol. 74, No. 072, includes an SEC notice dated April 10, to the effect that the NYSE was eliminating the roles of Competitive Trader and Registered Competitive Market Maker because, in part, their functions were now being performed by the SLP program/ participant(s). (See NYSE Rules 110 and 107A, which must be amended to effect the change). Obviously, the NYSE and SEC would not eliminate those two programs in reliance on the SLP program unless they knew the SLP program would last past April 30.

And, note that the original version of the SLP program—the 6-month pilot—and this extension both employed the expedited process mentioned in the above notice.

Most notably however, the SEC solicited comments on the SLP for the first and last time in November, when the NYSE first rolled out the SLP program and later amended the fees paid to the SLP participant(s). The only comments received were from the NASDAQ Stock Market LLC, which probably was most concerned about the SLP program encroaching upon its own turf, but the comments raise some concerns which are very well alligned with those voiced by Zero Hedge. The full text of the comments by Jeffrey S. Davis of the NASDAQ Stock Market LLC is presented below, but here are some very relevant snippets:

NASDAQ believes that the SLP Proposals grant the NYSE substantially unchecked authority to discriminate [*4] among NYSE members. The SLP Proposals lack codified standards and other vital elements of due process, and fail to explain how the NYSE will ensure that all members will be treated fairly and equally as required under Section 6 of the Exchange Act. For example

  • The NYSE proposes to create an SLP Liaison Committee consisting of NYSE employees, but it fails to explain whether and how that committee will represent the interest of members, when and how it will deliberate, how it will decide which firms become SLPs, how the NYSE will oversee the Committee to ensure the fair and equal treatment of members, or whether and how it will be governed by the board of The NYSE Group, the NYSE, or FINRA.
  • The NYSE proposes to establish a quota for SLP firms, but it fails to explain what that quota is, how it is established, why it exists, or whether it will vary by security. The proposal also fails to explain how SLP slots will be allocated among equally-qualified members before the quota is reached, what happens to equally-qualified firms once the quota is reached, or how SLP slots will be reallocated if an approved SLP fails to meet its continuing obligations. In contrast to NASDAQ’s market [*5] maker standards which permit an unlimited number of equally-qualified members,the SLP Proposals create a scarce status and then fail to explain how it will be distributed.
  • The NYSE proposes that the Liaison Committee will assign specific securities to qualified SLPs, but it fails to explain which securities will be assigned to an SLP, how the Committee will decide to assign SLPs to each security, or how the Committee will balance the number and types of securities assigned to each SLP. The proposals also fail to explain how the interests of members will weigh in that analysis, how the Committee will ensure the equal treatment of members, how that allocation process will interact with the SLP quota, or how the NYSE management or board will oversee the allocation process to ensure the fair and equal treatment of members.

Taken together, the SLP Proposals provide NYSE with the unparalleled ability to burden competition for order flow and executions without explaining why such ability is necessary or even prudent. For example, the SLP Creation Proposal limits SLPs to firms that engage in proprietary trading, excluding NES and others that operate on an agency basis either to comply [*6] with Regulation NMS (in the case of NES) or by choice. NYSE fails to explain why this limitation is necessary or prudent.

Now the parts below are very, very critical:

NYSE fails to explain why proprietary liquidity is more valuable than agency liquidity, or why proprietary liquidity should be favored over agency liquidity. NYSE claims that the proposal is designed to prompt liquidity provision but it simultaneously disqualifies large liquidity providers…

In NASDAQ’s view, these irregularities reveal that NYSE’s true motivation for the SLP Proposals is to discriminate among its members and to burden some members’ ability to compete with NYSE. NYSE’s failure to explain adequately either the operation or the rationale for its proposed rule is evidence that NYSE’s stated basis for the proposal is a pretext. NYSE’s proposals are a naked attempt to disadvantage one group of members — those that compete with NYSE — to benefit another class of members — those that do not compete with NYSE…

Perhaps most surprising is the NYSE’s aggressive attempt to implement these proposals on an immediately- effective basis. In doing so, the NYSE prompted the Commission to act inconsistently with past practice, inconsistently with its Rule Streamlining Guidance issued in July of 2008 n5, and inconsistently with its obligation to ensure that self-regulatory organizations comply with their obligations under Section 6 of the Securities and Exchange Act [*8] of 1934. NASDAQ, as an active proponent of the Rule Streamlining Guidance, is concerned that the NYSE will undermine that streamlining effort by attempting to leverage the Guidance in an inappropriate manner.

Is it at all surprising then that the NYSE has refrained from seeking additional commentary when none other than the NASDAQ itself has previously called you out on:

1) Steamrolling a program with little/none due SEC comment solicitation. 2) Establishing this very program for the sole benefit of specific NYSE members to the detriment of other members that compete with the NYSE. 3) In fact pushing ahead in violation of SRO obligations under Section 6 of the SEC 1934 Act.

And who is the one and only beneficiary of this rampant disregard for almost 80 years of market regulatory practice? Who is it that has now become the de facto provider of “market liquidity” which however has much more sinister connotations when reading through the comments of not just some blogger but the NASDAQ Stock Market itself? For the empirically proven answer I will refer you to my prior post on this matter.


Originally published at the Zero Hedge blog and reproduced here with the author’s permission.