Opinion ID: 8410533
Heading Depth: 2
Heading Rank: 3

Heading: Proprietary Data Feeds, Co-Location Services, and Complex Order Types

Text: The defendant exchanges in this case operate as for-profit enterprises that generate most of their revenue from the fees they charge for trades and the sale of market data and related services for those trades. The exchanges compete with one another to increase the trading volume on their particular exchanges. Plaintiffs contend in this case that the exchanges created three products and services for “favored” HFT firms—proprietary data feeds, co-location services, and complex order types—to provide these firms with more data at a faster rate than the investing public and thereby to attract HFT firms to trade on their exchanges.
Under Regulation NMS, each exchange must transmit certain information concerning trades on that exchange to a central network where the information is consolidated and then distributed. 17 C.F.R. § 242.603. This consolidated data feed provides basic real-time trading information, such as the national best bid and offer for a given stock. At issue in this case is the exchanges’ provision to firms of additional, costly proprietary data feeds that include more detailed information regarding trading activity. At the most detailed and expensive level, a proprietary data feed may provide data on every bid and order for a given stock on an exchange. Furthermore, although the exchanges are prohibited from releasing data on the proprietary feeds earlier than the data on the consolidated feed, see Regulation NMS, at 37,567, the proprietary data generally reach market participants faster because, unlike the consolidated data, they do not need to be aggregated. See Regulation NMS, 70 Fed. Reg. at 37,567. The SEC has “authorized] the independent distribution of market data outside of what is required by the [NMS] Plans,” so long as such distribution is “fair and reasonable” and “not unreasonably discriminatory.” Id. at 37,566-67. Applying this standard, the SEC has approved various exchanges’ proposals to offer proprietary feeds. See, e.g., Self-Regulatory Organizations; New York Stock Exchange LLC; Order Approving Proposed Rule Change to Establish Fees for NYSE Trades, 74 Fed. Reg. 13,293 (Mar. 26, 2009). At the same time, it has instituted enforcement proceedings against exchanges for providing proprietary data feeds that are not in compliance with SEC rules. See, e.g., N.Y. Stock Exch. LLC, Exchange Act Release No. 34-67857, 104 SEC Docket 2455, 2012 WL 4044880 (Sept. 14, 2012) (settled action). According to plaintiffs, because these proprietary feeds are cost prohibitive for ordinary investors ■ like plaintiffs, HFT firms receive more information at a faster rate and so are able trade on information earlier, which allows them to successfully “front-run” other market participants. Plaintiffs allege that, as a result, ordinary investors are greatly disadvantaged.
Some exchanges also rent space to investors to allow them to place their computer servers in close physical proximity to the exchanges’ systems. This proximity helps to reduce the “latency” period—the amount of time that elapses between when a signal is sent to trade a stock and a trading venue’s receipt of that signal. As with proprietary feeds, the SEC also regulates co-location services. Under the Exchange Act, the terms of co-location services must not be unfairly discriminatory and the fees must be equitably allocated and reasonable. See 15 U.S.C. § 78f(b)(4), (5). The SEC has approved the terms of particular co-location services as consistent with the Exchange Act, see, e.g., Self-Regulatory Organizations; the Nasdaq Stock Mid. LLC; Order Approving a Proposed Rule Change to Codify Prices for Co-Location Servs., Exchange Act Release No. 34-62397, 98 SEC Docket 2621, 2010 WL 2589819 (June 28, 2010), while also taking enforcement actions against exchanges for providing such services in violation of the Exchange Act, see, e.g., N.Y. Stock Exch. LLC, Exchange Act Release No. 34-72065, 108 SEC Docket 3659, 2014 WL 1712113 (May 1, 2014), Plaintiffs allege that co-location services are especially attractive to HFT firms, whose trading involves frequent buying and selling in short periods of time, and that such services are cost-prohibitive for most ordinary investors. According to plaintiffs, when co-location services are used in combination with proprietary data feeds or complex order types (or both), co-location services amount to a manipulative device because they allow HFT firms to access and trade on information:before it becomes publicly available.
The third product at issue in this -case is complex order types: pre-programmed, electronic ■ commands that traders use to instruct the exchanges on how to handle their bids and offers under certain conditions. These commands govern the manner in which the exchanges process orders in their trading systems, route orders to other exchanges, and execute trades. Concept Release on Equity Market Structure, 75 Fed. Reg. 3,594, 3,598 (Jan. 21, 2010). As with co-location services and proprietary data feeds, the SEC regulates complex order types, but it also has instituted enforcement proceedings against the exchanges for providing certain complex orders. The SEC, for example, brought an action against an exchange for providing order types that functioned differently from the descriptions that the exchange filed with the SEC and for selectively disclosing an order type’s functionality only to certain HFT firms. EDGA Exch., Inc., Exchange Act Release No. 34-74032, 110 SEC Docket 3510, 2015 WL 137640 (Jan. 12,2015) (settled action). Plaintiffs allege that the defendant exchanges developed several fraudulent and deceptive complex order types to benefit HFT firms at the expense of the plaintiffs. For instance, according to the plaintiffs, the' exchanges have created “hide and light” orders, that allow traders to place orders that remain hidden from the ordinary bid-and-offer listings on an individual exchange until a stock reaches a particular price, at which point the hidden orders emerge and jump the queue ahead of other investors’ orders. Plaintiffs also argue, and the exchanges dispute, that certain exchanges have not adequately disclosed the full functionality of these order types to all market participants. According to plaintiffs, this selective disclosure has caused harm to ordinary investors including, among other things, increased opportunity costs from unexecuted fill orders, adverse selection and price movement bias on executed fill orders, and increased execution costs. IY. Procedural History On April 18, 2014, the City of Providence filed a putative class action against the exchanges under §§ 6(b) and 10(b) of the Exchange Act and SEC Rule 10b-5. 3 The district court consolidated the action with several related cases and appointed several institutional investors as lead plaintiffs. On January. 12,2015, the Judicial Panel on Multidistrict Litigation combined this consolidated action with other similar cases. The exchanges then moved to dismiss the plaintiffs’ complaint, arguing that (1) the district court lacked jurisdiction; (2) the exchanges were absolutely immune from suit; and (3) the plaintiffs had failed to state a claim under the Exchange Act. On August 26, 2015, the district court determined that it had subject matter jurisdiction over this case. It held that the exchanges were absolutely immune from plaintiffs’ allegations concerning the proprietary data feeds and complex order types, but not co-location services. The district court further concluded that, even if the exchanges were not absolutely immune, the plaintiffs had failed to state a claim for a violation of § 10(b) and Rule 10b-5 based on a manipulative scheme. The district court therefore granted the exchanges’ motion and dismissed the complaint. Plaintiffs timely filed this appeal.