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September 20, 2013

An Old SIP in a Modern Market

By Christopher Nagy

Until this past August, almost everyone outside of the financial services industry had neither a clue nor a care as to what the Securities Information Processor - SIP- was and its purpose in the market. That all changed on Aug. 22, when the tape C portion of the Nasdaq OMX pricing feed suffered a massive failure and the market maker was forced to halt orders of all Nasdaq-listed securities for three hours.

Today there are 16 registered stock exchanges that fall under Section 6 with the U.S. Securities and Exchange Commission. Each of those exchanges also distribute private data feeds outside of the SIP, so why were they forced to close that day?

Christopher Nagy

It comes down to age. While we commonly refer to today's market structure as fragmented, the SIP dates back to nearly 40 years ago, when Congress passed the Securities Act Amendments of 1975. With an eye toward the future, Congress correctly recognized the emergence of technological advancements in the markets and ordered the SEC to create a national market system with market data at the center of the debate.

Thus, the Consolidated Tape Authority and SIP were born, and they continue to be run and funded by the exchanges through the collection of market data fees. The SIP is a central collection point whereby all exchanges must submit their best bids and offers, which are then redistributed to brokers and investors.

Another key piece of rule-making by the SEC made its debut in 1980. The Vendor Display Rule requires any vendor or broker of market data to provide the National Best Bid and Offer including top of book size. The rule was created so that investors wouldn't receive misleading or narrow views of the best trading price of a security. Thus, the Vendor Display Rule required brokers to become consumers of the SIP. At the time it made sense. In 1975, Congress, the exchanges and the SEC were grappling with significant changes in market structure. The Dow Jones climbed to 852, up more than 38 percent from the prior year. Fixed commissions were abolished, trading was extended to 4 p.m., and a record 35 million shares were trading daily while market data rates were bolstered to handle more than 36,000 messages per minute.

Could Congress have ever have imagined what a bottleneck those rules would create 40 years later? At the time, they surely could not have envisioned the exponential growth of exchanges, market data volumes and electronic trading speeds. Yet even with this unimaginable growth, it's ironic that today's issues are not that different from what they were back in 1975. In fact, those very rules designed to promote competition may actually hinder competition, harm market structure and increase costs today.

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