February 27, 2015
February 27, 2015
Brent J. Fields
Secretary
U.S. Securities and Exchange Commission
100 F. Street, N.E.
Washington, DC 20549
Dear Mr. Fields,
On February 19, 2015, BATS submitted a comment letter on the OCCs rule filing to implement a new capital raising plan (the Proposal), pointing out that the Proposal was deficient in as much as it failed to adequately analyze the burden on competition created by a capital raising plan that was not subject to a competitive process and that would result in a stream of dividends being paid to the OCCs equity shareholders in perpetuity. The OCC responded to the BATS comment letter on February 23, 2015 (the Response). BATS submits these supplemental comments to the Proposal and the Response:
1. In the Response, the OCC argues that the dividends to be paid to equity shareholder exchanges should not be viewed as additional revenue that simply can be used to subsidize the cost of services those exchanges provide to their members rather, the OCC argues that the dividends should be viewed as fair compensation for the equity shareholders capital investments and the corresponding risk they are subjecting themselves to. BATS would agree with this statement if the return on capital was in fact fair compensation however, BATS believes the return on capital is excessive, which is why it amounts to a subsidy. BATS estimates the rate of return to be in the range of 16% to 18% or more, which is far above market rates, particularly where, as here, the risk associated with the investment is low. The risk is low because to the extent the OCC is experiencing capital deficiencies, it will look first to raising fees before requiring replenishment capital from the exchanges and if replenishment capital is required the payment of dividends to the equity shareholder exchanges takes priority over the payment of any refunds to clearing members. In addition, the OCC makes much in its response of the fact that the proposed dividend stream is not being paid in perpetuity rather, the OCC notes that the capital plan makes no mention of its duration. The OCC argues that the capital plan could of course change over time and by virtue of this simple fact the OCC argues that it does not pay dividends in perpetuity. BATS of course agrees that the capital plan could be changed however, BATS views that likelihood as extremely low if for no other reason than it would require the unanimous vote of the equity shareholder exchanges to discontinue the dividends.
Moreover, the OCC argues that the Proposal does not create an unnecessary burden on competition because none of the non-Stockholder exchanges have presented a proposal under which they would provide a meaningful source of additional equity capital for OCC. BATS finds this statement curious for two reasons. First, it is the OCC's responsibility, not BATS', to propose a reasonable capital raising plan. Second, BATS was never invited to participate in a process under which it could have proposed equity capital. In fact, BATS was unaware of the Proposal until it was filed with the SEC. Given the importance of the OCC as an industry utility and the greatly mitigated risk of such an investment, had BATS been consulted, it would have offered to provide equity capital to the OCC at a rate of return significantly less than what the existing equity shareholder exchanges would receive under the Proposal. In fact, based on our conversations with clearing members, BATS believes there is ample industry support for clearing members to contribute the needed capital to the OCC rather than the existing equity shareholder exchanges at more favorable rates. And, this is precisely the point of our comment letter – by failing to subject its capital raising needs to a transparent, open, and competitive process, the OCC has put itself in a position whereby it is raising capital on sub-optimal terms at the expense of its clearing members and the non-equity shareholder exchanges. This was simply a bad process and to the extent the OCC is under time pressure to complete the capital raise that pressure would appear to be self-imposed – by the OCCs own admission it has been analyzing this issue for the last year behind closed doors, which would have been more than enough time for the OCC to have subjected its needs to a competitive process.
2. BATS is concerned about the governance process associated with the Proposal. In particular, the OCC notes in footnote 12 of its response to the comment letter filed by Howard Kramer on behalf of six market makers that during the board meeting at which the capital plan was approved, of the nine member directors, one did not attend, one abstained, four voted in favor, and three voted against. As a general rule, the abstention should be counted as a no vote, at which point the clearing members who attended the meeting were evenly split on the vote. Further, it appears that the five equity shareholder exchanges failed to recuse themselves from either the deliberation or the vote despite the existence of a significant economic interest in the outcome. And, importantly, at the time of the vote, the board had only three public directors and not the five required by Article III of the OCC's by-laws. Those vacancies were only filled over the last week. Without more information, it is impossible to be certain whether the OCC's governance process was adequate, but based on what is known and what can be inferred, the governance process looks seriously flawed in violation of the OCC's own by-laws, and board policies on conflicts of interest.
For these reasons and those stated in our comment letter of February 19, 2015, BATS respectfully requests that the SEC disapprove the Proposal.
At a minimum, given the significant issues associated with the Proposal, BATS respectfully requests that the Proposal not be approved by delegated authority but instead be referred for full consideration by the Commissioners.
Sincerely,
Eric Swanson
General Counsel and Secretary
BATS Global Markets, Inc.